Microcredit Interest Rates

Model for setting sustainable interest rates

This paper presents ways to set sustainable interest rates, and demonstrates how effective interest rates can be raised. Sustainable interest rates are set as a function of five elements, each expressed as a percentage of average outstanding loan portfolio. They are administrative expenses, loan losses, cost of funds, desired capitalization rate, and investment income.

The paper states that MFIs should charge clients a rate high enough to ensure their own sustainability rather than deliver subsidized credit. Methods to raise the effective interest rates include:

  • Computing interest on the original face value of the loan, rather than on the declining balance, as successive installments of principal are repaid;
  • Requiring payment of interest at the beginning of the loan, rather than spreading interest payments throughout the life of the loan;
  • Charging a commission or fee in addition to the interest;
  • Quoting a monthly interest rate, but collecting principal and interest weekly, counting four weeks as a month;
  • Requiring that a portion of the loan amount be deposited with the lender as compulsory savings or a compensating balance.

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About this Publication

By Rosenberg, R.