Uncovering Grameen Banks interest rate riddle
The MFTransparency report will verify that the allegations of charging 30 per cent interest on loans and an additional 10 percent in “forced savings” is manifestly false and utterly ill-conceived. The interest rates on all four categories of loans have been verified by MicroFinance Transparency, a USA based, globally recognized, international certification agency.
Click here to read The Financial Express article
Uncovering Grameen Banks interest rate riddle
In last December, Prime Minister Sheikh Hasina, accused Professor Muhammad Yunus of treating Grameen Bank (GB) as his personal property and claimed the group was “sucking blood from the poor”. This article examines the premises of such a disparaging comment: Was it simply a self-fulfilling political rhetoric or a gross economic illiteracy — on the part of her advisers–about what comprises interest rate?
There has long been some confusion and controversy about Grameen Bank’s interest rates on micro loans. I got a true picture of this when GB’s former deputy managing director Khalid Shams visited my house in Michigan in April 2008. He explained how GB’s interest rates are structured and told me that the rate on micro loans is less than 20 per cent. This article attempts to debunk the misinformation that keeps resurfacing driven by either usual ignorance or ill-will to cause ignominy to Prof Yunus.
GB offers four different types of loans each with its own interest rate as follows: Income generating loan at the rate of 20 per cent; house building loan at 8.0 per cent; interest rate on education loan (payable after completion of education) is at 5.0 per cent; and loans to a economically struggling family is given at 0.0 per cent interest. (Source:http://www.mftransparency.org/pages/category/resources/pricingcertifications). The above link will verify that the allegations of charging 30 per cent interest on loans and an additional 10 percent in “forced savings” is manifestly false and utterly ill-conceived.
The interest rates on all four categories of loans have been verified by MicroFinance Transparency, a USA based, globally recognized, international certification agency. The interest rate on private commercial banks’ (PCB) loans is around 14 per cent. It still sounds too high-doesn’t it? Traditional PCBs can charge lower rate than GB because of the economy of scale –higher volume leads to lower per unit cost. PCBs make collateralized large volume commercial and real estate loans. They also invest in the stock market. There are various other sources of income for PCBs such in investing in Treasuries.
The GB is not in the same business as the PCBs. Let me ask bluntly: How many of us know why we have to pay interest on borrowing money from banks? Alternatively, why do we have to be paid interest on our deposits in banks? The interest charged on loans or paid on savings account, is for losses in the purchasing power of money over time due to inflation and then some. Suppose the inflation rate in a hypothetical economy is approximately 10 per cent and the inflation forecast indicates that this inflation rate will persist over the next year. Suppose you have Tk 50,000 with which, instead of buying a laptop today, you lent the money at zero interest rate for one year. After one year, can you still buy the same laptop with the Tk 50,000? The answer is possibly no.
Since the inflation rate is 10 per cent, the price of that laptop must have gone up by say Tk5,000, that is your loss of purchasing power. If you charged 5.0 per cent user fee or interest on your loan you would not have lost that purchasing power. So, interest on loan is charged to hold the real value or purchasing power of money loaned out. For any banks or microcredit institutions, simply charging interest rate equal to the inflation (INF) rate will not keep it in operation.
They have to account for various business operational costs (BOC) such as salaries and benefits to employees, rents for office space, travelling, telephone, office supplies including computers, copy machines, and so on. Also there are loan default risk (DR), future inflation uncertainty (FBU) and business profit (BP). So interest rate (IR) on loans must equal: IR = INF + BOC + DR+ FIU + BP. For Grameen Bank, let us use some reasonable figures for the factors. Suppose the average inflation rate is 9.0 per cent, cost of operations is 5.5 per cent of the loan amount, default risk is 0.5 per cent, and profit is 4.5 per cent. Thus, IR = 9% + 5.5% + 0.5.0% + 0.5% + 4.5% = 20 per cent This is approximately the interest rate GB charges for income generating loans. In the formula, I accounted for losses that GB accrues from three other loans. For example, at 9.0 per cent inflation rate GB barely loses 1.0 per cent purchasing power on its house building loan by charging 8.0 per cent interest rate while by charging 5.0 per cent on education loan GB is losing 4.0 per cent value of its money (purchasing power).
For these two loans, I ignored operational costs, default risks and interest income and zero profit. But if you think the numbers in the above formula are somewhat high, and then you can assume those higher numbers will compensate for part of the losses from the other loans. Now the question is if the 20 per cent interest rate on income generating loan is excessive or exploitative? If the answer is no, then let us see “who’s sucking the blood from the poor”.
After much search and research, I finally discovered why there exists such a large discrepancy in quoting GB’s interest rates being 30 per cent instead of the 20 per cent. It all depends how one computes the interest rates. The 30 per cent rate is based on a formula which assigns approximately 10 per cent to borrowers’ transaction costs. Here is the explanation even though it will appear outrageous. GB borrowers are required to attend weekly meetings in the local offices.
That costs them rickshaw fares and time spent in the meetings and some other ancillary costs. That additional 10 per cent (above 20 per cent) is assigned to the time and money the borrowers incurred once a week which they could use for producing the goods and other activities. This is not to say that this transactions cost has no value but it is an unusual way of computing interest rate and I have not seen or heard about it before.
Besides, in many weeks there are no scheduled meetings. Hence, such a calculation of interest rate is simply appeasing to anti-Yunus and anti-GB cliques. According to David Roodman, Senior Fellow, Center for Global Development, this calculation was done by a Bangladeshi economist. (Source: http://www.youtube.com/ watch?v=2mdPS4rLb4M&NR=1). Thus, the above mentioned interest rate formula manipulated by the Bangladeshi economist appears as follows: IR = 9.0 % + 5.5% + 0.5 % + 0.5% + 4.5% + 10% = 30%. There was no evidence if the Bangladeshi economist accounted for the weeks when there are no scheduled meetings (and bank holidays). Anyway, this method of interest rate calculation is unheard of and deliberately misguiding.
Referring back to the 20 per cent rate formula, if the inflation rate comes down to say 5.0 per cent, then GB’s lending rate should also come down to at least 15 per cent since at lower inflation operational costs will also take a cut. So, one can easily see that “inflation” is the blood sucker — not the Grameen Bank. In fact, there are other “blood suckers” – the microcredit NGOs. Here is a true story: In 2009, I met a microcredit credit NGO chief in Michigan who told me that her NGO borrows funds from banks at 14 per cent interest rate and then lends them at a slightly lower rate to small borrowers. I asked her how is that possible — “borrowing at a higher rate and then lending at a lower rate”. She said on my face that “You will not understand- it’s complicated”. I asked her, “why not try me?” Once I pressed her hard she added the details of various “tricks and tracks” which showed that her NGO’s effective lending rate summed up to about 30 per cent. This is one case for which I would not hesitate to do some “foul mouthing” – leveling it as “blood sucking from the poor”.
Speaking at a Social Business event at the American International School in Dhaka on March 23, Prof. Yunus called upon his distractors by saying: “Now time has come to distinguish microcredit from non-microcredit. Microcredit is something that works for the people and the whole organization is dedicated for their welfare. I am not against people doing business. But I will request them not to use the word microcredit when they do other businesses. People might get confused with it.” The writer, formerly a physicist and a nuclear engineer, is a professor of economics at Eastern Michigan University.