When pro-poor microcredit institutions favour richer borrowers: A moral hazard story

Abstract

We suggest an explanation for the existence of “mission drift,” the tendency for Microfinance Institutions (MFIs) to lend money to wealthier borrowers rather than to the very poor. We focus on the relationship between MFIs and external funding institutions. We assume that both the MFIs and the funding institutions are pro-poor. However, asymmetric information on the effort chosen by the MFI to identify higher-quality projects may increase the share of loans attributed to wealthier borrowers. This occurs because funding institutions have to build incentives for MFIs, creating a trade-off between the quality of the funded projects and the attribution of loans to poorer borrowers.