Is Microfinance Growing Too Quickly?

> Posted by Courtney Piper
Is microfinance’s rapid growth coming back to bite us?  MFIs grew exponentially from 2003-2008, adding new borrowers at an annual rate of 21 percent and growing loan portfolios at 34 percent per year.  Although this expansion indicates significant progress toward full financial inclusion, some say that this breakneck growth can contribute to deterioration in the quality of MFIs’ loan portfolios and may have led to massive delinquency rates in Bosnia and Herzegovina, Morocco, Nicaragua and Pakistan starting in 2008.
In a recent paper entitled “Is Microfinance Growing Too Fast?”, MIX Lead Researcher Adrian Gonzalez tested the relationship between high levels of MFI growth and deteriorating portfolio quality.  Using data reported to the MIX from 2000-2008, Gonzalez concludes that growth, measured as the increase in number of borrowers per MFI, negatively affects portfolio quality only at annual rates exceeding 250 percent, far greater than what most MFIs experienced.  In effect, the data suggests that MFIs can grow their clientele up to 250 percent annually without experiencing a significant deterioration of portfolio quality. Other factors, including the strength of MFIs’ management teams, the quality of its management information system, and the existence of functioning credit bureaus, are actually more influential when it comes to portfolio quality, and more indicative of how successfully an MFI will manage rapid expansion. 
How can MFIs expand in step with the market while avoiding the risks of overheating?  By expanding into new markets, MFIs benefit from a more diverse portfolio and are less likely to experience portfolio deterioration related to clients’ over-indebtedness.  If MFIs limit their growth only to competitive (often saturated) markets, they are more likely to add new clients who have outstanding loans from other institutions.  These multi-indebted clients pose a potential credit risk to MFIs when they continue taking on new debt with servicing requirements that exceed clients’ ability to pay.  And MFIs who lend to already debt-strapped clients risk reversing the benefits of financial inclusion by trapping their clients in an ongoing, stressful cycle of debt servicing.
The findings of Gonzalez’s paper support the business case for the Smart Campaign which maintains that MFIs can mitigate risk by working closely with clients to identify suitable types and sizes of loans, thereby reducing over-indebtedness and potential delinquency.  To learn more about how the Campaign is helping MFIs avoid over-indebtedness, check out “Smart Note: Facing Over-indebtedness at Partner Microcredit Foundation” and other resources at www.smartcampaign.org.

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