How the Fed’s rate hikes will compress borrowers

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Maya Rathore’s success story started when she got a microloan to buy her own sewing machine and start a business. His “kirana” store, located in a small Indian town, is the size of a parking space, but offers everything from clothes to cosmetics to diapers.

Rathore lives across from Jyoti Verma, who is also a seamstress and received her first microcredit about five years ago. She goes door-to-door selling shirts and sarees, each for less than $5, and earns around $400 a month. Rathore earns double and they each pay just over $40 in monthly installments on their fourth microloan from Belstar, a non-bank finance company in India.

Thousands of miles away in Alton, Illinois, Cassandra Campbell started a family building and restoration business with a $17,291 microloan from the nonprofit Justine Petersen Housing and Reinvestment Corp. , Where JustinePetersen.org. Campbell, a black entrepreneur, runs her business with her husband and two sons, and is so busy she stopped accepting projects in April because she has to work through her waiting list first.

The three women, although from different backgrounds, have a common goal: to develop their business. Equipment for making potato chips and sari materials will be Rathore’s and Verma’s main expense, respectively. Campbell wants to buy a house to restore it and resell it for a profit. Another microloan will be needed to get things done for all three, the women said Barrons. But their visions could become difficult to achieve if microfinance lending rates increase significantly.

While microfinance lenders providing loans to low-income entrepreneurs do not rely on benchmark rates to refinance overnight, there will be a trickle-down effect with higher interest rates. Banks and private wealth – domestic and international – are their main sources of capital, and the era of cheap money lending is over.

At the top of the funnel is the US Federal Reserve, which is making several interest rate hikes this year to curb inflation. Last week, a Consumer Price Index report for May showed prices rose more than expected. The Fed begins its two-day meeting on Tuesday and is expected to raise its benchmark interest rate again.

Emerging market central banks are also facing inflationary pressures as US interest rates drive up the cost of dollar-denominated debt. India and Malaysia took surprise measures to raise their key interest rates.

In the United States, consider national microlender Justine Petersen, who had a 1% borrowing rate from banks at the start of the pandemic. “Some were incredibly generous [and offered] funds as a grant, with no obligation for JP to repay the funds,” said Galen Gondolfi, the nonprofit’s chief strategy officer, citing a $5 million grant in 2020 as an example.

Cut to 2022 and the institution is close to closing a $5 million package with a 4% interest rate. The bank’s offer is tied to the prime or preferred customer rate, which is based on benchmark rates. At least 25%, or $30 million, of the nonprofit’s overall loan portfolio outstanding is linked to the prime rate. The average rate in 2022 was 3%, compared to 2% in 2020, but it will increase further as bank investments come with higher rates.

For now, Justine Petersen, based in St. Louis, Mo., is charging borrowers an interest rate of 8% to 9%. This is higher than the 6% offered over the past two years. “We try to offset the cost by accessing government programs like the American Rescue Plan Act (ARPA) and other assistance programs,” Gondolfi said. But it will most certainly increase further in the future, he said.

Leaders of the Rural Business Center in Lyon, Nebraska, have already raised rates by 0.75% to an average interest rate of 6.91%. “It should be effective for six months when we see the atmosphere again,” said director of loan services Kim Preston. Barrons in an email. The hike was made to track similar lenders and Small Business Administration lending rates, she said.

But New York-based Grameen America, which provides microloans to low-income women entrepreneurs, has no short- or medium-term plans to pass on the rate hikes.

“Our interest income can offset [the hikes]said Rajitha Swaminathan, vice president of program strategy and member services. Grameen America’s interest income, or loan-generated capital, was $22.18 million in 2021, up 87% from the previous year. “We should be able to handle this,” she said. The Lender, with singer Jennifer Lopez as brand ambassador, has a single product: a basic loan with an interest rate of 18% payable on a weekly declining balance for 26 weeks. This means that the cost of a six-month loan of $1,000 is approximately $45.

In emerging markets, an area where the role of microfinance institutions is much more pronounced, look at India’s Belstar, majority-owned by

Muthoot Finance

(533398.India), the largest company providing gold-backed loans in India. Belstar is primarily dependent on bank borrowing and expects to see overall price increases on the loans it gets from lenders after India’s central bank raised rates for the first time in two years in May.

As of last month, the company began charging borrowers an interest rate of between 21.75% and 22.60%, up from a high of 19.65% at the start of the year.

Besides banks, Belstar gets about 5% of its borrowing from financial services companies like Northern Arc Capital in India, which is backed by international investors like Accion, a Washington, D.C.-based nonprofit lender with investments in microlenders around the world. It is common for microfinance organizations in emerging markets to have direct or indirect ties to impact investors in developed markets.

John Fischer, chief investment officer of Accion, spoke with the management of several portfolio companies about the response to the rate hike. “In anticipation [of the rate increases]they get [funding] offers at slightly higher rates than what they were getting last year,” he said.

For borrowers like Maya Rathore, Jyoti Verma and Cassandra Campbell, timing is everything. They are not looking for another tranche of debt until they meet their current obligations. But when they reach out, it’s unclear what interest rates the microfinance institutions will offer.

Write to Karishma Vanjani at [email protected]

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