Contribution of Microfinance to Financial Sector Development and Growth

This paper examines the interaction between microfinance and growth.

Increasing growth of microfinance in developing countries in the last few decades indicates that alternative means of financing could play a significant role in financial intermediation and economic development. This paper addresses the lack of research on interaction between microfinance and growth. It identifies transmission channels and defines empirical methodology to test the direction of causality. The study examines the dynamic impact of microfinance and the nature of transmission paths. Findings include:

• There is evidence that microfinance Granger-causes economic growth, although impact differs by income groups and development stages of the country;
• Microfinance reveals negative dynamics through current values for middle-income countries, and positive and smaller impact through lagged values for low-income countries;
• Estimation of indirect transmission channels reveals that microfinance is better captured in narrow monetary base;
• Microfinance interaction with banking sector remains ambiguous and warrants further research.

Microfinance contribution is positive only in less developed countries where formal financial intermediation is immature leaving space for alternative methods like microfinance.