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ABSTRACT
A rapidly growing Microfinance industry experiences a rising level of competition. While
competition is known to bring positive effects for customers, lower interest rates in the financial
industry, one cannot jump to a generally positive conclusion in Microfinance right away. While there
are certainly benefits arising, with more institutions offering more products, there are also negative
issues to consider. These adverse effects do not only affect the clients but also the organizations and
other stakeholders, ranging from deteriorating performance to customer over-indebtedness. This
paper will discus the most important findings about competition within the Microfinance industry
and pose some critical questions to consider.
IN T ROD U CT IO N
LIT ER A TU RE RE V IE W
By constructing a Lerner index, Assefa, Hermes and Meesters (2010) have found
empirical evidence that performance levels of MFIs differed significantly in high and low
competitive environments. The empirical investigation was based on 362 MFIs and 1247
observations in 73 countries, using data from the MIX market. The results showed that there
are adverse effects of competition for the MFIs. Overall, intense competition is negatively
associated with MFI performance, which was measured by outreach, efficiency, loan
repayment and profitability. With more MFIs entering the market, one would expect
outreach to be positively correlated with competition, meaning more people can be served
when competition increases. However, with rising default rates and falling profits the MFIs
prefer to stick with existing markets, where borrowers are considered safe and bring them
good return, thus lowering outreach. Other factors, which contribute to lower performance,
include information asymmetry, borrower over-indebtedness or changing clients behavior
(e.g. decreasing loan repayment); leading to a decline in efficiency and profitability of MFIs.
This calls for measures that ensure a minimization of the negative effects of competition
while still permitting growth within the industry. Assefa et al (2010) suggest that more
information sharing between MFIs, the elimination of information asymmetries and high
lending standards as well as efficient service provision are measures to address the problem
adequately.
Another research on the effect of competition on MFIs was made by Hermes, Lensink
& Meesters (2008). They examined the correlation between MFIs outreach and efficiency
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and uncovered a negative relationship. Their findings indicate that with a commercialization
of the industry, which more competition implies, MFIs become more concerned with their
financial efficiency. This in turn might cause them to turn their back on the poor and less
profitable customers. However, the study also shows that a more diversified portfolio of
products, such as savings and insurance compared to the traditional loans only, will be
offered, which is positive for clients.
Apart from performance problems another crucial consequence of competition on
MFIs deserves attention. With a market, that is reaching saturation, increasing competition
leads to lenders changing their behavior. MFIs try to maintain their customer base and
decrease their costs by lowering lending standards or decreasing screening efforts (Schicks
and Rosenberg, 2011). This results in higher risk borrowers and thus leads to a decline in
repayment and higher default rates. Furthermore, over-aggressive marketing such as
pressuring borrowers to take out a new loan after they have just paid off an old one adds to
the risk. Altogether, the changing behavior might trigger a very recent but severe
consequence - the rising risk of over-indebtedness.
So far we can conclude that the institutions themselves are generally worse of when
facing increased competition. Given the social objective of this industry it is however, much
more important to look at the borrower.
PART II: THE BORROWERS PERSPECTIVE
The rising level of competition implies a higher debt level among MFI clients, which
seems to have a direct impact on their economic and social wellbeing. In their explanatory
paper Schicks and Rosenberg (2011) examine conceptual issues and limited empirical
evidence about over-indebtedness in the microcredit market. They found that increasing
competition has adverse effects on clients and can eventually lead to borrower overindebtedness. There exist several definitions of over-indebtedness; in this context however,
we talk about over-indebtedness if borrowers have serious problems repaying their loans
(Schicks and Rosenberg 2011). This often implies a further impoverishment and increased
vulnerability of borrowers. There are several factors, which contribute to over-indebtedness.
First of all one has to acknowledge that clients do not always behave as fully rational homo
economics as assumed by classical economic theory (Rosenberg and Schicks 2011).
Behavioral economics (Kahnemann & Tversky 1979) has found that biases, such as an
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market, lenders will not be aware of the fact that their clients may be slipping into too much
debt, ultimately jeopardizing their financial health, but also putting the customer under more
strains. Therefore, the paper calls for optimized information sharing between lenders, maybe
even the establishment of credit bureaus. This must not only include la lista negra but also
la lista blanca, meaning not only the bad but also the good need to be monitored.
PART III: OTHER STAKEHOLDERS
We so far have been focusing on the two obvious and most important stakeholders,
which are directly influenced by rising competition. In this section we have picked out two
additional stakeholders from the microfinance stakeholder network, namely incumbent &
commercial banks and employees.
McIntosh, Janvry and Sadoulet (2005) found in their empirical research that increased
competition induces a decline in repayment performance and lower savings amounts
deposited with the incumbent Village Bank. For their analysis they used data from Ugandas
largest incumbent microfinance institution. They uncover that the entrance of competing
lenders does not affect incumbent lenders ability to attract new client nor does it cause them
to lose clients. However, with no formal information sharing mechanism, borrowers rather
take multiple loans than abandon the incumbent lender, which leads to a deterioration in
repayment performance and to a drop in savings for the incumbent village banks. The
authors stress the necessity of institutional information sharing on client indebtedness levels
in order to assess the risk of double dipping.
Moreover, employees play an important role, when facing wrong incentives they can
add to the problem. Bad staff incentives include the encouragement of over-lending, offering
wrong products, obscuring loan terms and the use of abusive collection practices (Schicks
and Rosenberg, 2011). However, if MFIs set the right incentives for employees and increase
the awareness of the problem of over-indebtedness through employee training, there is a
good chance that staff can actually help to minimize the problems which intense competition
brings along.
PART IV: POLICY IMPLICATIONS & CRITICAL QUESTIONS
There is one overwhelmingly clear fact presented in all of the papers examined - the
need for information sharing in the industry is great and increasing with the rise in
competition. Many call for a credit bureau that stores customers repayment history in a
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central database accessible for all lenders. One can ask whether this is the sole issue that
could increase the benefits of the industry for both its protagonists, lender and borrower.
Moreover, Vogelgesang (2003) shows that this can have the intended effect, but also
cautions about that move. In an empirical study the author takes a look at the Bolivian
market, which she calls one of the most saturated microfinance markets. According to her
study of Caja los Andes, the biggest MFI in the area, a higher level of competition also
implies multiple loans, but also more timely repayment. She attributes this to the reputation
effect as customers credit history is monitored. This shows the positive effect of credit
bureaus other studies call for. It could be an important starting point for a comprehensive
policy approach in the microfinance market. However, monitoring can also have adverse
effects itself. As a study by McIntosh, Sadoulet and de Janvry (2006) shows, the use of credit
bureaus leads to a negative selection process. While it has little effect on the existing
customer base, new customers are selected with a preference for the wealthier ones, leaving
the poorer customers on the sidelines. This is not what MF set out to achieve.
Certainly the increased adverse effects need more awareness. There might also be the
need to call on the growing industry to think back to its root goal: social advancement. More
lending is fine and making profits, too. But keeping the focus on the social goal might help
to make both parties better off.
We have to ask ourselves if these adverse effects are strong enough to cause concern?
We have already shown that borrowers can get into serious repayment trouble, causing them
to suffer. Future perspectives so far dont give any reason to be optimistic about
improvements of this critical situation. Rather, the opposite is the case, as the market reaches
saturation, the problems are becoming more severe. This calls for an intensification in
attention, research and resources on the issue.
The question in this context is not whether microcredit has negative consequences for
the borrowers, but whether the benefit of microcredit still outweighs its negative effects.
Expectations about what microcredit can achieve have become more modest lately (Schicks
and Rosengard, 2011) and thus influence the level of acceptance for negative effects. If
microcredit helps the poor to deal better with poverty rather than raising millions out of
poverty the tolerance for negative effects should be much smaller.
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CO N CLU S IO N
Overall, we can observe that the behavior of stakeholders plays a central role, as they
influence each others financial wellbeing and thus can cause a vicious circle of negative
effects.
BI BLI OG R A PH Y
and Performance of
Microfinance
Institutions
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