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Title of Journal: J Bus Ethics

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Abbravation: Journal of Business Ethics

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Springer Netherlands

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10.1016/0301-0104(85)85032-1

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1573-0697

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Microfinance Performance and Social Capital: A Cross-Country Analysis

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 cross-border 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 asset-poor 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 cross-country 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 hypothesis.Microfinance 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 mid-1970s 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 self-employment 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. 180).In 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 reduction.1 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 2013).Notwithstanding the criticism microfinance has received, the sector still obtains a substantial amount of cross-border funding.2 The largest part of this funding is from public sources (e.g., 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 (El-Zoghbi et al. 2011).3 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 world.In 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 (i.e., their business model is socially sustainable) and when they can reach this for the longer term (i.e., 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 MFIs.From 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 so-called group loans with joint liability to incentivize asset-poor 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 contract.To explain the drivers of the financial and social performance of MFIs, research has mostly focused on institution-specific factors, such as the type of loans issued, governance, and the formal type of the institution (see, e.g., 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 country-level disparities in terms of social capital availability are related to the MFI performance.This 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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