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Do interest rates matter? Credit demand in the Dhaka slums

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  • Dehejia, Rajeev
  • Montgomery, Heather
  • Morduch, Jonathan

Abstract

“Best practice” in microfinance holds that interest rates should be set at profit-making levels, based on the belief that even poor customers favor access to finance over low fees. Despite this core belief, little direct evidence exists on the price elasticity of credit demand in poor communities. We examine increases in the interest rate on microfinance loans in the slums of Dhaka, Bangladesh. Using unanticipated between-branch variation in prices, we estimate interest elasticities from −0.73 to −1.04, with our preferred estimate being at the upper end of this range. Interest income earned from most borrowers fell, but interest income earned from the largest increased, generating overall profitability at the branch level.

Suggested Citation

  • Dehejia, Rajeev & Montgomery, Heather & Morduch, Jonathan, 2012. "Do interest rates matter? Credit demand in the Dhaka slums," Journal of Development Economics, Elsevier, vol. 97(2), pages 437-449.
  • Handle: RePEc:eee:deveco:v:97:y:2012:i:2:p:437-449
    DOI: 10.1016/j.jdeveco.2011.06.001
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    More about this item

    Keywords

    Microcredit; Interest rates; Loan demand; Credit constraints;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • O13 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Agriculture; Natural Resources; Environment; Other Primary Products

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