Competition and Microfinance

During the last ten years the number of microfinance institutions (MFIs) has remarkably increased, especially in areas within Central America, East Africa, and Bangladesh. Although many people state that competition between microfinance institutions can be positive for both the microfinance industry and for the poor, this paper highlights the negative consequences of a not controlled competition.

The main finding of this paper is that in monopolistic markets non-profit institutions seeking to maximise their credit reach into an area will achieve the same results whether or not grant funding is constrained to poor borrowers. Yet in competitive markets it is critical that grant funding be constrained to the poor.

The paper concludes by providing some relevant policy implications:

• Donors should provide grants exclusively for geographical expansion of MFI activity into poor and remote areas;
• Donors should reserve grants to institutions which offer contracts that are clearly non-competitive among "profitable" borrowers, such as certain kinds of joint liability arrangements where loan amounts are small and organisational costs are high;
• Centralised risk-management structures, such as credit bureaus, are required to identify default cases and monitor the outstanding loans.