Investigating causal relationship between social capital and microfinance

Purpose - The aim of this paper is to investigate causal link between social capital and microfinance by testing the role of social capital in explaining the household's access to microcredit under the group‐based lending approach. Design/methodology/approach - Household level primary data was collected from a rural district of Pakistan. Principal component analysis (PCA) was applied to construct a social capital index, whereas two logit models were developed to predict the probabilities of access to credit. Besides, few qualitative statements have also been used to supplement the results from main empirical analysis and to understand the impact mechanism of social capital on microfinance participation. Findings - Participation in local organizations, heterogeneity of associations and level of both generalized and institutional trust were identified as the key dimensions of structural and cognitive social capital to influence households' access to credit. On the other hand, when these dimensions were combined in a single social capital index, the result indicated that social capital index has no significant effect on microfinance participation. This result provides support to the argument that grouping all the dimensions of social capital into one index may run the risk of losing the explanatory power of social capital. Practical implications - The results of the study could be encouraging for governments and other development agencies. The existing social capital could be utilized in the design and delivery of microfinance programs as well as other rural development activities. The results of the study also encourage policy makers to invest in the creation of social capital either directly or by providing environment supportive of its creation. Originality/value - The study is a contribution to the limited empirical literature on social capital and microfinance. This study is the first of its kind in Pakistan and hopefully will contribute to the limited knowledge on social capital literature in the country generally and in the context of rural development specifically.