Do Interest Rates Matter? Credit Demand in the Dhaka Slums

This paper uses data from SafeSave, a credit cooperative in the slums of Dhaka, to examine how sensitive borrowers are to increases in the interest rate on loans. It tests the assumptions that:

• Poor households that take advantage of microfinance are not very responsive to changes in interest rates;
• They seek access to credit, not necessarily cheap credit;
• The institutions offering credit can raise the interest rates without fear of losing the core customer base;
• MFIs can offer credit at a sufficiently high interest rate to cover their operating costs, and at the same time remain appealing to low-income borrowers.

The paper uses an unexpected price increase by SafeSave to examine the degree to which poor households reduce their borrowing when faced with a higher interest rate. It states that:

• SafeSave operated three urban branches, with slightly different products and prices in one of the branches;
• It compares times at which product rules changed in two locations but not in the third.

The paper finds that:

• Borrowers are highly sensitive to interest rate changes;
• Less wealthy households are particularly sensitive to the interest rate increase;
• When the interest rate increased, the bank's portfolio shifted away from its poorest borrowers.

The paper concludes that the rate increase helped SafeSave to improve its financial condition, but not without a cost in terms of outreach to its poorest clients.