How Rising Competition among Microfinance Lenders Affects Incumbent Village Banks

This paper uses data from Uganda's largest incumbent microfinance institution (MFI) to analyze the impact of entry by competing leaders on client behavior. The paper:

• Exploits the interactions between MFIs in Uganda to analyze how borrowers respond to competition between different kinds of lenders;
• Reviews major theoretical predictions found in the literature, and develops four hypotheses explaining client behavior;
• Performs the following three different, but related analyses. It examines:
  • The determinants of lender location decisions, to gain an understanding of the market segments occupied by different kinds of lenders;
  • The effect of competition on group performance in the incumbent MFI;
  • The differential effects of competition from various kinds of lenders on individual clients with specific characteristics.

The paper finds that:

• Competition in the country is recent and predominantly urban;
• Placement decisions are strongly affected by district-level characteristics;
• Increased competition induces a decline in repayment performance and in savings deposited with the incumbent "Village Bank", suggesting multiple loan-taking by clients;
• Individuals who operate larger businesses are the ones more likely to leave the incumbent "Village Bank", when a solidarity group lender enters the marketplace;
• There is no formal information sharing mechanism about clients' credit histories;
• Competition does not affect client enrolment rate, dropout rate or loan volumes.

The paper concludes that improved mechanisms for sharing information on client indebtedness levels should be able to overcome problems associated with improper assessment of risk under multiple loan-taking.