Discrimination in Microfinance: The Role of Credit Officers

This paper studies the effect of high incentives on credit officers' discriminatory practices. Using an agency model, the paper states that incentive contracts may help align the officer's behavior with the MFI's mission. MFIs face a trade-off between increasing outreach and fighting discrimination as such incentives are costly, and available budget is limited. The model assumes the same size of loans for all clients. The paper's model of discrimination might lead to the erroneous impression that discrimination disappears when the credit officer selects a poor client from the discriminated group over a less poor client from the favored group. This is incorrect, because the MFI wants to select as many very poor clients as possible but is blind to discrimination taking place within poverty classes. The paper finds that in equilibrium, a non-discriminating welfare-maximizing MFI may be better off paying its credit officers a smaller incentive and allowing discrimination to some extent. This raises the question of whether the MFI should complement its welfare optimization with a kind of equity requirement. Such an additional anti-discrimination constraint, however, might paradoxically make the MFI deviate from its mission.