Why do microfinance institutions charge higher interest rates than banks? The role of operating costs

• We explore why MFIs charge high interest rates to poor borrowers. • We find that MFIs incur more operational costs than banks for every dollar of lending. • This is because high marginal operating costs are inherent to the MFIs' business model. • Hence, high marginal operating costs matter in MFIs’ loan pricing. • MFIs provide credit to borrowers with no creditworthiness, but they bear the cost of credit risk. Microfinance interest is at the center of debate on lending to the poor because microfinance institutions (MFIs) charge significantly higher interest than conventional banks to borrowers with no creditworthiness. We contribute to the debate by documenting that MFIs spend more than banks for every dollar of lending. It occurs because the high marginal operating cost of lending is inherent to the microfinance business model - MFIs spend more than banks to mitigate high credit risks in lending to the poor. This study shed light on MFIs’ systemic limitations in poverty alleviation as envisaged in the sustainable development goals (SDGs).