In most contexts, micro-finance is attempting to substitute even costlier debt that the poor may be taking from informal sources like moneylenders. For small ticket loans, the opportunity cost is high, so poor do take loans at high rates as there is also  the factor of service at their doorstep. But as the loan sizes increase (Rs. 50,000 being a kind of threshold in India), the rates become unsustainable for small enterprises. Overall my view is that the pricing needs to be seen from the angle of cost of funds plus operating costs and risk cost. If the Micro-finance institution is charging way beyond their costs and making big profits, they need to be regulated and rationalized. Also see my article on can Micro-finance Alleviate Poverty in India?

Article Can Microfinance Alleviate Poverty in India?

Private micro-finance institutions are nothing but neo-Money Lenders; the public micro-finance such as 'Women Self-Help Groups', that are sponsored by designate public banks/co-operative societies/NGOs, lend loans to group members at lowest interest rate i.e. 4%-6%, in India; the very objective of such micro-finance is to eradicate poverty through women empowerment, economically, socially and politically. Please refer my publications on same issues in Research Gate and my books-Amazon.com

@ Emmanuel V Murray, Thank you for your precise answer.

I wonder the higher rates charged from the poor clients are justified on the basis of higher operational and risk cost. Some researchers justify the higher rates based of natural principles such as "Poverty penalty "  while the other justify for the sustainability of MFIs.... 

It is also a common experience that MFIs which even get self-sustainability by charging higher rates, even do not reduce the rates but sometime due to competition and targeting maximum clients for profitability.  

I surprise, is sustainability of microfinance institutions  the ultimate objective  of MFIs or helping the poor and their access to financial services for alleviation of poverty and self-employment generation? why we try to justify MFIs from institutional perspective and their needs but do not consider the feasibility,affordability and profitability from the poor sides?

I need your expert opinion on it 

Well, MFIs does not necessarily mean only microfinance banks rather it takes into consideration NGOs, cooperatives, SHGs, Non-banking financial institutions, Islamic microfinance institutions etc..Majority of the MFIs across the globe are non-banking, non-regulated and non-Prudential institutions. If there objective is just making profit why they do not declare themselves as "for-profit" Institutions and in that case  what is the difference between commercial banks and MFIs? Why they claim that they are working for their "double bottom objectives" (social and financial), then what is the social goal?

Importantly, MFIs are getting subsidized loans, grants, donations etc., what those stuff means just to accumulate money for what?

Well, What we are talking about is not eradication of poverty by MFIs but alleviation of poverty. of course, we are talking about absolute poverty not relatively poverty.

Regarding, self-sustainability of MFIs, It was my basic question whether the ultimate objectives of MFIs is self-sustainability? of course, no and that was the only difference between conventional financial intermediaries and the moment started by Dr. Yunus for microfinance institution. Sustainability of MFIs was desirable for availability of  affordable funds to the poor and financially marginalized communities not accumulating of profit from the poor.

Now, whether access of poor to financial capital can alleviate poverty or not is a question, which definition of poverty we believe in? There is difference of opinions among the researchers....suppose we believe in capitalistic view point of poverty... then poverty is resulting from the lacking of access of poor people to financial capital and in this case that is the major reason of poverty. So, in this context, the provision of funds to the poor at affordable channel may help the poor to reduce their financial poverty.

However, this approach is very controversial and very influential empirical studies could not conclude it absolutely positive even in the champion country of Microfinance  (Bangladesh).

Dear Zahoor,

Responding to your query, The operational costs in India are on an average about 10% for the MF institutions. Initially, as noted by you, it was thought that the institutions would reduce pass on the benefits of improved efficiency to the poor clients, but it never happened. The high profitability attracted investors who were looking for high returns in quick time, and drove the institutions to profiteering, till the regulator had to step in and cap the interest rates. Prior to being regulated, some of the MFIs charged upto 60% per annum EIR. Today the maximum would be 30%, with average cost of funds at @ 13 to 14% and Operational cost at @ 10%. The only way to check them from becoming exploitative is tightly regulating them.

I think there are two aspects in your question, one is the commercial, that is if microfinance is commercial or not. The other is its cost.

Concerning the first, not all the MFI are commercial, many of them are NGO. In that case, they do not have to put high interest rates because their aim is to help, not to make money.

Concerning costs, microfinance is more expensive than traditional banking because you have to work with many clients who ask for small quantities of money. That can be partially solved with group lending and with technology, but it´s still expensive and difficult because of the small quantities MFI lend.

The poor can pay high rates. This has been demonstrated by Amendariz Aghion and Morduch (2005) in their book The Economics of Microfinance. Commercialization is the product of high interest charges. MFIs that are NGOs do targeted lending most of which do not survive. It is commercial microfinance that survive because of their non-dependence on subsidies. The issue of commercialization is all about sustainability. If MFIs are commercialized they will be able to serve large number of clientele. What we need to understand is that being poor does not not mean that you cannot take high interest loan and pay back. What matters most is the use of the loan. The poor spend a lot on funerals, marriage ceremonies etc especially in West Africa so there is no point in saying that they cant pay high interest rates. In fact some studies have shown that the poor is insensitive to loan prices.

Dear Zahoor:

                     Just one comment about the discussion above. Microfinance is the usual banking business offering several banking products but in small amounts. For instance assurance, borrowing, lending and the like. It is an evolution from microcredit, which was the first attempt to give banking services to the poor. In fact, that is one of the first successes of microcredit, make the world realize that poor people do need banking services. 

                   Why is this important for your discussion? Because if a MFI accepts deposits, then it can lend money at lower rates than if it takes capital from other sources (except donations obviously). 

                   So, as it says in one of the answers, microfinance does not  erradicate  poverty, but it helps ending the problem. Microfinance, with all its tools, makes the life of poor people more human.

Regards

Gustavo Concari