Generally, the poor tend to pay higher interest rates than the rich when taking out a loan. In India, a fruit seller who has taken out a loan to support her business must pay 4.69% interest a day. “If you borrowed 100 rupees today and kept it until tomorrow, you would need to repay 104.69 rupees.” Because of these high interest rates, the founders of microfinance institutions “were called to action”. The poor do not receive loans from “a proper lending institution like a commercial bank or a cooperative”. Instead, they borrow from moneylenders, relatives, shopkeepers etc. The interest rates and the lack of oversight of the loan, i.e. extortion, not paying the loan back, etc. has caused the rise of Microfinance Institutions (MFIs) in “poor” countries.
A famous Microfinance Institution, the Grameen Bank, founded by Nobel laureate Mohammed Yunus, “has reached anywhere between 150 million and 200 million borrowers, mainly women.” The accountability of a loan is communal. The loans are normally given to groups, so each person is “liable to each others’ loans and hence have a reason to try to make sure that the others pay.” The MFI’s also use the “powers of shame”. They use “connections within village social networks to put pressure on recalcitrant borrowers.” This method is effective and does not cause physical harm. However, most other non MFI lenders tend to come after borrowers aggressively.
When one thinks of the MFI and the recent economic crisis that the world has experienced one must question how economic crises effects interest rates, borrower rates, the rates of paying back the loan and the businesses that are being supported by the loans.
As financial markets struggle internationally, some microfinance institutions have begun to see downstream effects in the form of rising lending rates. As financial markets struggle internationally, some microfinance institutions have begun to see downstream effects in the form of rising lending rates.
Interestingly in times of financial crises the MFI’s have been steady and stable. According to Benjamin Kahn “there is little doubt that MFIs will benefit from close ties with their local communities, from knowing their borrowers well, from having an ownership structure that includes shareholders with a strong interest in their well-being, from conforming to local financial regulations and from making good use of local savings.”
Being involved in the community level is advantageous, the Institution is familiar with the community on a personal level and thus it is easier and more profitable and less risky for both the institution and borrower. But one must not ignore unexpected external and internal events that could drastically alter the stability of microfinance and could possibly worsen the situation of the borrowers who strive to improve their lives.