Microfinance Performance and Social Capital A Cro

Authors: Luminita Postelnicu Niels Hermes

Publish Date: 2016/09/19

Volume: 153, Issue: 2, Pages: 427-445

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Abstract

In recent years the microfinance industry has received a substantial amount of crossborder funding from both public and private sources This funding reflects the increasing interest in microfinance as part of a more general trend towards socially responsible investments In order to be able to secure sustained interest from these investors it is important that the microfinance industry can show evidence of its contribution to reducing poverty at the bottom of the pyramid For this it is crucial to understand under what conditions microfinance institutions MFIs are able to reduce poverty This paper contributes to this discussion by investigating the relationship between the extent to which social capital formation is facilitated within different societies and the financial and social performance of MFIs This focus on social capital formation is important because in many cases MFIs use group loans with joint liability to incentivize assetpoor borrowers to substitute the lack of physical collateral by their social capital Hence the success of a large part of the loan relationship between MFIs and their borrowers depends on the social capital those borrowers can bring into the contract We carry out a crosscountry analysis on a dataset containing 100 countries and identify different social dimensions as proxies for how easy social capital can be developed in different countries We hypothesize that microfinance is more successful both in terms of their financial and social aims in societies that are more conducive to the development of social capital Our empirical results support our hypothesisMicrofinance institutions MFIs focus on providing financial services in most cases by offering very small loans to poor households that are excluded from the formal financial system The practice of microcredit started in the mid1970s and since then it has grown rapidly The market for microcredit has been booming especially since the early 2000s Although the global financial crisis led to a reduction of the growth of microfinance activities Wagner and Winkler 2013 microfinance has remained high on the agenda of policy makers as a potentially important instrument to reduce poverty The main driver of its growth has been the belief that having access to finance is crucial for the poor as this helps them to smooth their consumption generate business opportunities and improve their inclusion in the formal economy in the long run Collins et al 2009 By facilitating selfemployment and entrepreneurship access to credit would help the poor to lift themselves out of poverty Morduch 1999 Armendáriz and Labie 2011 For this reason some have argued that the microfinance industry should be seen as ethically progressive Hudon and Sandberg 2013 Others have made the claim that microfinance is “…one of the fastest growing corporate social responsibility CSR tools in the finance sector” Pohl and Tolhurst 2010 p 180In recent years however microfinance industry has become subject of increasing criticism In fact some even go as far as claiming that the industry is currently facing an ethical crisis Hudon 2011 This crisis was triggered by a number of events starting in 2007 with the critical attention the Mexican MFI Compartamos received when it was found out that its financial success was at least partly based on interest rates in excess of 100 their clients had to pay Lewis 2008 Also in 2007 an authoritative impact study was published showing that microcredit does not contribute to improving the living conditions of the poor Banerjee et al 2013 This study was followed by several other impact studies showing little evidence that microcredit has a positive impact on poverty reduction1 And finally in 2010 MFIs in India were accused of using exploitative lending techniques and using forceful loan recovery practices leading to the suicide of several Indian MFI clients Biswas 2010 Mader 2013Notwithstanding the criticism microfinance has received the sector still obtains a substantial amount of crossborder funding2 The largest part of this funding is from public sources eg multilateral institutions governmental donors etc but private funding from commercial banks pension funds insurance companies private equity firms etc has been growing and has actually grown at a faster rate than that of public funders during recent years ElZoghbi et al 20113 This growth reflects the increasing interest in microfinance as part of a more general trend towards socially responsible investments SRI These investments combining investors financial objectives with concerns about environmental social and governance issues have become increasingly popular around the worldIn order to be able to secure sustained interest from these investors it is important that MFIs can show evidence of their contribution to reducing poverty at the bottom of the pyramid For this it is crucial to understand under what conditions MFIs are able to contribute to poverty reduction ie their business model is socially sustainable and when they can reach this for the longer term ie their business model is financially sustainable In this respect MFIs are often characterized as hybrid institutions Battilana and Dorado 2010 Morduch 1999 The current study can be seen in this light as we contribute to the literature on the determinants of the financial and social performance of MFIsFrom its start in the 1970s a large part of the microcredit offered to the poor has been characterized by innovative lending methodologies implemented by MFIs in order to increase the probability of repayment of loans In many cases these MFIs use the socalled group loans with joint liability to incentivize assetpoor borrowers to substitute the lack of physical collateral by their social capital Hence the success of a large part of the relationship between MFIs and their borrowers depends on the social capital those borrowers can bring into the contractTo explain the drivers of the financial and social performance of MFIs research has mostly focused on institutionspecific factors such as the type of loans issued governance and the formal type of the institution see eg Mersland et al 2011 as well as on macroeconomic factors and the formal institutional context see Ahlin et al 2011 Hermes and Meesters 2011 Yet there is very little evidence with respect to how countrylevel disparities in terms of social capital availability are related to the MFI performanceThis may be due to the difficulty of quantifying the different facets of social capital Nahapiet and Ghoshal 1998 summarize these different facets into three categories structural social capital the presence or absence of relationships between individuals the configuration of their networks the characteristics of interpersonal connections such as network connectivity density relational social capital the type of relationship developed through past social interactions like respect trust acceptance friendship sociability and cognitive social capital shared norms and languages shared narratives

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