Background:
These notes summarize the presentations and discussions on sustainable interest rates in microfinance that took place on 16 May 2013 at a workshop organized by the International Finance Corporation (IFC), the Microfinance Working Group (VMFWG) and Tinh Thuong Microfinance Institution (TYM) in Hanoi. The State Bank of Vietnam, the Consultative Group for Assisting the Poor(CGAP) and the Microfinance Working Group presented their views on the issue of interest rate in microfinance and the presentations were followed by a discussion between key stakeholders.
Main messages from the presentations and discussions:
Sustainable microfinance can significantly help the unbanked in Vietnam. In Vietnam, like in many countries, a large majority of adults do not have access to the reliable financial services (savings, credit, insurance, transfers) that they need to manage their financial lives, reduce their vulnerabilities and raise their income. Instead, they use informal savings and informal money lenders who often charge 100 percent per annum in Vietnam. More than thirty years of global experience proves that microfinance can significantly reduce the gap of financial exclusion. In Vietnam, the microfinance sector is still small but it already serves hundreds of thousands of poor people.
Participants at the workshop agreed that microfinance institutions (MFIs) should operate sustainably to recover their costs and expand their services to more poor people. This is in line with Decision No 2195 / QĐ-TTg from the Prime Minister which stipulates that “Vietnam needs to build a safe and sustainable microfinance system”. Because the loan interest is an MFIs’ main income source, it should cover all the operational costs (e.g. staff salaries, transport), cost of fund (e.g. cost of borrowing money), loan loss expenses (for non-performing loans), and a profit to continue and expand its operations. Sustainability is also key for microfinance clients. Poor people and micro-enterprisesneed permanent access to diverse financial services (e.g. savings, transfer, credit), not just microcredit one off financial services. When MFIs are financially sustainable they can offer a broader range of financial products and serve their clients on a permanent basis.
Vietnam microfinance interest rates for loans are higher than banks but lower than in the rest of the world. Globally and in Vietnam, microfinance lending interest rates are higher than bank rates. This is because serving a large number of small loans at people’s doorstep is much more expensive than making a few big loans at a bank branch. When they borrow money, clients have different costs involved which include the financial cost (interest rates), the transaction costs (e.g. travel fees), and the opportunity cost (e.g. time spent). As highlighted by the VMFWG, with doorstep access from MFIs, poor people in Vietnam have lower transaction costs and lower opportunity costs than with commercial banks. Because a significant portion of those costs from the clients are transferred to the MFIs, the operational costs of the MFIs are much higher than those of the banks who usually do not serve the poor. Therefore, in order to absorb those costs, the interest rate charged by the MFIs for their services are higher than those from commercial banks.
According to CGAP, compared with international standards, microcredit interest rates in Vietnam are lower than the average in the rest of the world and have declined over the past few years . The estimated average microfinance lending rates are about 27 percent per annum globally whereas they are close to 22 percent in Vietnam(using interest yields as a proxy).
The SBV ceiling for short term lending interest rate could cause significant long term damage to the microfinance sector.
According to SBV Monetary Policy Department, Circular No.10/2013/TT-NHNN dated 10 May 2013 imposes a lending interest rate ceiling for microfinance institutions and PCFs at 11 percent per annum as part of its monetary policy instruments. This ceiling is temporary, and in the future institutions will be able to have a negotiated interest rate with clients. The ceiling is also limited to short term loans (i.e. less than 12 months), and for specific sectors. In addition, the rule only applies to clients that are considered by the MFIs “in strong and healthy financial conditions”. While MFIs might apply different approaches to the regulations, the presentations from CGAP and VMFWG as well as comments from the participants highlighted several negative consequences for MFIs and their clients from the current interest rate ceiling:
- Because serving poor and remote clients is expensive, the ceiling could force MFIs to serve less poor and less rural clients. Poor clients would then have to go back to the money lenders. This has happened in countries that have imposed a ceiling.
- Several MFIs may not be able to recover their costs with the current ceiling, and some of them, including the leaders in the sector, may have to close down, which will mean that less poor clients will get financial access. Indeed, short term loans for micro-businesses constitute a large share of MFIs’ loan portfolio and therefore a significant source of their income.
- The ceiling could push MFIs to be less transparent about their pricing whereas all actors in the industry believe that having transparent interest rate is crucial. In several countries, interest rate ceilings have encouraged MFIs to be less transparent because they could not align their rate with the ceiling.
- The ceiling will discourage commercial banks from going “downscale” and serve lower client segments in the future. While commercial banks could play a significant role in improving access to finance for low-income people, micro and small enterprises in Vietnam they will not be able to do so with such low interest rates.
Conclusions:
Several participants advised SBV to exempt microfinance institutions from the interest rate cap. Considering the discussions from the workshop summarized above, and given the potential negative effect of the cap, accordingto several participants including from the Government Office, CGAP, the VMFWG and several MFIs, it is advisable to review the current interest rate regulation for microfinance and make it more conducive given the higher cost of MFIs. Several speakers agreed that there should be an interest rate ceiling exemption for microfinance providers.
Most participants agreed that more transparency will also be necessary for microfinance. Several participants raised the issue that there is some unclarity about the required methods of calculation and display of interest rates in the industry (Decision No. 652/2001/QĐ-NHNN dated 17 May 2001 by SBV Governor). As a result, many clients do not understand the true cost of the loan. They recommended that MFIs and all other lending institutions apply transparent and educational methods to inform their clients about the lending terms and interest rates they incurred in line with responsible finance practices. Communication is more important when loans are addressed to low income people that may lack the capacity to understand how those terms are established and how interest rates are calculated. Therefore information should be delivered in a way that is easy tounderstand and compare for them.