Differences in bank and microfinance business models: An analysis of the loan monitoring systems and funding sources

Microfinance institutions (MFIs) use an alternative financial intermediation system (business model) to offer banking services for the marginal people where collateral-based conventional banking has not been effective. They facilitate collateral-free lending through close loan monitoring and possess a distinct capability to collect savings via donations (besides deposits). We assert that the unique intermediation model presents MFIs with a lower credit risk; however, that comes at the cost of higher business risk. We provide empirical support for our argument by analyzing a broad cross-country dataset comprising banks and MFIs from 68 countries. We show that MFIs maintain a lower non-performing loan ratio but retain higher cash and capital ratios and a smaller deposit ratio than banks. We provide insights into the areas of variation between two dissimilar models for financial intermediation, associated risks, and prospects for integrating them within a common regulatory framework.