I've been told that passengers with baggage tend to be less price sensitive and airlines want to charge these more. It used to be that business travellers would pay a higher cost (less price elastic) and liked to be home on Saturday nights hence that rule to discorage them from using cheaper fares. Now it is thought that it is those with baggage who are less price sensitive so will apy more for their trip.
I am not aware of handling agreements (do LoCos still use the standard Iata ground handling agreement?) but I would imagine that there there is a cost per bag handled. There could be additional security charges. Maybe someone has inside knowledge.
Other factors:
Increased fuel costs from the additional weight, discussed elsewhere, probably not that high for short haul.
Not having to unload baggage (and possibly lose a slot) if the passenger doesn't turn up.
More space for cargo - although that may not be relevent in many cases, particularly for LoCos.
LoCos of course like quoting low basic costs and making money on anciliaries (you may have come across tradesmen like that). It seems to work for them although I like to know what expect in advance. On one occasion I lost my boarding pass but I was flying with a legacy carroer and printed off a replacement. If it had been Ryanair & been charged £40 (is that really the cost) I would have been livid and not flown with them again yet the fare may have been £40 lower than a legacy carrier fare. Do not think that people always act in what appears to be a rational way.