Credit Elasticities in Less-developed Economies: Implications for Microcredit

This paper examines the recommendation that microfinance institutions (MFIs) should increase interest rates to eliminate reliance on subsidies by testing the hypotheses of inelastic demand for microcredit using data from a field experiment in South Africa.With the aid of a 'for-profit' South African lender in a high-risk consumer loan market, the study team worked to randomize individual interest rate direct mail offers to over 50,000 former clients, conditional on the clients' former rates.The study:

• Calculated the profit-maximizing pricing strategy,
• Identified the effects of price changes on clients served;
• Explored the assumption that liquidity-constrained consumers may borrow more when offered longer maturities.

The study found that:

• Demand was downward sloping but relatively flat throughout a wide range of rates below the "Lender's" standard ones;
• The revenue gains from cutting rates was not enough to offset the revenue losses on inframarginal borrowing;
• Price sensitivity increased sharply when individuals were offered a rate above their prior loan's rate;
• Loan size was far more responsive to changes in loan maturity than to changes in interest rates.

The study:

• Recommends that some MFIs should consider using maturity rather than (or in addition to) price to balance profitability and targeting goals;
• Concludes with directions for related research that would further inform credit market practice and policy in developing countries.