Relationship Between Profitability of Microfinance Institutions (MFIs) and Provision of Financial Capital to Business Start-ups: Mediating Effect of Institutional Governance Quality.

Abstract

The seminal paper by Shahriar et al (2016) on the role of profit orientation in determining the decision by MFIs to extend loans to business start-ups inspired research on the credibility of the industry’s commitment to supporting microentrepreneurs. However, little is known about the way MFIs with different institutional logics perspective tailor financial services to the needs of microentrepreneurs at different stages of their development in countries with weak institutions. This study fills this gap in three main ways: First, it examines whether MFIs trade-off finance to the poorest microenterprise start-ups to achieve higher profitability. Second, it considers whether the governance structure of an MFI is closely related to its depth of social outreach. Third, it investigates whether the quality of institutions in the country where an MFI operates mediates the relationship between MFIs’ profitability and depth of social outreach and how these interactions vary across the different MFI organisational forms. The results of a quantile regression using a MiXMarket data set of 938 organisation-year observations from 566 MFIs operating in 93 developing economies from 2010 to 2016 indicate that: (1) highly profitable MFIs, achieved their financial success by rationing credit to medium scale start-up borrowers at the 50th and 75th quantiles, (2) regulations that reinforce a cooperative-style democratic governance system incentivises profit oriented MFIs to revert the trade-off between profitability and outreach to the medium and large-scale start-ups (3) institutional quality reforms that combine several dimensions of state governance mechanisms motivated MFIs to considerably ration credit extended to borrowers in the median 50th quantile. Policies to integrate state institutions with MFI governance structures to promote entrepreneurial finance are discussed.