Economic and Social Roles for Microfinance Institutions: Exposition, Approaches, and Suggestions

Abstract

Microfinance institutions (MFIs) play a very important role in the development process of a country. For example, they complement the Formal Financial Institutions (FFIs) in the mobilization of savings, in directing savings and other resources to competing investment opportunities, in providing other financial services suitable especially to small-scale borrowers, and in the policy transmission mechanism. There is ample literature on MFIs. There are theories or arguments that MFIs exist just because of the inefficiencies of FFIs—implying that the MFIs would exit the financial markets if FFIs were at their maximum levels of efficiency. Other theories posit that the institutions have a raison d’etre of their own; just like microeconomic theory tells us that small firms will exist side by side with big firms due to economies of scale, leading to the small firms supplying a specified section of the market, MFIs exist to complement the big firms. The FFIs and MFIs offer highly differentiated financial services to specific segments of the market. In a game theoretic approach, the two categories of institutions participate in a win-win game in the act of providing the two differentiated products to the market. Technologies are such that, due to indivisibilities, if the big firm expanded, it would operate under capacity, i.e. with excess capacity. The MFI services are particularly tailored to specific clientele that FFIs are unable to serve adequately. These and other theories on MFIs or FFIs are, however, not the particular concern of this paper. This paper is, however, focused on the unique question of the nature, design, evaluation, and dynamics of the social role of a microfinance institution (MFI), as opposed to its economic role. The economic role is taken as the normal or traditional role for an MFI to generate profit or a surplus as a result of its operations, whereas the social role refers to the voluntary role of entertaining philanthropic objectives as a complement to the MFI’s economic role. These roles will be defined in more details and contrasted later in the paper. It is hoped that the logic and analyses in the paper apply to all MFIs, including the savings and credit co-operative societies (SACCOs) in Uganda. To the best of my knowledge, no theory appears to exist on this subject of the social versus the economic roles of an MFI.