Is exchange rate risk priced in microfinance?

• High microcredit interest rates have been attributed to different factors.
• Many MFIs are exposed to different types of exchange rate risks.
• MFIs transfer this risk to clients through higher interest rates.
• MFIs charge higher interest rates in countries with floating exchange rate regimes.

High microcredit interest rates have often been a source of criticism against the microfinance movement. Research has focused attention on the cost structure of interest rates and more recently on the macroeconomic and macro-institutional factors. While cost structure is probably the most important determinant of interest rates, other factors can also matter. This paper uses an innovative measure of foreign exchange risk to explore its impact on microcredit interest rates. We show that microfinance institutions that operate in countries with fixed exchange rate regimes tend to charge lower interest rates than those operating in countries with floating exchange rate regimes.

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