Small-scale lending to the poor and previously unbankable is a booming
industry, and there is now a proliferation of these ‘microfinance’ institutions
and growing competition between them. According to research by Professors
Craig McIntosh, Alain de Janvry and Elisabeth Sadoulet, published in the
October 2005 issue of the Economic Journal, this has not led to catastrophic
increases in defaults or wholesale market meltdown as many have feared.
With 2005 designated as the International Year of Microcredit by the United
Nations, increasing focus is being put on generating hard evidence as to how
microfinance institutions operate. The tremendous success of the
microfinance revolution over the past decade has led to a proliferation of
lending to those who were previously considered unbankable. As pro-poor
lending institutions have multiplied, competition in these markets has
correspondingly intensified.
Because this kind of lending is done without formal collateral, several authors
have suggested that these markets will be prone to catastrophic increases in
defaults once borrowers face numerous potential lenders. But the extent to
which borrowers can take advantage of a multiplicity of lenders depends on
the extent to which lenders share information about clients. To date, very little
empirical evidence has been presented to help us understand how such
lenders interact in competitive marketplaces.
This study uses data from Uganda’s largest incumbent microfinance institution
to analyse the impact of entry by competing lenders on the behaviour of
clients who were already taking loans from the incumbent. The researchers
find that:
• The entry of competing lenders induces a deterioration in repayment
performance and a decrease in savings deposits among borrowers of
the incumbent lender. This is consistent with a model of competition
whereby clients do not abandon the incumbent but rather take multiple
loans, thus damaging their repayments to the incumbent.
• Because mandatory savings and minimum savings balances are
standard among microfinance institutions, clients who take multiple
loans are forced to share their scarce savings among the institutions
from which they borrow, reducing their level of savings with the
incumbent.
• Strikingly, there is no change in the dropout rate or the client enrolment
rate when competitors enter the market. Similarly, loan volumes do not
change under competition. This appears to disqualify theories that
predict a rapid movement of clients from one lender to another when
multiple lenders are present.
• So-called ‘village banking’ institutions, which focus on poorer clients by
using larger lending groups, are most vulnerable to competition from
institutions that use a lending methodology with smaller loans that
targets wealthier clients, thus cherry-picking from the village banking
institution.
• Interestingly, borrowers with large businesses and high cash flows are
the most likely to leave the incumbent as new lenders enter. While it is
likely that some of this comes from the demand side, it implies that new
lenders are able to identify the most promising existing clients and
target them selectively.
• Despite the absence of any formal mechanism for information sharing
in Uganda (indeed, the country lacks the individual identification
numbers necessary to set up such a mechanism), lenders are able to
share enough information on clients to prevent a wholesale meltdown
under competition.
• This is not altogether surprising, as credit officers from different
organisations are known to meet informally to discuss the performance
of clients in their neighbourhoods. But the evidence of people taking
multiple loans implies that existing informal information sharing
networks are not able to overcome the problem of identifying a
borrower’s total outstanding indebtedness.
• Interestingly, clients in districts with higher levels of education behave
as if local information sharing were better. Asymmetric positive
information, then, may present a problem that requires a more formal
mechanism for information sharing than now exists in the country, such
as a credit bureau.
Subsequent research being conducted by the authors in Guatemala has
confirmed the substantial improvements in performance under competition
that can arise when microfinance institutions use credit bureaus. The
country’s Crediref Bureau, implemented in 2002, has led to reductions of
default and missed payments of over 25% from their pre-bureau levels.
ENDS
Notes for editors: ‘How Rising Competition among Microfinance Institutions
Affects Incumbent Lenders’ by Craig McIntosh, Alain de Janvry and Elisabeth
Sadoulet is published in the October 2005 issue of the Economic Journal.
Craig McIntosh is at the University of California, San Diego. Alain de Janvry
and Elisabeth Sadoulet are at the University of California, Berkeley.
For further information: contact Craig McIntosh on +1-858-822-1125 (email:
ctmcintosh@ucsd.edu); or RES Media Consultant Romesh Vaitilingam on
0117-983-9770 or 07768-661095 (email: romesh@compuserve.com).