Microfinance, Subsidies, and Dynamic Incentives

This paper analyzes the link between an MFIs lending policy and the interest rate a moneylender charges the less poor. The paper develops a two-period model of a credit market to study the interaction between a monopolistic moneylender and a subsidized MFI. It analyzes two cases - one where a moneylender has a monopoly over the credit market for two periods and is faced with an initial loss on first period lending operations, and another where an incumbent moneylender is joined by a subsidized MFI. The paper uses the dynamic model to examine key policy issues regarding subsidized lending and poverty alleviation. Study findings include:

• There is a positive relationship between the size of the subsidy and the degree of MFI outreach to the poor;
• As the subsidy increases, outreach widens, improving the expected payoff to the agent who applies for an MFI loan;
• Expanding outreach beyond a point distorts agents incentive to work and save, and lowers effectiveness of the MFIs policy with regard to poverty minimization;
• When MFI subsidy is small, a monopolist moneylender may actually want to have the MFI in the market.