Profitability and Interest Rates: Does the Commercialization of Microfinance Institution Lead to Higher Interest Rates?

Date Published: 
Jun 2013
Flosbach, J.

Testing the correlation between high interest rates and profitability of MFIs

This paper examines the relationship between the profitability of MFIs and the interest that these institutions charge their clients. It introduces the conceptual framework of triangle of microfinance (involving financial sustainability, outreach, and impact), describes the research methodology, and presents the results of a data analysis performed on a data set of 193 MFIs. Key findings include:

  • Statistical analysis revealed a negative correlation (-0.127) between the return on equity and the real annualized percentage rate , and a correlation coefficient of -0.154 for the nominal interest rate;
  • By including the life-cycle theory into the interpretation, it was observed that MFIs that are just about to reach financial self-sufficiency charge the highest interest rates;
  • Following the youth stage is the growth stage, where MFIs use gains from cost savings and increased efficiency to improve their competitive position by lowering their interest rates;
  • Finally, maturity stage offers MFIs a chance to either further lower their interest rates by virtue of several suitable factors or not do so to increase their profitability.

The paper concludes that if the interest rate of microloans is accepted as a proxy for the impact of microfinance, then commercialization is not the problem of microfinance, but it is part of the solution.