Subsidy Uncertainty and Microfinance Mission Drift

This paper shines light on subsidy-dependent microfinance institutions (MFIs). Firstly, our model shows that subsidy uncertainty can have pervasive effects on MFIs’ poverty-reduction mission. In particular, we argue that supply-driven uncertainty can lead to mission drift. MFIs maximize utility by serving the poor on the one hand, but must be financially sustainable on the other. Under the fear that subsidies can dry up, MFIs lend to wealthier clients in order to build precautionary savings. In a subsidy-uncertain world this is a rational reaction by MFIs struggling to preserve a pool of poor clients. We show that the incidence of mission drift increases with subsidy uncertainty. Secondly, we test the predictions of the model on original data collected from rating agencies assessment reports on 230 MFIs active in 60 countries over the period 1999-2006. Using both cross-section and panel-data regressions, we estimate the effect of subsidies on poverty reduction as proxied by average loan size, interest rates, and outreach. Our results suggest that more subsidies are associated with smaller loan sizes, but that higher subsidy uncertainty is positively correlated with higher interest rates. We also find that subsidy uncertainty is negatively correlated with outreach.