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Applied Economics Letters

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Does the Grameen Bank exert market power over

borrowers?
ab b
Subir Bairagi & Azzeddine Azzam
a
Centre for Policy Dialogue, Dhaka, Bangladesh
b
University of Nebraska-Lincoln, Lincoln, NE 68503–0922, USA
Published online: 03 Apr 2014.

To cite this article: Subir Bairagi & Azzeddine Azzam (2014) Does the Grameen Bank exert market power over borrowers?,
Applied Economics Letters, 21:12, 866-869, DOI: 10.1080/13504851.2014.894623

To link to this article: http://dx.doi.org/10.1080/13504851.2014.894623

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 Applied Economics Letters, 2014
Vol. 21, No. 12, 866–869, http://dx.doi.org/10.1080/13504851.2014.894623

Does the Grameen Bank exert

market power over borrowers?
Subir Bairagia,b and Azzeddine Azzamb,*
a
Centre for Policy Dialogue, Dhaka, Bangladesh
b
University of Nebraska-Lincoln, Lincoln, NE 68503–0922, USA

In this article, we use the recently developed stochastic frontier estimator of

Downloaded by [University of Tasmania] at 07:42 14 October 2014

market power to test whether or not the Grameen Bank’s lending rates are
consistent with marginal cost pricing. We find that they are not and, on average,
the markup is about 3% above marginal cost. However, the markup is consider-
ably dwarfed when compared to the markups charged by commercial microfi-
nance institutions. Their lending rates are reported to range from 97% to 165%
above marginal cost.
Keywords: Grameen; market power; stochastic frontier; microfinance

JEL Classification: D21; D43

I. Introduction commercial MFIs in 73 countries. The authors find that

In a New York Times article titled ‘Sacrificing Microcredit
for Megaprofits’, Dr. Muhammad Yunus1 wrote that at the
time when he launched the Grameen Bank to provide
loans to the poor, he ‘never imagined that one day micro-
credit would give rise to its own breed of loan sharks’
(Yunus, 2013). The ‘loan sharks’ Dr. Yunus had in mind
are commercial microfinance institutions (MFIs) that, he
claims, charge excessive interest rates, harming the very
borrowers microcredit is supposed to help. Dr. Yunus
went on to suggest capping interest rates and that ‘the
ideal “spread” between the cost of the fund [what the
bank pays to procure the money to lend] and the lending
rate should be close to 10 %.’
Restated in industrial organization terms, what Dr.
Yunus is suggesting is that commercial MFIs exert mar-
ket power over borrowers, whereas the Grameen Bank
does not.
With regards to commercial MFIs exerting market
power over borrowers, recent empirical work seems to
support Dr. Yunus’s claim. Assefa et al. (2013), in the only
paper we are aware of on market power in microfinance,
used a cost function to estimate the Lerner index for 362
the average MFI in their sample ‘seems to enjoy quite
some level of market power, enabling them to charge
interest rates above marginal cost’ – the average Lerner
index is 0.582 and ranges from 0.492 for MFIs in South
Asia to 0.622 for MFIs in the Middle East and North
Africa. The authors conclude that their results support
the claim of those who consider ‘commercialization of
the microfinance sector as a potential threat to its longer-
term stability and success, especially in terms of its finan-
cial objectives.’
With regards to the Grameen Bank itself having no
market power, we are not aware of any prior analysis to
find out if that is the case. Our purpose in this article is to
do so. Specifically, we use the recently developed stochas-
tic frontier estimator of market power (Kumbhakar et al.,
2012) to test whether or not the Grameen Bank’s lending
rates are above marginal cost. We find that they are, but
not by very much.
As we mentioned earlier, with the exception of the
Assefa et al.’s (2013) work, there are no other studies
that look specifically at market power among MFIs. The
focus of the microfinance literature so far has been on the
extent to which microfinance in general and the Grameen

*Corresponding author. E-mail: aazzam1@unl.edu

1
Bangladeshi Nobel Peace Prize winner in 2006.

866 © 2014 Taylor & Francis

 Does the Grameen Bank exert market power over borrowers?
Bank in particular lifts people out of poverty (Hossain,
1988; Khandker et al., 1988; Pitt and Khandker, 1998;
Menon, 2006; Rahman, 2010; Basher, 2012), empowers
borrowers (Hashemi et al., 1996; Amin et al., 1998;
Basher 2007; Rahman et al., 2009; Aslanbeigui et al.,
2010), how group monitoring affects loan repayment in
theory (Rai and Sjostrom, 2004) and in practice (Hermes
et al., 2006), cost-effectiveness (Khandker et al., 1995;
Schreiner, 2003) and X-efficiency (Hassan and Tufte,
2001).
The rest of the article is organized as follows.
Section II highlights the stochastic frontier methodol-
ogy for estimating market power. Section III adapts the
methodology to the Grameen Bank. Section IV presents
data and results. Summary and conclusion are in
Section V.
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II. Theoretical Model
Briefly, the starting point of Kumbhakar et al.’s (2012)
theoretical model is the basic inequality P > MC, indicat-
ing that a firm with market power sets price, P, above
marginal cost, MC. Multiplying both sides of the inequal-
ity by (inverse) average cost Y/C, where Y is output and C
is total cost, allows converting the inequality into the
equality
PY @ ln C
¼ þ u; u  0 (1)
C @ ln Y
where PY =C is the revenue share in total cost,
@ ln C=@ ln Y is the scale elasticity and u is nonnega-
tive one-sided term representing the markup. The
expression for @ ln C=@ ln Y is obtained from the trans-
log cost function. The relationship between the
markup and the degree of market power is straightfor-
ward. Denoting the degree of market power by
θ ¼ ðP  MC Þ=MC,2 Kumbhakar et al. (2012) show,
using Equation 1, that
u
θ¼ (2)
@ ln C=@ ln Y
Consistent with the efficient structure/market power lit-
erature (Harris, 1988), Equation 2 confirms that a firm’s
degree of market power rises, falls or remains constant
when technology exhibits decreasing returns to scale
( @@ ln C @ ln C
ln Y >1), increasing returns to scale ( @ ln Y <1) or
constant returns to scale ( @@ ln
ln Y ¼ 1).
C
2
Rather than the Lerner index ðP  MC Þ=P:
867
III. Application to the Grameen Bank
The translog cost function for the Grameen Bank is
assumed to take the following form:
ln C ¼ α0 þ αy ln Y þ 0:5αyy ðln Y Þ2 þ β1 ln w1
þ β2 ln w2 þ β3 ln w3 þ γy1 ln y ln w1 þ γy2 ln y ln w2
þ γy3 ln y ln w3 þ 0:5fβ11 ðln w1 Þ2 þ β22 ðln w2 Þ2
þ β33 ðln w3 Þ2 þ 2β12 ln w1 ln w2 þ 2β13 ln w1 ln w3
þ 2β23 ln w2 ln w3 g þ θyT ln yT þ δ1T ln w1 T
þ δ2T ln w2 T þ δ3T ln w3 T þ θT T þ 0:5θTT T 2
(3)
where cost ðC Þ, output ðY Þ and factor prices w1 ; w2 and w3
are defined in a manner similar to Ariss (2010).
Specifically: C ¼ total cost, Y ¼ total assets, w1 ¼
price of labour, w2 ¼ price of physical capital, w3 ¼
price of borrowed funds and T ¼ time index.
Using Equation 3, the expression for @ ln C=@ ln Y is:
@ ln C
¼ αy þ αyy ln Y þ γ1y ln w1 þ γ1y ln w2 þ γ1y ln w3 þ θyT T
@ ln Y
(4)
Substituting Equation 4 into 1, we arrive at the stochastic
version of the supply relation Equation 3:
PY
¼ αy þ αyy ln Y þ γy1 ln w1 þ γy2 ln w2
C (5)
þ γy3 ln w3 þ θyT T þ u þ v
Imposing the homogeneity restriction
γy1 þ γy2 þ γy3 ¼ 0; and assuming u is half-sided normal,


i.e., ,N þ 0; σ 2u , and v is the usual two-sided normal, i.e.,


v ,N 0; σ 2v , Equation 5 can be estimated using the same
maximum likelihood method used to estimate a stochastic
cost frontier. The difference is in interpretation of the one-
sided error term u. When estimating a stochastic cost
frontier, the one-sided term measures cost inefficiency.
When estimating Equation 5 the one-sided term is the
markup.
IV. Data and Results
The data for estimating Equation 5 were gathered from
the Grameen Bank Annual Reports and the bank’s
website for the 1985–2012 period. Table 1 defines the
variables used in estimating Equation 5 and presents
their respective descriptive statistics. Table 2 lists the
 868 S. Bairagi and A. Azzam
Table 1. Variable definition and descriptive statistics

Variable name Definition Unit Mean SD Min Max

Revenue PY Total income before provision Million USD 92.61 108.69 1.44 383.91
Cost C Salaries and other related expenses + interest Million USD 87.79 103.15 1.43 361.61
expenses + other expenses + provision expenses
Asset Y Loan and advances before provision + investment Million USD 638.59 712.73 11.95 2436.07
+ cash and bank balance + fixed assets + other assets
Salaries and other related expenses
Price of labour w1 USD/year 1454.82 1008.11 201.03 3774.32
Number of employee
Other expenses
Price of w2 USD/year 0.72 0.42 0.21 1.50
physical fixed assets
capital
Interest expenses
Price of w3 USD/year 0.06 0.02 0.03 0.09
borrowed All funding
funds
Time T time trend
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Table 2. Parameter estimates (Equation 5) 1.03% of marginal cost, confirming that the Grameen
Bank’s lending rate is not equal to marginal cost as one
Coefficients SEs.
would expect from a perfectly competitive bank.3
αY 0.9918 0.00004 However, the Grameen Bank’s degree of market power
αYY −0.0317 0.00001 is considerably dwarfed by that of commercial MFIs in
α1Y 0.0276 0.00001 Assefa et al.’s (2013) study. In that study, the lending rates
α2Y 0.0135 0.00000 range from 97% to 165% of marginal cost.4
αYT 0.0055 0.00000

Table 3. Estimates of markup, degree of market power and V. Summary and Conclusion
returns to scale
In this article, we use the recently developed stochastic
Bootstrap 95% Confidence
Coefficient SE interval frontier estimator of market power to test whether or not
the Grameen Bank’s lending rates are consistent with mar-
Markup, ^u 0.0327 0.0080 0.0170 0.0484 ginal cost pricing. We find that they are not and, on average,
Degree of 0.0325 0.0082 0.0164 0.0485 the lending rate is about 3% above marginal cost. However,
market
power, θ^
the markup is considerably smaller than the markups
Returns to 0.9977 0.0032 0.9915 1.0040 charged by commercial MFIs, where the lending rates are
scale: reported to range from 97% to 165% above marginal cost.

parameter estimates of the supply relation and their

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