Small-scale lending to the poor and previously unbankable is a booming industry, and there is now a proliferation of these ''microfinance'' institutions and growing competition between them. According to research by Professors Craig McIntosh, Alain de Janvry and Elisabeth Sadoulet, published in the October 2005 issue of the Economic Journal, this has not led to catastrophic increases in defaults or wholesale market meltdown as many have feared.
With 2005 designated as the International Year of Microcredit by the United Nations, increasing focus is being put on generating hard evidence as to how microfinance institutions operate. The tremendous success of the microfinance revolution over the past decade has led to a proliferation of lending to those who were previously considered unbankable. As pro-poor lending institutions have multiplied, competition in these markets has correspondingly intensified. Because this kind of lending is done without formal collateral, several authors have suggested that these markets will be prone to catastrophic increases in defaults once borrowers face numerous potential lenders. But the extent to which borrowers can take advantage of a multiplicity of lenders depends on the extent to which lenders share information about clients. To date, very little empirical evidence has been presented to help us understand how such lenders interact in competitive marketplaces.
This study uses data from Uganda''s largest incumbent microfinance institution to analyse the impact of entry by competing lenders on the behaviour of clients who were already taking loans from the incumbent. The researchers find that:
• The entry of competing lenders induces a deterioration in repayment performance and a decrease in savings deposits among borrowers of the incumbent lender. This is consistent with a model of competition whereby clients do not abandon the incumbent but rather take multiple loans, thus damaging their repayments to the incumbent.
• Because mandatory savings and minimum savings balances are standard among microfinance institutions, clients who take multiple loans are forced to share their scarce savings among the institutions from which they borrow, reducing their level of savings with the incumbent.
• Strikingly, there is no change in the dropout rate or the client enrolment rate when competitors enter the market. Similarly, loan volumes do not change under competition. This appears to disqualify theories that predict a rapid movement of clients from one lender to another when multiple lenders are present.
• So-called ''village banking'' institutions, which focus on poorer clients by using larger lending groups, are most vulnerable to competition from institutions that use a lending methodology with smaller loans that targets wealthier clients, thus cherry-picking from the village banking institution.
• Interestingly, borrowers with large businesses and high cash flows are the most likely to leave the incumbent as new lenders enter. While it is likely that some of this comes from the demand side, it implies that new lenders are able to identify the most promising existing clients and target them selectively.
• Despite the absence of any formal mechanism for information sharing in Uganda (indeed, the country lacks the individual identification numbers necessary to set up such a mechanism), lenders are able to share enough information on clients to prevent a wholesale meltdown under competition.
• This is not altogether surprising, as credit officers from different organisations are known to meet informally to discuss the performance of clients in their neighbourhoods. But the evidence of people taking multiple loans implies that existing informal information sharing networks are not able to overcome the problem of identifying a
borrower's total outstanding indebtedness.
• Interestingly, clients in districts with higher levels of education behave as if local information sharing were better. Asymmetric positive information, then, may present a problem that requires a more formal mechanism for information sharing than now exists in the country, such as a credit bureau.
Subsequent research being conducted by the authors in Guatemala has confirmed the substantial improvements in performance under competition that can arise when microfinance institutions use credit bureaus. The country''s Crediref Bureau, implemented in 2002, has led to reductions of default and missed payments of over 25% from their pre-bureau levels.
''How Rising Competition among Microfinance Institutions Affects Incumbent Lenders'' by Craig McIntosh, Alain de Janvry and Elisabeth Sadoulet is published in the October 2005 issue of the Economic Journal. Craig McIntosh is at the University of California, San Diego. Alain de Janvry and Elisabeth Sadoulet are at the University of California, Berkeley.
