Transaction Cost as Part of Operating Costs in Microcredit Disbursement

One of the predominant criticisms of microcredit is its prohibitively high interest rates for impoverished borrowers, ranging from 20% to even as high as 80%. But these rates are not necessarily due to the rapacious nature of lenders. Loans, whether large or small, both extract certain administrative costs from the lending institution. Furthermore, "Microcredit is an industry that is heavily dependent on personal contact for its execution" (Microcredit, 2009, Microcapital). Ironically, microcredit is even more "time-consuming and resource intensive" for financers than conventional banking (Microcredit, 2009, Microcapital). It requires careful, personal screening of borrowers, most of whom do not have a 'credit score' or the type of personal financial history that is available to bankers in the developed world

"Administrative costs are not proportional to loan size" or the wealth of the borrowers (Microcredit, 2009, Microcapital). A microlender will have to deal with one-on-one with borrowers with low financial literacy and often low literacy overall. They also may lack traditional forms of "collateral, financial statements, or records in the database of a credit reporting bureau…Lending to, and collecting from, such clients, requires time-consuming personal interaction" (Microcredit, 2009, Microcapital). Lending small sums to many borrowers leads to multiplied administrative costs, and as these borrowers often repay their loans at more frequent intervals, which increases the administrative costs to the lending institution as well.

The potential benefits of microloans to the borrower must be weighted against the inevitability of such high interest rates "It is a simple fact of business that costs must be covered in order to continue operation. Further premiums must still be added to the interest rate to account for the many and varied risks assumed by a micro-lender" (Microcredit, 2009, Microcapital).

Reference

Microfinance interest rates as a function of transaction costs. (2006, January 9). Microcapital

Monitor. Retrieved November 22, 2009 at http://microcapitalmonitor.com/cblog/index.php?/archives/129-Microfinance-Interest-Rates-as-a-Function-of-Transaction-Costs.html