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Quick: What’s the Grameen Bank’s Interest Rate?
September 24, 2010
Something I’ve been fuzzy on is what interest rate the Grameen Bank charges. Seems like the sort of thing an aspiring microfinance expert should know.
Fortunately, the Grameen Bank is the world’s best-documented microcreditor. One can, for example, quickly learn from the Bank’s website that the rate is 16 percent.
…except that another page on the site says the rate is 10% on a “flat” basis, which means that when someone borrows 1000 taka and repays in weekly installments over the course of year, she pays 100 taka total in interest. Since she pays that 100 taka on a average balance of 500 (the balance falls steadily from 1000 to 0 over the year), her effective interest rate is more like 100/500 = 20%. That’s twice the flat rate, as the Grameen site makes clear.
So: 20%.
This lines up pretty well with MixMarket’s numbers on Grameen’s gross portfolio yield, which is the ratio between interest received and loans outstanding. They have the GPY coasting from 22.4% in 2005 to 19.6% in 2009.
Ah, Microfinance Transparency would remind us, but the true cost of credit includes more than the interest rate. Clients may be required to put some of their borrowings into creditor-run savings accounts as a kind of collateral—”forced savings”—which reduces available credit without proportionally reducing interest payments and thus effectively raises the rate. There may be up-front fees too. In the case of Grameen, each member must buy a 100 taka share of the Bank once her forced savings balance is high enough to pay for it.
And the complications have complications. True, a Grameen member can’t get that 100 taka back until she quits the bank, but in recent years Grameen has paid handsome dividends on those shares—for instance, 100% of face value for 2006, 30% for 2009.
And is forcing people to save purely a cost? One reason people borrow is that it disciplines them into regularly setting aside small amounts in order to make big purchases. Forced savings does that too. If people keep borrowing and repaying, all the while building up their forced savings accounts, then their net debt may fall and so will the associated stress.
Another complication: today, Grameen clients must save into two different accounts, with different rules. 2.5% of each new loan, and additional savings each week, go into the Personal Account—from which the money may immediately be withdrawn. Another 2.5% goes into the Special Account, to which access has historically been much more limited. Asif Dowla, Grameen’s first accountant, says that the rules were recently changed to free up access to even the Special Account. On the other hand, I’m told that Grameen officers often exercise discretion over the interpretation and implementation of rules (Grameen clients have little access to the documents stating their rights). And those officers have a strong incentive to limit access to savings because it is their insurance against missed payments. They can dip into the savings to keep their branch’s payment record clean. So it does not seem safe to assume that Grameen members can easily access all their savings.
So it turns out that computing the interest rate is a complex business. Not only are there several factors to consider, but the impact of some of them depends on a borrower’s loan history. For instance, that one-time 100 taka stock purchase matters much less to someone who routinely borrows 10,000 taka/year than someone who stays at 2,000. In fact, if the latter someone is forced to save 10% of her loan each year, then after nine years, she’ll be borrowing 2,000 while holding savings of 1,800, for a net loan of just 200. If she pays 20% interest on each gross borrowing of 2,000, that works out to 200% interest on her net borrowing! A cycle later, her net credit goes to zero, and her interest rate is infinite–which calls this whole framework, viewing forced savings as a pure cost, into question.
This is how, roughly speaking, Karl Borden of the University of Nebraska constructed a scenario in which the Grameen Bank’s effective interest rate is 556.4% per year for ten years. (Borden also jacks up the rate, I believe, by mistakenly treating all forced savings as forever lost to the client, rather than simulating the eventual return of such savings to the savers.) That rate is mathematically equivalent to turning a seven-dollar debt into a billion-dollar one in 10 years. Those borrowers better be careful!
In a more realistic scenario, in which a client borrows and repays 2,000 the first year, 3,000 the next, 4,000 after that, etc.—but still treating savings as if it goes into a black hole—Borden gets an average rate of 44.1%.
In order to get to the bottom of this question, and inspired by a fantastic, general-purpose rate-calculating spreadsheet from Microfinance Transparency, I decided to build a custom spreadsheet for Grameen. Unlike the general tool, it accounts for the fact that Grameen pays on interest on savings (8.5%/year). It represents the repayment schedule a bit more precisely. (Standard one-year loans are repaid over 52 weeks, of which 6 are holiday grace periods; the first 45 of the 46 payments are 22 taka of principal repayment and 2 of interest per 1000 borrowed; the last is 10 each of principal and interest.) The spreadsheet also facilitates simulation of various 10-year scenarios. And it performs a proper internal-rate-of-return calculation, if you know what that means, to fully account for the compounding of interest.
In the default scenario, the borrower takes loans of 1,000, 2,000, … up to 10,000 over 10 years. I treat only the 2.5% of loans going into the Special savings account as inaccessible. I ignore the other forced savings on the idea that they are immediately accessible, so that a borrower can if she wants take the money right back out and add it to her borrowed funds. At the end of the 10 years, the borrower repays her last loan, takes out her accumulated Special savings (including interest), and leaves the Bank. I ignore the need to purchase the 100 taka share because of the wide uncertainty about Grameen’s future dividend payments. [But see update at end.]
My bottom line? 24.28%/year. But if I change the fraction of loans that borrowers are compelled to save from 2.5% to 5% (maybe some Grameen officers routinely block access to most savings), the credit interest rate rises to 28.75%. You can load the spreadsheet and change the parameters near the top in columns B and E, then view the resulting interest rate in cell H2.
Two last notes:
First, Borden did something else, quite special: he obtained weekly transaction data for all 43 borrowers in a Grameen “center” (borrowing group) in Rajbari District over eight years and used this to compute effective interest rates actually paid. Using a consistent (but flawed) methodology this lowered the rate from 44.1% to 35.6%. So it seems that deferred and missed payments are common enough to lower the effective interest rate substantially. The same should apply to my methodology: even for clients for whom my 24.28% is number is perfectly correct in theory may pay less in practice. On the other hand, clients who save money this way may pay with higher stress.
Second, inflation matters. 24.28% is a great deal if inflation is 24%—for then the real interest rate is just 0.28%. In fact, inflation in Bangladesh has run higher than in most rich countries, so what “feels” like 24.28% to a Bangladeshi would be more like 20.28% for an American:
On balance, Grameen Bank loans, like most microcredit in South Asia, seem pretty cheap.
On whether Grameen Bank clients are properly informed that what is billed as “10%” works out to more like 24%, see last year’s Reflections on Transparency.
Update: In response to Fehmeen’s suggestion, I have incorporated the mandatory share purchase and the dividends into the spreadsheet. To keep it consistent with the results I quote above, I have added a parameter to turn off this consideration. Change “Factor in share purchase?” in the upper left from 0 to 1 to enable it. Using a dividend rate of 30 taka/share (the rate of the last two years) lowers the nominal credit interest rate from 24.28% to 23.33%. Keep in mind, however, that with the Grameen Bank, as with any investment, risk and return ought to go together. The spreadsheet assumes, probably incorrectly, that dividends will be paid at the same rate each year like clockwork. It therefore reflects the high recent returns to ownership of Grameen shares, but not the associated risk.
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10 Comments on “Quick: What’s the Grameen Bank’s Interest Rate?”
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September 24th, 2010 at 2:20 pm
David, I see you’re really getting intrigued by the complexities of what initially seems like a simple question: What is the price of the loan?
As you have noted in your article, I’ve spent a considerable amount of time on the topic, and we have put up a lot of resources to help others learn more about pricing. I do hope others get as intrigued as you have in this very important topic.
I will add a couple of comments to your article:
1) It is difficult getting accurate data to calculate prices, unless you go right to the root source with specific questions. Information on websites can be outdated or inaccurate. We have not yet calculated Grameen’s exact price, but we do know that they, like nearly every other MFI in Bangladesh, charged flat interest for the past ten years or so. Then last year they changed to declining balance, the only large MFI in Bangladesh to do so. Their website says 16%, but I cannot confirm that. I do believe this is admirable of Grameen—to take the lead in shifting to a more transparent price when that price is sometimes considered higher than the competitions less-transparent price.
2) And if they say 16%, why is their portfolio yield higher? And why do your calculations come out even higher? It’s all a matter of definitions, as you can see from our MFT materials. First, 16% declining balance interest rate can generate a portfolio yield of 20% if there are other sources of income, such as fees. And if compulsory savings are included, the APR can rise even higher, as you calculated. What components go into the true price—interest? interest and fees? interest, fees, and savings? When regulators pass truth-in-lending laws, they make decisions about those points.
3) Finally, there really is no one single price for an MFI or for one of its products. Prices can vary even on a client-by-client level. Fees influence different borrowers in different ways, eg, a 2% up-front fee on a 6-month loan is twice as expensive as a 2% up-front fee on a 12-month loan. Grace periods also affect APRs when fees or flat interest are involved. What we do at MFTransparency is calculate the precise price from a range of loan samples provided by the MFI. The prices are rarely identical for all borrowers in the sample, but we analyze the differences and determine why they vary.
Thanks for raising this important issue, and also for referencing our material. We have more educational material and pricing information going up on our website each week.
Chuck Waterfield
CEO, MFTransparency
Promoting Transparent Pricing in Microfinance
September 25th, 2010 at 2:53 pm
Professor Yunus was very candid in his first book, Banker to the Poor, about charging a 20% simply interest rate on all loans, which roughly translated to 2% per weekly payment (according to the loan term) – that seemed menial when compared to the 10% daily rate charged by loan sharks. Of course, the book said nothing (nothing that I remember, at least) about forcing borrowers to buy shares (it simply indicated borrowers were owners) and there were no clear figures discussing the mandatory savings either.
You mention you left out the impact of the 100taka shares – why not compute a set of EAIR figures corresponding to different dividend rates. Surely, the EAIR fell significantly in 2006 owing to the 100% dividend.
September 25th, 2010 at 10:05 pm
As if this is not complicated enough, let me add few more issues.
a. A borrower, in addition to business loans mentioned by David, can have a housing loan at 8% interest rate, and a higher education loan for their offspring at 5%. So, one has to calculate an effective interest rate that the borrower faces by using the outstanding loan percentage as weights.
b. Many borrowers now have more in savings that in loan outstanding. Many of these savings are parked in high-yielding (10%–12%, which worries David a great deal) long term savings schemes (GPS, Time deposit etc.). So, one has to compute net interest rate for borrowers who have more savings than credit.
Too many people underestimate the beneficial aspects of the compulsory savings which as David mentioned are no longer collected. Behavioral economists would suggest that these provide a default option for people who would not have saved otherwise. These are “nudges” to get people to save and it allows a way to protect these from social demand. The book Portfolio of the Poor documented that the poor use “Money Guard” to essentially achieve the same goal.
September 26th, 2010 at 8:39 am
Fehmeed, thank you for your suggestion, which I have incorporated into the spreadsheet. See the “update” at the end of the main post above.
Asif I share the spirit of your comments, but would add:
1. The education and housing loans are distinct loan contracts, so I thought it best to analyze each type of loan separately. Also, they are pretty rare: education loans account for 2.9% of outstanding loan amounts, and housing loans just 0.3%. If those loans are bigger than standard ones, then they account for even smaller fractions of loans and borrowers.
2. I just started reading Nudge, the influential book on the use of behavioral economics in public policy. The authors sharply distinguish between making choices for people and redesigning the “choice architecture” to they perceive choices differently (e.g., by having the default be that when you start a new job, part of your pay goes into retirement savings rather than the opposite default). In favoring the latter, they are going beyond economics and into political philosophy, as they recognize. The science of how people make economic choices does not tell us when it is right to make choices for them as opposed to altering how the choices are presented to them. And in fact the line between the two is blurry. Anyway, this is why I chose to treat compulsory savings that are not immediately accessible as a cost, but did not penalize compulsory savings that are immediately accessible. It seemed a reasonable place to draw the line.
November 14th, 2010 at 6:50 am
Dear David,
I’m Rashed, Asst. Manager, PKSF. I’d like to make some comment on this topic. You wrote- “Since she pays that 100 taka on a average balance of 500 (the balance falls steadily from 1000 to 0 over the year), her effective interest rate is more like 100/500 = 20%. That’s twice the flat rate, as the Grameen site makes clear.” This is not true. GB is cuurently taking 1100 tk for a loan of 1000 tk with 25 tk for each of the 44 weeks . You have made two mistakes. First, the balance does not fall from 1000 to 0, it falls from 1000 to 24.49 and not over the year, over 44 weeks. So if we calculate the declining balance interest rate or APR will be 22.48% and the EIR will be 25.07% with out considering holidays or other charges.
November 14th, 2010 at 12:06 pm
Rashed, it is my understanding, as stated in the post, that in the Grameen bank system, there are 46 payments spread over 52 weeks, intermixed with 6 bank holidays; and that the first 45 payments on a 1000 taka loan are 24 taka and the last one is 20, which adds up to 1100. You need to consider the holidays because a 52-week loan with 46 payments is not the same as a 46-week loan with 46 payments. Sources: http://www.westga.edu/~bquest/2009/gameen09.pdf and Annex 4 of http://www.vedamsbooks.in/no52045.htm. The spreadsheet linked to above carefully incorporates these assumptions in computing the interest rate. Can you point me to evidence that the assumptions are incorrect?
November 15th, 2010 at 3:13 am
Dear David,
I wrote that I’m not considering any holidays as well as any other charges (for a while lets assume they offset each other). GB is currently taking 25tk for each of the 44 week, and the holidays will not be more than 3 in an average. Whatever, considering 3 holidays (may appear in the middle of any installment) their may be a range of which the highest will be 22.42% and the lowest will be surely more than 20%.
Another thing is that you can not just say people are using Tk 500 over the years even if it took 365 days. Take a example of a Tk 1000 loan disbursed at January 1, now the installment (suppose an weekly annuity of tk 20) begins at January 8 then continues till December 31 for 52 weeks (Ignore holidays). (The PIR will be about 0.149%, APR will be 7.77% and EIR 8.05%, – “I’ve calculated it using solver in excel”). Now the borrower can use 1000 tk for the first week, then at January 8 he/she repays tk 20(Principal 18.51, S. Charge 1.49) and thus can use a balance of 981.49 again for a week. The process continues (for every 20 annuity the S. charge gets lower and thus principal gets higher by that amount), and at December 31 he/she makes the last inst. (Pr 19.97, S.charge 0.03). So he/she uses a balance of 19.97 for the last week (from Dec 25 to 31). There is no way the balance can fall to zero and the avg. balance must be greater than 500. Remember he/she is getting the money at Jan 1 but start paying from Jan 7. Had the installment also begun at Jan 1 it would be possible that the balance falls to zero. I hope you understand.
November 17th, 2010 at 12:12 am
Thank you, Rashed.
Your point that the average balance is slightly higher than 50% of the loan is interesting. I hadn’t thought of that. However:
1. A correct analysis of the loan must include the final payment, which does bring the balance to 0, however momentarily. Yes, the loan balance may immediately go back up if the person takes another loan, but to consider that is to mix information about the second loan into analysis of the first.
2. The consideration does not affect any of the bottom-line interest rates I compute, which are (compounded) internal rates of truth based on detailed simulations of cash flows and don’t refer to average balances.
3. For uncompounded rates, this consideration affects the results less than omitting holidays, which you choose to do. If you are concerned about attaining such perfect precision, you need to factor in both things.
November 24th, 2010 at 1:21 am
Thank you, David.
I didn’t reply as I was on a vacation. However, what I want to tell is Grameen banks APR is not 20% as they say, considering the variation of grace period it most of the times it will be around 21.5%. And the EIR will be much higher considering the compulsory savings and other charges.
To calculate the APR or EIR (they are always compounding) for any micro credit loan having weekly payments and grace periods ( before the first installment or holidays within installment) we have to calculate the PIR(Periodic interest rate. And if we calculate correctly it is possible to explain it with cash flow as well as average balance.
February 8th, 2011 at 11:47 am
I think the interest rate is very high whether it is 20 % or 25%.