Credit Elasticities in Less-Developed Economies: Implications for Microfinance

Publication Details

American Economic Review, 2008, vol.98, iss.3, pp.1040-1068. Available From:

Link to Source
Dean Karlan,Jonathan Zinman
South Africa
Sub-Saharan Africa (includes East and West Africa)
Equity Focus
None specified
Evaluation design
Instrumental Variables (IV), Randomised Control Trials (RCT)
Journal Article


This study examines the impact of two contracting parameters, interest rate and maturity, on take-up of micro-credit loans in South Africa. Take-up is a critical determinant of profits for lenders, as well as the effectiveness of non-profit micro-credit initiatives targeting particular groups of borrowers. Lower interest rates should increase take-up by reducing the cost of borrowing, whilst longer maturity periods may also increase take-up by allowing borrowers to spread out costs over a longer time period.
This study tests these predictions through a randomised controlled trial. The authors partner with a for-profit lending firm, which offered loans with randomly selected interest rates through a direct mailing to 58,168 former clients in 86 predominantly urban branches. Ninety-six per cent of the offers were at below-standard interest rates, slightly more than 1 per cent were at above-standard interest rates and the remainder were at the standard rate. Additionally, the mailing contained a randomly assigned, but nonbinding, maturity suggestion of 4, 6 or 12 months to low- and medium-risk borrowers; high-risk borrowers were offered a 4-month maturity, per the firm’s policy. However, low- and medium-risk borrowers could select any of these three maturities when taking out the loan. In total, 4,540 clients applied for loans at the offered interest rates, and 3,887 were approved for loans.To identify the effects of interest rate on take-up, the authors estimate ordinary least squares models treating a dichotomous indicator of take-up as the dependent variable. Because not all clients chose the suggested maturity, the authors use an instrumental variable strategy to estimate the impact of maturity, using the suggested maturity as an instrument for the actual loan maturity.

Main findings

This study finds that increases in interest rate at or below the lender’s standard rate are associated with a slight, but significant, decrease in take-up. For the portion of the sample offered loans at rates at or below standard, the marginal effect of a 100-basis-point increase in the interest rate is a reduction in take-up of 0.289 percentage points. However, the effects of interest rate are stronger at rates above standard. For the portion of the sample offered such rates, take-up decreased by 1.7 percentage points for each 100-basis-point increase in the interest rate. Moreover, for the entire sample regardless of interest rate, sensitivity to interest rate appears to be stronger for female and low-income borrowers. For these borrowers, the marginal effect of a 100-basis-point increase in interest rate is reductions in take-up of 0.359 and 0.320 percentage points, respectively.
With respect to loan maturity, the authors report that each additional month of maturity significantly increases borrower demand for loans by 15.7 per cent. This effect is strongest amongst low-income borrowers; for this sub-sample, the marginal effect of 1 additional month of maturity is a statistically significant 21.4 per cent increase in demand. Conversely, for the sub-sample of high-income borrowers, the effect is only 5.0 per cent and statistically insignificant. From a policy perspective, these findings suggest that maturity may have a stronger influence on loan take-up than interest rate. This in turn implies that both profit-maximising lenders and lenders seeking to target specific groups should consider altering maturity terms to promote take-up. At the same time, given reported default rates, the findings presented in this paper imply that increasing rates would be unprofitable for lenders. However, profit-maximising lenders also have no incentives to reduce rates, as the increase in take-up would not offset losses from the reduced rates.

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