Banks and Microbanks

This paper examines the effects of competition on MFI profitability and outreach. It tests whether the presence of formal, regulated financial service providers in an economy affects the profitability and outreach of financial institutions that target the under-banked and unbanked.Microfinance banks (microbanks) target low-income communities, and most make loans without requiring collateral. The study finds evidence that competition matters. Results indicate that:

• Greater bank penetration in the overall economy is associated with microbanks pushing toward poorer markets;
• Trend of microbanks pushing towards poorer markets is reflected in smaller average loans sizes and greater outreach to women;
• Strong evidence indicates that microbanks are relying on commercial funding and using traditional bilateral lending contracts, rather than group lending methods.

The analysis considers plausible alternative explanations for the correlations, including relationships that run through the nature of the regulatory environment and structure of the banking environment; but fails to find strong support for these alternative hypotheses. The evidence appears to be driven by direct competition and contestability.