Interest Rate Behavior and Lending in Microfinance

Topics: Debt, Microfinance, Interest Pages: 22 (6452 words) Published: March 23, 2013
An Essay
Interest Rate Behavior and Lending in Microfinance

Abstract: This essay analyzes factors which affect interest rate behavior and its subsequent impact on lending in microfinance. Here we have used regression model for our analysis. Furthermore comparison has been drawn among the different sources of loans outside Bangladesh. Here the experience of microfinance outside Bangladesh like India, South and South-East Asia, Latin America has been fully illustrated. This essay conducts analysis on the basis of the existing literatures on Microfinance.

Interest Rate Behavior
Determinants of interest rate of lending in Micro-finance:
* to expand and improve business operation
* recruiting personnel ,
* marketing the services ,
* improving financial information system,
* constructing new offices
* Default
* Unwillingness to pay
* Poor
* Economic recession
* Inability to pay
* Staff identifying
* Checking creditworthiness
* processing loan applications,
* disbursing loans, monitoring
* collecting repayments,
* costs of the space occupied,
* communications, transport,
* support staff,

* Grant
* Equity
* Foundation
* Trust
* Saving Account
We can observe that in MFI lending there is higher interest rate than the commercial bank’s lending rate. The interest rate charged here is higher as cost of funding, processing, cost of risk of loan losses and profit are higher in this case. The graph below shows the different ingredients interest rate.

As above-mentioned factors are very much crucial in this sector that is why require extra attention and thereby require the MFI to charge high interest rate. Rosemberg, R., A. Gonzalez and S. Narain (2009) and Gonzalez (2010), suggest that though small loan provided by the MFI has low default rate but has higher administrative cost that most of the cases cannot be offset by economies of scale. These administrative costs are the single largest contributor to interest rates. Finally, they suggest that, a bigger loan size may help them to reduce their lending interest rate. Further, they also emphasize if higher loans were received by more experienced borrowers then credit risk would decline and thereby interest rates. Lending in Micro-finance:

Accordingly the loan transaction may be described in the following steps. First, the financial firm decides how much to charge and what the optimal loan size to offer must be in order to reach its profitability goal. Once known the value of the lending interest rate and the average loan size the financial institution offers, a potential customer decides whether s/he wants to request a loan. Taking into account the credit history of the potential borrower and its income-expenditure stream, the financial institution builds a risk profile of the individual. With this at hand, they decide where to lend or not. The loan transaction process is given below:

P.cotler of Groningen university with his vast research wanted to show that profitability will increase when lending interest rates and/or productivity and/or the loan size increase or when the funding cost declines .He also showed that The lending interest rate will be negatively correlated with the loan size.So if they wish to achieve a higher profitability it is likely that all else equal they will offer loans of higher size. When microfinance institutions start operations they usually offer loans of small amounts because they do not have much capital or experience and debtors tend to be people without credit history. We find that the lending interest rate is negatively correlated with the productivity of financial institutions and years of operation and positively correlated with the funding costs. What Can Reduce the Interest Rates in Microfinance?

P.cotler also shows that probability that financing boosts growth is weakened if interest rates are extremely high....
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