Microfinance, country governance, and the global financial crisis

Abstract

This study examines the influence of country institutional and governance characteristics on the performance of microfinance institutions (MFIs) during the global financial crisis of 2008–2009. Using a dataset of 364 MFIs from 47 countries during the 2004–2011 period, we investigate whether MFIs operating in environments characterized by higher institutional quality were more resilient to the effects of the global crisis. We find that microfinance performance is positively related to institutional country characteristics and that MFIs located in countries with stronger governance are less severely impacted by the global financial crisis. Also, our results show that the influence of country governance on microfinance performance is prevalent across MFIs subject to different degrees of regulation and with different individual characteristics. Our objective is to contribute to the body of research that attempts to identify the country institutional characteristics that influence how severely financial institutions are impacted by financial crises. This analysis, which to our knowledge, is the first attempt for the microfinance industry, is particularly relevant since the negative effects of financial and economic shocks are specially felt by the low-income individuals that MFIs serve.

Keywords::

• microfinance institutions
• financial crisis
• country governance
• performance

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

^1. United Nations 2006, “Building inclusive financial sectors for development”, New York.

^2. See, for example, Kirkpatrick (2009) for an explanation of the failures in the governance of financial institutions that led to the 2008–2009 global financial crisis. Erkens, Hung, and Matos (2012) also relate weaknesses in the governance of traditional financial institutions to the last financial crisis.

^3. North (1990) defines institutions as “the rules of the game of society”. Institutions are designed to reduce uncertainty and achieve efficient outcomes.

^4. A financial crisis may affect MFIs and their clients through multiple venues. During a liquidity crisis, MFIs experience limited access to funds and increased funding costs. Consequently, both lending growth and profitability are negatively affected. In addition, the economic slowdown deteriorates the ability of clients to repay their loans, affecting microfinance asset quality and sustainability. Microentrepreneurs’ vulnerability may also decrease their demand for new loans and, consequently, their incentive to repay the current ones, further impacting the portfolio growth, asset quality, and ability to cover costs of MFIs.

^5. See, for instance, Hartarska 2005; Hartarska and Nadolnyak 2007; Mersland and Øystein strøm 2009; Ahlin, Lin, and Maio 2010; among others.

^6. Haussmann tests results indicate we cannot estimate our regression model using MFI random effects.

^7. The WGI are one of the most widely used indicators of country governance among policy makers, academics, and foreign aid donors. They cover over 200 countries since 1996 and rely on individual sources of data that are aggregated using an unobserved components model to construct six dimensions of governance. The WGI are described in detail in a series of papers including Kaufman, Kraay, and Mastruzzi (2004, 2006, 2010), among others.

^8. The low levels of confidence that characterized global financial markets during the second half of our sample period, 2008–2011, together with the gradual integration of microfinance into the global financial system may explain the stronger influence of country governance on microfinance that we find, compared to Ahlin, Lin, and Maio's (2010) study, which is based on an earlier period.

^9. Results are not tabulated to conserve space but are available from the authors upon request.