Development and Determinants of Credit Interest Rates of Microfinance Institutions

Abstract: As millions of poor borrowers rely on microcredit products to finance various aspects of their lives, the price of such products cannot be rated important enough. This study analyzes the development and determinants of credit interest rates of microfinance institutions globally between 2005 and 2014. The purpose is to understand why interest rates vary so much in absolute level and development between world regions, countries and even within countries. To study the variation and find the determinants, a dataset from MixMarket containing 9,320 observations from 2,039 microfinance institutions is employed. First, the development of interest rates and major cost channels of microfinance institutions are scrutinized in a descriptive analysis. Second, in a fixed-effects econometric analysis the relationship between personnel expenses and interest rates and average salaries of microfinance institution employees and interest rates is studied. Findings suggest that with the increase of personnel expenses by one percentage point, portfolio yield (as proxy for interest rates) increases by 0.32 percentage points. When average salaries (measured in relative terms) increase by one unit, portfolio yield increases by 0.0248 percentage points. The study contributes by identifying personnel expenses as a major cost channel and average salaries as a major institution-specific factor of microfinance interest rates. Building on this, managers of microfinance institutions might want to assess to what extent and how they can reduce their personnel expenses. Furthermore, policy makers keen on improving the supply of affordable credit to the poorest of their population could focus on laying the foundations for microfinance institutions to have sufficient access to qualified human capital. This might ultimately benefit borrowers and stakeholders.