Issue 2 (June)

Microfinance loans have long been associated with relatively high interest rates. There is a wide variation of interest rates charged by microfinance institutions (MFIs) across countries, as well as some dispersion of interest rates across MFIs within the same country. The source of interest rate variation can result from institution specific characteristics such as, average loan size and the composition of female borrowers. The dispersion in prevailing interest rates in the formal financial sector across countries may partially contribute to the variation of microfinance interest rates across countries. I use yield on gross loan portfolio as a proxy for the average interest rate on loans, the average loan balance as a measure of average loan size, and lending rate for commercial loans to represent the interest rate in the formal financial sector. This study attempts to analyze the dispersion of interest rates on microfinance loans by showing its association with loan size, female composition of borrowers, and the prevailing lending rates. Using a large panel of 1,531 MFIs, I show that microfinance interest rates have a statistically significant negative relationship with loan size, and a positive association with commercial lending rate and the female composition of borrowers.