Determinants of defaulting by collateral lending groups in microfinancing: A probit regression approach

Abstract

Orientation: Despite the use of group lending, microfinance institutions (MFIs) are still faced with the risk of default by borrowers and the absence of physical collateral means that there is no recourse to borrower assets for repayment. It is therefore imperative to understand characteristics of loan default as a means to reduce possible erosion of the capital base of MFIs.

Research purpose: The study identified determinants of loan default for collateral lending groups in microfinancing.

Motivation for the study: Default on loans, which can be caused by characteristics of the lending groups themselves, has the undesirable effect of eroding the capital base of MFIs and threatening their continued existence. This study aims to identify those characteristics of loan default which could erode the capital base of MFIs.

Research design, approach and methods: The study used the probit regression model to identify characteristics of loan default by collateral lending groups in microfinance in order to assist MFIs with insights regarding which factors to eliminate and which to enhance in the design of the groups to which they lend.

Main findings: The key findings of the study indicate that probability of default decreases with larger groups, more female borrowers in a group and larger borrower savings. The results also indicate that probability of default increases with larger loan amounts and with borrowers who have more business experience.

Practical and managerial implications: Microfinance institutions should consider having a feeder programme where borrowers whose businesses have become successful and larger can be passed on to bigger commercial banks instead of continuing to borrow from the MFIs as part of a group lending scheme.