Do interest rates matter? credit demand in the Dhaka Slums

Dehejia, Rajeev and Montgomery, Heather and Morduch, Jonathan (2005): Do interest rates matter? credit demand in the Dhaka Slums. Published in: ADB Institute Discussion Paper No. 37

Abstract

If the demand for credit by the poor changes little when interest rates increase, lenders can raise fees to cost-covering levels without losing customers. This claim is at the core of sustainable microfinance strategies that aim to provide banking services to the poor while eschewing long-term subsidies, but, so far, there is little direct evidence of this. This paper uses data from SafeSave, a credit cooperative in the slums of Dhaka, Bangladesh, to examine how sensitive borrowers are to increases in the interest rate on loans. Using unanticipated between-branch variation in the interest rate we estimate interest elasticities of loan demand ranging from -0.73 to -1.04. Less wealthy accountholders are more sensitive to the interest rate than (relatively) wealthier borrowers (an elasticity of -0.86 compared to -0.26), and consequently the bank’s portfolio shifts away from its poorest borrowers when it increases the interest rate.

• Item Type: MPRA Paper
• Language: English
• Keywords: microfinance; credit; demand
• Subjects: O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O17 - Formal and Informal Sectors ; Shadow Economy ; Institutional Arrangements; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O16 - Financial Markets ; Saving and Capital Investment ; Corporate Finance and Governance; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

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