In search of the determinants of microfinance lending rates

One of the most significant discussions about microfinance institutions (MFIs) concerns the apparent exorbitant interest rates they charge. Due to these high interest rates, MFIs are observed as an exploiter despite all the effort they make to eliminate poverty. Such negative views need to be verified, and therefore, more research is required to understand why these interest rates are high. This thesis studies the determinants of the interest rates in MFIs, particularly investigating the role of scale economies in controlling the higher interest rates. For that purpose, data for thirty-four large MFIs from eight Asian countries for nine years (2005 to 2013) have been used to find empirical evidence. Two approaches have been employed, replicating the Cotler and Almazan (2013) methodology, a fixed effect model (FE) for single equation estimation and three-stage least squares (3SLS) for simultaneous equation estimation. The results suggest that operating costs need to be reduced in order to control the interest rates. In addition, large MFIs are prone to achieve sustainability and efficiency more easily, thus possessing more power to exercise economies of scale that leads to lower interest rates. The outcomes of this study have important policy implications---in particular, not to restrict MFIs’ growth but in fact, to support larger MFIs for they are able to reduce their interest rates. Moreover, the empirical findings in this thesis help to shed light on understanding the way microfinance operates today and suggests the scope for improvements.