The Interest Rate Debate in Microfinance

Introduction:

Over the past two decades Microfinance Institutions (MFIs) and NGOs have made use of a range of designed features, i.e they have focused on reaching the poor by keeping the loan sizes small, targeting women, adopting group based lending systems, mobilizing small and frequent savings deposits and have tended to set interest rates at higher levels than in the past. The issue of high interest on micro-loan has been criticized since the beginning of the modern microfinance movement in the late 1970s, but it intensified in the last few years as it is drawing more public and political attention. These institutions which give micro-loans to low-income borrowers in developing and transition economies are charging higher interest rates and fees high enough to cover their costs and thus making their operations financially sustainable. They have repeatedly argued that doing so will best ensure the permanence and expansion of the services they provide. Sustainable (i.e., profitable) microfinance providers can continue to serve their clients without needing ongoing infusions of subsidies, and can fund exponential growth of services for new clients by tapping commercial sources, including deposits from the public. On the other hand, a group of observers who do not agree with this argument say that MFIs that claim to be helping poor people nevertheless charge interest rates that are considerably above the rates richer borrowers pay at banks. No wonder this seems wrong to these observers who do not understand, or do not agree with, the argument that MFIs can usually serve their poor customers best by operating sustain-ably, rather than by generating losses that require constant infusions of undependable subsidies.

2. The Debate

To start with the debate that, ‘are the interest rates charged by the MFIs excessively high’? we know that there is no perfect answer to this question as there are huge variations in interest rates charged by the MFIs around the world. Also another matter of concern is that how high interest rates and profits would be qualified as “excessive”. Before continuing with this discussion it is important to understand what an interest rate is.

In simple terms, the interest rate is the price of money. As a price it is made up of a number of components as far as a lender is concerned. It is the means through which the lender:

• pays for the cost of the funds that are being lent (cost of capital); if these are from savers then the savers are likely to expect a return which will at least cover inflation and so maintain the value of the savings;
• recovers the cost of providing the services (costs of administration); the costs of the staff employed to given and recover loans, and costs of the offices, vehicles and stationery that are necessary to provide that service;
• covers losses as a result of those who default on their loans (costs of default).

Now-a-days, the MFIs have accepted the need to charge interest rates which cover inflation and make a contribution to costs. This means interest rates which are positive in real terms and are comparable to those charged by formal-sector banks (sometimes termed as market interest rate). This differs from earlier practices in the sense that when the provision of credit from NGOs, MFIs and State Banks were actually at subsidized rates. This cheap credit was attractive to borrowers outside the target group, and was diverted away from its intended purposes; and loans were often not repaid. The combination of cheap credit and widespread default resulted in rapid erosion of loan funds. Thus it’s very important to charge a rate of interest that covers the cost of inflation, administration, and default so that the loan fund is able to revolve and maintain its value.

On the other hand an interest charge represents money taken out of clients’ pockets, and in this case the clients are poor. Moreover, the MFIs claim to be helping the poor, because that is their ultimate motive and the interest rates charged by these MFIs are much higher than what the rich borrowers pay at bank. Again the costs become high due to some avoidable inefficiencies which the poor people who are generally the client’s of these MFIs have to bear in the form of higher interest rates. So, charging higher rates of interest by these MFIs would not only be unreasonable but also inhuman.

Now there’s another intense dispute about how high interest rates and profits should be to qualify as “excessive”. According to CGAP expert Rich Rosenberg, “There are huge variations in the interest rates and related circumstances of individual MFIs around the world.” So CGAP did a study on 500 MFIs around the globe to shed some light on this issue. The study found that the median interest rate for sustainable (i.e., profitable) MFIs was about 26 percent in 2006. The 85 percent interest rates charged by Compartamos (a Mexican MFI ) was truly exceptional. Less than 1 percent of borrowers pay rates that high. MFI interest rates also declined by 2.3 percentage points a year between 2003 and 2006, much faster than bank rates.

We will look at the factors that affect the interest rates in microfinance:

Higher cost of funds – We know that MFIs have to pay more than banks for the borrowed money and MFI managers don’t have much to do to control the costs.

Low default rates - While the cost of funds is necessarily reflected in MFI interest rates, rates are not being inflated by unreasonable loan losses. Default rates are very low—about 1.9 percent in 2006. Higher administrative expenses - Tiny loans certainly require higher administrative expenses, which are not substantially offset by economies of scale. The good news is that the learning curve of MFIs as they age produces substantial cost reductions. While we cannot quantify how much avoidable fat remains to be trimmed from MFI operating costs, one must expect substantial inefficiency when most MFIs are relatively young, and when few national microfinance markets are competitive. We know of no evidence to suggest that MFIs are out of line with the normal evolution of efficiency for businesses in such markets, and administrative costs have been declining by about a tenth per year since 2003.

Competition – Its not fact that competition will always lower interest rates. But interest rates do appear to have dropped in the markets where micro-credit has already become competitive, except for Bangladesh.

Profits - The study found that profits are not a predominant driver of interest rates. For the median MFI, the imprudent scenario of complete elimination of all profit would cause its interest rate to drop by only about one-sixth. And MFI owners earn less on their investment than commercial bank owners in the first place. The median return on MFI equity in 2006 was moderate—12.3 percent, compared to 17.7 percent for banks. Profits of sustainable MFIs, measured as a percentage of loan portfolio, have in fact been dropping by about one-tenth (0.6 percentage points) per year since 2003. Contradictory to this, the most profitable tenth of the worldwide micro-credit portfolio produced returns on equity above 34 percent in 2006—high enough to raise concerns about appropriateness for some observers. Much of this profit is captured by NGOs and never reaches private pockets. But some of it does go to private investors. Now the question is whether such profits are “exploitative” or not will depend, not only on the observer’s standard for what a reasonable profit is, but also on individual MFIs’ circumstances, including the risk levels faced by investors when they committed their funds.

In his study Rosenberg argues that, “How all this information is put together is up to each individual….. The real question is whether unreasonable rates are more than occasional exceptions. We don’t find evidence suggesting any widespread pattern of borrower exploitation by abusive MFI interest rates. We do find strong empirical evidence that operating costs are much higher for tiny microloans than for normal bank loans, so sustainable interest rates for microloans have to be significantly higher than normal bank interest rates. We also find that interest rates, operating costs, and profits have been declining quite rapidly in recent years, and we would expect this trend to continue in the medium-term future.”

3. Conclusion

Our ultimate goal or motive behind this debate is to search the answer for the question that “what should be the ideal or optimum rate of interest?” This is what that has been bothering the majority of the people in most of the countries. The ideal situation would be that the interest rate should be enough to cover the cost of operation and would also allow some profit for capitalization but it should not be so high that it appears exploitative. What I feel is that the ability to cover all the administrative costs through the interest charged to borrowers is only likely to develop over a period of time, as the system of lending becomes more efficient, and the number of borrowers receiving loans increases. Attempting to recover costs in the early stages of the scheme is likely to result in interest rates which are excessively high.

When comparing interest rates with those of formal-sector banks it is also important to recognize the hidden costs that poor borrowers face when they approach banks. They may be charged loan fees, heave to organize ‘gifts’ for bank staffs, and incur transport costs to get there. Worse they may be treated with disdain and even contempt – not a monetary cost, but a cost all the same. The actual price that a borrower is paying for loans from these sources is therefore higher than the interest rate alone; and the attitude of bank staff can make the transaction even more burdensome. This is why loans which carry interest rates comparable to the formal sector are still likely to be positively regarded by clients.

There is also an ongoing campaign for capping the rate of interest to protect the poor from the exploitation of greedy MFIs, who on some ground or other charge higher rates either to enjoy their luxury or to bear the costs of their inefficient high operational costs. But, for the sake of competitiveness and provision of quality services, it is better not to have capping but to form a consensus on a range of interest rates that will ensure a win-win situation for both the lenders and the borrowers. This may be possible with the government/central bank/regulatory body playing a leading role.

The rate of interest of MFIs should not, however, be compared with the rate of money lenders, but it may be compared with the commercial rate to show how cost-effectively MFIs operate. MFIs provide small loans to hundreds of borrowers at a rate of interest, which in many cases is not much higher than the commercial rate. As Muhammad Yunus suggests, it should not ever be more than 10 percent higher than the market rate.

Thus we can reach our objective (i.e an optimum interest rate or the ideal situation) by creating an environment where all the parties involved in the society ( practitioners, governments, donors, banks, corporations, NGOs, foundations, wholesale funds, networks, civil society and others) join hands and come together and work effectively and efficiently to eradicate poverty.

Adieu MSE !!!

Yes it’s almost a year that I am writing again. Actually there was so much to do these days (though not much productive) that I found very less time to update my blog. In these days some of the memorable incidents that I can share are my internship at Institute of Financial Management and research (IFMR), it was my first experience of working in an office. It was good, as I got to learn a lot about microfinance, their mission, their process of work and the different organizations and institutions that are involved in achieving its goal. I’m indebted to this internship because due to this I got to choose my course of further research and study.

Secondly was my first trip to Pondicherry, with my friends. It is an amazing place. It might be because I love beaches. I can spend the entire day sitting in front of the sea, and watch how the violent waves come and hit the shores at different intervals. It’s a phenomenon that has been happening for years and will keep on happening till the end. I really became addicted to this place, because I made very frequent visits to this place after the first visit. I would love to spend the last days of my life in such a peaceful place. The other attractions here are the Aurobindo Ashram, Matrimandir and the French colony. Thirdly, my MSE days are over. I have come back to Calcutta to my home.

There are a lot of incidents and experiences at MSE which if I start saying, can’t be finished. I’ll really miss those small jokes, the small fights, pulling each other’s towel while going to take a shower, those mid night dinners, staying awake the whole night doing nothing, those booze parties in the terrace, I’ll miss them all. I will really miss all my friends.

Now those days are gone. I won’t be able to get those days back. You never know whether I’ll be able to meet those friends again or even when we meet whether we can have the same fun that we used to have before. Yes, we can’t get back those moments again. They are memories now. The life we led in MSE was amazing, we had fun which is unforgettable. The experiences can’t be described in words.

Time really flies. How these two years past so quickly we didn’t understand….. Wish we could have stayed for some time more. But as all good things comes to an end, so has our MSE days!!! So our juniors made the stay more memorable with the wonderful farewell they organized. The theme was ‘Masquerade’. We were not supposed to reveal our identity. So we gave a surprise to the others by keeping ourselves in disguise. I dressed as Dushyashan, (a character in Mahabharata). Then the juniors organized an award distribution ceremony and then some games which were really fun. [In the picture, from the left, its me as Dushyashan, Anil as Duryodhan and Mohit as Yudhisthir]

They made a wonderful decoration. The most striking thing was the decoration on board, they made a design which from far would look loke an abstract art but as you come near you the see the names of all the second years. The games and the award ceremony was fun. Another touching thing were the speeches of the Director and the professors.

Next the presentation they made was really touching. In the evening we had dance party in the auditorium and then dinner. It was a wonderful evening that enriched our memories at MSE.

City of Joy - here I belong......

Rythm Divine.....

We all at some point of time have had wrong misconceptions about therapists and the term ‘therapists’ has also been used in the wrong context. But after knowing about Tripura Kashyap and her dance therapy one would realise that venturing into an unexplored territory is about having confidence and strength to pull you through difficult times.After finishing her graduation in classical dance from Kalakshetra College of fine arts Chennai, Tripura Kashyap started her career as a performing artist in Chandralekha Dance Company in Chennai. She continued to work as a performing artist and a choreographer for many years. But she always craved to do something extraordinary with her art. To boldly go where no one has gone before does indeed require a leap of faith and a hope for a market that may not even exist but she was determined to overcome all hurdles when she was introduced to the concept of ‘dance therapy’. Dance therapy is the psychotherapeutic use of dance for emotional, cognitive, social, behavioural and physical conditions.The therapy enhances emotional and physical unity of individuals, making effective changes in feelings, cognition and physical functioning. Her brother who is physically challenged was her source of inspiration. “I used to see him responding to various forms of music and that made me think about the possibilities of using dance as a tool for healing. I wanted to know more about dance therapy and hence, I studied dance therapy at Hancock Center for Movement Therapy in US,” says Kashyap. On her return from the US, Kashyap started Apoorva Dance Theatre in Bangalore. Later she received the Ashoka International Fellowship for her innovative work in dance/movement therapy. “During the fellowship, I travelled all over India training special educators and trainers to use dance therapy as a way of healing. It was an enriching experience,” adds Kashyap. Later Kashyap founded Rainbow Inc, a school where various forms of art like dance, drama etc. are used as therapeutic tools. She is currently researching on the therapeutic potentials in Indian dance forms under a fellowship of the Indian cultural ministry. One of the country’s first dance/movement therapists, Kashyap has many awards to her credit including the ‘Sangeeth Nadak Academy’ award, recognising her contribution to dance/movement therapy. “Dance, for me is a direct expression of oneself through the body. And I want people to understand the significance of gauging a person’s behaviour through the very simple art of dance.” says Kashyap.
She has proved that "where there's a will, there is always a way".

Ekaant.....

I think that Aishwariya and Hrithik make a good pair 'onscreen'. So I was quite enthusiastic to see the movie Jhodha Akbar by the director Ashutosh Gwarikar. The opportunity came all of a sudden. As usual after the hectic class of Actuarial Maths I was feeling tired so after lunch was planning to take a nap. But Anil came up to my room and asked what I’m going to do in the afternoon. I had no idea so he gave me the proposal of going for a movie. I felt very excited because the cost of the ticket would be only 10/- (Satyam cinema has got a speciality which you won’t find anywhere in India. One can see the movie for only Rs. 10 which is available for the first three rows in the hall. So all the rickshawalas, thelawalas, factory workers and students stand in long queues for these tickets. So one should go at least before an hour to get the ticket otherwise would have to wait for the next show.) We went stood in the line but since it was a huge line we didn’t get so went to Spencer’s did window shopping and then returned to get the tickets for the 7:30 show. But the wait was worth it. I liked the really liked the movie. 'Jodhaa Akbar' is a sixteenth century epic romance with heavy doses of electrifying drama and wide canvas battle sequences. Possibly being the most ambitious and gutsy film to come out in the scenario of Indian cinema in recent years, 'Jodhaa Akbar' creates an unchartered cinema territory, breaking new ground in its filming and its mis-en-scene.

Ashutosh Gowariker takes on the mammoth task of making a prequel to 'Mughal-E-Azam', writing the possible love story between Emperor Akbar and Jodhabai, which starts as a marriage of alliance when King Bharmal of Amer gives his daughter’s hand in marriage to Emperor Akbar.

From the Battle of Panipat where the thirteen-year-old Jalaluddin was crowned to his conquests and his benevolent and just role that won him the title of ‘Akbar,’ meaning ‘The Great,’ the film traces the graph of the mighty emperor and his love for the defiant Rajput princess. While 'Mughal-E-Azam' was Salim’s love story, 'Jodhaa Akbar' is Akbar’s love story. No other comparisons can be made between these two films, and both are masterpieces in their own sense, as well as rich and wide in their staging. But 'Jodhaa Akbar' is a film for today, contemporary in its outlook, with the central love story flavoured with political conspiracies and palace intrigue, and a very important film that besides its dramatic entertainment makes us to realise the many shades of secularism and its importance.

Hrithik Roshan as Akbar is magnificent, giving a fantastic performance that has to be seen to be believed; his vocal intonations and commanding expressions, working on every facial muscle in delivering his lines, makes you almost believe he is a Mughal. When he proclaims ‘Yeh hamaara Mulk hai’ or when he says ‘Hamle ke liye tayyaar’ or when he admonishes his religious adviser Saadir Adasi in his court for interfering in matters of governance, you realize what a fine actor Hrithik is. But among all I liked 'Ekaant....' when he orders his subjects to go for his privacy with Malaika Hindustan. It amused us a lot. Gowariker may have taken his time to make this film, but the effort is all there on the screen. You see a mature Hrithik who not only delivers fine dialogue with great command, but Gowariker puts him through an elephant taming sequence, a sword duel with Jodhaa, battles, and a climactic combat with the main villain; making good use of the build and prowess of the star, the director makes this magnum opus as young and contemporary as possible and at the same time vividly detailed in time.
Aishwarya Rai Bachchan as Jodhaa is so real and convincing as a Rajput princess that you feel she has never before looked so good in a role. Aided by the grand jewellery and costume finery, she shines as the princess who makes the greatest sacrifice for her people, consenting to a marriage of alliance with the Mughals. The grace of her swordplay coupled with some fine horse-riding makes you wonder what kind of preparation went behind this film. Kudos to Gowariker for making his stars every inch the character they are enacting, and more.

The Insurance Industry

Introduction:
We can say that insurance appears simultaneously with the appearance of human society. We know of two types of economies in human societies: money economies (with markets, money, financial instruments and so on) and non-money or natural economies (without money, markets, financial instruments and so on). The second type is a more ancient form than the first. In such an economy and community, we can see insurance in the form of people helping each other. For example, if a house burns down, the members of the community help build a new one. If the same thing happens to one's neighbour, the other neighbours must help. Otherwise, neighbours will not receive help in the future. From here came the concept of Insurance. Now with the growth of our civilization and with it the growing importance of trade and industrialization there has been a growing demand for insurance.
The basic human trait is to be averse to the idea of taking risk. There is always an urge to minimize the risk and take protection against possible failures. Any risk may be insured against at a premium commensurate with the risk involved. Insurance is a complex mechanism and it is consequently hard to define. However in simple terms it has two fundamental characteristics:
(a) Transferring or shifting of a risk from one individual to a group; (b) Sharing loses, on some equitable basis, by all members of the group.

India is a perfect market for Insurance:
With a population of 1.1 billion, India is a perfect market for insurance and can generate sufficient long-term funds for development of infrastructure sector. "You cannot be anything but bullish about the Indian market if you are a multinational. With 1.1 billion population, relatively young population, relatively well educated population, this is a perfect market for insurance," says MDRT President James E Rogers. Insurance is also important as it leads to capital formation. Countries with strong insurance industries should have strong infrastructure and strong capital formation. According to Rogers, “It generates long term capital to build super highways, mortgages for buildings, at the same time it protects families and businesses in case somebody dies." Since India and China are fast growing economies. So in respect to it he suggests “It would be foolish not to be interested in this part of the world, especially India, and increasing our membership because this is an economic story that is very exciting and we want to be a part of it. The country has the potential to add 40,000 members to the organization, which is an international association of professionals representing 476 companies spread over 76 nations. In terms of the financial sector, he added, India is in an excellent position to grow in exponential fashion in the short run”.
“Indian Insurance Industry Forecast (2007-2009)”, provides extensive research and objective analysis of the growing insurance industry, its product quality, and services in India. This report helps to analyze the leading-edge opportunities critical to the success of the insurance Industry in India. Detailed data and analysis helps investors, financial service providers, and global banking players to navigate through the evolving insurance market in India.
Key Findings:
(1) Taking into account the changing socio-economic demographics, rate of GDP growth, changing consumer behavior and occurrences of natural calamities at regular intervals, the Indian life insurance market is expected to reach the value of around Rs 1683 Billion in the year 2009. The market is expected to grow at a CAGR of more than 200% YOY from the year 2006.
(2) In 2006-07, pension premium contributed about 22.11% to total premium income of insurers. Interestingly, the figure in the first nine months to December 2005 was 25.22%.
(3) In the non-life segment, the established players control 65% of the market. So it is their monthly performance that determines how the market as a whole would perform.
(4) In Motor Insurance Business, Public sector covers almost 68% of the market value whereas the private sector just had 32% market share till September 2006.
(5) In Accident Insurance Business, private sector players have almost 53% market share with ICICI Lombard as the lead player. Public sector players constitute about 47% market value with New India as the leading player followed by United India.

Liberalization of the Insurance Industry
An insurance policy protects the buyer at some cost against financial loss arising from a specified risk. Different situations require different mix of risk – cost combinations. Insurance companies thereby offers scheme of different kinds. Among the emerging economies, India is one of the least insured countries but the potential for the further growth is phenomenal. The demand for insurance is likely to increase with rising per capita incomes, rising literacy rates and increase of the service sector. After the Korean and Taiwanese insurance sectors were liberalized, the Korean market has grown 3 times faster than GDP and Taiwanese market has grown at a rate of almost 4 times than that of its GDP. Further opening of sectors to private firms will foster competition, innovation and a variety of products.

Role of the IRDA:
IRDA’s primary function is to protect consumer interests. This means ensuring proper disclosure, keeping prices affordable but also insisting on some mandatory products and most importantly making sure that consumers get paid by insurers. Further ensuring the solvency of insurers is a very important function of regulatory authority. IRDA has evolved a set of operational guidelines to deal with maintaining the solvency of the insurers. Growth of insurance business entails better education and production to customers, creating better incentives for agents and intermediaries.

Conclusion:
Privatization of insurance is a now a reality towards further liberalization of the Indian economy. With the opening up of the industry after reforms, private sector operators in collaboration with their overseas partners are likely to bring in a more professional and focused approach. Hence in this millennium, Insurance Industry is likely to play an important role in changing the economic landscape of the country.

Sarang,2008

Well Saarang the IIT(Madras) fest , perfect hangout for young guys and gals....... This year I got a chance to visit SAARANG,2008 with my friends ands thats for free. It was a good luck for me that I got to see such a wonderful thing due to a frnd studying there....."Good Luck" because it was the bad luck of my frnd that he couldn't attend due to his personal reasons and so I could go in his place. There was so much craze to see Lucky Ali's performance and also two rock bands 'Firebrands' and a Delhi based band 'Prestorika'. It was good I loved it.....specially the crowd. I thought Chennai lacks good chicks...but from that day I had to change my opinion. Besides the shows there were exhibitions which exhibited handicrafts, designer wear based on rural culture of India, pottery and different handworks. In another place I found people doing 'rangoli' with different coloured powders I also tried my hand in it. The purpose of it was to pull the people together and have a feeling of togetherness and integrity. Thats the theme. We friends walked around the campus and praised its beauty, its cleanliness, its vastness. A person doen't need to go out of the campus ....u can get everything inside. Slowly it became dark and we were getting excited to go in and see the show. Nyways I'm not a fan of Lucky Ali ya like some of his nos. But the ambience of the place excited me. At 7:30 the show started. He sang his popular nos. like "Ek pal ka jeena..." , "Na tum jano na hum..." , songs in SUR, etc.During the show every body put there mobile's display screen on and waved there hand ........ It seemed thousands of stars flowing in the sky. It was awesome.