Microfinance and Financial Sector Development

This paper analyzes whether development of the formal banking system in the MFI's host country is a significant determinant of MFI performance in terms of outreach and profitability.The study relates MFI performance to a number of variables that capture the development of the banking sector, using a panel dataset of 1,073 institutions over 10 years. The study finds that MFIs reach more clients and are more profitable where access to the formal financial system is low. Other findings include:

• MFIs respond to a need that banks do not fulfil, and flourish where the formal banking sector fails;
• MFIs are less profitable where interest rates are higher, demonstrating their dependence on banks for additional funding;
• MFIs are less profitable where inflation is high, suggesting that MFIs benefit from formal financial system stability.

Overall, the results show that the macroeconomic environment is crucial to MFI performance and outreach, and MFI impact is contingent on financial sector development.