MITIGATING LOAN REPAYMENT TROUBLES DURING MICROFINANCE EXPANSION: EVIDENCE FROM A LARGE PANEL

Abstract

(ProQuest: ... denotes formulae omitted.)1.INTRODUCTIONOne of the core objectives of microfinance institutions (MFIs) is the provision of banking/financial services to non-traditional customers known as poor and low-income households or businesses. A significant challenge facing these institutions is the struggle for financial self-sufficiency. This means controlling most of the risks in the loan portfolio through adequate loan collection and timely loan repayments. Doing so, provides for further extension of funds to other borrowers, resulting in further outreach and development (Crabb and Keller, 2006).Examining this challenge in the presence of uncontrolled is of importance, since fast microfinance could pose substantial strain on MFIs' mission, making it harder for them to operate sustainably in such an unconventional market structure. In addition, the 2004-2008 surge in microfinance provides a great opportunity to test this hypothesis.There is a paucity of empirical work on the effects of the unprecedented rapid microfinance expansion that occurred between 2004 and 2008. Practitioners have speculated that this phase in microfinance activities has led to increased loan delinquency. According to Gonzalez (2009), the increase in the number of borrowers during the expansion averaged 21 percent per year while loan portfolio jumped by a staggering 34 percent per year on average.Chen et al. (2010) and Stephens (2009) examine some of the emerging economies qualified as high growth markets and show that in 2008, these markets1 experienced devastating loan delinquency rates. These studies feed into the narrative that aggressive in microfinance lending may pose higher credit risk to MFIs as loan recovery efforts become more challenging. Chen et al. (2010) identified key contributing factors to poor loan repayment rates among which microfinance is mentioned. However, they present no empirical evidence.In this paper, we use a new and improved proprietary comprehensive dataset that includes a large cross-section of MFIs to estimate the effect of rapid microfinance expansion on loan delinquency. The use of such a comprehensive data mitigates that kind of measurement error that plague many microfinance studies (missing data) and allows us to estimate linear panel models. Given that the effects of microfinance expansion may not be visible during the boom years (2004-2008), we extend our dataset from 2003 to 20132 to include post-boom years. For proper identification of the effect of microfinance expansion on loan delinquency, we control for aspects of microfinance (micro) and beyond-microfinance (macro) design.2.DETERMINANTS OF LOAN REPAYMENTLoan repayment is the most revealing of the five3 performance areas of a MFI (Rosenberg, 2009). So, the ability to collect loans is critical to the success of MFIs. We use the loan loss rate to proxy loan repayment.... (1)The loss loan rate measures how well a MFI collects its loans and our presumption is that higher values of loan loss rate are associated with lower repayment rates.To measure the impact of microfinance on loan delinquency, it is important to control for factors that may explain changes in loan repayment. The choice of control variables is motivated by the literature. We hypothesize that loan repayment is influenced by the of lending,4 the percentage of female borrowers,5 other (micro) institutional factors6 such the personnel allocation ratio (percent of staff devoted to credit control), the quality of prudential regulation, the quality of technical assistance, operational self-sufficiency, financial intermediation and credit risk (portfolio at risk more than 30 days) and macroeconomic variables7 (GNI per capita rate and inflation) that may affect the ability of the MFI to recover loans.Following the Microfinance Information Exchange (MIX) Market definition, operational self-sufficiency is calculated as follows:. …