THE PENNSYLVANIA STATE UNIVERSITY SCHREYER HONORS COLLEGE DEPARTMENT OF FINANCE MICROCREDIT INTEREST RATES AND ONLINE MICROLENDING MODELS QISHUAI WANG FALL 2014 A thesis submitted in partial fulfillment of the requirements for baccalaureate degrees in Accounting and Finance with honors in Finance Reviewed and approved* by the following: James Miles Professor of Finance, Joseph F. Bradley Fellow of Finance Thesis Supervisor Brian Davis Clinical Associate Professor of Finance Honors Adviser Dennis Sheehan The Virginia and Louis Benzak Professor of Finance Faculty Reader * Signatures are on file in the Schreyer Honors College. i ABSTRACT This thesis introduces the origins of microfinance, explains the reasons why microfinance institutions (MFIs) charge high interest rates, and examines the determinants of microcredit interest rates. Three fundamentally different online microlending platforms – Kiva (http://kiva.org), Kiva Zip (https://zip.kiva.org), and Zidisha (https://zidisha.org) – are explored in depth and compared to each other (Appendix A-1). This thesis discusses each platform’s operating model, interest rates, repayment rates, repayment terms, risks, and financial performance. Screenshots of a lender’s loan portfolio and a borrower’s repayment schedule on each platform are provided. A case study is performed on Kiva’s Field Partners to analyze their repayment performance, loan characteristics, and borrowing cost comparison with MFIs in the Field Partners’ countries. This thesis demonstrates that the partner-facilitated microlending model, as exemplified by Kiva, is the most costly to borrowers but the least risky option for lenders; the trustee endorsement model, as exemplified by Kiva Zip, is the most affordable to borrowers but not yet sustainable; and the direct person-to-person microlending model, as exemplified by Zidisha, is beneficial to borrowers, self-sufficient, and transparent, but highly risky for lenders. ii TABLE OF CONTENTS List of Figures .............................................................................................................. iv List of Tables ............................................................................................................... v Acknowledgements ...................................................................................................... vi Chapter 1 Introduction ................................................................................................. 1 My Involvement in Microlending ......................................................................... 1 Purpose of Thesis .................................................................................................. 2 Terminology ......................................................................................................... 3 Chapter 2 Literature Review ........................................................................................ 7 Muhammad Yunus and Grameen Bank ................................................................ 7 Why Do MFIs Charge Such High Interest Rates? ................................................ 9 Components of Microcredit Interest Rates ........................................................... 10 Do High Microcredit Interest Rates Exploit Poor Borrowers? ............................. 13 Chapter 3 Kiva: Partner-Facilitated Lending ............................................................... 16 How Kiva Works .................................................................................................. 16 Interest Rates, Portfolio Yield, and APR .............................................................. 17 Profitability (Return on Assets) ............................................................................ 21 Repayment Rate .................................................................................................... 21 Risk ....................................................................................................................... 23 Due Diligence ....................................................................................................... 24 Monitoring of Field Partners ................................................................................ 26 Donations, Revenues, and Expenses .................................................................... 27 Snapshots of Kiva ................................................................................................. 28 Chapter 4 A Case Study of Kiva’s Field Partners........................................................ 36 Introduction ........................................................................................................... 36 Repayment Performance on Kiva ......................................................................... 37 Loan Characteristics on Kiva ................................................................................ 40 Borrowing Cost Comparison ................................................................................ 41 Notes on Calculations ........................................................................................... 43 Chapter 5 Kiva Zip: Trustee Endorsement Person-to-Person Lending ....................... 46 How Kiva Zip Works ............................................................................................ 46 Interest Rates ........................................................................................................ 46 iii Borrower Requirements ........................................................................................ 47 Trustee Requirements ........................................................................................... 48 Repayment Rate .................................................................................................... 50 Risk ....................................................................................................................... 51 Snapshots of Kiva Zip .......................................................................................... 51 Chapter 6 Zidisha: Direct Person-to-Person Lending .................................................. 55 How Zidisha Works .............................................................................................. 55 Interest Rates ........................................................................................................ 57 Borrower Requirements ........................................................................................ 58 Repayment Terms ................................................................................................. 59 Repayment Rate .................................................................................................... 59 Risk ....................................................................................................................... 63 Feedback Ratings .................................................................................................. 64 Consequences of Repaying Late or Defaulting on a Loan ................................... 65 Donations, Revenues, and Expenses .................................................................... 66 Snapshots of Zidisha ............................................................................................. 67 Chapter 7 Conclusion ................................................................................................... 76 Appendix A Comparisons and Benchmarks ................................................................ 80 Appendix B Snapshots of Kiva, Kiva Zip, and Zidisha ............................................... 84 Appendix C Kiva Field Partners .................................................................................. 95 Bibliography ................................................................................................................ 131 iv LIST OF FIGURES Figure 1.1 Interest Rates: Key Concepts and Definitions ............................................ 6 Figure 2.1 MFI Interest Yield Distribution, 2011 ........................................................ 14 Figure 2.2 Global Interest Yield Trends, 2004-2011 ................................................... 14 Figure 2.3 Drivers of Interest Yields, as % of Yield, 2004-2011 ................................ 15 Figure 2.4 MFI vs. Commercial Bank Returns on Average Assets and Equity .......... 15 Figure 3.1 Yield vs. APR ............................................................................................. 31 Figure 3.2 Kiva Field Partner Risk Ratings ................................................................. 31 Figure 3.3 Kiva’s Income Statement for Fiscal Year 2012 ......................................... 32 Figure 5.1 Kiva Zip Maximum Loan Amounts and Loan Terms ................................ 53 Figure 5.2 Kiva Zip Repayment Rate in U.S. and Kenya from January 2012 to September 2013 ........................................................................................................... 54 Figure 6.1 Zidisha Total Loan Cost ............................................................................. 69 Figure 6.2 Zidisha On-Time Repayment Rates from 2009 to March 25, 2014 ........... 69 Figure 6.3 Zidisha On-Time Repayment Rates from December 2012 to May 2014 ... 70 Figure 6.4 Zidisha’s Statement of Activities for Fiscal Years 2011 and 2012 ............ 71 Figure 6.5 Zidisha’s Revenue from Program Service Fees in Fiscal Year 2012 ......... 72 Figure 6.6 Zidisha’s Allocated Expenses in Fiscal Year