Profitability and outreach of microfinance: Mission drift theory and evidence from Uganda

Abstract

The microfinance movement has received enthusiasm as a poverty alleviation tool that has the potential to become a self-sustaining industry. Large-scale poverty reduction through financially sustainable institutions is the ultimate promise of microfinance. However, in the 1990s, a debate emerged regarding the possibilities of achieving this promise. Others argue that microfinance institutions should reduce their dependency from donors and governments by becoming financially self-sufficient, commercial institutions that can borrow from the commercial capital markets and that way grow to serve large numbers of poor people. Others, however, fear that a profit-seeking approach into microfinance will result in the poorest of the poor clients being discarded; a phenomenon called mission drift.

The debate on mission drift still remains unsettled, and there is a clear need for representative empirical studies that attempt to identify the patterns of profitability and outreach of microfinance. The aim of this thesis is to shed light on this ongoing debate by studying whether mission drift is a justified worry: is there evidence of a trade-off between the financial performance and depth of outreach of microfinance?

This thesis studies the research question both by reviewing the relevant literature and earlier empirical evidence from both sides of the debate, and by conducting an empirical analysis of profitability and outreach in a case country; Uganda. The empirical analysis employs the 2006 Census of Tier 4 Microfinance Institutions in Uganda, which offers a representative picture of the microfinance industry in the country. Profitability patterns are studied by comparing the performance of different groups of institutions. A regression analysis on the individual lenders of Uganda studies the trade-offs between profitability and outreach to determine whether these institutions are susceptible to mission drift.

The main finding of the thesis is that mission drift is a possible concern for certain institutions. Institutional forms and methods of operation have an important effect in determining the possibilities of profitability and outreach. The regression analysis on Ugandan individual lenders finds evidence that increased profitability tends to worsen outreach, though this finding is not conclusive. Further attention needs to be paid to this possibility of a trade-off, and lending practices ought to be designed adequately in order to prevent mission drift.