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Credit risk of
What drives credit risk of microfinance
microfinance institutions? institutions
International evidence
Naima Lassoued
Ecole Superieure de Commerce de Tunis,
Received 8 March 2017
Université de la Manouba, Tunisia Revised 22 July 2017
Accepted 24 July 2017
Abstract
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Purpose – The purpose of this paper is to shed light on the factors that affect microfinance institutions’
(MFI) credit risk. These factors include MFIs’ characteristics and country-level indicators.
Design/methodology/approach – This empirical study uses an unbalanced panel data of 638 MFIs from
87 countries observed over a period ranging from 2005 to 2015. Random-effects models are used to estimate
the models.
Findings – The results reveal that group-lending methodology, percent of loan granted to women and
diversification activities reduce credit risk; credit quality is enhanced by the relevance of the information
published by public or private bureaus and law enforcement cost increases credit risk. Finally, credit risk
tends to be limited in a good institutional environment.
Practical implications – Several implications can be drawn in light of these findings. For MFIs’ managers,
using group lending or granting more credit to women and diversifying their activities enhance their credit
quality. Furthermore, authorities need to strength debt repayment institutions and reinforce institutional
environment to help MFIs to limit their credit risk.
Originality/value – Previous studies focus on specific MFIs’ practices that enhance repayment rate or on
country-level indicators. One of the contributions of this paper is the use of both types of indicators.
Keywords Risk management, Credit risk, Microfinance institutions, Debt enforcement
Paper type Research paper
1. Introduction
In order to boost for self-employment and income-generating projects, microfinance
provides financial services to low-income clients that are often excluded from traditional
banking services (Ledgerwood, 1999). It has grown in popularity since the success of the
Grameen Bank in Bangladesh in 1983. Indeed, the number of microfinance institutions
(hence denoted MFIs) was 618 in 1997 serving 13,478,797 borrowers throughout the
world[1]. By the end of 2012, the number of MFIs reached 3,713 institutions granting credits
to 203,509,307 borrowers. MFIs were promoted as an essential tool used by major
international organizations and major donors to fight poverty. It allows for the creation of
employment and income opportunities to increase productivity and income of vulnerable
groups. Therefore, it seems to be a tool that supplements the financial sector.
Despite the growth, success and popularity of microfinance, many MFIs are struggling to
achieve financial self-sufficiency. They mainly survive on grants given by various international
agencies (including the World Bank) because of their social role. In fact, the main problem for
these institutions is information asymmetry between lender and borrowers, especially in
underdeveloped market (Stiglitz, 1990). Indeed, unreliability of financial information and
absence of conventional collateral complicate the screening and the monitoring process of
borrowers. Moreover, because poor clients are too risky, MFIs tend to focus on this category
of customers as some commercial lenders are reluctant to lend for such highly risky groups
(Hulme and Mosley, 1996). To overcome this type of risk, many lending innovations have been
proposed. Among these, the group-lending practice is the most important instrument to International Journal of Managerial
Finance
address the problem of lack of collateral that group lenders are required to guarantee. © Emerald Publishing Limited
1743-9132
Furthermore, to maximize repayment rates, some MFIs award incrementally larger loans upon DOI 10.1108/IJMF-03-2017-0042
IJMF each successful repayment and deny defaulters access to future loans (Galema, 2011).
In addition to these practices, MFIs diversify their activities and do not focus uniquely on
granting loans to the poor. They shifted to savings and insurance services.
Like other financial institutions, MFIs are not safe from financial crisis as the subprime
crisis revealed the dangers of providing an increasing array of higher risk loans to higher
risk borrowers. Indeed, financial crises have exhausted capital suppliers and increased
over-indebtedness of micro-entrepreneurs. As a result, many of them failed or swarmed into
financial stress (Servin et al., 2012). Therefore, managing risks by identifying the factors and
practices that affect the payment default rate for MFIs seems to be a crucial step for them to
ensure financial sustainability while reaching their social goals. Accordingly, in this study,
we try to identify the determinants of credit risk for MFIs. Specifically, we consider two
different categories of determinants, MFIs’ characteristics (non-systematic) and economic
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D’Espallier et al. (2011) investigated a sample of 350 MFIs in 70 countries. The results
pointed out that more women borrowers are associated ceteris paribus with lower portfolio
risk, lower write-offs and lower credit-loss provisions.
Ayayi (2012) studied credit risk determinants in a selected group of Vietnamese MFIs
and East Asian and Pacific MFIs. The author found that while liquidity has a positive
impact, size of gross loan portfolio and operating inefficiency have a negative impact on
MFIs’ credit risk. Furthermore, the author showed that raising operational financial
sustainability is associated with an improved portfolio quality.
Another research line focused on the effect of country-level institutional and
macroeconomic data on MFIs’ risk. The idea is that the microfinance industry is subject to
strong cross-border influence from international capital providers and international
knowledge transfer (Mersland et al., 2011). This line of research bears on the work of
La Porta et al. (1998) who found that legal systems and creditor rights promote credit
markets. For instance, Djankov et al. (2007) found evidence indicating that law
enforcement quality, creditor rights and information sharing positively correlate with the
private credit to GDP ratio. Brown et al. (2009) found that information sharing correlates
with lower credit costs in transition countries and that this correlation is stronger in
countries with poor legal systems.
Among the few authors who focused on MFIs, we mention Gonzalez (2007)
who examined whether changes in GDP per capita significantly affect MFIs’ portfolio
risk (30-day and 90-day portfolio risk, loan loss rate and write-off ratio). The author
examined a sample of 639 MFIs in 88 countries observed during 1999-2006. He found no
evidence for a relationship between MFIs’ asset quality and growth. An exception was for a
30-day portfolio risk, where a statistically significant relationship was found. These tests
indicate that microfinance portfolios are highly resilient to economic shocks.
Krauss and Walter (2009) examined microfinance systemic risk using annual data of
325 MFIs operating in 66 emerging markets during 1998-2006. The studied MFIs did not
show any risk exposure to international capital markets. When exposed to GDP, these
MFIs display highly significant correlation indicating that MFIs are not detached from
their respective domestic economies.
Finally, Galema (2011) explored the effect of creditor rights, information sharing and
law enforcement quality on MFIs’ risk taking. The author found that contract enforcement
days negatively correlate with MFIs’ risk taking while in countries with strong creditor
rights contract enforcement days reduce MFIs’ risk taking. In addition, the author found
that only unregulated and nonprofit MFIs take less risk as a result of longer contract
enforcement procedures.
Overall, previous research focused on the effect of specific MFIs’ practices, especially
group lending and gender diversity, on repayment rates, performance (e.g. Morduch, 1999;
D’Espallier et al., 2011) and credit risk (PAR_30) (Crabb and Keller, 2006). Specifically, the
IJMF latter study investigated only the effect of gender diversity, loan size and group lending on
credit risk in a small sample of 37 MFIs. We extend this study in three ways: first, we
add other MFIs’ practices likely to affect credit risks like savings, insurance services and
non-interest income activities. Second, we introduce a set of country-specific variables
representing debt enforcement that could determine credit risk. Third, we use a more
representative sample in view of generating representative findings. Moreover, the second
strand of literature which examined the effect of country-specific indicators on MFIs’ risk
focused on a single pre-subprime crisis (e.g. Gonzalez, 2007; Galema, 2011). Unlike these
studies, we used a sample that covers a more recent period spanning from 2005 to 2015.
3. Research hypotheses
3.1 MFIs’ characteristics
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3.1.1 Group lending. The group-lending methodology seems to be a key innovation that
expanded the poor’s access to credit in developing countries (Morduch, 1999). This
contracting instrument is likely to mitigate the risks associated with information
asymmetry. Indeed, group borrowers are related by a joint liability, when one of them
switches to risky projects (moral hazard), the probability that their associates will have to
pay the liability increases. Thus, group members are encouraged to screen other clients
(Madajewicz, 2011). However, other line of research argues that group lending may generate
additional costs like group contracting costs, training borrowers on group procedures,
higher degree of supervision and a higher frequency of installments. These costs increase
interest rates of such microcredit loans leading to higher repayment risks (Savita, 2007).
Despite the aforementioned disadvantages of the group-lending methodology, we expect
that it will negatively affect credit risk:
H1a. Group lending negatively affects credit risk.
3.1.2 Severe repayment monitoring. Microfinance practitioners impose regular repayment
deadlines in order to maintain high repayment rates in the absence of collateral.
This monitoring takes place on a weekly or a monthly basis (Armendariz de Aghion
and Morduch, 2000). According to Morduch (1999), this mechanism has many advantages.
First, it excludes undisciplined borrowers at an early stage before accumulation
of their unpaid debt. Second, severe repayment monitoring may guarantee the bank a
minimum level of liquidity. Third, MFIs that use this practice target a specific customer
category with an additional good-standing income since the repayment process begins
before their investments generate returns. We expect that this tool negatively affects
credit risk. Then, in light of this discussion, we expect that severe repayment monitoring
inhibits credit risk:
H1b. Severe repayment monitoring negatively affects credit risk.
3.1.3 Savings requirement. Savings is perceived as financial collateral provided by
borrowers to secure a loan. Indeed, many MFIs ask borrowers for savings to be qualified for
a loan (Armendáriz de Aghion and Morduch, 2010). Morduch (1999) argues that some MFIs
require deposits to reinforce contracts and these funds serve as insurance against loan
default, death or disability. Similarly, Tchakoute-Tchuigoua (2014) point out that many
MFIs ask from borrowers to pay an additional percent of the contracted loan. These
contributions are usually deduced from the contractors’ loans in addition to loan
amortization and thus are forced to deposit savings. These imposed savings can be
withdrawn upon loan maturity, but only after MFIs recover their debts. We expect savings
requirement to decrease credit risk:
H1c. Savings requirement negatively affects credit risk.
3.1.4 Insurance. Insurance consists in collecting relatively small premiums from a customer Credit risk of
and funding relatively large payouts to the small portion of that population that suffers microfinance
losses from a specific risky event. It can provide low-income households a greater degree of
protection against property, death, health and disability risks. In fact, this population
institutions
category is highly vulnerable to these risks. In case of an event, loss will be covered by a
large number of people, at a much lower cost or premium per person (Kumar and Qazi,
2016). Therefore, insurance could be an effective tool allowing for alleviating credit risk of
vulnerable borrowers. Therefore, a negative relationship between credit risk and insurance
is expected:
H1d. Insurance negatively affects credit risk.
3.1.5 Gender diversity. Empowering women is an important aspect of microfinance since
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women face peculiar barriers that men do not face. Compared to men, women were found to
display better debt repayment performances (Yunus, 1999). Many arguments are given
to explain this better recovery rate for woman than for men. First, women are highly
aversive to risk than men (Croson and Gneezy, 2009). They are likely to choose relatively
less risky projects (Sharma and Zeller, 1997). Second, they generally enjoy hard work ethics
and financial discipline (Bhatt and Tang, 2002). Third, women depend more on MFIs since
they have fewer opportunities to escape poverty in developing countries as they have
limited access to education and are committed to their families and communities. This latter
limitation impedes their ability to take advantage of potential educational or professional
opportunities elsewhere (Boehe and Cruz, 2013). Despite the shared agreement on the high
repayment rate of women borrowers, some authors call into question this relationship.
For instance, Crabb and Keller (2006) argue that lack of access to capital for women induces
greater risk. For Phillips and Bhatia-Panthaki (2007), women have less access to funding
than men; therefore, they tend to invest in traditional projects that are not profitable or
competitive, enabling them to repay their loans at the due date.
We expect that female loan percentage has a negative effect on credit risk:
H1e. The percent of women borrowers negatively affects credit risk.
3.1.6 Income diversification. Theoretically, like other financial institutions, MFIs shift
toward non-interest income to compensate for their shortfall in interest margins on
lending activities. Then, they rely on alternative income types other than interest-based
income. We expect that for well-diversified financial institutions, where non-interest
income is important, credit risk should be lower than for less-diversified financial
institutions. Indeed, MFIs may charge lower rates on loans if they will gain additional fees
from borrowers. Moreover, MFIs have an information advantage about their borrowers
thanks to additional services.
Accordingly, we formulate the following hypothesis:
H1f. Income diversification negatively affects credit risk.
credit risk:
H2b. Creditor rights negatively affect credit risk.
3.2.3 Information sharing. In economies where information asymmetry is high, lenders are
not able to evaluate borrowers’ true credit quality, thus adverse selection problems will
increase. Therefore, the existence of public or private credit agencies contributes to secure
defaulting borrowers, since adverse selection problems are mitigated. Jappelli and Pagano
(2002) and Padilla and Pagano (2000) argue that credit agencies may act as a borrowing
disciplinary device since borrowers will be more cautious about their repayment records if
lenders share their information on defaulting customers. In addition, information sharing
helps to reduce operating costs, including the cost of screening potential borrowers ex ante
and that of monitoring existing credit contracts. Hence, lending quality is improved by
ex ante mitigating adverse selection of loan contracts and mitigating moral hazard during
loan contracts (Zhao et al., 2011).This leads to the following hypothesis:
H2c. Information sharing negatively affects credit risk.
3.2.4 Governance quality. The governance index describes the legal and judicial framework
as compiled by Kaufmann et al., 2010). The index includes the following six sub-indices:
voice and accountability, political instability and violence, government efficiency,
regulatory quality, rule of law and corruption control. According to Godlewski (2004),
an inadequate regulatory and supervisory regime and a weak legal and institutional
framework characterized by bureaucracy and political instability negatively affect crediting
banks. Indeed, such a context reduces the efficiency of regulation. Moreover, many studies
explain that in emerging markets weak legal, institutional and supervisory devices hinder
either the process of granting credits or the process of loan control and recovery later.
Therefore, we expect that well-functioning institutions and good governance decrease MFIs’
credit risk. Hence, our last hypothesis is as follows:
H2d. Good governance quality negatively affects credit risk.
To examine determinants of MFI, credit risk, we estimate the following regression models
using the following general form:
PAR_30ijt ¼ b0 þ b1 GR_LENDijt þb2 REP_SHCijt þb3 SAV_DUMijt
þb4 INS_DUMijt þb5 WOM_BORijt þb6 DIVERijt
þb7 LAW_ENFijt þb8 CRED_RIGHijt þb9 INF_SHARijt
þb10 GOV_INDijt þControl variablesijt þeijt (1)
Credit risk is modeled as a function of various MFIs and country-specific factors and
i denotes MFI, t time period and j country.Where PAR_30 is the Portfolio at Risk30;
GR_LEND the group lending; REP_SHC the severe repayment evaluation; SAV_DUM the
savings; INS_DUM the insurance; WOM_BOR the women borrowers; DIVER the income
diversification; LAW_ENF the law enforcement cost; CRED_RIGH the creditor rights index;
INF_SHAR the information sharing; and GOV_IND the governance index.
Bearing on the literature on credit risk (e.g. Crabb and Keller, 2006; Gonzalez, 2007;
Krauss and Walter, 2009; D’Espallier et al., 2011; Galema, 2011), we include the following
control variables.
Capital adequacy ratio. MFIs often maintain a minimum level of capital required to meet
financial obligations and address unexpected losses. However, according to the moral
hazard hypothesis (Berger and DeYoung, 1997), highly capitalized MFIs generally grant
riskier loans. Therefore, the sign of the relationship between the capital adequacy ratio and
credit risk is expected to be positive or negative.
Size. We expect that size negatively correlates with credit risk because larger MFIs are
more diversified and likely to be more experienced to grant a wider variety of loans and deal
appropriately with defaulting borrowers.
Profitability. We suggest that it negatively affects credit risk. Indeed, profitable MFIs are
less pressured to generate income and thus less constrained to engage in risky credit
offerings. However, unprofitable MFIs are constrained to engage in more uncertain credits
to sustain their profitability.
Outstanding loans. A significant portion of outstanding loans in MFIs’ total assets
increases MFIs’ default risk. Since financial risk increases with leverage, a positive relationship
between a banking firm’s risk and leverage is expected (Tchakoute-Tchuigoua, 2015).
Outreach measured by average loan size. We expect a positive effect of outreach on credit
risk because for an individual MFI borrower, it is difficult to reimburse excessive high
amounts (Gool et al., 2011).
GDP growth. We include GDP growth to control for the macroeconomic cycle. During
periods of economic expansion, higher income is generated and borrowers’ repayment
capacity is improved, thus reducing credit risk. Conversely, during recession periods, level
IJMF Panel A: Africa
Angola 1 0.16%
Benin 9 1.41%
Burkina Faso 12 1.88%
Burundi 7 1.10%
Cameroon 12 1.88%
Chad 2 0.31%
Congo 6 0.94%
Cote d’Ivoire 5 0.78%
Ethiopia 3 0.47%
The Gambia 2 0.31%
Ghana 11 1.72%
Kenya 9 1.41%
Mozambique 6 0.94%
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Namibia 1 0.16%
Niger 7 1.10%
Nigeria 11 1.72%
Rwanda 3 0.47%
Senegal 7 1.10%
Sierra Leone 3 0.47%
South Africa 5 0.78%
Sudan 1 0.16%
Tanzania 7 1.10%
Togo 4 0.63%
Uganda 10 1.57%
Zambia 4 0.63%
Zimbabwe 1 0.16%
Total 149 23.35%
Panel B: East Asia and the Pacific
Indonesia 5 0.78%
Vietnam 12 1.88%
Philippines 14 2.19%
Cambodia 17 2.66%
China 10 1.57%
Papua 2 0.31%
Samoa 1 0.16%
Tonga 1 0.16%
Total 62 9.72%
Panel C: Eastern Europe and Central Asia
Albania 5 0.78%
Armenia 6 0.94%
Azerbaijan 17 2.66%
Bosnia and Herzegovina 6 0.94%
Bulgaria 8 1.25%
Georgia 9 1.41%
Kazakhstan 8 1.25%
Kosovo 6 0.94%
Kyrgyzstan 3 0.47%
Moldova 3 0.47%
Mongolia 7 1.10%
Montenegro 3 0.47%
Romania 6 0.94%
Russia 10 1.57%
Tajikistan 11 1.72%
Table I.
Sample distribution (continued )
Turkey 3 0.47%
Credit risk of
Ukraine 2 0.31% microfinance
Total 113 17.71% institutions
Panel D: Latin America and The Caribbean
Argentina 10 1.57%
Belize 1 0.16%
Bolivia 8 1.25%
Brazil 12 1.88%
Chile 5 0.78%
Colombia 13 2.04%
Costa Rica 9 1.41%
Dominican Republic 7 1.10%
Ecuador 13 2.04%
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El Salvador 14 2.19%
Guatemala 11 1.72%
Guyana 1 0.16%
Haiti 3 0.47%
Honduras 20 3.13%
Jamaica 5 0.78%
Mexico 21 3.29%
Nicaragua 17 2.66%
Panama 2 0.31%
Paraguay 6 0.94%
Peru 17 2.66%
Suriname 1 0.16%
Uruguay 1 0.16%
Venezuela 2 0.31%
Total 199 31.19%
Panel E: MENA region
Egypt 4 0.63%
Jordan 4 0.63%
Lebanon 3 0.47%
Morocco 6 0.94%
Tunisia 1 0.16%
Total 18 2.82%
Panel F: South Asia
Afghanistan 11 1.72%
Bangladesh 15 2.35%
Bhutan 1 0.16%
India 10 1.57%
Nepal 12 1.88%
Pakistan 30 4.70%
Sri Lanka 18 2.82%
Total 97 15.20% Table I.
coefficients are adjusted for cluster effects at country level as suggested by Peterson (2009).
Predicted
Variables Abbreviation Description sign
MFI-level data
Portfolio at Risk30 PAR_30 Outstanding balance. Loans overdue W 30 days/gross
loan portfolio
Portfolio at Risk90 PAR_90 Outstanding balance. Loans overdue W 90 days/gross
loan portfolio
Provision for Loan LLP Provision for loan impairment/assets
Impairment
WOR WOR Value of loans written off during period/average gross
loan portfolio
Group lending GR_LEND Dummy variable equal to 1 if the MFI uses group lending −
and 0 otherwise
Severe repayment REP_SHC Dummy variable equal to 1 if the MFI uses robust −
evaluation repayment evaluation and 0 otherwise
Saving SAV_DUM Dummy variable equal to 1 if the MFI accepts deposits −
and 0 otherwise
Insurance INS_DUM Dummy variable equal to 1 if the MFI accepts insurance −
and 0 otherwise
Women borrowers WOM_BOR Percentage of borrowers who are women −
Capital adequacy ratio CAP_ADQ Equity/total assets −/+
Size SIZE Natural logarithm of total assets −
Diversification DIVER Non-interest income to total income −
Profitability PROF Return on asset ratio −
Loan portfolio OUTS_LOAN Outstanding loan portfolio/total assets +
Outreach OUTREACH Natural logarithm of average loan balance per borrower +
Country-level data
Quality of law LAW_ENF Contract enforcement costs +
enforcement
Creditor rights index CRED_RIGH The strength of the legal rights index measures the −
degree to which collateral and bankruptcy laws protect
borrower and lender rights and thus facilitate lending
Information sharing INF_SHAR Dummy variable equals 1 if a public credit registry or a −
private credit bureau exists and zero otherwise
Governance index GOV_IND Governance index from Kaufmann et al. (2010) −
GDP growth GDP_GR Growth rate of gross domestic product on annual basis −
Inflation INFLATION Inflation rate (in percentage terms) +
Table II. Interest rate INT_RATE Real interest rate is the lending interest rate adjusted +
Variables description for inflation
5. Results Credit risk of
5.1 Descriptive statistics microfinance
Table III presents summary statistics for all variables. As we can see, the mean of PAR_30 institutions
is 0.058. It seems that loan portfolio in our sample is healthy and close to the average
reported by previous studies (Galema, 2011; Tchakoute-Tchuigoua, 2015).
For risk management indicators, we found that 17.4 percent of MFIs employ the
group-lending methodology. Most MFIs of our sample (86.1 percent) use repayment
schedules, 58.2 percent of MFIs offer their customers savings services and 44.6 percent
offer insurance services. It is worth to note is that 64.6 percent of borrowers are women.
This finding confirms that MFIs’ lending often targets women more than men (Crabb and
Keller, 2006). As for diversification, we found that non-interest income represents,
on average, 3 percent of income, suggesting that MFIs’ activities are highly focused
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on lending.
The mean of the capital adequacy ratio is 0.321, indicating that MFIs maintain a level of
capital adequacy ratio above the minimum required in most countries. Moreover,
outstanding loans represent on average 75 percent of assets. Average profitability is 0.014
with a minimum of −0.161 percent and a maximum of 0.117.
Looking at the country-level variable, 88.9 percent of MFIs operate in countries
with an information-sharing agency. Average contract enforcement costs are
38.9 percent of claims. Galema (2011) reports a mean of 36.1 percent. This implies that
for a debt contract of $1,000, for instance, the creditor pays on average $389 in
enforcement costs.
The creditor rights index is 0.409 indicating that MFIs operate in countries with lower
creditor protection rights. In addition, the governance index indicates a weak legal and
institutional frameworks as the mean is 0.400, less than 0.5
For the economic context, we found that GDP growth in particular presents a
high disparity across countries with a minimum of 0.158 percent and a maximum of
compared to individual lending. This finding confirms H1a, suggesting that the group-
lending practice alleviates information asymmetry (Madajewicz, 2011) and moral hazard
risks (Kono and Takahashi, 2010). More specifically, the probability that group members
will have to pay the liability increases when one of them switches from safe to risky projects.
Therefore, group members are incited to monitor each other. This finding confirms previous
results in different contexts. For instance, Crabb and Keller (2006) report a negative effect of
group lending on PAR_30 in a sample of 37 MFIs, using quarterly data. Others show that
group lending improves repayment rates (e.g. Zeller, 1998).
The coefficient of WOM_BOR is negative and statistically significant at the 1 percent
level. This result is in line with H1e, assuming that women have less credit risk compared to
men. This finding can be explained by the dependence of women to MFIs. In fact, women
have fewer opportunities to escape poverty in developing countries as they have limited
access to education and are committed to their families and communities, which impedes
their ability to take advantage of potential educational or professional opportunities
elsewhere (Boehe and Cruz, 2013). Our result supports the findings of many studies
2009) and out of the crisis period. The results, displayed in Table V, show that during the
crisis (model (1)) country-level indicators seem to matter more than MFIs’ characteristics.
For the formers, we found that only the coefficient of SAV_DUM is statistically significant
with a negative sign (at the 1 percent level) suggesting that savings can be an effective risk
management tool to face the crisis. More specifically, when borrowers are unable to pay
their debt, MFIs use savings to compensate the due debt amount.
Turning to country-level variables, we found that the coefficient of INF_SHAR is
negative and significant in accordance with our previous findings reported in Table IV.
Furthermore, the coefficient of CRED_RIGH is positive and statistically significant at the 5
percent level, implying that during the crisis period stronger creditor rights lead to higher
credit risk. In fact, creditor protection encourages MFIs to take more risk by lending
customers with financial difficulties, which are amplified by the crisis.
Model (2) displays the results estimated by excluding the crisis years. We confirm
our previous estimation for the baseline model (Table IV ). In fact, we found the same
significant coefficients.
Second, we test whether credit risk determinants differ by legal status. In fact,
shareholders or investors of profit MFIs want to maximize returns while shareholders or
donors in nonprofit MFIs want to further the institution’s social goals. In both cases, MFIs
should manage their risk in a sustainable way.
We also rerun our model for regulated and unregulated MFIs since regulated MFIs are
usually subject to capital regulations, reducing owners’ risk taking by forcing them to invest
more capital (Kim and Santomero, 1994).
Our results, displayed in Table VII, indicate that profit and nonprofit MFIs have
approximately the same specific determinants; GR_LEN and WOM_BOR matter for both
groups. However, the coefficient of DIVER is negative and significant for profit MFIs,
suggesting that the former reduce their risk by using non-interest income activities. As for
the nonprofit group, the coefficient of outreach is negative and significant indicating that
credit amounts decrease credit risk. This finding implies that nonprofit MFIs could reduce
credit risk by lending large amounts to safer borrowers.
As for the country-level indicator, we found that only the coefficient of LAW_ENF is
significant for profit MFIs. For nonprofit MFIs, the country-level indicator seems to be more
relevant. Indeed, information sharing (INF_SHAR) and institutional environment
(GOV_IND) decrease risk, though creditor rights (CRED_RIGH) increase credit risk.
In light of these findings, it seems that credit risk for nonprofit MFIs depends more on
economic and institutional factors since these institutions have mainly social goals.
Columns (3) and (4) display the results for regulated and unregulated MFIs. It seems
that regulated and profit MFIs (nonprofit and unregulated) have the same determinants.
This similarity seems logical since according to Cull et al. (2011) nonprofit MFIs are in
general unregulated.
6. Conclusion
A large literature looking at cross-country development highlights the importance of MFIs
in alleviating poverty. Because of their importance, there is widespread interest in
understanding the factors that affect MFIs’ risk management. At the same time, the recent
financial crisis has revived interest in how the institutional and regulatory environment
affect credit risk. In this regard, the purpose of this paper is to explore the main
determinants of credit risk in MFIs around the world. In addition to specific factors, we
considered institutional variables as determinants of credit risk allowing for a more
comprehensible view of how to manage credit risk.
Examining a sample of 638 MFIs from 87 countries over the 2005-2015 period, we found
that the group-lending methodology, percent of loan granted to women and diversification
activities are the important MFI features that reduce credit risk.
Furthermore, for the country-level indicators, we found that information published by
public or private agencies affects, while law enforcement cost increases it. Our results
indicate that credit risk also tends to be limited in a good institutional environment.
These findings are found to be robust during and out of the crisis period and using several Credit risk of
sensitivity tests. microfinance
Several implications can be drawn in light of these findings. MFIs’ managers should not institutions
fear to use the group-lending methodology or to grant more credits to women. Moreover,
they should diversify their activities by entering into new business lines to reduce risk.
The results send strong signals about the role of institutional quality in limiting credit
risk of MFIs. It is obvious that strengthening debt enforcement institutions is crucially
needed in order to enable MFIs to limit their credit risk. Therefore, authorities need to
encourage setting up credit agencies, if they do not exist and find adequate solutions
to reduce enforcement costs. Finally, a prerequisite seems to be a strong institutional
environment that helps MFIs to limit their credit risk.
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Notes
1. www.microworld.org
2. Correlation matrix is not reported because of space constraints.
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Corresponding author
Naima Lassoued can be contacted at: naima.lassoued@sesame.com.tn
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