Interest rate cap for MFI

Microfinance refers to the financial services which are offered to the poor persons who are generally considered as low income earners. This group of people does not typically have access to the banking services mostly because they cannot afford the charges that are levied. Microfinance is premised on the notion that the low income individuals can in most cases move themselves out of poverty if they are given access to financial services. Governments all the world over have used microfinance as a way through which they can en poverty. The microfinance institutions (MFI) always offer small amounts of money loaning facilities, savings and other small financial services. Modern microfinance can be attributed to the 2006 Nobel laureate, Mohamed Yunus, who carried out experiments regarding lending to the poor in Bangladesh. Interest cap refers to the limit on how much interest rates may increase over a single adjustment period. Interest caps helps to protect he borrowers from the shocks while also ensuring that the MFI are not disadvantaged due to reductions in the interest rates (Carr, 2002). The essay is a discussion of the importance of the interest caps in enabling the poorest individuals to access funds from MFI. Although all the MFIs have the objective of allowing the poor to access credit facilities, some of the MFI charged very high interest rates which ended up blocking the very poor from accessing the services. Due to the above fact, governments have implemented interest rates caps so that the interest rates which were charged on the borrowers could be controlled for the poor since they lacked the power to bargain for better terms. The first reason why the interest caps for the MFI is implemented is because the caps have the ability to limit the exposure to the volatile interest rates which would have otherwise been experienced. Interest caps allow the borrowers to benefit when interest rates fall while protecting them from very high interest rates (Cusatis and Thomas, 2005). The poorest people can therefore borrow cheaply while they are completely protected against any wild increases in the interest rates that are charged on the borrowings. An upper ceiling, also referred to as the cap, is set on the floating rate of interest. The poor borrowers can therefore not be faced with a situation where the borrowing costs exceed the amounts that were capped. Through the operations of the interest caps, the loans comparatively become cheaper thus the incomes of most people will be boosted (Ledgerwood, J. et al, 2006). The benefit brought about by the greater access to the microfinance is the improvement of the incomes of the households as well as the increase in the profitability of businesses as they pay lower rates. When the interest rates are capped, the people can access credit more cheaply (Fabozzi, Choudhry and Mann, 2003). Interest caps also increase the profitability of the businesses that the people who have acquired the loan enter into. It does this through the fact that the people will pay slightly lower interest rates as compared to the huge amounts of money which they would have paid in the event that there were no interest caps. The interest caps also increase the people’s ability to accumulate assets. Moreover, interest rates caps also protect the vulnerable borrowers from the exploitation by the MFI which are profit motivated. The caps ensure that the poorest people can access credit at reasonable prices. It can thus be said that the interest rates caps is one way of protecting consumers. Gonzales (2011) and Rigbi (2010) both agreed on the fact that the credit cap have the ability to protect t consumers. Rigbi argued that the interest cps protected the consumers who are naïve and thus would enter into credit contracts which would be irrational as the overall effect would be a reduction in the utility that the person derives from the loan. The fair pricing of loans from the MFI is an element of consumer protection. While protecting the consumers from the various forms of exploitation, the interest caps also increase other credit products which are affordable to the consumers and thus the consumers experience an increased power to bargain (Howell, 2009). In addition to the above, interest rate caps also reduces the rate of loan default and the other adverse effects of debt trappings. This is because the interest cap has an effect of opening the credit to the mainstream institutions. These institutions will attempt to use the non exploitative credit methods which are suited for the poorest people (Goldberg, Palladini and mondiale, 2010). The comparatively lower interest rates will attract the people who had been discouraged from taking the loans due to the high loan default rates which had characterised the loan facilities before the introduction of the caps. The caps on the rates of the interest will make most of the people to be debt free. However, although the effect of interest caps is positive in most cases, it can significantly reduce the access of the poor to the microfinance and credit facilities of the poorest. Due to the small amounts of the loans that the MFI deal with, they require a higher number of staff to deal with the clients thus a higher operational cost (Bateman, 2011). Since the expansion of MFI depends on the retained profits, caps on the interest rates will act as a discouragement factor to the MFI from entering into the service of the poor. Due to the fact that MFI deal with a high number of clients for instance 2000 clients who require loans of 100 dollars each. The MFI will require a greater staff as well as a higher level of administration when compared to the financial institution which receives one customer requiring 200,000 dollars. The interrelation between the loan size and the cost will greatly affect the MFI who target the poorest of the borrowers. In conclusion, the most important goal of microfinance is to reduce the costs that are to be incurred by the poor borrowers. The focus should therefore not b much on the prices of the loans but also consider the factors that influence the decisions of the poor to borrow for instance; loan amounts and the product terms, the length of time between the application for the loan and the time they get the loan, ability to access future loans and the quality of the service offered by the microfinance institutions. MFI should, with or without the interest caps, be able to provide the poor with affordable access of the credit. The MFI should be made to operate under a regulated environment so that they cannot exploit the poor people who depend on these loans so that they can move out of the cycle of poverty. However, the interest caps on the MFIs should be done in such a way as to maintain the objective of the access of the poor and the ability of the MFI to expand in a ‘non-exploitatory’ environment. Bibliography Bateman, M. (2011) Confronting microfinance: undermining sustainable development, Sterling, VA: Kumarian Press Carr, J. (2002), Replicating microfinance in the United States, Washington, D.C.: Woodrow Wilson Center Press Cusatis, P. and Thomas, M. R. (2005) Hedging instruments and risk management, New York: McGraw-Hill Fabozzi, F., Choudhry, M. and Mann, S. (2003) Measuring and controlling interest rate and credit risk, Hoboken, NJ: Wiley Goldberg, M., Palladini, E. and mondiale, B. (2010) Managing risk and creating value with microfinance, Washington, D.C.: World Bank Gonzales, A. (2011) "Sacrificing Microcredit for unrealistic goals", Microcredit Information Exchange [online] Accessed 6 January, 2012 Howell, N. (2009) "National consumer credit laws, financial exclusion and interest rate caps: The case for diversity within a centralised framework", Competition and Consumer Law Journal, 17(2): 212-233 Ledgerwood, J. et al (2006), Transforming microfinance institutions providing full financial services to the poor, Washington, DC: World Bank Pubns Rigbi, O. (2010) The Effects of Usury laws: Evidence from the online loan market, Ben-Gurion University.