In investigating the factors that affect the interest rate charged on microcredit, the respondents were asked what were the lowest and highest rates that they received in 2014. A regression analysis was then conducted on 386 microcredit borrowers. Table 5.9 presents the two results of OLS estimates for the factors that affect the interest rate charged on microcredit. The model is free from multicollinearity, but heteroscedasticity exists. Therefore, the standard error is presented in robust standard error to solve that problem.
Table 5.9 shows two different models using different dependent variables but the same sets of independent variables. Models 1 and 2 use the lowest and highest interest rates, respectively. Both are continuous variables. The dependent variable interest rate charged on microloans is
hypothesized to be influenced by six sets of variables: owner characteristics, SME characteristics, loan characteristics, choice of microcredit provider, networking, and creditworthiness. However, based on the results in Table 5.9, the interest rate charged on microcredit loans can be explained by SME characteristics, loan characteristics, networking and creditworthiness. For both models, owner characteristics show inconclusive evidence regarding effect on interest rate charged.
The age of the enterprise has a negative coefficient which indicates an inverse relationship between the age of the enterprise and the interest rate charged. This implies that increase in the age of the enterprise leads to a decrease in interest rate because the lender may view mature SMEs as established enterprises. Furthermore, the lender may be prepared to finance riskier borrowers if they can subsequently offset the higher default rate by applying higher interest rates to young SMEs. Surprisingly, short duration is negatively related to a higher interest rate. A negative relationship between short duration and interest rate charged in Model 1 specifies that short term loans tend to have lower interest rates than medium term ones. The estimated coefficient indicates that the interest rate charged by a lender for a short term loan is 0.42 percent lower than for a medium term. This finding is similar to those of Diabate (2000) and Rose and Hudgins (2005) who found that a
higher interest rate is charged for longer loan duration because of the increase in the lender’s risk of
the borrower defaulting from the loan because of income interruption. Lenders observed that SMEs choosing to borrow for short times are less risky because they are confident and committed to repaying the loan. Ceteris paribus, the shorter the loan duration, the lower the risk which leads the lender to offer a lower interest rate. However, this variable is insignificant in Model 2.
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Table 5.9 Estimated results of the Determinants of the Interest Rate Charged on Microloans Lowest interest rate Highest interest rate
Model (1) Model (2)
Independent Variables Coefficient Robust HC3 Standard
Error Coefficient Robust HC3 Standard Error Constant 5.358 0.705 14.183 0.728 Owner/Manager Characteristics Gender 0.143 0.154 0.197 0.227 Age (2) 0.006 0.194 0.123 0.311 Age (3) 0.119 0.223 0.294 0.366 Married 0.030 0.208 -0.314 0.277 Education
-0.090
0.118
0.006
0.184
SMEs’ Characteristics Age of Enterprise -0.024 0.013* -0.026 0.022 Manufacturing sector 0.031 0.2440.026
0.351
Service sector 0.108 0.237 0.237 0.319 Size of Enterprise -0.008 0.017 -0.002 0.037 Loan characteristics Short term -0.417 0.240* -0.377 0.284 Long term 0.171 0.142 0.216 0.176 Loan amount 0.364 0.211* 0.925 0.343*** Monthly paid 0.631 0.439 0.393 0.535 Microcredit provider Commercial Bank -0.157 0.165 0.138 0.197 MFI -0.107 0.134 -0.230 0.244 Networking Commercial bank-0.038
0.047
-0.108 0.065* MFIs0.060
0.045
-0.037 0.058 Creditworthiness Accounting book -0.782 0.115*** -1.011 0.171*** No. of observations 386 386 R-squared 0.204 0.206*, ** and***, represent the 10%, 5% and 1% significance levels, respectively
Robust Standard error applied HC3 options by STATA to correct heteroscedasticity problem
114 Loan amount is positively associated with the interest rate charged on a microloan; this is significant at the 10% and 1% levels for Models 1 and 2, respectively. If the loan amount is over RM25, 000, the lender tends to charge a higher interest rate. A larger loan implies higher risk for the lender because
of borrowers’ higher probability of default so the lender charges a higher interest rate for a bigger
loan. Normally microcredit is offered at a low amount to low income people. Therefore, the interest rate increases for those who borrow over RM25, 000.
Interestingly in Model 2, by networking with a commercial bank an SME receives a lower interest rate. This result is statistically significant at the 10% level. Nguyen & Ramachandran (2006) and Rand (2007) found that firms with a previous borrowing relationship with a bank can borrow at a lower interest rate and have a higher probability to obtain another loan. Since the lender has inadequate
information about a borrower’s risk profile, higher average interest rates are charged to all
borrowers regardless of their risk profile (de Aghion & Morduch, 2006). Networking can help lenders to obtain information about the borrower so consequently the interest rate imposed is not as high. As hypothesized, the explanatory variable accounting books is statistically significant at the 1% level for both models. Relative to those not having accounting books, SMEs with them experience lower interest rates than those who do not. The estimated coefficient for accounting books is - 0.782 and -1.011 for Models 1 and 2, respectively. This indicates that the interest rate charged decreases by 0.78% and 1.011% if SMEs have accounting books that display the business transactions to the
lender. The availability of financial statements can help the lender to assess the borrower’s risk level
because financial transactions provide evidence of the financial transparency in practice (Lee & Sohn, 2017) and show the behaviour of the SME in managing money.
In summary, a lender may charge a lower interest rate if SMEs have been established for many years, borrow for a short term with a small loan amount, network with a commercial bank and have
accounting books. The risk is associated with the price of microcredit.