Transaction Costs in Group Micro Credit in India: Case Studies of Three Microfinance Institutions

This paper argues that microfinance providers need to look at innovative ways to reduce costs, so that interest rates would come down in a sustainable manner. The paper states that:

• Transaction costs are an important contributor to lending costs in the microfinance sector;
• High transaction costs in microcredit stem from the small size of the microfinance loan;
• Literature from India suggests that the intermediation of non-governmental organizations and self-help-groups in the credit delivery system reduces the transaction costs of both banks and borrowers.

The paper presents case studies of three MFIs in India engaged in microcredit using the group-lending model. It also presents conclusions about transaction costs drivers and their implications for MFIs as well as for policy makers and recommends that:

• MFIs should:
  • Increase the number of groups per square kilometer and reduce the collection frequency to save filed-worker time and conveyance costs;
  • Minimize the number of fixed layers in their system, examine alternate revenue generating activities as well as alternatives to the branch model;
  • Take into account life cycle costs including default costs over the group life cycle when pricing loans.
• Policy makers should take into account transaction costs when examining MFI interest rates;
• Government-funded campaigns could help in bringing down group formation costs and attracting MFIs to new areas.