Subsidize the Institution Not the Customer

We start with short-term subsidies. Some donors argue for a strategy wherein the aim is to "subsidize the institution, not the borrower." If taken literally, the statement is nonsensical: A program without subsidies must pass along all costs to customers one way or another.18 Thus, any subsidy to the institution means that fewer costs have to be passed on to customers; directly or indirectly, customers gain through lower prices.

But, if not taken literally, the strategy has some appeal: It simply translates as "subsidize start-up costs, not ongoing operations". In terms of customers, consider a long-term situation in which the institution can be financially self-sufficient when charging an interest rate of, say, 30 percent per year to customers. But, in the first eight years of business, 30 percent would not cover all costs; instead the lender would have to charge, say, 45 percent. Then, the strategy here would be to charge the customers 30 percent from the very first day of operation (and for all time thereafter) and to take a subsidy of fifteen cents per dollar lent for the first eight years.

Figure 9.1 depicts the strategy in a setting where average costs fall over time. The figure shows initial costs start at r0 but fall steadily until time t*, at which time costs have reached the long-term level r*. A subsidy that covers all costs greater than r* that are incurred before t*

Figure 9.1

Subsidies for startup costs. Customers always face the long-term interest rate r*.

Figure 9.1

Subsidies for startup costs. Customers always face the long-term interest rate r*.

allows the program to charge borrowers interest rates of r* from the very start of operations. After time t*, the program can continue to charge customers r* and exactly cover the ongoing costs of lending without subsidy. The initial subsidies mean that the customers do not have to help shoulder start-up costs.

As mentioned in chapter 1, the argument echoes the "infant industry" arguments for tariff protection familiar from the theory of international trade. The case is sound in principle, but lessons from trade in practice are less favorable: It has proved hard to wean industries off protection once it starts, and some protected industries are far from their infancy. To be effective, donors need a credible exit strategy based on clear benchmarks (based, for example, on achieving efficiency gains by set dates) that push microlenders to achieve cost reductions in time for the withdrawal of subsidies.

Another form of subsidization that is less controversial than others is to subsidize public goods that the institution might otherwise not provide (notably, data collection and impact evaluations from which others in the field might also benefit). Subsidizing technical assistance (e.g., for setting up a new management information system or designing incentive schemes) also carries little of the negative weight of long-term subsidies since, by its nature, it is short-term and fosters institution-building.

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Secrets of the Credit Industry

Secrets of the Credit Industry

Legal strategies that credit bureaus, creditors and debt collectors do not want you to know! How to use consumer credit protection laws, without hiring a lawyer, and without going to court! At some point in your life, either you, or someone you know will need this information.

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