FAIR INTEREST RATES A CREATIVE APPROACH Herman WM Abels

1. FAIR INTEREST RATES A CREATIVE APPROACH Herman WM Abels

2. Breaking News Foreclosure on a Goat SAN FRANCISCO—Representatives from One World Finance, a U.S.-based microcredit provider, confirmed Monday that they had initiated foreclosure proceedings on a goat in southern India following a borrower's repeated failure to make her $2.20 monthly loan payments. "I tried to work with Ms. [Subha] Thangam on this, but once she fell a full $6.10 behind, I had to repossess the goat," said loan officer Michael Conrad, who stated that he was just doing his job and that it was "not [his] fault" if certain subsistence farmers were living beyond their means. "I'd love to recoup the entire $22 loan at auction, but given the glut of foreclosed and abandoned goats in the area, I'd be lucky to get even half that." Conrad also acknowledged that the owner had left the goat in "pretty bad shape“ and had even stripped it of its hair for potential resale on the paintbrush market.

3. The Blame Game So Mrs Thangam and her goat are in bad shape. The loan did not work out well for them. Who is to be blamed for that? • Is it the MFI: lending too easily, charging excessively? • Is it the customer: overstretching herself? • Is it the investor: demanding too high a return? • Is it the regulator: not installing price controls? • Is it the market: allowing for exploiting vulnerabilities? • Or is it just tough luck: collateral damage?

4. Basically a Good Mix Microfinance applies both market and social objectives • From the market approach we take • Laissez fair market development • Limited regulation • Insistence on full commercial prizing • And from the social approach we adopt • The poverty alleviation drive • The “access for all” paradigm: inclusive finance

5. Convincingly Applied? The market and social mix shows various inconveniences • Development grants do not directly benefit end-users • Rarely factored into retail prices • Rather benefit supply side players • The development notion applied is restrained • Development impacts are not convincingly proven • Resulting in growing disconnects • Socially with civil society • Politically with local governments

6. A Creative Approach Modifies the mix and creates equitability • Borrowers need protection against • Over-indebtedness • Usurious and unsustainable interest rates • Harsh or semi-illegal repossession practices • Practitioners need to be able • To sustain and grow their institutions • And investors need to be able to • Earn a decent return on investment

7. Equitability Explained Markets need full regulation • Which goes beyond self-regulation • Or principles of client protection • And is to be installed and enforced by governments • Borrowers have a right to be protected • By their own governments • Not to be left at the goodwill of supply side players • As the only way to create a level playing field • Need for access not to overrule client rights

8. Full Regulation Unavoidable and necessary to deal with the main evils • That will damage the industry if not controlled • Lending beyond borrower’s handling capacity • Charging usurious or unaffordable rates • Multiple lending to the same borrower • There is growing need for industry consolidation • Entirely focusing on quality of service delivery • Putting quantitative goals on the backburner • And full acceptance of governments as stakeholders

9. Market Segmentation This requires carving up the market in segments • What can be left to the market, leave to the market • Withdrawal of development aid from that segment • Autonomous growth, local capitalization • Regulation driving innovation and price reduction • For the unfeasible segments, alternative concepts apply • Using public and donor support • Creating client and system sustainability over time • As legitimate proxies for ‘inclusiveness’

10. Creating Feasibility How to make unfeasible market segments feasible? • Taking into account • Borrowers’ limited earning capacity • Investors’ need for decent return on investment • And practitioners’ need for sustainability • The answer is in strengthening earning capacity • By dedicated BDS, VCF and other interventions • And in wholesale risk deduction • Allowing for modest but adequate returns

11. Earning Capacity Essentially to be achieved by moving beyond microfinance • Microloans do no trigger rural development • What does is rural enterprise development • In combination with infrastructure development • Removal of institutional barriers • And adequate (long-term, affordable) finance • Microloans do not trigger urban development • What does is formalizing the urban economy • With job creation through SME development

12. Risk Reduction To be achieved at both the supply and demand side • By offering local investors near risk-free returns • As alternative to massive T-bill buying • And tapping into liquidity of domestic markets • Thus lowering cost of capital for (M)FIs • Clients can be offered much lower rates • By offering longer-term, larger business loans • And business support reducing project risk • Through (M)FIs, reducing operational costs

13. Basic Risk Matrix

14. Basic Risk Matrix

15. Basic Risk Matrix

16. Basic Risk Matrix

17. Basic Risk Matrix

18. Basic Risk Matrix

19. Basic Risk Matrix

20. Complicated? Not really: it is how Public Private Partnerships work • The public sector decides on policy priorities • Attending to market segments that are • Commercially unfeasible but developmentally critical • The private sector invests and leads • With risk reduction support from public sector • Through performance-based contracting • And the civil society sector comes in • To guard community interests and build capacities

21. Example? It is how health systems work in many OECD countries • The public sector decides on policy priorities • Affordable access to quality care • By capping profits and offering low-risk returns • The private sector invests and leads • Through accessing low-cost capital • And making modest yet acceptable returns • And the civil society sector comes in • By guarding patient interests

22. A Creative Approach Therefore is based on multi-sector cooperation • That engineers respective roles and capabilities • Into functional PPPs that allow all sectors to make their required returns in financial and/or social terms • And makes finance really inclusive

23. And Ms. Thangam? Under a creative PPP approach • She would not have borrowed beyond her means • Or her loans would have been rescheduled • Without destroying her marginal earning capacity • She would still have her goat, probably a few more • Without having over-glutted the local market • Perhaps she would have been a shareholder in a professional goat farm • And also her goat would have been in much better shape

24. Thank You