Carrie Lui, Insu Song and John Vong
Abstract MFIs have a high interest rate burden due to the small amount per trans- action of microcredit and inevitably high operating cost per transaction. To ensure financial viability and to expand the depth and breadth of their operations, MFIs have to adopt cost recovery interest rates on microcredit, hence, MFIs have to charge interest rate high enough, usually substantially higher than the bank loan risk free interest rate. The major factors determining the interest rate on microcredit are the cost of funds, operating costs, loan loss cost and capital for business expansion. To illustrate the impacts of the above factors on interest rate, we present a summary of the current cost structures of microfinance institutes (MFIs) in three Southeast Asia countries, Cambodia, Vietnam, and Indonesia. Then, we review existing studies for the roles of mobile technologies for lowering the interest burden.
21.1 Introduction
Access to reliable and affordable financial services such as savings, credit, payments, transfers, and insurance are vital to manage daily lives in modern economy [1], yet over half of the world population are still unbanked. Chaia et. al. [2], CGAP [3]
and Ardic et. al. [4] suggested that as at the end of 2009, 2.75 billion people (56 % of the global population) do not have access to formal financial services. A recent survey of 150,000 adults aged 15 and above in 148 different economies conducted by World Bank reported that over 50 % of the respondents did not have any account at any financial institutions. While 89 % of adults in developed countries have access to financial services, it is only 41 % in developing countries.
C. Lui ()
School of Business/IT, James Cook University, Cairns Campus, Cairns, Australia e-mail: [email protected]
I. Song·J. Vong
School of Business/IT, James Cook University, Singapore Campus, Singapore, Singapore e-mail: [email protected]
J. Vong
e-mail: [email protected]
P. Mandal (ed.), Proceedings of the International Conference 185 on Managing the Asian Century, DOI 10.1007/978-981-4560-61-0_21,
© Springer Science+Business Media Singapore 2013
186 C. Lui et al.
For the unbanked, poverty (no cash on hand), relatively high costs associated with accessing banking services, and inconvenient locations (due to long distance) of branches are reported as the major reasons for not using any banking services. A third (approximately 800 million people) of the unbanked population in Asia, who are in the lowest income category (i.e. living on under $ 5/day), simply cannot afford the high costs of commercial banking services. For commercial banks, providing banking service in these low-income communities is very difficult. The main reasons are high fixed costs of banking systems and the costs for running banking activities (e.g., credit scoring and lending) required by commercial banks. Some commercial banks also hesitate to invest in these markets due to lack of confidence and to avoid supporting potential future competitors. The mechanism to provide a self-sustainable business model to serve these markets continues to be a challenge.
In the last few decades, many MFIs have emerged to provide financial services and microcredit to the unbanked sector. For example, solidarity lending and village banking pioneered by Grameen Bank [5] in Bangladesh, KWFT (www.kwft.org) in Kenya, WING in Cambodia (www.wingmoney.com) [6], and many others. It is believed that microfinance is an effective instrument to alleviate poverty by providing financial service, particularly microcredit and savings accounts to the low-income individuals and microenterprises [7,8].
Even though microfinance began in Bangladesh in the 1970s, after 30 years, there are still half of the population in the world was still outside the reach of MFIs.
Majority of existing microfinance solutions are operated on labor-intensive business models that involve posting transactions from one ledger to another manually with paper systems. These not only pose a substantial challenge for these MFIs to scale fast enough to serve the huge demand of the unbanked population, but also create difficulties to be accounted for legitimate activities and frauds. In particular, the substantial portion of operating costs is due to manual labor. Credit officers have to maintain frequent contact and close relationship with customers to enforce loan contracts and to control risk of lending as the MFI customers can not provide collateral or credit histories. Operating costs are inevitably high for each loan transaction as well. Therefore, MFIs charge much higher interest rates than banks to ensure the permanence and expansion of the services without ongoing needs of subsidies from donations. The global average loan interest rates of MFIs is around 35 % [9]. The high microcredit interest rates have been heavily criticized and a number of countries have legislated interest rate cap on microcredit. In summary, for MFIs to scale fast enough to serve the huge demand of unbanked population and maintain financial sustainability, they require new business models and innovations to lower the interest burden by (1) lowering the operating cost, (2) accounting for legitimate activities and frauds, (3) lowering or mitigating risks of microcredits.
This study aims to understand the causes of interest burden of MFIs and discusses the roles of mobile technologies and financial market innovations for MFIs to lower the interest burden. To illustrate the impacts of the different factors on interest rate, we present a survey of current cost structures of microfinance institutes (MFIs) in
21 Lower the Interest Burden for Microfinance 187 Fig. 21.1 Interest income as
percentage of gross loan portfolio for 2011
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
Combodia Vietnam Indonesia
Income and Fee Incomes as % of Gross Loan Portfolio
Southeast Asia. Then, we review existing uses of mobile technologies for lowering the interest burden.
21.2 Impacts of Costs on Interest Burden
For MFIs to be financial viable, they need to use their loan interest income to cover the operating costs which comprise of cost of funds, loan loss expenses, and other operating expenses (e.g., equipment and wages):
Income>Cost of funds+Loan Loss expenses+Operating expenses (21.1) Lowering interest burden would require lowering one of the three components on the right side of the equation. In this section, we will discuss how these components may affect interest income of an MFI. Financial information on MFIs is drawn from the database of the Microfinance Information Exchange (MIX). Not all MFI report to MIC, but those that do currently over 2000 MFIs worldwide in 110 countries. We use the adjusted financial information of these MFIs to compensate for the effect of any subsidies they receive and, thus, try to present a picture of what the industry would look like if they had to pay market costs for all of their resources. We present the cost structure of MFIs in three Southeast Asia countries: Cambodia, Vietnam and Indonesia. We collected a dataset that includes 58 MFIs that report their results to MIX for 2011. 9 out of the 58 MFIs have a negative net income after taxes and before donations; hence they are not financially viable. They are excluded from this analysis. Among the 49 financial viable MFIs, there are 15 from Cambodia, 21 from Vietnam, and 14 from Indonesia.
In looking at interest rates, we use percentage of income from loan on gross loan portfolio (GLP), which is the total amount that cash borrowers pay the MFI during a period for interest and fee from loan divided by the average outstanding GLP over the same period. Figure21.1shows the minimum, 25th percentiles, medians, 75th percentiles and maximum interest and fee incomes of MFIs as % of GLP. The values