Analyzing Microcredit Interest Rates: A Review of the Methodology Proposed by Mohammed Yunus

MIX Data Brief No. 4

6 Pages Posted: 25 Mar 2010

Date Written: February 2010

Abstract

In 2007, Muhammad Yunus (Nobel Peace Prize Laureate and founder of Grameen Bank, one of the largest microfinance providers in Bangladesh), proposed a new methodology for the evaluation of microcredit interest rates based on an interest rate premium, defined as the difference between the interest rate charged by the MFI and the cost of funds at the market rate paid by the MFI. In particular, this methodology defines three zones:

• Green Zone: (Interest Rate – Cost of Funds) ≤ 10 percentage points. According to Professor Yunus, these are the “poverty-focused” microcredit programs (p. 69). • Yellow Zone: (Interest Rate – Cost of Funds) ≤ 15 percentage points. • Red Zone: (Interest Rate – Cost of Funds) > 15 percentage points. Professor Yunus labels institutions operating in this zone as “profit-maximizing” MFIs, adding that these programs are “commercial enterprises whose main objective appears to be earning large profits for shareholders or other investors”. Prof., Yunus even referred to this as the zone of the “moneylenders” and “loan sharks”. This paper analyzes global microfinance institutions using this methodology, and determines characteristics of MFIs that do fall into the different zones. The main conclusions from this analysis are: • Three out of four microfinance institutions worldwide fall into the ‘red zone’. • The categorization can almost entirely be explained by operating expenses, rather than profits, since operating expenses represent 62 percent of all the expenses that need to be covered by the average yield and 80 percent of expenses covered by the premium, as defined in the methodology. • Looking across the broad universe of MFIs, there is no evidence that institutions in any ‘zone’ are taking supernormal profits. Removing all profits from all MFIs would not substantively change the distribution of MFIs into green, yellow and red zones. • Most MFIs that have low average loans sizes (suggesting they reach poorer clients) are being mislabeled as in the ‘red zone’. • Not-for-profit NGO MFIs are more likely to be in the red zone than for-profit MFIs (like banks) and credit unions. Combined, these factors suggest that the proposed methodology is an imperfect tool for understanding the operations of an institution and identifying solutions for bringing affordable credit to the poor. The main challenge for the industry remains to improve operating efficiency, within feasible levels.

Keywords: microfinance, microcredit, interest rates, Yunus, money lenders, usury

JEL Classification: microfinance, microcredit

Suggested Citation

Gonzalez, Adrian, Analyzing Microcredit Interest Rates: A Review of the Methodology Proposed by Mohammed Yunus (February 2010). MIX Data Brief No. 4, Available at SSRN: https://ssrn.com/abstract=1571814

Adrian Gonzalez (Contact Author)

World Bank Group ( email )

2121 Pennsylvania Avenue, NW
Washington, DC 20433
United States

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