Subsidizing Microcredit Interest: How Important Is It to the Poor?

Ethiopia is characterised by a high degree of poverty among the population. Although Government strategy identifies microfinance as a good entry point for achieving development objectives and there are 23 licensed MFIs in operation, only a small proportion of people have access to their facilities. Thus the rural financial landscape remains dominated by informal mechanisms. The Amhara Credit and Savings Institution (ACSI) was established in 1997. By September, 2004 it had over 337,000 active loan clients but the estimated potential market in the region is about 2.9 million clients.

This paper, which has been written by the Head of the ACSI Planning and Monitoring Department, explores how reaching out to more clients in remoter areas will increase operational costs, particularly in light of the level of support that the poorest clients need. However, ACSI has continued to commit itself to a low interest rate, namely 12.5%, even though the transaction costs of providing microcredit in remote and isolated areas are much higher than those for providing standard commercial loans. The author questions this policy and observes that subsidising the interest paid by clients usually has a counterproductive role by reducing the very “access” by the poor that it sets out to promote.

In conclusion this paper suggests that while setting a realistic interest rate should not be a licence for higher costs and inefficiency, if an MFI is to offer its financial services to poor and marginalised people living in remote and peripheral rural areas (with non-existent, inadequate or defective infrastructure) and who require very small loan sizes and hence high transaction costs, interest rate capping should not constitute a bottleneck.

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