Financial Development and the Efficiency of Microfinance Institutions

Abstract

This paper investigates whether the country-level financial environment in which microfinance institutions (MFIs) have to work affects their operations. In particular, we argue that the efficiency of MFIs 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. On the other hand, however, well-developed financial markets may also substitute for MFIs, which reduces demands for their services, thus potentially reducing their efficiency. Given the fact that the relationship may go both ways, we empirically investigate the direction of the relationship between measures of financial development and measures of MFI efficiency, using data for 435 MFIs over the period 1997-2007.

Keywords: microfinance, financial development, SFA

JEL Classification: G21, O16, I39, C49