Market segmentation, social capital and welfare–outreach in microfinance: a case study of Indonesia

Abstract

This PhD thesis is a study of microfinance in relation to market segmentation, social capital, operational contradictions, and the welfare impact of microfinance on the rural poor in parts of Central Java, Indonesia. Four important aspects of microfinance are examined. Firstly, we investigate the institutional characteristics of microfinance clients and institutions, and confirm that heterogeneous clients and institutions lead to market segmentation in microfinance. Such market segmentation arises in relation to various motives of the poor and obstacles faced by them in utilising microfinance services. There are evidences that poor people are not homogeneous individuals in terms of access to finance. While some can access the microfinance services of microbanks, many others face socioeconomic constraints in utilising such services. Microfinance markets thus tend to segmented because, on one hand, the poor are only capable of accessing semi-formal and informal MFIs, due to their low levels of income and education, and limited networks. On the other hand, because of having sufficient incomes and assets, the non-poor prefer to utilise microbanks, due to larger loans provided and low interest rates.The various motivations of the poor in utilising loans lead MFIs to face information and enforcement problems, due to the interchangeability of loan usages. The differing capacities of MFIs to overcome such problems then contribute to the presence of market segmentation in microfinance. Although microbanks have financial resources to lend, they are unable to gather information about the creditworthiness of the poor. Microbanks also lack efficient ways of enforcing loan repayments, due to being operationally distant from the social networks of the poor. As a result, microbanks prefer to penetrate up-market segments by setting loan contracts in favour of non-poor clients. They are unwilling to increase loan supply to the poor because doing so can worsen their loan portfolio. In contrast, semi-formal and informal MFIs, such as cooperatives and moneylenders, are more capable of overcoming informational and enforcement problems of lending to the poor, due to living and working in villages. These MFIs can maintain profitability, while serving poor clients by linking loans to the social networks of the poor.Secondly, the impact of social capital on microfinance is substantially investigated. This study emphasises that social capital enhances the access of poor people to microfinance. For instance, maintaining kinship relationships can enhance access of the poor to formal finance through the role of relatives as loan references in applying for microbank loans. Maintaining friendship and business networks can reduce informational constraints of accessing microbanks, as the poor can gather knowledge of banking procedures from friends and business associates. From the lender’s perspective, MFIs that consider social capital as important in lending decisions tend to have higher rates of loan repayments.Thirdly, this study rigorously examines the trade-off between profitability and the outreach of MFIs to serve the poor. It finds that a focus on profitability potentially undermines the outreach of formal MFIs (e.g., microbanks). In contrast, semi-formal and informal MFIs are capable of maintaining profitable operations in conjunction with serving the poor. These MFIs can maintain profitability while serving the poor by linking microfinance to the social networks of the poor. Fourthly and finally, this study examines whether access to microfinance services contributes to the welfare of the poor. Specifically, access to microfinance services is found to have the potential to improve the level of children’s education, and increase the degree of confidence in dealing with other people. Access to microfinance services can also reduce the probability of the poor experiencing household financial distresses. Overall, the present study recognises that microfinance has the potential to improve the welfare of the poor.