Sunday, July 05, 2009

How to Read Interest Rate Paid by The Poor

You may often hear this as argument against informal moneylenders to the poor: they charge exorbitant annual interest rate. For example, IDR 2500 a week for IDR 100K loan means 261 percent annualized interest rate.

But that's not quite accurate.
One of the lessons from the diaries is that interest paid on very short-duration loans is more sensibly understood as a fee than as annualized interest. When researchers annualize all interest rates, they maybe following standard accounting practices, but distorting the real picture.
--Portfolios of the Poor by Collins, Morduch, Rutherford, Ruthven, p.22

What is the real picture? For instance, paying that interest, --no, fee--, will enable a poor to buy new cloth for his/her kid to celebrate Eid festival. A very rational motive. And perhaps, thinking at annual base is a luxury for the poor.


  1. Either fee or interest, 261% is still a hefty percentage...

  2. MF, yes, if you annualize it. But it's more likely a very short duration loan. e.g two or three weeks. The cash flow, I guess, is more relevant concern, and that is why, for instance, you have shampoo in small sachet at our warungs, although in sum the price would be higher than the larger bottle shampoo's.