Many of us have thought for a long time that microcredit clients are not very sensitive to interest rates.   But is that actually true?  Does the interest rate impact clients’ decision to take the loan, or are most borrowers so eager for reliable credit (or in need of funds right now), that they do not weigh the interest rate of the loan that heavily in their decision to borrow?

A recent CGAP-commissioned study by Innovations for Poverty Action measured borrowers’ sensitivity to interest rates at 132 branches of Mexican MFI Compartamos. A randomized trial offered some potential borrowers a lower interest rate relative to another group of potential borrowers, offering a range of interest rates from 3 to 4.5% a month. The results were interesting:

1. Loan uptake was 22.3% in low-interest rate clusters, versus 15% in high interest-rate clusters. Evidently, interest rates mattered to a substantial numbers of clients. 

2. Over an 18-month period, lower interest rate groups took more loans and bigger loans. Take-up rates for the lower interest rate groups were 22.3%, versus 15% amongst the higher interest rate groups. Similarly, average loan size disbursed grew by 21% in the lower interest rate groups post-treatment, resulting in an average loan size that was 4% larger than in the higher interest rate groups post-treatment.

3. Existing clients were particularly influenced by the change in interest rates, with a 17% increase in loans disbursed, versus an 11% increase amongst new clients (defined as their first loan disbursed within the current month). Maybe the existing clients were more sensitive to rate differentials because they had a baseline (the rate on their prior loans) to compare the new rates with?

4. The business case will depend on the individual MFI. In some cases, MFIs might improve profits by lowering their rates, as the revenue gained from doing more lending might exceed the revenue lost due to the lower interest rate.  In Compartamos’ case, however, the revenue gains from additional lending did not fully offset the revenue losses from the lower rates. But the balance might tip the other way if other factors are considered—for instance, gains from other services that the new customers eventually buy, or reputational value.

Now that we have some strong evidence that interest rates do matter to many of Compartamos’ borrowers, I think we could benefit from further field trials to answer two additional questions on this topic:

1. Were the new borrowers attracted by the lower interest rates people who would not have borrowed otherwise? In other words, do lower rates produce an increase in aggregate credit use, or do they just move borrowers back and forth among competing MFIs?

2. Beyond the immediate gains and losses from reduced interest rates, can we quantify some of the other elements in the equation? To do so we will need studies of total client profitability that go beyond revenue gains in the first year or two of the client’s relationship with the MFI. Glenn Westley’s recent paper on the business case for small savers looked at marginal rather than average costs, and the profitability of other products eventually sold to the client, and came away with some promising results on long-term client profitability, even if short-term profits weren’t present.  Also, does the larger average loan size produced by lower rates bring with it lower operating cost ratios?  A $400 loan produces twice the revenue of a $200 loan, but the administrative cost of the two loans might be pretty much the same.

Stay tuned for more work in this area, as CGAP is currently funding two other Innovations for Poverty Action studies of interest rate sensitivity, and we look forward to sharing their results in the future.

–Rafe Mazer and Rich Rosenberg