Microfinance: the impact of institutional environment in Latin America and South Asia
Creators: name: Yeoh, Yin Huey
Publisher: name: RMIT University
Year: 2024
Subjects: classificationCode: 380199
subject: Applied economics not elsewhere classified
classificationCode: 380202
subject: Econometric and statistical methods

description: In recent years, microfinance has grown drastically. In emerging economies, microfinance institutions (MFIs) are used to provide financial services to the poor that have been deemed “unbankable” by the traditional banks. The emergence of the microfinance industry is seen as an answer to an unmet demand by the relevant literature (see, among others, Robinson, 2001; Littlefield and Rosenberg, 2004), but MFIs have not evolved equally everywhere. During their development, MFIs have experienced different fates; some have expanded while others have ceased to exist. But what explains this disparity?<br><br>To explain these regional differences, many scholars have focused on investigating the relationship between MFIs’ performance and changes in the macroeconomy together with the institutional environment of the country MFIs operate. According to Vanroose (2006), the environment in which MFIs operate plays a vital role in these cross country differences. Despite this, in the literature not much attention has been paid to the relationship between the microfinance sector and its environment.<br><br>To fill this gap, this study intends to contribute to the current state of knowledge by empirically investigating the relationship between institutional environment and the performance of MFIs, by comparing South Asia and Latin America. In doing so, this study aims to analyse: (1) Does institutional environment matter for the performance of MFIs in South Asia and Latin America? Do MFIs perform better in the context of well-developed institutions? (2) What are the differences between the performance of MFI in South Asia and Latin America?<br><br>These questions are addressed by employing a two stage least squares (2SLS) regression. The dataset of this study consists of 20 countries and 373 MFIs containing financial performance, outreach, institutional environment variables and macroeconomic indicators of Latin America and South Asia from 1996 – 2014. The robustness of the models is also tested with different variables from various studies.<br><br>One of the key findings is that MFIs in South Asia and Latin America service different clientele, in line with the findings of the previous literature. Specifically, MFIs in South Asia serve poorer clients while MFIs in Latin America attend to richer clients. In addition, it is also observed that microfinance industry is experiencing mission drift0F[1] where some of the MFIs are seen to be gradually giving out larger loans1F[2].<br><br>The main estimations further indicate that institutional environment of the host economy plays a role in the performance of MFIs such that regulations deter MFIs from accomplishing their responsibility as banking for the poor. However, the impact of institutional environment is different for each region. In South Asia, well-developed institutions negatively affect the performance of MFIs. On the other hand, the results suggest MFIs in Latin America is no different than commercial banks. In particular, MFIs in Latin America suffer from weak enhancement of rule of law and political instability. The results also disclose that corruption makes it tougher for MFIs in Latin America to maintain sustainability and profitability.<br><br>These evidences then may help governments in South Asia and Latin America to undergo institutional reforms to support the development of microfinance industry. In conclusion, microfinance industry in both regions appears to perform better in a non-regulated environment, implying that it could be better for governments to deregulate the sector.<br><br><br>[1] Mission drift in microfinance refers to the phenomenon where an MFI increases its average loan size by reaching out to unbanked wealthier customers while crowding out the core poor (Armendáriz and Szafarz, 2009).<br><br>[2] Larger loans is an indication that an MFI has moved into new customer segments in the pursuit of profitability because it targets richer communities that have the ability to take on larger loans.