Microloan Rates, Business Cycle, and Transmission Channels

Abstract

Microfinance institutions (MFIs) are crucial in enhancing financial inclusion in developing countries. Nonetheless, one of their main challenges is their ability to be profitable while serving the poor and the excluded, especially during bad times. Accordingly, this study aims to determine whether the loan pricing (interest rate) that microfinance institutions (MFIs) charge responds to the business cycle, specifically, if rates are higher in bad times than good ones. Our empirical investigation consists in regressing MFIs rates on the business cycle proxy. We find a negative relationship between microfinance interest rates and the business cycle using a sample of 1,481 MFIs over 15 years (2003–2018). Further analysis suggests that the negative relation documented only concerns for-profit MFIs whose characteristics are close to conventional banks. This indicates that MFIs, mainly for-profit MFIs are likely to increase their real rate during times of stress. An analysis of potential attenuation mechanisms of the cyclical effects suggests that MFIs using proximity lending methodology, or those that benefit from subsidies, are less cyclical and could better intermediate through the cycle. Our findings are robust to several specifications, including the dynamic GMM estimation and propensity score matching (PSM).

Keywords: Business cycle, Microfinance, Microloan pricing, Group lending, Subsidy.