“Microfinance is the provision of financial services to low-income clients or solidarity lending

groups including consumers and the self-employed, who traditionally lack access to banking and
related services.”

Microfinance is not just about giving micro credit to the poor rather it is an economic
development tool whose objective is to assist poor to work their way out of poverty. It covers a
wide range of services like credit, savings, insurance, remittance and also non-financial services
like training, counseling etc.

Salient features of Microfinance:

 Borrowers are from the low income group

 Loans are of small amount – micro loans
 Short duration loans
 Loans are offered without collaterals
 High frequency of repayment
 Loans are generally taken for income generation purpose

Competition between microfinance institutions (MFIs) in developing countries has increased

dramatically in the last decade. We model the behavior of non-profit lenders, and show that their
non-standard, client-maximizing objectives cause them to cross-subsidize within their pool of
borrowers. Thus when competition eliminates rents on profitable borrowers, it is likely to yield a
new equilibrium in which poor borrowers are worse off. As competition exacerbates asymmetric
information problems over borrower indebtedness, the most impatient borrowers begin to
obtain multiple loans, creating a negative externality that leads to less favorable equilibrium loan
contracts for all borrowers.

Competitive Relationship Between Mainstream and Microfinance Banks

Microfinance today is a far-ranging and dynamic sector that offers loans, provides savings and
remittance services, and sells insurance to more than 100 million of the poor. Microfinance
companies have increased in complexity and diversity in the income levels of the customers they
serve, their use of subsidies, regulation and governance structures, and the breadth and quality
of services offered.

Loan Repayment

Loans are MFIs’ largest assets and the largest source of risk resides in their loan portfolio.
Therefore, maintaining better portfolio quality will mostly depend on clients’ 23 repayment
performance. Increased competition and the associated deterioration in lending standards by
MFIs to grab largest market share is a growing concern and microfinance experts have expressed
their frustration over the upward trend in defaults and over-indebtedness.8

Efficiency and Financial Performance

The relationship between competition and efficiency is interesting and old one. It is explored
widely in other markets with two notable and competing hypotheses. The first is the “quite life
hypothesis” which states firms with market power may use the power to allow for inefficient
resource allocation than extracting rents from consumers, thereby enjoying a “quite life”. The
other hypothesis is the “efficient structure hypothesis” that argues firms with higher efficiency
have lower costs and higher profits. This, in turn, may help them gain larger market shares, which
leads to higher concentration.

Conclusion

Given significantly large numbers of people in developing countries are financially excluded and
the relative success of MFIs in promoting access to finance for the poor, it is not surprising to see
MFIs get the attention they are enjoying. With the growth of the microfinance sector and
increasingly varied players comes intense competition, which the effects on MFIs outcomes are
not clear.