---
title: "Microfinance Ethics: Group Loans and High Rates"
description: "Argandoña on microfinance ethics: group-loan pressure, five arguments for high rates, the Compartamos case, and a small loan's effective rate."
url: "https://staging.khoi.co.uk/en/blog/tai-chinh-vi-mo-va-dao-duc"
lang: en-GB
author: "Lê Quốc Khôi"
date: 2026-11-03
updated: 2026-11-03
topics: ["Corporate finance"]
tags: ["Microfinance", "Grameen Bank", "Effective interest rate", "Business ethics", "Social business"]
---

# Microfinance: small loans, big ethical questions

## Key takeaways

- The 2006 Nobel Peace Prize went to Muhammad Yunus and Grameen Bank, half each, with the citation "for their efforts to create economic and social development from below" (Nobel Foundation, 2006). Argandoña writes that literature on the ethics of microfinance was "very limited" when he wrote (Argandoña, 2010).
- Group lending lets members share information, monitor each other and apply the pressure of shame or reprisal, but many authors argue against joint liability: free-riding, adverse selection, moral hazard, a domino effect. Argandoña writes that if social pressure is to counteract those perverse incentives it must be very strong, "perhaps unjust" (Argandoña, 2010).
- Rates are often above 100% a year. Argandoña sets out five arguments for them: in his conclusion, cost structure and risk may justify a high rate, though it stays very high. On fairness, he writes that it cannot be said such a rate is unfair, but extraordinary profit comes from market power, and high rates probably shut out some of the lowest-income clients (Argandoña, 2010).
- Compartamos: a rate of about 120% against 31% at similar institutions is the basis of criticism of its 2007 listing, while some institutions saw the listing as a model; Argandoña calls the view that microfinance institutions profit at the cost of the poor mistaken (Argandoña, 2010).
- The effective-rate calculation for a 5 million dong loan is hypothetical and mine, not the source's.

Suppose a partner asks you to put money into a rural microcredit fund, and boasts: "a 97% repayment rate". It sounds safe. But it leaves three questions open: what real interest rate do borrowers pay, how are they pressed to repay, and where do the profits go. This post reads Argandoña's working paper (2009, published as a book chapter in 2010), one of very few that deal directly with the ethics of microfinance. The background case is [Grameen Bank](https://staging.khoi.co.uk/en/case/grameen-bank-microfinance) in the library.

## What is microfinance, and why did it win a Nobel prize and still draw dispute?

It means small loans to poor people, mostly women, without physical collateral. According to Argandoña, the features usually identified, following Armendáriz de Aghion and Morduch (2005) and based on Grameen Bank's practices, include group lending, joint liability, frequent public instalments, loan sizes that grow with each round, and savings; he notes there is no agreement on each feature (Argandoña, 2010). See the glossary entries on [microfinance](https://staging.khoi.co.uk/en/glossary#microfinance) and [joint liability](https://staging.khoi.co.uk/en/glossary#joint-liability-lending).

In 2006 the Nobel Peace Prize was split between Yunus and Grameen Bank, with a citation about efforts to "create economic and social development from below" (Nobel Foundation, 2006). The Nobel summary page gives only the citation and the split; it says nothing about interest rates or how the lending works. Argandoña repeats that citation in his introduction, then says plainly that literature on the ethical side of the activity is "very limited" (Argandoña, 2010).

## Where does group lending press on the borrower?

It presses through the model's most distinctive feature. According to Argandoña, groups form more easily because members already know each other; the group shares information, each member pays in public before the others, and members monitor each other and use reputation, shame or even threats of reprisal as pressure on a defaulter (Argandoña, 2010).

The same mechanism carries risks. He cites many authors who argue against joint liability, with these problems: free-riding, adverse selection ([adverse selection](https://staging.khoi.co.uk/en/glossary#adverse-selection)), moral hazard ([moral hazard](https://staging.khoi.co.uk/en/glossary#moral-hazard)), and a domino effect when an obligation that is too heavy lets one default drag the group down. If social pressure is to counteract those perverse incentives, in his words, it must be very strong, "perhaps unjust" (Argandoña, 2010).

## Can a rate above 100% a year be defended?

Some defend it, though not with a single argument. Argandoña notes that microcredit rates are often high, sometimes above 100% a year, and lists five arguments (following Goodwin-Groen, 2004, whom he cites) (Argandoña, 2010):

| Argument | What the source says | Limit |
|:--|:--|:--|
| Alternatives also charge very high rates | Informal lenders and pawnshops may charge up to 20% a day | A comparison with informal lenders, not with cost |
| Microenterprise returns are high | 117% to 847% in India, Kenya and the Philippines, on a 2005 UN figure he cites | Sample averages, not every borrower's return |
| The real rate includes a risk premium | Lenders add the expected loss to every loan; repayment is close to 97%, but borrowers remain a high-risk group, exposed to poor harvests, epidemics and recession | High repayment goes with group pressure |
| Funding costs | Lenders raise money from private investors, and its cost is high because it includes their clients' risk premium | No figure given |
| Operating costs | A $50 loan costs about as much to process as a $10,000 one | An argument about small scale, not about efficiency |

The "Limit" column is my own comment, not the source's. The source adds a comparison: according to Cull and colleagues (2008), whom Argandoña cites, the median rate of non-profit microfinance NGOs is 25% a year, against 13% for commercial banks on ordinary loans (Argandoña, 2010).

Then Argandoña asks two ethical questions. On costs, he concludes that high rates may be justified by the lender's cost structure and the borrowers' risk, although they remain very high. One, fairness in exchange (commutative justice): with limited competition, clients have little bargaining power. He writes that it cannot be said a high rate is unfair, but the lender should remember that extraordinary profit comes from market power rather than efficiency, and social-responsibility policies should consider the best use of it, such as cutting rates or funding social activities (Argandoña, 2010). Two, fairness in distribution: high rates are likely to shut out some clients, probably those with the lowest incomes; the ways out are cross-subsidy, outside subsidy or giving up part of the profit, provided this does not endanger the institution's sustainability (Argandoña, 2010).

## What does the Compartamos case show?

It shows one transaction read in two ways. According to Argandoña's footnote, Compartamos was created in 1990 as a non-profit, became a commercial bank in 2000 (60,000 clients) and had 616,000 clients in 2006, then listed in 2007. Some institutions, such as ACCION International, saw the listing as a model; others criticised it sharply as a betrayal of the spirit of microlending, because Compartamos charged clients about 120% a year against 31% at similar institutions (Lewis 2008 and Yunus 2007, as he cites them) (Argandoña, 2010). The 120% figure is the basis of the criticism, not Argandoña's own verdict on Compartamos; I did not read those two sources.

His position is in his section on profit. He calls the criticism of those who seek a profit from the poorest mistaken: institutions supply resources that help borrowers improve their situation, so asking for the capital and interest back is reasonable, and to say they profit at the cost of the poor is to treat business as predatory (Argandoña, 2010). He adds that this does not settle the question of sustainability against reaching the poorest (Argandoña, 2010).

## How expensive is a small loan, really?

The number on the contract is usually lower than the real cost. A hypothetical example, worked by me: borrow 5 million dong, repaid in equal instalments over 50 weeks, with a flat 20% interest on the principal. Interest is 1 million, the total repayment 6 million, so 120,000 dong a week. But because the borrower repays principal gradually while interest is charged on the whole principal, the effective rate is much higher: about 38.5% a year (weekly rate times 52), or about 46.7% with compounding.

Now add a compulsory deposit of 5% (250,000 dong), held back and returned in the final week with no interest. The borrower receives 4.75 million but still pays 120,000 a week, so the cost rises to about 42.1% (about 52.2% with compounding). The source contains no such calculation. It shows that "what is the rate?" means little without asking how it is calculated, which fees come with it and whether a deposit is compulsory.

Why the gap between 20% and 38.5%? A flat rate charges interest on the full 5 million for all 50 weeks, although by the last week the borrower owes only one instalment's worth of principal. The average amount outstanding is therefore about half the loan, so the same 1 million of interest is a far larger share of the money really used. That is simple arithmetic on my invented loan, not a finding of the paper, but it is why a flat-rate loan and a declining-balance loan should both be converted to an annual effective rate before comparing them.

## Which questions help when dealing with a microfinance lender?

Five questions of mine, drawn from the paper; they are not Argandoña's standard.

1. What is the annual effective rate, including fees and compulsory deposits?
2. Is there joint liability, and what does the group bear when one member defaults?
3. Can clients choose another provider, or are there only one or two on the market?
4. Is extraordinary profit used to lower rates, fund social activities or pay shareholders?
5. What evidence is there of effects on clients, and for which group was it measured?

Argandoña concludes that microfinance deserves a positive ethical appraisal if carried out with prudence, honesty and reasonableness, but is not a panacea (Argandoña, 2010).

## Going deeper: what I read and what I did not

The library records the source as a 2010 book chapter in a Wiley collection, with a DOI. The copy I read is a working paper from the 2009 conference of the European Business Ethics Network (EBEN), posted openly on a development-finance portal; its text still says "This chapter…", meaning it predates publication. So I give no page numbers, and quotations may differ from the published version. Argandoña cites Goodwin-Groen, Cull, Lewis, Yunus, Rosenberg, the United Nations and the Financial Times; I read none of them, so every figure from those sources is his account of them. His footnote 12 on Compartamos cites only Rosenberg (the listing) and Lewis and Yunus (120% and 31%); the 1990, 2000, 60,000 and 616,000 facts carry no source.

The Nobel page I read was the summary, with only the citation and the split. I did not read Yunus's Nobel lecture. The post does not cover Grameen Bank after 2009, the impact debates that arose later, or Vietnamese microcredit law. The five questions and the effective-rate calculation are mine, and so is the "Limit" column in the table of five arguments.

## Frequently asked questions

### Does microfinance help poor people escape poverty?

Argandoña says studies do not agree, but leans towards the best empirical studies supporting microfinance's effectiveness; in a footnote, studies on whether the poorest benefit more or less give opposite results (Argandoña, 2010). This post draws no conclusion on impact, because I read only his working paper.

### Is a rate above 100% a year always usury?

Argandoña does not answer with a number. On costs, he concludes that high rates may be justified by the lender's cost structure and the borrowers' risk, although they remain very high (Argandoña, 2010). On fairness, he writes that it cannot be said a high rate is unfair, but that extraordinary profit comes from market power rather than efficiency, and that high rates are likely to shut out some of the lowest-income clients.

### Why are Grameen Bank and other lenders reducing the share of group loans?

Argandoña's paper says many microfinance institutions do not work with groups, and that some of those that do, Grameen Bank among them, are reducing the share of group loans in their portfolio (Argandoña, 2010). He offers a reason with a hedge: it may be for efficiency, since many advantages of treating credit as a group do not need joint liability.

### Can a Vietnamese business use this post to assess a microcredit lender?

Use it as a list of questions, not a standard. It rests on a 2009 conference paper and says nothing about Vietnamese law or the Vietnamese market. The five questions near the end are my own grouping from that source.

## References

- Argandoña, A. (2010) ‘Microfinance’, in Boatright, J.R. (ed.) Finance ethics: critical issues in theory and practice. Wiley, pp. 419–434. https://doi.org/10.1002/9781118266298.ch22
- Nobel Foundation (2006) *The Nobel Peace Prize 2006: summary*. nobelprize.org. Available at: https://www.nobelprize.org/prizes/peace/2006/summary/.

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