The Role of Donors and DFIs in Overcoming Barriers

MFIs are making inroads in serving rural areas and agricultural clients. The vast array of models and technologies being tested will undoubtedly reveal ways to reduce costs and mitigate risks. Microfinance has benefited immensely from support provided by donors and DFIs, and there are several ways they can usefully contribute to further developments and confront important threats facing the industry. This section identifies these actions.

Political Interventions and Interest Rate Ceilings

Political interventions were common under the subsided agricultural credit paradigm and recent events, such as the No Pago movement in Nicaragua, have begun to threaten microfinance. The liberalization of interest rates was an important reform in many countries following the end of the old paradigm. It provided an important incentive for the microfinance industry because it permitted charging interest rates high enough to cover costs and risks of making small loans to poor people. The highly profitable IPOs of Compartamos in Mexico and SKS Microfinance in India generated a huge debate, however, about the appropriate interest rates to charge poor borrowers. Incidents of suicides by indebted borrowers in Andra Pradesh, India, prompted government officials and politicians to urge borrowers to stop repaying their loans even though the link with microcredit is tenuous (Harper, 2011). Bangladesh announced interest rate caps for microloans at 27 percent, a sign of growing backlash against the industry once hailed as the magic bullet to cure poverty.[1]

International agencies should support efforts to educate and advocate on behalf of market-oriented interest rates. They need to disseminate examples of rates of return in agriculture higher than assumed so cheap interest rates are less critical to borrowers than policy makers expect. Interest rate caps create serious impediments for financial institutions to expand financial services to the poorest, to those living in distant locations, and to farmers operating in risky environments (Campion et al., 2010).

Subsidize Institutions and Public Goods

Subsidies for institution building and financial infrastructure contributed to the success of microfinance, and are less distorting than interest rate subsidies granted directly to borrowers. The key to reducing interest rates for credit is increased MF efficiency and competition. Subsidies to MFIs for use in designing products and systems and for training and human capital formation contribute to that objective.

Subsidies to create public goods that benefit the entire financial sector may generate even higher returns than subsidies to specific institutions. Examples include improving property rights, collateral registries, credit bureaus, special courts for credit defaulters, and other support institutions. International agencies play a useful role by advocating a long-term approach to financial market development, by conducting analyses to identify gaps in support institutions, and by proposing measures to address them.

  • [1] Financial Times, November 10, 2010.
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