Integrating Market Conditions into Regulatory Decisions on Microfinance Interest Rates: Does Competition Matter?

The microfinance industry has developed and commercialized rapidly since its early days,
exacerbating competition and the attention paid to profits. As a response, many governments
have been tempted to limit microcredit interest rates. Although such a measure is often
considered as socially counterproductive, its outcome has not been investigated through a
large econometric study centred on financial inclusion. Using a consolidated dataset including
986 microfinance institutions from 73 countries over the period 2015-2018, we first assess the
effect of interest rate restrictions on the size of the loans provided by microfinance institutions,
through fixed-effect regressions. Going one step further, we use a moderation analysis with
multiple indicators, including the Herfindahl-Hirschman and Lerner indexes, to understand
how market conditions affect this initial relationship. The findings not only confirm that
institutions subjected to interest rate caps tend to provide larger loans, but also suggest that
competition exacerbates this phenomenon. By integrating market conditions into the
analysis, this paper investigates the outcome of regulation in a financial inclusion context
through a more systemic approach than what is commonly done.