Cost Dynamics of Microfinance Institutions with Rural and Urban Loan Portfolios

Abstract

This study investigates cost dynamics of Microfinance Institutions (MFIs) engaged in joint production of rural and urban loans. Employing a translog cost function, the paper examines economies of scale, cost complementarities, and elasticities of substitution using three MFI categories: those offering both deposits and loans (Dep-MFIs), those offering only loans (Non Dep-MFIs), and the aggregate sample. The analysis utilizes data from 2008 to 2015, sourced from over 1,000 MFIs worldwide. Results indicate increasing economies of scale for all MFI categories, with Dep-MFIs demonstrating the most significant cost reductions over time. Urban loans are generally more expensive to produce for Non-Dep-MFIs, while rural loans remain costlier for Dep-MFIs and the aggregate sample. Despite positive but minimal cost complementarities, approximately one-fifth of Dep-MFIs experience negative cost complementarities, suggesting potential learning effects. These findings contribute to the literature on financial inclusion by offering empirical insights into cost efficiencies and production dynamics within MFIs.