Reducing risk for the poorest of the unbanked and uninsured

The range of interest rates applied to micro-credit loans can be chilling.  45% to 85% in Africa, 30% in India and a jaw-dropping 155% in Mexico.

“What should be the appropriate rate of interest?” thunders Jacques Toureille, general manager at the Aga Khan Agency for Microfinance.  The occasion is the Doing Good and Doing Well conference hosted by IESE Business School in Barcelona, Spain.

 “The problem is that costs are high,” says Michael Steidl, MD of Micro Service Consult in Germany.  “A single loan officer can handle at most 300 clients a year.  Our average loan is for $500.  Just to cover the salary of the loan officer, we have to charge an equivalent price of 8% interest.”

Of course, there isn’t just the loan officer.  There are three costs: the financial cost of borrowing the money that is lent to clients, the operational cost of serving that loan, as well as the loan loss reserve to cover defaults.

Smaller loans, at the $50 level, still have these fixed costs.  The easiest way to lower interest rates is to increase the size of the loan.  However, then one is lending too much money to people whose average income mean that it is impossible for them to repay these loans.

When governments intervene to set fixed usury rates then the average loan value increases.  In Colombia, the average was $534 before a recent cap, which jumped to $1,250 afterwards.  Tens of thousands of people who would have been able to afford smaller loans at a high price now cannot get a loan at any price.

Yet, this is no call for unregulated lending.  “The greatest problem we have is that banks deliberately fail to tell clients what their loans are costing them,” shouts Chuck Waterfield, the founder of MicroFinance Transparency.  Chuck is demanding that banks publish their real lending rates, known as the Annual Percentage Rate (APR). 

The micro-credit industry is the big success of emerging market development.  The Grameen Bank in Bangladesh has made a superstar of its founder, Dr Muhammad Yunus.  Billions of dollars have flooded into the sector.  In Mexico, where interest rates are so high, more than 300 micro-credit banks compete for business.

This has led to over-indebtedness as the poorest take out dozens of loans, leading many to fear that a new credit bubble is waiting to explode.  Insuring against these default risks is still unsolved.

When the average person gets sick and takes a few days off work, the results are difficult.  When a bread-winner in an impoverished family falls ill, the costs and impact can push an entire family to the brink of starvation and set them back a generation.

Providing insurance for these risks is a valuable service.  Figuring out how to make the cost of investment attractive to the poor is the real challenge; or “providing an overcrowded bus, not a merc” in the words of Mukti Bosco of the Healing Fields Foundation in Hyderabad, India. 

Healing Fields offers wage compensation for people falling ill, hand-holding within a local hospital, health education and disease prevention, as well as working with government to expand local health services.  They do this for a mid-sized Indian family for $5 a year.

The more people who contribute to health insurance, then the lower the costs are individually.  The least efficient way is for people to pay directly.

Despite this initiative, these organisations have still not found a compelling reason for the poorest to buy.  “Global insurance companies have no idea how to make this work,” is the honest appraisal by   Michael Anthony, head of Global Microhealth at Allianz.

As old as the industries of insurance and credit lending are, providing services at these microscopic levels is still unknown, risky and difficult.  All the more reason for the debate about appropriate reward for appropriate risk to continue.