Targeted Microfinance Risk Subsidies
Expert TheoryReview
Private microfinance institutions cannot sustainably offer grace period loan contracts because market interest rates required to break even under selection and moral hazard are too high or politically unviable, trapping micro-entrepreneurs in low-growth investments.
Picture this
Imagine a city government that pays a small insurance premium to a private bike-share company so it can offer free helmets to riders. The small payment covers the cost of lost helmets, encouraging far more people to ride bikes safely and boosting local economic activity well beyond the original cost of the subsidy.
What the evidence says
A targeted public subsidy of Rs 150 per borrower renders microfinance lenders indifferent between classic and grace period contracts at standard 17.5% APR interest rates, generating an estimated annual social return on public capital of 178% based on an average monthly profit gain of Rs 287 per client.
- Who was studied
- N = 845 MFI microfinance borrowers in Kolkata, India (simulated financial model calibrated from experimental profit and default data).
- How
- Empirical credit market model simulation evaluating government subsidy requirements to offset lender default losses relative to client long-term profit gains.
What to do
Establish first-loss government loan guarantee pools for microfinance lenders that introduce deferred payment options for business expansion borrowers.
From the source
"A subsidy of Rs 150 per client would make the MFI indifferent between only offering the regular contract and offering both the regular and grace period contracts at the baseline 17.5 percent interest rate... the implied social rate is a return of 178 percent per year."
101_290 microfinance and entrepreneurship AER2013.pdf