Microcredit Interest Rates

Topic :

This Occasional Paper published by CGAP outlines a method for estimating the interest rate that an MFI will need to realize on its loans, if it wants to fund its growth primarily with commercial funds at some point in the future. The model presented is simplified, and thus imprecise. However, it yields an approximation that should be useful for many MFIs, especially younger ones. Each component of the model is explained and then illustrated with an example based on the planning tool, MicroFin.

Many of the technical terms associated with interest rates are explained in the paper. Part A focuses on setting a sustainable interest rate; part B explains how to calculate effective interest rates for a variety of interest charging scenarios; and part C explores the theory and practice of exorbitant interest rates.

This paper provides a useful reference source for anyone working in a financial institution and should help to clarify the effects of flat rates, initial fees, up-front interest payments, compulsory savings and so on.

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