The Effect of Interest Rate On Microfinance Institutions in Uganda: Case Study of Pride Microfinance-Kabalagala Branch

ABSTRACT The study is an exploratory research design which sought to determine the factors relied upon by microfinance institutions while charging interest; finding out the effect of interest on the performance of microfinance institutions and suggesting possible alternatives to control this effect. The study relied on qualitative and quantitative methods of data collection and analysis and data was gathered from PRIDE Microfinance in Kabalagala. The study also relied on secondary data upon which information related to the specific aims of the study was reviewed. Pride relies on different factors to determine its interest rate. It considers the requirements of the law, the institutional development needs, cost of operation, expected profit, need and convenience of borrower and exceptional knowledge. The study also established that, the Tperformance of Pride Microfinance was affected in such a way that clients resort to borrowing from various sources, high level of defaulting, strict law impositions, operate upon abstract market structures and suffocated means of expansion. It was suggested that microfinance institutions can improve on their performance by devising pro-poor micro credit services which are effective, providing conventional knowledge, widening outreach, ceiling interest rate charges, and through negative taxes for interest charged. It is concluded that the main source of income for microfinance institutions is interest and because of this the institutions are less willing to advise the clients to act rationally, but at the end of it all, the perfo1mance of the institution is also affected. Individuals therefore are provided with loans that they do not qualify to be given, for this the institutions need to be regulated on their interest motive, or else their performance continues to be sluggish. The study recommends that microfinance institutions undertake an advisory role before providing loans, need for roadmaps to be presented for particular business plans, educating people to learn how to borrow; meeting demands of borrowers, promoting consumer development programs and maintaining interest rates charges as tax free.

TABLE OF CONTENT

DECLARATION ............................................................................................................................ i

APPROVAL ................................................................................................................................... ii

DEDICATION .............................................................................................................................. iii

ACKNOWLEDGEMENTD ........................................................................................................ iv

TABLE OF CONTENT ................................................................................................................ v

LIST OF TABLES AND FIGURES ............................................................................................ x

LIST OF ACRONYMS ............................................................................................................... xii

ABSTRACT ................................................................................................................................ xiii

CHAPTER ONE ............................................................................................................................ !

GENERAL INTRODUCTION .................................................................................................... 1

1. 0 Introduction ............................................................................................................................... I

1. I Background of the Study ........................................................................................................... I

l .2Statement of the Problem ........................................................................................................... 3

1.3 Purpose of the Study ................................................................................................................... 4

1.-+ Objectives of the Study ............................................................................................................. 4

1.4.!General Objective .................................................................................................................... 4

l .4.2Specific Objectives .................................................................................................................. 5

l .5Research Questions .................................................................................................................... 5

V

l.6Scope of the Study ...................................................................................................................... 5

1.6.1 Geographical Scope ................................................................................................................. 5

l .6.2Content Scope .......................................................................................................................... 5

l.6.3Time Scope .............................................................................................................................. 6

l.7Significance of the Study ........................................................................................................... 6

1. 8 Conceptual Framework Showing the Interest Rate and Performance of Micro finance

Institutions ....................................................................................................................................... 6

CHAPTER TWO ...................................................................................................................... 9

LI1,ERA TURE REVIEW ........................................................................................................ 9

2.0lntroduction ................................................................................................................................ 9

2. l The Theory Micro finance Institution (MFI) ............................................................................. 9

2.2 Factors Contributing to the Determination oflnterest Charges in MFis ................................ 12

2.2.1 Operating Costs and Losses ................................................................................................. 12

2.2.2 Sustainability ofMFis and Expansion of their Operations .................................................. 12

2.2.3 Expected Profits ................................................................................................................... 13

2.2.4 Access to Credit important than Cost of Credit ................................................................... 13

2.2.5 Compellations of the Law .................................................................................................... 14

2.2.6 Inelasticity of Conventional Wisdom ................................................................................... 14

2.3 Effect oflnterest Rate on Performance ofMicrofinance Institutions ..................................... 15

2.3.1 Low Returns on Loan Portfolios .......................................................................................... 15

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=According to Tumwine and Mukubwa (2007), the government of Uganda experienced poor

yields ............................................................................................................................................. 15

2.3.2 Stifle Business Expansion and Lead to High Default Rates ................................................. 15

2.3.3 Through Restrictions of the Law .......................................................................................... 15

2.3.4 Low Quality Products due to Inadequate Marketing Infrastructure ..................................... 16

2.3.5 Multiple Borrowing .............................................................................................................. 16

2.4 Solutions to Challenges ofMicrofinance Institutions Due to Interest Rate ............................ 16

2.4.1 Introduce Interest Rate Ceilings ........................................................................................... 16

2.4.2 Income Incentives to MFis ................................................................................................... 17

2.4.3 Designing Appropriate Strategies for the Poor .................................................................... 17

2.4 .4 Subsidizing Institutional Rates ............................................................................................. 1 7

CHAPTER THREE ................................................................................................................ 18

METHODOLOGY ................................................................................................................. 18

3.0lntroduction .............................................................................................................................. 18

3. I Research Design ....................................................................................................................... 18

3 .2 Study Population and Area ...................................................................................................... 18

3.3 Sample Size ............................................................................................................................. 19

3.4Sample Procedure ..................................................................................................................... 20

3.5Data Collection ......................................................................................................................... 20

3.5.!Sources of Data ..................................................................................................................... 20

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Primary Data .................................................................................................................................. 20

3.5.2 Research Instruments ........................................................................................................... 21

Interviews ...................................................................................................................................... 21

3 .6 Data Processing ..................................................................................................................... 21

3. 7Data Analysis ........................................................................................................................... 21

3.8 Ethical Consideration .............................................................................................................. 22

CHAPTER FOUR ..................................................... , ............................................................ 23

PRESENTATIONS, INTEPRETATIONS AND DISCUSSIONS ........................................ 23

4.0 Introduction ............................................................................................................................. 23

4.1 Demographic Representation of the Respondents ................................................................... 23

4.1.1 Gender of Respondents ........................................................................................................ 23

4.1.2 Age of the Respondents ........................................................................................................ 24

4.1.3 Marital Status of the Respondents ........................................................................................ 25

4.1.4 Education Levels of the Respondents .................................................................................. 27

4.2 Factors Considered in Detennining Interest Rate Pride Microfinance ................................... 28

4.3 How Interest Rate on Loan Portfolios Affects Performance ofMicrofinance Institution ...... 31

4.4 Solutions to the Challenges Experienced due to Interest Rate ................................................ 35

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CHAPTER FIVE .................................................................................................................... 39

SUMMARY OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS ................. 39

viii

5.0 Introduction ............................................................................................................................. 39

5. I Summary of the Findings ......................................................................................................... 3 9

5.1.1 Factors Considered in Determining Interest Rate by MFis .................................................. 39

5.1.2 Interest Rate on Loan Portfolios and the Performance ofMFis ......................................... .40

5.1.3 Solutions to Problems Faced by Media ................................................................................ 40

5.2 Conclusion of the Findings ...................................................................................................... 41

5.2.1 Factors Considered in Determining Interest Rate by MFis .................................................. 41

5.2.2 Interest Rate Charged on Loan Portfolios and the Performance ofMFis ........................... .41

5.2.3 Solutions to Problems Encountered .................................................................................... .41

5.3 Recommendations ................................................................................................................... 42

5.4 Recommendation for Future Research .................................................................................... 43

REFERENCES .............................................................................................................................. 44

APPENDICES ............................................................................................................................... 47

APPENDIX (A): RESEARCH INSTRUMENTS ......................................................................... 47

INTERVIEW GUIDE ................................................................................................................... 50

APPENDIX B: TIME FRAME ..................................................................................................... 51

APPENDIX C: EXPECTED BUDGET ........................................................................................ 52