Transaction Costs of Micro Financing and Interest Rates: A Case of Uganda

Abstract

There are limited studies on lending costs by financial institutions in Uganda, with the majority of studies focusing on interest margins as opposed to the transaction costs of micro financing. Besides, the majority of studies conducted focus on the developed world with limited information on Sub-Saharan Africa.  This paper generates a list of transaction costs of micro financing and examines their impact on interest rates. Understanding transaction costs of micro financing, is vital for policy makers in determining the transaction costs that financial institutions must consider in determining the interest rate to minimize the cost of borrowing.

Findings revealed that highly perceived transaction costs of micro financing include: Staff salaries and wage costs, Printing costs and Rent costs. Opportunity costs of time taken negotiating with the potential borrower and costs incurred in reading an agreement with the other party in a transaction are not perceived as transaction costs of micro financing. Costs of collecting repayments, the costs of following up on non-payment, monitoring costs, costs of borrowing on the side of the financial institution, exposure to interest rate risk costs  and volatility of interest rates in the market costs, were indicated to greatly affect the interest rate charged by the financial institutions.