CREDIT RISK IN ISLAMIC AND CONVENTIONAL MICROFINANCE INSTITUTIONS: THE IMPACT OF DONATIONS, BRANCHLESS BANKING, AND BORROWER CHARACTERISTICS

Abstract

The microfinance industry has emerged as an important part of efforts to enhance the financial inclusion of economically disadvantaged individuals. However, due to its focus on financially disadvantaged clients lacking collaterals or a stable source of income, credit risk is an imperative concern for microfinance institutions (MFIs). This dissertation focuses on credit risk in MFIs and explores important factors that may influence the quality of their credit portfolios. Using an international sample of MFIs over a 20-year period, this dissertation explores three primary research questions. The first question comparatively assesses the influence of specific borrower characteristics on credit risk across Islamic and conventional MFIs, focusing on the proportion of lending to women, groups, and rural borrowers. The second research question examines the nexus between donations to Islamic MFIs, and their credit risk and social outreach, in comparison to that of conventional MFIs. The third question explores the relationship between the extent of branchless banking adoption and MFIs' credit risk. Collectively, the findings of this dissertation are relevant to MFI risk managers and policy makers and can guide prescriptions of risk mitigation policies appropriate for the specificities of Islamic and conventional MFIs. The results present encouraging insights for Islamic MFI donors and managers on the possibility of promoting the financial inclusion of women and rural borrowers without compromising the quality of MFI credit portfolios. This study also finds that Islamic MFI managers appear to prioritize social outreach, with less concern shown for financial outcomes due to sustainable access to abundant donations in Islamic MFIs compared to their conventional peers, who face greater donor scrutiny. Donations are found to contribute to positive financial inclusion outcomes for both Islamic and conventional MFIs, a promising implication for society and donors alike. The findings also indicate that investments in branchless banking present promising outcomes by encouraging financial inclusion and improving long-term repayment rates among MFIs. However, short-term adverse credit risk outcomes may deter financially-oriented MFIs from branchless banking investments since favorable outcomes are only attained with scale.