• Commercialisation of microfinance

Commercialisation of microfinance

This briefing note asks: "Does competition result in lower interest rates to microcredit customers?" The question is set against the fact that, despite the assumed logic that interest rates on microloans would fall with increased competition, in some countries where microfinance is considered competitive, interest rates have remained stubbornly high. To address this question, this Focus Note analyses the experiences of Uganda, Bangladesh, and Bolivia.

The different experiences of these countries suggest that lower interest rates are not the inevitable result of market development but are more likely to result when certain conditions are present: there must be sufficiently large providers in the market, with sufficient incentive and sufficient ability to reduce their rates.

The study notes that price competition in microfinance generally follows other competitive strategies than the accepted model of market development. It also notes that the microcredit market, in particular, has several features that may limit or change the nature of competition and its expected outcomes:

• the conventional approach assumes competition among profit-maximising firms. However, nongovernmental organisations (NGOs) that do not seek to maximise profit have been dominant, or at least important, players in many microcredit markets
• in some markets, donors and government-controlled wholesale funders have influenced lender behaviour through their control of funds. For example, when external funders impose restraints on pricing, microlenders are no longer free to make fully competitive pricing decisions
• group-based lending approaches can also make it more difficult for individual consumers to switch providers

Some of the paper's conclusions are:

• price is not the only, or even the primary, concern of clients. Clients place a lot of value on quality service, flexible product characteristics, and the availability of small loans
• the benefit of true competition is that it should encourage firms to respond to changing consumer needs
• if prices are set too low, providers are likely to avoid smaller loans to poorer clients or to exit the market altogether
• by pursuing lower funding costs and increased efficiency, many MFIs are seeking to build the headroom to sustain their profitability despite rate reductions
• consistent policies are needed to promote fair competition and create the conditions discussed earlier for lower interest rates to materialise. These include transparent, comparable pricing by providers, and promoting consumer financial literacy
• in addition to the benefits to the consumer, fair competition in an industry enables more productive firms to survive and grow.

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