Indicators of (Dis)empowerment: Interest Rates Overrated? Repayment Rates Underrated?

In my writing now, I am sorting through lines of thought on how microlender behavior enhances or reduces the freedom of poor borrowers---freedom in Amartya Sen's definition, as agency in one's own life. The oldest strand here is that of "usury," the idea that charging interest above some level (maybe zero) is unjust, akin to the full-bellied selling food to the starving for a profit. As you probably know, the Compartamos IPO revived within the microfinance world the ancient debate over usury. Compartamos borrowers paid 100%/year while the Compartamos founders earned millions of dollars---and the scorn of Muhammad Yunus. Probably most Compartamos critics accept that the poor should have to pay more for credit than the rich---lending in small amounts costs more per dollar---but see 100% as beyond the pale. Fortunately, a recent CGAP report finds that such rates are exceptional. Fears about high interest rates may be overwrought.It occurred to me that another oft-cited microcredit rate resembles the interest rate more than is usually appreciated, and perhaps ought to be worried about more: the repayment rate. Like the interest rate the on-time repayment rate in microcredit exceeds rich-world norms, enough to startle newcomers. Among 718 microfinance institutions (MFIs) that voluntarily supplied relevant data to the MIX Market for 2007, the median PAR 30 rate was 3.4%. That is: for half the MFIs, repayments overdue at least 30 days constituted 3.4% or less of outstanding loan balances. 85% reported PAR 30 below 10% of outstanding credit. This graph tabulates the MFIs in that 85%:MFIs are much quicker to showcase repayment rates close to 100% than they are to showcase interest rates that high. Not without reason, they take high repayment as a sign that the poor are reliable, that the poor value microcredit, and that microcredit business models work.But can repayment rates, like interest rates, be too high? Should we worry about 100% repayment rates as much as we worry about 100% interest rates? Should the near-perfection scare us? Perhaps it indicates a great asymmetry in favor of the lender, a fearsome capacity to extract repayment through peer pressure and offers of bigger loans down the road. In the mid-1990s a researcher named Shahin Yaqub theorized that BRAC's microlending was indeed empowering poor Bangladeshis---who then used their power to default more! Yet when borrowers resist paying back, microfinance quickly sinks into the red. Chasing down delinquents, cajoling and pressuring them to catch up, costs a lot compared to the small sums at stake. It throws sand in the gears of a smoothly-running machine for the mass production of credit. And if a few get away with defaulting, others will follow---why should I pay back if you don't?---leading to what BRAC's Imran Matin called the "unzipped state."The question is whether at the margin there is a trade-off between covering costs and scaling up on the one hand, and, on the other, empowering clients. Or more to the point: the question is whether MFIs are making this trade-off in the way that their socially motivated funders and financers would want. I don't have good answers to these questions.It does strike me that if the Compartamos IPO is the touchstone controversy for the interest rate question, then the previous big microcredit blow-up---in Andhra Pradesh, India, in 2006---is a rough counterpart for the repayment rate. What happened there remains murky to this day. According to Prabhu Ghate's contribution to What's Wrong with Microfinance?, one factor was the rivalry between fast-growing private microfinance and an equally ambitious program backed by the government and the World Bank, which put bureaucratic interests at odds with microcredit. Local officials seemed to have marshaled ire at the private MFIs to justify locking down some of their offices and locking up some of their officers. Newspapers carried inflammatory and dubious stories about debtors committing suicide. Yet thoughtful observers of the controversy proved unable to dismiss it as pure politics. Although the MFIs' clients paid some of the lowest interest rates in microcredit (in the mid-20s), some may have had good reasons to be angry. Ghate writes:

The point at which peer group pressure becomes coercive is an extremely difficult one. However one clear lesson...is that the policy of 100 percent repayment and 'zero tolerance' for default carried a very high cost in terms of client dissatisfaction, and provided ample material to be exploited by interested parties. Clearly there is a need for flexibility to accommodate cases of extreme distress in which a borrower is unable to pay because of critical illness, hospitalization, and so on. A second lesson is that there is a great need for action research to provide answers to the question of how flexible MFIs can afford to be, even in cases of lesser distress (such as failure of a business) in rescheduling loans, without affecting repayment discipline generally, and how much operational costs would go up to introduce such flexibility.

The Andhra issue also made me think of our message of zero tolerance to delinquency. Sure I swear by it, but what does it mean in practice? Were the MFI staff right to be coercive in recovering loans? How far does one go? Do you seize assets? Do you stand in front of their house and shame them till they pay back? I don't have answers but we need to get a handle on this. There's got to be a balance between sound financial practices and looking after the welfare of clients.I'm writing this really to get to the core issue; we need to integrate a social performance bottom line to the one we have on financial performance. We need strong sustainable financial institutions. But for many of us this is fundamentally so that we may provide poor people with better choices and better services that they can then use to take greater control over their lives and improve their conditions. It is time we focused on this more strongly.