Scope economies from rural and urban microfinance services

Abstract

Microfinance institutions (MFIs) operate in both rural and urban credit markets and provide financial services to the poor not served by commercial banks. MFIs must keep operating costs low to better serve their clients. We evaluate whether MFIs can lower their costs by exploiting economies of diversification from serving both rural and urban markets rather than specializing in only one. We apply a novel method to estimate scope economies that minimizes the well‐known “excessive extrapolation” and accommodates MFIs' heterogeneity. Analyzing panel data on MFIs from 105 countries over 2008–2018, we find that about half of loan‐only MFIs benefited from diversification and enjoyed scope economies of 16.6% while over two thirds of savings‐and‐loan MFIs experienced scope diseconomies of 11.7% suggesting advantages from specialization. Over time, the declining magnitudes and the prevalence of scope (dis)economies in both groups suggest that loan‐only MFIs have been able to serve costlier marginal clients while savings‐and‐loan MFIs have been learning and decreasing their scope diseconomies. Stakeholders encouraging the transformation of MFIs into regulated savings‐and‐loan institutions that serve both rural and urban markets should be aware of the presence of scope diseconomies for that business type and offer adequate support.