Risk Transfer versus Cost Reduction on Two-Sided Microfinance Platforms

Bryan K. Bollinger, Song Yao

Research output: Working paper

Abstract

Microfinance can be an important tool for fighting global poverty, since it decreases intermediaries' capital costs, increasing individuals' access to loans and possibly lowering interest rates. However, the mechanism by which intermediaries administer loans has huge welfare implications. Using an analytical model of microfinance with intermediaries who disburse and service loans, we demonstrate that profit-maximizing intermediaries may have an incentive to increase interest rates because much of the default risk is transferred to lenders. The effects of interest rates on administration costs, borrowers' demand, and lenders' willingness to lend can serve as disciplining mechanisms to mitigate this interest rate increase. Using data from Kiva.org, we find that interest rates do not affect lender decisions at Kiva, which removes one of these disciplining mechanisms. With the low observed default risk in most geographic regions, the estimated demand elasticity of -0.825 is sufficiently large for the downward forces on interest rates to outweigh the upward default-risk transfer force, if administrative costs are small. However, some areas exhibit high default rates and in North America, where default rates are 1.53%, the average loan APR is well above the average, indicating that rates may be higher due to the transfer of risk to lenders.
Original languageEnglish (US)
PublisherSocial Science Research Network (SSRN)
Number of pages38
StatePublished - Jul 30 2016

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    Bollinger, B. K., & Yao, S. (2016). Risk Transfer versus Cost Reduction on Two-Sided Microfinance Platforms. Social Science Research Network (SSRN). http://ssrn.com/abstract=2816421