Are competitive microfinance services worth regulating? Evidence from microfinance institutions in Sub‐Saharan Africa

• DOI: http://doi.org/10.1002/ijfe.1800
• Author: Javed G. Hussain,Amin Karimu,Samuel Salia,Ishmael Tingbani
• Date: 01 January 2021
• Published date: 01 January 2021

RESEARCH ARTICLE

Are competitive microfinance services worth

regulating? Evidence from microfinance institutions in

Sub-Saharan Africa

Amin Karimu

1

| Samuel Salia

2

| Javed G. Hussain

3

| Ishmael Tingbani

4

1

Department of Economics, University of

Ghana Business School (UGBS), Legon,

Ghana

2

Department of Accounting and Finance,

De Montfort University, Leicester, UK

3

Department of Accounting and Finance,

Birmingham City University,

Birmingham, UK

4

Department of Accounting and Finance,

Bournemouth University,

Bournemouth, UK

Correspondence

Samuel Salia, De Montfort University,

Leicester, UK.

Email: s.salia@wlv.ac.uk

Abstract

In recent years, there is increasing appetite for regulation of microfinance ser-

vices after the 2008 financial crisis. Policy questions such as whether competitive

microfinance institution (MFI) requiresstrong regulation to reduce, for example,

credit risk or competition and regulation operate in the opposite direction,

which each tends to dampen the effect of the other, are an empirical issue that

this paper provides answers based on data on Sub-Saharan Africa (SSA) for the

period 1995–2015, utilizing panel data approaches. Finding from the study indi-

cates that low competition increases credit risk among MFIs in SSA, which regu-

lation helps reduce such behaviour. The effect of regulation on credit risk is

conditional on the level of competition, at the first percentile of competition

(imply more competition); regulation does not reduce credit risk behaviour of

MFIs but does at competition level above the 25th percentile (imply less compe-

tition). Regulation, on the other hand, does not affect operational risk at any

level of competition. These findings have implications for policy formulation on

the regulation and operations of MFIs in SSA. Our findings suggest that the MFI

industry could be regulated efficiently if policymakers develop policies targeted

at reducing credit risk exposures of MFIs than their exposure to operational risk.

KEYWORDS

Competition, financial services, microfinance, portfolio risk, regulation

JEL CLASSIFICATION

G23; G32; G38

1|INTRODUCTION

Microfinance institutions (MFIs) play an essential role in

most developing countries as they provide financial ser-

vices, including poverty reduction intervention measures

to a significant share of the population that is unserved

by the formal financial institutions. About 2.5 million

adult population of the World is unbanked in 2014

(World Bank, 2016), which the majority live in Sub-

Saharan Africa (SSA). The severity of the implication of

such a vast size of the unbanked population on poverty

alleviation and lack of job creations especially for SSA is

that, majority, close to 90% of the unbanked population

are in rural areas (Gentil and Servet, 2002), where pov-

erty levels are endemic, with fewer job opportunities.

Therefore, the lack of banking services to mobilize funds

at lower cost for the impoverished rural population to

create a small business, invest into agriculture to provide

Received: 10 November 2018 Revised: 8 March 2019 Accepted: 13 September 2019

DOI: 10.1002/ijfe.1800

476 © 2019 John Wiley & Sons, Ltd. Int J Fin Econ. 2021;26:476–492.wileyonlinelibrary.com/journal/ijfe

the needed food requirement, and earn some income, fur-

ther perpetuates the incidence of poverty in such areas.

Over the recent decade, as a consequence of the prob-

lems associated with the poor not having access to the for-

mal banking services on their livelihood, poverty outcomes

and the associated social menace, coupled with the promis-

ing positive effects that MFIs are making, especially in serv-

ing the poor unbanked segment of the population, have

resulted in a plethora of different MFIs in developing coun-

tries, some with goals beyond the social intervention or

developmental goals such as pure profit motives. This phe-

nomenon is partly a result of the success story of the

microfinance model (Garrity and Martin, 2018), which leads

to an increase in the commercial oriented type of MFIs to

enter the microfinance segment of the financial market.

The increase in MFIs from both types—development

oriented MFIs and commercial oriented MFIs—in recent

years in developing countries createscompetition amongst

these firms to provide financial services to the poor

(Bateman, 2019). The increase in competition amongst

MFIs due to the increase in the number of MFIs operating

in the World financial market from 10 million in 1997 to

more than 100 million in 2007 (Assefa et al. 2013) creates

some level of competition that may have negative conse-

quences such as taking unnecessary risk in the quest to

outcompete competitors for clients and markets.

Economic theory suggests that competition will result

in lower prices for products produced due to lower cost of

production, more output, and generally a welfare improve-

ment for the society relative to the less competitive market

environment. However, unhealthy competition may also

result in competing firms taking unnecessary pricing, mar-

keting, organisational, and overall business strategies that

expose them to more risk. On the other hand, having few

firms with significant power may also create excessive

risk-taking behaviour in the absence of regulation as this

was the case in the 2008 financial crisis. The question

whether competition is good or bad will depend on the

strength in these two opposing effects of competition rela-

tive to few firms with significant market power, the level

of competition and whether the reference is to the firm,

consumer or clients, or society. If competition is creating

more risk-taking behaviour relative to the lower prices

and increase in output (outreach in the case of MFIs)

effect, it is prudent that authorities regulate the

microfinance market to curb competition and reduce the

unnecessary risk-taking behaviour of the MFIs. Therefore,

whether the government should regulate MFIs will

depend on whether competition was high and as a conse-

quence, creating unhealthy competitive behaviours

amongst firms in the microfinance industry. If competition

is not creating unhealthy outcomes and regulation is

imposed, it will create a less favourable outcome than if

regulation is not imposed.

The recent financial crisis has increased appetite for

more regulation towards the financial sector in general

and may also be the case for MFIs for countries that have

experienced some Ponzi scheme-types of operations of

some MFIs such as in Ghana, DKM Diamond

Microfinance Company Limited that went bust in mid-

2015 due to its Ponzi type of scheme it offered to clients.

However, the policymaker will have to assess the two

opposing effects to determine if regulation is necessary,

especially in the case of MFIs given their core mandate to

pool resources to provide microloans to the segment of

the society, who cannot access the main financial institu-

tions such as banks for such microloans. Therefore,

whether it is optimal for the government to regulate

MFIs is conditional on the level of competition and the

consequences thereof relative to less competition.

Whether the policymaker should regulate MFIs or not

is an empirical question, which has not received much

attention, especially about risk-taking behaviour. To the

best of our knowledge, there is no study in the MFIs liter-

ature that empirically examined the joint effect of regula-

tion and competition on risk-taking behaviour of these

firms, especially in the SSA context. The closest studies

we have found in the literature are: Assefa et al. (2013),

who looked at the effect of competition on performance;

Hartarska and Nadolnyk (2011), Purkayastha et al.

(2014), Triki et al. (2017), and De Quidt et al. (2018), they

focussed on market structure, the effect of regulation on

performance, or growth of the MFIs.

This paper aims to provide some answers in that

regard by providing an understanding of the relationships

between risks (portfolio risk and operational risk) and

both regulation and competition in the case of SSA. We

achieved this by adopting a sample of 1,574 MFIs in SSA

for the period 1995–2015. Evidence from the study sug-

gests that low competition increases credit risk amongst

MFIs in SSA, which regulation helps reduce such behav-

iour. In particular, we find that the effect of regulation on

credit risk is conditional on the level of competition, at

the first percentile of competition (imply more competi-

tion); regulation does not reduce credit risk behaviours of

MFIs but does at competition level above the 25th per-

centile (imply less competition). On the other hand, we

find that regulation does not affect operational risk at

any level of competition.

This paper aims to contribute to the literature through

assessing the sequencing impact of market concentration

and regulation on the risk of MFIs in SSA. Contribution

of this article is in three folds: first, to provide an under-

standing of the nature of relationships between credit

KARIMU ET AL.477