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Do Interest Rates Matter? Credit Demand in the Dhaka Slums

Published on October 8, 2009

This study attempts to show how sensitive borrowers are to rises in interest rates. The primary result of the study is that borrowers at SafeSave decreased loan demand significantly as a result of the increase in the interest rate. A one percent increase in the interest rate resulted in a range of .73 percent to .88 percent decrease in loan demand over the 12 month period.

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Do Interest Rates Matter? Credit Demand in the Dhaka Slums

This study attempts to show how sensitive borrowers are to rises in interest rates. It measures the change in overall demand for loans after an increase in the interest rate. The study was done at SafeSave, a credit cooperative in Dhaka, Bangladesh. SafeSave has the convenience of a credit cooperative as the loan officers visit borrower’s homes, but also the flexibility of a bank in terms of repayment schedule within a given month. However, outstanding interest must be paid on a monthly basis. For the study, interest rates were unexpectedly raised from 2 percent per month to 3 percent per month in two branches of SafeSave but not a third branch, which was the control group. The data is from 1999 to 2001, was collected monthly, and 5,147 customers, not all of whom participated throughout the study. Average loan size ranged from USD 48 in the branches that underwent interest rate change, to USD 37 in the branch that did not.

The primary result of the study is that borrowers at SafeSave decreased loan demand significantly as a result of the increase in the interest rate. The change was measured in terms elasticity, the percentage change in loan balance after the change in interest rate. A one percent increase in the interest rate resulted in a range of .73 percent to .88 percent decrease in loan demand over the 12 month period. This is, of course, remembering that the change from 2 to 3 percent per month in the interest rate is actually an overall increase of 50 percent, meaning that the one point increase in interest rates actually resulted in a loan demand decrease ranging from 36.5 percent to 44 percent over the course of 12 months. Overall, this decrease is explained by borrowers taking smaller and more frequent loans after the interest rate jump, and repaying them more quickly.

Additionally, less wealthy borrowers appear to decrease their loan demand more than wealthier borrowers due to the increase in interest rates. The categorization of “less wealthy” and wealthy was based on initial savings balances. The elasticity of the less wealthy borrowers was -.86, and the elasticity of the wealthier borrowers was -.26. This means that the interest rate jump from 2 to 3 percent per month resulted in loan demand of less wealthy borrowers to decrease by 43 percent, and loan demand of wealthier borrowers to decrease by 13 percent.

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