Measuring the Efficacy of Financial Intermediation: A Transaction Costs Approach

Vighneswara Swamy

Published: December 2020

This study focuses on the transaction costs of borrowing by the poor and provides an empirical assessment. In doing so, this study addresses two salient questions: (a) what are the transaction costs for borrowing poor? and (b) how significant are these transaction costs for the poor in deciding whether to borrow from an institutional or an informal source? The study area includes southern, western, northern, eastern, and central regions of India. Using a stratified random sampling approach this study captures comprehensively all the forms and variants of microfinance intermediation in India. The sample also covers three broad social categories—scheduled castes and scheduled tribes, other backward classes, and other social groups—and studies three major approaches to financial intermediation: the direct lending model, self-help groups (SHG) and microfinance institutions (MFI). The results indicate that borrower transaction costs in the direct lending model are 9.06% in rural areas, 9.57% in semi-urban areas and 10.93% in urban areas, with an overall average of 9.85%. Under the SHG lending model borrower transaction costs range between 3.62% in rural areas, 3.70% in semi-urban areas and 3.93% in urban areas, with an overall average of 3.75%. Similarly, the MFI lending model has borrower transaction costs of 7.70% in rural areas, 7.91% in semi-urban areas, 8.43% in urban areas, and the average is 8.02%. The findings provide the required insights for policy support needed to lessen the burden on the beneficiaries of microfinance. Accordingly, the SHG lending model, with the lowest borrower transaction costs, is suitable for microfinance intermediation in rural areas.

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