The determinants of interest rates in microfinance: Age, scale and organizational charter

• Author: Uchenna Tony‐Okeke,Aqsa Aziz,Simplice A. Asongu,Jacinta C. Nwachukwu
• Date: 01 August 2018
• Published date: 01 August 2018
• DOI: http://doi.org/10.1111/rode.12402

REGULAR ARTICLE

The determinants of interest rates in microfinance:

Age, scale and organizational charter

Jacinta C. Nwachukwu

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Aqsa Aziz

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Uchenna Tony-Okeke

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Simplice

A. Asongu

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1

Coventry University, Coventry, United

Kingdom

2

African Governance and Development

Institute, Yaound

e, Cameroon

Correspondence

Jacinta C. Nwachukwu, School of

Economics, Finance and Accounting,

Faculty of Business and Law, Coventry

University, Priory Street, Coventry, CV1

5FB, United Kingdom.

Email: jacinta.nwachukwu@coventry.ac.

uk

Abstract

This study compares the responsiveness of microcredit

interest rates with age, scale of lending, and organiza-

tional charter. It uses an unbalanced panel of 300 microfi-

nance institutions (MFIs) from 107 developing countries

from 2005 to 2015. Three key trends emerge from the

results of a 2SLS regression. First, the adoption of formal

microbanking practices raises interest rates compared with

other forms of microlending. Second, large-scale lending

lowers interest rates only for those MFIs that already hold

legal banking status. Third, age of operation in excess of

8 years exerts a negative impact on interest rates, regard-

less of scale and charter type of MFI. Collectively, our

results indicate that policies that incentivize mature MFIs

to share their knowledge will be more effective in helping

the nascent institutions to overcome their cost disadvan-

tages compared with reforms to transform them into

licensed banks. For MFIs that already hold permits to

operate as banks, initiatives to increase loan sizes are key

strategic pricing decisions, irrespective of the institution’s

age. This study is original in its differentiation of the

impact on interest rates of regulations that promote formal

banking principles, credit market extension vis-

a-vis

knowledge sharing between mature and nascent MFIs.

DOI: 10.1111/rode.12402

Rev Dev Econ. 2018;22:e135–e159. wileyonlinelibrary.com/journal/rode ©2018 John Wiley & Sons Ltd

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e135

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INTRODUCTION

The global microfinance movement has received intense media attention since 2010. This has

thrown the spotlight on two key concerns. The first is the high interest rates charged by microfi-

nance institutions (MFIs) by comparison with formal sector commercial banks, raising allegations

of monopolistic pricing (Rosenberg, Gonzalez, & Narain, 2009; Yunus, 2011). The second is

related to fears of “mission drift”as many MFIs transform into regulated profit maximizing banks

with a consequent reorientation in their services towards the better-off among their poor clients

(Hartarska & Nadolnyak, 2007; Frank, 2008; Tchakoute-Tchuigoua, 2010; Mersland & Strøm,

2010, Roberts, 2013; D’Espallier, Goedecke, Hudon, & Mersland, 2017).

Ultimately the interplay between the characteristics of MFIs and the nature of the aforemen-

tioned concerns in the debate is an empirical matter. Unfortunately, these important issues have

remained largely untested, primarily because of a lack of variation in the attributes of MFIs includ-

ing the pattern of interest rates charged by different institutions. In this paper, we resolve this diffi-

culty by using a panel framework comprising 300 financially self-sufficient MFIs (hereafter

referred to as FSS-MFIs) from 107 countries across six developing regions from the Microfinance

Information eXchange (MIX) database (2016).

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The decision to focus on financially “successful”

MFI’s derives from the argument by Rosenberg et al. (2009) and Cull, Demirg€

ucß-Kunt, and Mor-

duch (2009) that the inclusion of subsidized MFIs substantially lowered the average interest rates

reported in previous studies. Further, Basharat, Hudon, and Nawaz (2015) found that the role of

firm characteristics in determining the lending interest rate in the microfinance industry may

depend on whether the institution is financially efficient or not. Nonetheless, Cull et al. (2009)

reported that the correlation between financial outcomes in terms of operationally self-sufficiency

(OSS) and financial self-sufficiency (FSS) is positively significant at ca 0.89. Such a high correla-

tion, although not perfect, indicates that the two measures of financial performance are somewhat

interchangeable.

This study contributes to the microfinance empirical literature in two ways.

First, it investigates whether the annual average interest rates observed for FSS-MFIs with the

legal entitlement to conduct traditional banking activities are significantly higher than the rates

charged by MFIs with a different charter status. We differentiate between the interest rates of rural

and other microbanks (hereafter referred to as MICROBANKs) vis-

a-vis those of nongovernmental

institutions (NGOs), nonbank financial institutions (NBFIs) and credit unions/cooperatives located

in Sub-Saharan Africa, North Africa and the Middle East, Eastern and Central Europe, East Asia,

South Asia and Latin America regions.

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The results should highlight the responsiveness of micro-

credit interest rates to changes in the regulatory frameworks that oversee the practices of MFIs in

developing economies. A similar empirical study by Campion, Ekka, and Wenner (2010) examined

the relationship between operational self-sufficiency and portfolio yield in a study of 29 institutions

in seven Caribbean countries from 2005 to 2008. However, their study was constrained by data

and methodological issues. This paper reduces these limitations by increasing the number of MFIs,

countries, time periods, and by using a more rigorous econometric method.

Second, statistics show that MFIs that are classified as financially self-sufficient institutions by

MIX analysts tend to be older with larger levels of lending. We therefore investigate the interac-

tion between interest rates, scale economies and years of experience of microbank vs. nonbank

credit providers. The outcome should help reveal the extent to which policy actions that promote

the learning that comes from years of practice and growth in the scale of loan operation are likely

to be more effective pricing strategies than initiatives that encourage microfinance institutions to

transform into formal banks.

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