Financial Development and the Efficiency of Microfinance Institutions

Microfinance is an instrument for achieving responsible finance as its aim is to contribute to the financial inclusion of poor households and small businesses. We investigate whether the country-level financial environment in which microfinance institutions (MFIs) work affects their operations. In particular, we argue that the efficiency of MFIs and their capacity to contribute to increasing financial inclusion of poor households and small businesses is determined by the extent to which financial markets of countries are developed. On the one hand, well-developed financial markets provide an environment in which MFIs are able to flourish and increase their efficiency, which increases their capacity to contribute to financial inclusion. On the other hand, well-developed financial markets may also substitute for MFIs and/or may lead to MFI clients taking up multiple loans, reducing efficiency. We find strong evidence that MFI efficiency is positively associated with the level of financial market development.