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How Competition Affects the Performance of Microfinance Institutions in Bangladesh?

Shahid Khandker's picture

The spectacular expansion of microcredit programs in Bangladesh, including a growing number of borrowers availing credit from multiple microfinance institutions (MFIs), have brought recent concerns that MFI competition might be taking a toll on the industry in terms of reduced rates of loan repayment and a higher incidence of overlapping debt. Microfinance programs have been running in Bangladesh for more than two decades, reaching more than 10 million households, nearly half the rural population. By 2008, the annual disbursement of microfinance programs was close to US$1.8 billion with an outstanding balance of US$1.5 billion. The country’s wholesale microcredit agency, the Palli Karma Shahayak Foundation (PKSF), with support of the World Bank has orchestrated microfinance penetration through a wide network of small but highly competitive partner organizations.

The past 20 years of microfinance expansion in Bangladesh can be divided into three phases. The first phase (roughly before 1994) had limited expansion with a focus more on rural nonfarm activities via mobilizing group savings and lending. The second phase (roughly 1995–2004) witnessed a rapid expansion of microfinance with PKSF emerging as the wholesale funding agency, and a large number of small NGOs entering the market with access to institutional funds for their own lending (as opposed to relying on the savings of borrowers). The third phase (i.e., post 2004) witnessed fierce competition among the microfinance institutions. During this phase, a variety of microfinance and other non-credit products (such as skill-based training and marketing assistance) were developed to meet the specific needs of the clients, including programs for the ultra-poor. Urban areas were also increasingly targeted, and newer MFIs emerged that placed a greater emphasis on profitability. To help temper risky borrowing and lending during this expansion, the Bangladesh government passed legislation in 2006 that included requiring all MFIs to be licensed, and establishing a Microcredit Regulatory Authority (MRA) to monitor MFI activities and targeting.  In 2011, the MRA also set a ceiling on interest rates for loans at 27 percent.

Given the rapid growth and diversification of microfinance programs in Bangladesh over the years, as well as recent policy attempts to regulate this growth, an obvious question that arises is whether MFIs are able to recover loans in a timely manner as their client base expands and diversifies. Although several policy claims and institution-specific studies have argued that MFIs are increasingly targeting risky borrowers and that competition induces wider problems of overlapping household debt across MFIs, little nationally-representative evidence has been presented on the supply-side decisions and performance of MFIs over the last several years.

In a recent paper, using newly available panel data from Bangladesh on supply-side issues facing MFIs from 2005–2010, we examine MFIs’ recent roles in credit markets amid increased competition, including trends in their pricing of products, targeting strategies and portfolio shifts in recent years, as well as their ability to recover loans from their borrowers. By focusing on a country context with one of the broadest expansions of MFIs in recent years, we hope to shed light on the role of public policies in supporting sustainable microfinance markets.

Our findings do not support the view that newer MFI entrants are less risk-averse in their targeting, or that increased borrowing among households due to microfinance institution competition has lowered recovery rates. However, we find that newer MFIs tend to attract riskier clients in urban areas, while the opposite is true in rural areas. More interestingly, loan recovery rates are the highest among the newest microfinance institutions for women in rural areas, suggesting that microfinance institutions may offer distinct products to attract better-risk clients. The portfolio of newer MFIs also has a greater share of lending for agriculture, and fewer savings products.