Do natural catastrophes shake microfinance institutions? Using a new measure of MFI risk

Abstract

Using financial data for more than 1000 microfinance institutions (MFIs) from about 80 developing and emerging market countries, I explore the impact of natural disasters on the financial fragility of these MFIs. For this purpose, I apply a two-stage approach. First, as MFI risk is a multifaceted concept, it is hard to capture by a single indicator. However, previous studies still depend mainly on single and arbitrary chosen measures. In contrast, my improved measure for MFI risk is constructed using factor analysis including 17 different financial risk measures. Factor analysis is a statistical data reduction technique used to explain variability among observed random variables in terms of fewer unobserved random variables called factors. In the second step, I use the factor scores obtained from the factor analysis as my dependent variable in a dynamic panel model. The main findings suggest that the financial risk faced by MFIs increases significantly when a major disaster strikes. In particular, hydro-meteorological disasters have a larger impact on the financial soundness of MFIs than climatic or geophysical disasters. Finally, it turns out that the effect of most natural disasters depends to some extent on the size and scope of the catastrophe, the level of economic development of a country and the kind of clients a particular MFI serves. Based on these results, I conclude that natural disasters are a serious threat to the solvency and liquidity of a MFI. Regulators should in particular monitor and stress test the impact of disasters on risk measures related to capital adequacy and asset quality.