The study aims to pose the question: Has lending to small businesses been a source of increased risk in microfinance institutions (MFIs)? This question is pertinent given the higher levels of perceived riskiness of lending to small business operators owing to their opacity.
The study accommodates panel bias by using system generalised method of moments (GMM) estimators on micro-level data from 2004 to 2014.
Study findings indicate that lending to small businesses by MFIs does not affect credit and insolvency risk in these institutions. However, using disaggregated data, there is evidence that lending to small businesses by cooperatives significantly reduces their insolvency risk exposure. Conversely, lending to small business by micro-banks, cooperatives, non-bank financial institutions and non-governmental organizations does not significantly affect their risk exposure.
These findings imply that the technologies that have been used by MFIs in lending to small enterprises have helped them mitigate the problems of adverse selection and moral hazard.
Information economics theory postulates that small firms are excluded from formal financial markets owing to their opacity. The hypothesis has not attracted much empirical research interest; hence, this study aims to bridge this gap in knowledge.
