Interest Rates and Microfinance Performance in Eastern Africa

The contribution of microfinance industry to poverty alleviation has been overwhelmingly positive in many countries and regions. However, the most controversial dimensions which spark debate has often been interest rate charge by most microfinance institutions which seemingly miss the link towards the social mission for which the institutions were expected to perform. This has caused great concern about potential exploitations of poor borrowers by institutional lenders. This study therefore investigates to understand the possible effects of interest rates on microfinance performance. The research took sample of 73 microfinance institutions in 7 Eastern African countries using 2SLS model to examine the key variables. In so doing, nonlinear term and square of yield were added into the model as independent variables and portfolio at risk (PAR) was used as dependent variable in addition to other financial performance indicators to see whether high yield rate leads to default issues or otherwise among Eastern Africa microfinance institutions. The results demonstrate surprisingly otherwise as increase in yield rate reduced the level of portfolio at risk and the quadratic term was also insignificance though statistically positive. The research therefore confirmed that high interest rates do not lead to loans default but instead, it increased the financial performance through greater profitability in the region. We attribute these positive results to stable macroeconomics environments in the Eastern African region and the support given by government towards the development of small-scale businesses in the region.