Does Institutional Linkage of Bank‐MFI Foster Inclusive Financial Development Even in the Presence of MFI Frauds?
| Author | Sushanta K. Mallick,Shirley J. Ho |
| Date | 01 July 2017 |
| Published date | 01 July 2017 |
| DOI | http://doi.org/10.1111/sjpe.12124 |
DOES INSTITUTIONAL LINKAGE OF
BANK-MFI FOSTER INCLUSIVE
FINANCIAL DEVELOPMENT EVEN IN
THE PRESENCE OF MFI FRAUDS?
Shirley J. Ho* and Sushanta K. Mallick**
ABSTRACT
Growing reports indicate the presence of frauds in microfinance institutions
(MFIs), as it can occur in any organization in countries where there are weak
institutions, weak rule of law, and fraudulent behavior of MFI officers for per-
sonal gain. While there are increasing calls to launch financial governance of
these NGO MFIs, there are concerns as to whether frauds of this nature can
damage MFIs’ contributions to the credit market, particularly in the bank-link-
age program where the NGO MFIs act as third party intermediary. The purpose
of this study was to analyze the collusion decisions faced by MFIs and their
impact on the bank-linkage program, which has been offered as a solution to
help overcome adverse selection and moral hazard problems in the credit market
by harnessing local information via MFIs. Our results show that even when there
is a chance of collusion between MFI and the borrower, the linkage between
MFI and bank can still increase the probability that the borrower puts in full
effort, and therefore decreases the probabilities of both credit rationing and
strategic default. Such linkage in financing viable projects can make micro-finan-
cing more effective in achieving inclusive financial development and thereby pov-
erty reduction in rural areas.
II
NTRODUCTION
Former United Nations Secretary-General Kofi Annan, on 29 December
2003, said: ‘The stark reality is that most poor people in the world still lack
access to sustainable financial services, whether it is savings, credit or insur-
ance. The great challenge before us is to address the constraints that exclude
people from full participation in the financial sector’. Recently, Alliance for
Financial Inclusion (AFI) Executive Director Alfred Hannig highlighted dur-
ing the IMF-World Bank 2013 Spring Meetings: ‘Financial inclusion is no
longer a fringe subject. It is now recognized as an important part of the main-
stream thinking on economic development based on country leadership’.
*Department of Economics, National Chengchi University
**School of Business and Management, Queen Mary University of London
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12124, Vol. 64, No. 3, July 2017
©2017 Scottish Economic Society.
283
It is reported that ‘38% of adults in the world do not use formal financial ser-
vices, and 73% poor people are unbanked becauseofcosts,traveldistancesand
the often-burdensome requirements involved in opening a financial account’.
1
As
a means of fostering financial inclusion, microfinance institutions (M FIs) play
an important role in poverty reduction for developing countries. Lacki ng suffi-
cient collateral to pledge, most rural borrowers suffer from credit rationing prob-
lems, as borrowers’ asymmetric information increases the default risks caused by
adverse selection, moral hazard, and strategic defaults (Stiglitz and Weiss, 1981).
The literature has addressed two approaches that MFIs can help in mitigating
these information problems. The first approach argues that the group-lending
scheme in MFIs lending can reduce borrowers’ adverse selection problem by
peer monitoring or group pressure (Banerji, 1995; Ghatak, 1999; Ghatak and
Guinnane, 1999). The second approach contends that the linkage mechanism
between MFIs and commercial banks can generate information externality to
other banks and help restore the loan market through participation of multiple
banks (Fuentes, 1996; Bose, 1998; Conning, 1999; Jain, 1999).
For either of the two approaches, the credibility of MFIs is the key for the
mechanism to work. Unfortunately, frauds may occur in microfinance institu-
tions (MFIs) as it can happen in any other type of company, organization or
government institution in countries where there are weak institutions, weak rule
of law, and fraudulent behavior of MFI officers for personal gain. There are
increasing reports that local nongovernment (NGO) MFIs subcontracted by a
multi-million-dollar microfinance program are taking bribes from borrowers.
2
As documented on the microfinance gateway site (http://www.microfinancega
teway.org/) of CGAP (World Bank), there have been investor concerns about
corruption in MFIs. While there are increasing calls to launch financial gover-
nance on these NGO MFIs, many would worry whether frauds of this nature
can damage MFIs’ contributions to the credit market, particularly in the bank-
linkage program where the NGO MFIs act as third party intermediary to
reveal information about the borrower (see Bose, 1998). In a recent empirical
study, Al-Azzam (2016) provide evidence that microcredit interest rates respond
positively to corruption. The study reports asymmetry in this relationship in the
sense that while corruption has a positive and significant impact on interest
rates of unregulated MFIs, it has a negligible impact on interest rates of regu-
lated MFIs. Therefore, it is possible that countries with better regulation of
MFIs can have low incidence of bribery as in Dechenaux et al. (2014).
Using a sample of 832 MFIs from 74 countries for the period 2003–2011,
Sainz-Fernandez et al. (2015) identify different internal and external factors for
crises in microfinance institutions. They find that countries with high levels of
corruption can create disincentives for customers to pay back loans and thereby
MFI failure, as the control of corruption variable has a positive and insignifi-
cant coefficient with the mean value of control of corruption for these 74
countries staying at 0.556 (when the indicator ranges from 2.5 to 2.5 –from
1
http://www.worldbank.org/en/topic/financialinclusion/overview#1
2
See http://www.speroforum.com/a/17580/Microfinance-industry-breeds-corruption.
284 S.J.HOANDS.K.MALLICK
Scottish Journal of Political Economy
©2017 Scottish Economic Society
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