Model Solutions to Practice Questions 1.4

1. Capital Opportunities for All must consider its regulatory and economic environment when planning its growth and move towards viability. Financial self-sufficiency means that the institution must maintain the value of its equity by accounting for the cost of inflation. If interest rate caps are strictly enforced at 15%, the inflation of 18% would mean a negative real interest rate. The current maximum interest rate of 15% will not prevent the erosion of principal due to inflation. As Capital Opportunities for All is not a regulated institution, it is possible that they could charge more; yet, the inflation will still affect the real value of their equity and portfolio. In order to reach financial self-sufficiency, CAO would have to price its products to cover these costs.
   
   
2. Negative attitudes towards sustainable interest rates might stem from a variety of factors, including:

• Prevalence of subsidized credit delivery
• History of inefficient institutions charging high interest rates, creating an image of interest as mere profit, not as the revenue and the basis for covering the costs of a sustainable institution
• Religious and cultural norms on financial gain and usury

In most instances, access to credit is the first consideration for a poor client, not the price. Showing the client that the institution is offering a quality product, with minimal cost structure, that meets the needs of the client (is convenient, flexible, and does not require collateral) is the best way to address attitudes about interest rates. Moreover, a viable MFI will also show the client that the institution intends to remain in the community over the long term, meeting her future needs as well.

3. Answers will vary, but should consider many of the following:

• Inflationary environment
• Currency stability (especially if the MFI has transactions in a local currency, a neighboring currency, as well as hard currency)
• Financial policy and regulation, including interest rate ceilings, and controls on institutional types
• General economic stability
• Market development, particularly in transition or subsistence economies
• Levels of poverty
• Literacy
• Health, particularly in the face of widespread catastrophic illness
• Attitudes towards sustainable interest rates
• Legal framework, including judicial process, right of law, and property rights
• Presence of subsidized competitors in the market