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Interest Rates and Financial Performance of Microfinance Institutions: Recent Global Evidence

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Abstract

Recent controversies regarding the high interest rates being charged by microfinance institutions (MFIs) have been justified in the name of financial sustainability. This article investigates whether MFIs’ high interest rates improve profitability, reduce repayment rates and lead to mission drift. Within an agency theoretic framework, instrumental variables (IV) estimations have been employed to account for the endogeneity issues using a comprehensive global panel database consisting of 379 MFIs in 71 countries for 6 years – from 2003 to 2008. Results show that real yield on loan portfolio – a frequently used proxy for interest rates – has a positive and highly significant impact on MFIs’ financial performance and loan repayment rates. We further find that loan delivery methods have a significant impact on financial performance. Individual-based lenders tend to show a greater profitability but only up to a certain level. We also find that individual-based lenders are prone to mission drift as compared to village banks.

Abstract

Les taux d’intérêt élevés pratiqués par les institutions de microfinance (IMFs), et que certains justifient au nom de la viabilité financière, ont récemment fait l’objet de controverses. Cet article pose la question de savoir si ces taux d’intérêt élevés améliorent la rentabilité, réduisent les taux de remboursement des prêts et éventuellement conduisent à une dérive de mission. Dans un cadre théorique conceptuel, et pour rendre compte des problèmes d’endogénéité, des estimations par variables instrumentales (VI) sont effectuées sur une base de données exhaustive de panel concernant 379 IMF dans 71 pays pendant six ans, entre 2003 et 2008. Les résultats montrent que les rendements réels des portefeuilles de prêts – qui servent souvent de variable de substitution aux taux d’intérêt – ont un impact positif et très significatif sur la performance financière des IMF et les taux de remboursement des prêts. Nous constatons en outre que les méthodes d’octroi des prêts influencent significativement la performance financière. Les institutions octroyant des crédits sur une base individuelle ont tendance à présenter une rentabilité plus élevée, mais seulement jusqu’à un certain seuil. Nous constatons, qui plus est, qu’elles sont enclines à des dérives de mission que les banques villageoises.

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Notes

  1. In 2005–2006, in a district in the southern Indian state of Andhra Pradesh, the government closed 50 branches of four MFIs following allegations of unethical collections, illegal operational practices (such as taking savings), poor governance, high interest rates and profiteering (Ghate, 2007). In 2010, the crisis deepened with reports of suicides being linked to MFIs. This led the state’s chief minister to pass ‘An Ordinance to protect the women Self Help Groups from exploitation by the Micro Finance Institutions in the State of Andhra Pradesh’, resulting in MFIs’ loan collections dropping dramatically and further difficulties in refinancing loans with commercial banks and raising new equity, with MFIs becoming illiquid and insolvent. Similarly, a CGAP study on Mexico’s high-profit generating IPO of Banco Compartamos found that they were charging interest rates in excess of 100 per cent to borrowers.

  2. See, for example, Baltagi (2008) for a thorough discussion on the FE–RE model choice.

  3. Comparing MIX data with the Microcredit Summit Campaign data that have a bias towards social objectives, Bauchet and Morduch (2010) find a negative relationship between operational self-sustainability and percentage of female borrowers in the MIX data but a positive link in the Microcredit Summit data that have a greater representation from Asian MFIs.

  4. It is not necessarily the case that the last year’s explanatory variable must impact on this year’s endogenous variable. Thus, lagged values may not be strictly exogenous. Therefore, using the lags, especially in the case of a bi-causal relationship, only solves this problem from an econometric perspective. However, several researchers have used lagged explanatory variables as instruments in similar analyses (for instance, Mersland and Strøm, 2010; Kar, 2013).

  5. The median year of reporting is 5 (50th percentile). However, it is not the case that the older MFIs report data for all the 6 years while younger MFIs have observations for fewer years. For instance, in the data set, Grameen Bank, one of the oldest MFIs in Bangladesh, has reported data for only 4 years. On the other hand, newer MFIs such as Integrated Development Foundation (IDF) report for 6 years.

  6. These results are available from the authors on request.

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Kar, A., Swain, R. Interest Rates and Financial Performance of Microfinance Institutions: Recent Global Evidence. Eur J Dev Res 26, 87–106 (2014). https://doi.org/10.1057/ejdr.2013.33

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