What are the main factors in determining interest rates?

Dan Gaidula

Interest rates are determined locally by five main factors.  Here they are:

  • Rate of inflation in the country
    • Double digit inflation is not uncommon in developing countries.  Interest rates have to cover inflation.
  • Cost of capital
    • This refers to cash in the capital market (banks etc) that they use to relend to poor borrowers. Hundreds of billions of dollars will be needed to fund the billions of potential poor borrowers.
    • Cost of capital (COC) is often well into double digits 15-20% in developing countries.  Interest rates now must cover inflation + cost of capital (COC usually does cover some of the inflation, but often not all.)
  • Cost of providing the loan (MFI’s Overhead) is very high
    • This is due to the fact that the most successful operations usually visit borrowers 25-50 times a year at locations near the borrower’s homes and this takes an army of field loan officers, motorcycles and other support.
    • Traditional banks can’t do this.  Interest rates now must cover inflation + cost of capital + MFI overhead
  • Other associated services, such as health, savings, insurance and education services.
    • Some MFIs believe it is imperative that they extend other crucial services to the poor along with the loan.  These can include:
    • Health exams and other medical services such as family planning and reproductive and parenting education
    • Business advice and education/training
    • Marketing advice and assistance for their crops or products
    • Mandatory savings (often cited as necessary to escape poverty)
    • Health and/or life insurance
  • Profits or excess capital at year end
    • Profit, or for the non-profit “excess capital” is important to keep the MFI operating so that it can continue working to help the poor. Either way, the MFI must end up the year in the black or face going out of business.