Subsidy Uncertainty and Microfinance Mission Drift

This paper aims to demonstrate that subsidies will have a stronger impact on MFIs’ poverty reduction efforts if their volume and timing are less uncertain. MFIs have historically had the dual objective of reducing poverty and attaining self-sufficiency. The paper constructs a model to show that supply driven subsidy uncertainty can have pervasive effects on MFIs’ poverty reduction mission and can lead to mission drift. It states that MFIs lend to wealthier clients in order to build precautionary savings, under the fear that subsidies can dry up. This is a rational reaction by MFIs struggling to preserve a pool of poor clients in a subsidy uncertain world.

The paper demonstrates that the incidence of mission drift increases with subsidy uncertainty. It tests the model’s predictions on original data from rating agencies’ assessment reports on 230 MFIs from 60 countries during 1999-2006. It uses cross-section and panel data regressions to estimate the effect of subsidies on poverty reduction as proxied by average loan size, interest rates and outreach. Results suggest that:

• More subsidies are associated with smaller loan sizes;
• Higher subsidy uncertainty is positively correlated with higher interest rates;
• Subsidy uncertainty is negatively correlated with outreach.