Outreach, Sustainability and Leverage in Monitored and Peer-Monitored Lending

This paper studies the contract design problem facing microfinance-lending organizations (MFOs) that want to maximize the impact and outreach of their lending activities to a target population of poor borrowers while remaining financially sustainable. Tradeoffs between outreach, sustainability and financial leverage are shaped by the endogenous monitoring and delegation costs that arise within a chain of agency relationships subject to moral hazard between borrowers, loan staff, MFO equity-owner and outside investors. All else equal, sustainable MFOs that target poorer borrowers must charge higher interest rates, have higher staff costs per dollar loaned and are less leverages. Analysis of data for 72 MFOs tends to support the findings.

The paper also sheds light on the important question of how incentives and governance structures for proper loan monitoring and recovery (including peer-monitoring) can be provided to loan staff and other delegated monitors within MFOs.

The rest of the paper presents:

• The basic model, showing how costly monitored lending can serve to lower collateral requirements and/or increase loan size. The marginal cost of extending outreach and impact to the poor is analyzed and basic tradeoffs between outreach, impact and sustainability derived when there are both fixed and variable costs to lending;
• An analysis to consider more complex financial intermediary structures, involving MFO equity owners as delegated monitors for outside investors and hired staff as delegated monitors for owners. The shape of the staff renumeration contract and the possibilities of leverage are discussed. The costs and benefits of using peer-monitors are also analyzed;
• A discussion of the model's prediction in light of findings from a recent survey of MFOs;
• Further policy implications and concludes that given the huge level of resources being pledged to microfinance support it seems important to develop better frameworks within which to measure 'performance' and 'impact' of funding and interventions.