Small groups, large profits: Calculating interest rates in community-managed microfinance

Ole Dahl Rasmussen

doi:10.3362/1755-1986.2012.030

Small groups, large profits: Calculating interest rates in community-managed microfinance

Savings groups are a widely used strategy for women's economic resilience - over 80 per cent of members worldwide are women, and in the case described here, 72.5 per cent. In these savings groups it is common to see the interest rate on savings reported as ‘20-30 per cent annually’. Using panel data from 204 groups in Malawi, I show that the correct figure is likely to be at least twice as much. For these groups, the annual return is 62 per cent. The difference comes from sector-wide application of non-standard interest rate calculations and unrealistic assumptions about the savings profile in the groups. As a result, it is impossible to compare returns in savings groups with returns elsewhere. Moreover, the interest on savings cannot be compared with the interest rate on loans. I argue for the use of a standardized comparable metric and suggest easy ways to implement it. Development of new tools and standards along these lines are fortunately under way from key players in the sector and should be welcomed by donors, politicians, and practitioners to improve transparency and monitoring.

Allen, H. and Panetta, D. (2010) Savings Groups: What Are They? Washington, DC: SEEP Network.

Ardener, S. and Burman, S. (eds) (1995) Money-Go-Rounds, Oxford: Berg.

Brown, R.L. and Zima, P. (2011) Mathematics of Finance, 2nd edn, New York: McGraw-Hill.

Collins, D., Morduch, J., Rutherford, S. and Ruthven, O. (2009) Portfolios of the Poor: How the World's Poor Live on $2 a Day, Washington, DC: Princeton University Press.

De Mel, S., McKenzie, D. and Woodruff, C. (2008) ‘Returns to capital in microenterprises: Evidence from a field experiment’, The Quarterly Journal of Economics 123: 1329.

EU Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on credit agreements for consumers and repealing Council Directive 87/102/EEC.

Graeber, D. (2011) Debt: The First 5,000 Years, New York: Melville House Publishing.

Homer, S. and Sylla, R.E. (1996) A History of Interest Rates, New Brunswick: Rutgers University Press.

Ksoll, C., Lilleør, H.B., Lønborg, J.H. and O. D. Rasmussen (2012) ‘The impact of community-managed microfinance in rural Malawi: Evidence from a cluster randomized control trial’, presented at the NOVAFRICA Conference, Lisbon, 7-8 September.

Lusardi, A. and Mitchell, O.S. (2007) ‘Baby Boomer retirement security: The roles of planning, financial literacy, and housing wealth’, Journal of Monetary Economics 54: 205-24 <http://dx.doi.org/10.1016/j.jmoneco.2006.12.001≯.

MFTransparency (2011) Excel tool: Calculating Transparent Prices v2.10, Washington, DC: MF Transparency.

Rhyne, E. and Rippey, P. (2011) ‘Crossfire: Formal vs. informal sector savings’, Enterprise Development & Microfinance 22: 87-90 <http://dx.doi.org/10.3362/1755-1986.2011.011≯.

Shipton, P.M.D. (2010) Credit between Cultures: Farmers, Financiers, and Misunderstanding in Africa, New Haven, CT: Yale University Press.

The Economist (2011) ‘Small wonder: A new model of microfinance for the very poor is spreading’, The Economist, 10 December 2011.

Truth in Savings Act (1991) FDIC Improvement Act of 1991, Subtitle F - Truth in Savings.