MICROFINANCE PAPER WRAP-UP: Competition and Wide Outreach of Microfinance Institutions by Hisako Kai

Written by Hisako Kai of Kobe University published September 9, 2009 as Munich Personal RePEc Archive (MPRA), Paper Number 17143, 12 pages, available at http://mpra.ub.uni-muenchen.de/17143/

Hisako Kai describes how most MFIs that aim for socioeconomic improvements, which are termed ‘socially-motivated’ MFIs, gear their efforts towards expanding their levels of outreach, both in terms of providing to the poorest of the poor (‘wide outreach’) and maximizing their number of clients (‘length outreach’). Attaining wide levels of outreach requires MFIs to utilize external subsidies and cross-subsidies, where gains from more profitable clients are used to subsidize loans to unprofitable borrowers. The assumptions made are that poorer clients tend to have higher default rates, while the relatively more wealthy clients receive larger loans and are thus more profitable to MFIs.

Many previous theoretical studies, some of which are listed in the bibliography below, [2] [3] [4] [5] claim that competition has adverse impacts on profitability and cross-subsidization of socially-motivated MFIs, which could lead to limitations on their wide outreach capabilities. First, they show that competition causes a decrease in “dynamic incentive,” which refers to the event where clients are able to obtain loans from other lenders without paying back their original loans to their initial lender, thus decreasing their payback incentives. As clients borrow from multiple lenders, default rates increase, and profitability and cross-subsidies of MFIs fall. Second, these studies argue that competition may lead to a decrease in ‘productive’ clients for socially-motivated MFIs. Profit-centered MFIs that enter the industry target the wealthiest out of the pool of poor clients with larger loans, which causes these clients to switch over from incumbent, socially-motivated MFIs that provide smaller loans. Third, new MFI entrants may lead to a fall in interest rates.  Though this may benefit borrowers, the overall income that MFIs generate from interest rates will decline, leading to a drastic decrease in cross-subsidies used for poorer clients. These analyses claim that that the adverse effects of competition place a budget constraint on socially-motivated MFIs, and lead to either lessened ‘financial self-sufficiency’ (FSS), which is defined by the Microfinance Information Exchange (MIX) as the ability for an MFI to operate without external subsidies, or a limit on their level of wide outreach.

Despite the fact that theoretical literature suggests that competition among MFIs leads to these main effects, Ms. Kai argues that there is insufficient empirical research to conclude that competition affects wide outreach or causes poorer borrowers to drop out of the MF market. Instead, she aims to study the impact of competition among MFIs on levels of wide outreach, to assess whether they can still reach the poorest of the poor, and financial self-sufficiency (FSS) on socially-motivated MFIs, through an empirical analysis involving 450 MFIs from 71 countries, using data on these MFIs from 2003-2006.

The results of the empirical research depict that intense competition between different types of MFIs does harm wide outreach capabilities of socially-motivated MFIs, which leads to poorer borrowers dropping out of the market. However, it does not worsen FSS or lead to an increase in subsidy dependence, as hypothesized through previous theoretical studies, which shows that competition does not increase MFI dependence on external subsidies. Ms. Kai also concludes that the harms of competition on wide outreach decrease as MFIs gain experience. More experienced MFIs allow their wide outreach to be reduced by less, as they have greater market power and possibilities for technological advancement, making them less vulnerable to increased competition.

By Radhika Chandrasekhar, Research Assistant

Bibliography

[1] Competition and Wide Outreach of Microfinance Institutions. http://mpra.ub.uni-muenchen.de/17143/

[2] McIntoch, C., de Janvry, A., and Sadoulet, E. (2005) “How rising competition among microfinance institutions affects incumbent lenders” Economic Journal 115(506), 987-1004.

[3] McIntosh, C. and Wydick, B. (2005) “Competition and microfinance” Journal of Development Economics 78, 271-298.

[4] Hoff, K. and Stiglitz, J. (1998) “Moneylenders and bankers: Price-increasing subsidies in a monopolistically competitive market” Journal of Development Economics 55(2), 485-518.

[5] Navajas, S., Conning, J., and Gonzales-Vega, C. (2003) “Lending technologies, competition, and consolidation in the market for microfinance in Bolivia” Journal of International Development 15, 747-770.

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