Transaction costs in group microcredit in India

Abstract

PurposeExisting literature indicates that transaction costs are a major contributor to high interest rates on microcredit loans. The purpose of the study was to examine the composition of transaction costs to be able to draw implications on how lending rates in microcredit could be reduced in a sustainable manner.Design/methodology/approachAs the study required in‐depth insights on the processes being followed within a micro finance institution (MFI), the case study method was used. Three established MFIs mainly engaged in microcredit – using group‐lending model – were studied.FindingsThe results of the study indicate that the key drivers of direct transaction costs are field worker compensation and number of groups handled per field worker. Collection activity is the single largest contributor.Research limitations/implicationsGeneralisations based on the case studies should be done with caution.Practical implicationsIt is suggested that MFIs, in order to reduce direct transaction costs, increase the number of groups per square kilometer. In order to reduce indirect costs, MFIs should minimize the number of layers of fixed costs in their system and examine alternative revenue‐generating activities that can be undertaken with minimal incremental costs. Policymakers need to take into account transaction costs when examining the interest rates charged by MFIs. The regional variation in transaction costs that the study has found is an important factor that suggests that no uniform view can be taken on the rates charged by MFIs in different regions.Originality/valueNo other studies have focused on transaction costs of a microfinance institution in India.