On mission drift in microfinance institutions

This paper sheds light on a poorly understood phenomenon in microfinance which is often referred to as "mission drift": A tendency reviewd by numerous microfinance institutions to extend larger average loan sizes in the process of scaling-up. . We argue that this phenomenon is not driven by transaction cost minimization alone. Instead, poverty-oriented microfinance institutions could potentially deviate from their mission by extending larger loan sizes neither because of "progressive lending" nor because of "cross-subsidization" but because of the interplay between their own mission, the cost differentials between poor and unbanked wealthier clients, and region-specific clientele parameters. In a simple one-period framework we pin down the conditions under which mission drift can emerge. Our framework shows that there is a thin line between mission drift and cross-subsidization, which in turn makes it difficult for empirical researchers to establish whether a microfinance institution has deviated from its poverty-reduction mission. This paper also suggests that institutions operating in regions which host a relatively small number of very poor individuals might be misleadingly perceived as deviating from their social objectives. Because existing empirical studies cannot differentiate between mission drift and cross-subsidization, these studies can potentially mislead donors and socially responsible investors pertaining resource allocation across institutions offering financial services to the poor. The difficulty in separating cross-subsidization and mission drift is discussed in light of the contrasting experiences between microfinance institutions operating in Latin America and South Asia.