Interest Rate Ceilings and Microfinance: The Story So Far
This paper aims to elucidate the relationship between interest rate ceilings and microfinance. It presents the current state of knowledge by reviewing literature and anecdotal evidences provided by experts, and by surveying interest rate ceilings around the world.The paper outlines the rationale for high microcredit interest rates and the historical performance of subsidized lending schemes. It also examines the impact of interest rate ceilings on microfinance clients, namely:
- Limited access to market, either through market contraction or due to the absence of microfinance lenders;
- Less transparency regarding the total cost of loans.
The paper explains the forms of interest rate ceilings in developing countries and describes the challenges inherent in implementing such ceilings:
- Interest rate controls, associated with pervasive governmental control over the financial system and enforced rigorously;
- Usury rates, depending on the level of the interest rate ceiling and the level of enforcement; this affects microfinance operations, particularly in remote or rural areas;
- De facto ceilings, making it impossible for other players to compete if they charge sustainable interest rates.
The paper concludes with policy recommendations on promoting lower interest rates without imposing interest rate ceilings, through:
- Efficiency, scale, and competition;
- Consumer protection: Public disclosure of loan costs allows borrowers to comparison-shop for loans, stimulates competition among lenders and compels them to become more efficient to stay in business.
