Transaction Costs of Lending to Vulnerable People

Real cost of loans under microfinance from different sources was a matter of discussion for long due to its variation across the agencies concerned. The factors underlying the debate on transaction costs of micro-credit have been analysed in this paper to gain a clear understanding of issues involved. Components such as delivery mechanism, staff, scale of business, size of loan, frequency of repayment, investment in technology used and infrastructure, etc. influenced the cost of loan in addition to cost of fund and risk cost involved. Studies carried out to understand the cost structure in providing credit to rural areas and microfinance clients observed that the cost of public sector banks in providing small loans to customers was much higher compared to private sector banks. Studies also revealed that Indian MFIs have been much more efficient than the global counterparts with their operating expense ratios lower than the global levels. The paper suggest that the MFIs that seek to maximise profits are required to reduce their transaction costs and widen the gap between operating costs ratio and the margin cap. The objective of delivering credit at reasonable interest rates to vulnerable borrowers cannot be achieved by managing transaction costs alone, finance costs have to be reduced for which government may have to think of providing targeted subsidies.