Financial Stability Challenges in Microfinance - Drivers of the Pre-Crisis Credit Boom

Abstract

This paper uncovers the drivers of the credit boom in microfinance in developing and emerging market countries before the onset of the financial crisis. We find that key macroeconomic variables as well as credit growth in the traditional banking sector are significant factors explaining microfinance credit growth. Moreover, the ability of microfinance institutions to secure external funding beyond deposits and equity is a key variable determining the size of the boom. Thus, our results suggest that microfinance is subject to similar financial stability challenges that have been observed in the traditional banking sector. We also find robust evidence that commercialization contributes to the boom as microfinance banks experience more rapid growth than non-governmental institutions. By contrast we only find weak evidence that credit expansion is more pronounced in more difficult and underdeveloped microfinance markets.