Microfinance institutions (MFI) the strive for operational and financial sustainability. The former is an indicator that the MFI can, at the very least, break even based on its current operations and sources of funding, including loans, grants, and donations. The latter takes into account where an MFI gets its money. Since money from donors is basically free, an MFI that receives grants and is just barely breaking even would be unsustainable were that source of money to dry up. In a perfect world, MFIs would not need to rely on any donor funding and could get all of their capital through loans at commercial rates. To reach that point, MFIs need to operate efficiently and reduce the costs of doing business, but also charge interest rates that will allow them to make enough money to cover their costs. When subsidized interest rates are introduced, it be damaging to the microfinance market as a whole. Joanna Ledgerwood explains this dynamic in the Microfinance Handbook, the bible of microfinance practitioners:
Subsidized lending programs provide a limited volume of cheap loans. When these are scarce and desirable, the loans tend to be allocated predominantly to a local elite with the influence to obtain them, bypassing those who need smaller loans (which can usually be obtained commercially only from informal lenders at far higher interest rates). In addition, there is substaintial evidence from developing countries worldwide that subsidized rural credit programs resulti n high arrears, generate losses both for the financial institutions administering the programs and for the government and donor agencies, and depress institutional savings, and consequently, the development of profitable, viable rural financial institutions. Continue reading