Cheap Credit and Incentives in Financial Institutions: The Case of Global Microfinance

Abstract

We exploit shifting international relationships to analyze political shocks to the supply of financing for microfinance institutions (MFIs). MFIs whose host nations improve their relationships with the nations of their lenders receive more credit and enjoy reduced borrowing costs. These MFIs quickly hire more credit staff and increase lending in the medium-term, but portfolio quality and productivity decline. Compensation policies at subsidized MFIs display no evidence of rent extraction, as average wages remain stable. The emphasis on incentive pay increases, reflecting an appropriate response to the diminished termination risk for employees.