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Mission Drift in Microfinance, the influence of institutional and country risk indicators on the trade-off between the financial and social performance of microfinance institutions.

Pim Engels, October 2009

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Summary :

Investments in microfinance allow for a financial return, complemented with a social return from the instrument’s poverty alleviation potential. The interest of institutional investors, like ING Micro Finance, in this dual return investment opportunity of microfinance is growing. At the same time, however, the microfinance industry is facing growing pains.

Previously, microfinance institutions (MFIs) were encouraged to rapidly become financially sustainable. Establishing a commercial microfinance market was thought to enhance the global outreach of microfinance. Consequently, a group of MFIs is rapidly commercialising and increasingly competes to attract capital from institutional investors. More recently, a social performance movement advocates the measurement and assessment of the impact and outreach of MFIs.

Tension between the financial sustainability- and social performance advocates is rising. Rapidly commercialising MFIs show signs of mission drift, whereby the average loan size of an institution increases as a result of a shift in the composition of new clients. Reaching out to wealthier clients, while crowding out poorer clients, enhances profitability.

This research aims to find empirical evidence on the phenomenon of mission drift. The research is taking into consideration important investment decision-making indicators for foreign institutional investors in microfinance. The dataset contains data of 600 MFIs operating in 84 countries around the world in 2007.

First, the research concentrates on the role of institutional and country risk indicators in predicting the financial and social performance of MFIs. Evidence shows that regulation, network membership and institution’s size do not affect the financial performance of MFIs. The institution’s years of age are negative quadratic related to the financial performance. Country risk rating is negatively associated with the financial performance of MFIs. Alternatively, regulation, size and country risk rating negatively affect the social performance of MFIs. Network membership positively affects the social performance of MFIs. Years of age do not affect the social performance of MFIs. Next, the research explorers the influence of institutional and country risk indicators on the trade-off between the financial and social performance of MFIs. Strong evidence for the existence of a trade-off between the financial and social performance of MFIs is found. Nevertheless, by balancing the (1) profitability, (2) cost efficiency, and (3) productivity of the institution, MFIs can prevent the occurrence of mission drift. The regulation and size of institutions make MFIs more susceptible, while network membership make MFIs less susceptible to the occurrence of mission drift. Young MFIs are more susceptible to mission drift, while more mature MFIs are more susceptible to reverse mission drift. No evidence is found suggesting that MFIs operating in country associated with a high country risk rating are more susceptible to the occurrence of mission drift.

Based on these findings, institutional investors can prioritise institutional and country risk rating indicators in order to assess the balance between the financial and social performance of MFIs.