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

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.