Are donor funds used effectively? An examination of Islamic and conventional microfinance institutions

Purpose - This study aims to compare the nexus between donations to Islamic and conventional microfinance institutions (MFIs) and their credit risk, financial performance and social outreach. Design/methodology/approach - The authors use fixed effects and two-step system generalized methods of moments models with internal instrumentation. The analysis is conducted on an international sample of 1,519 MFIs in 55 countries during 1999–2019. Findings - Islamic MFIs receiving greater donations experience an increase in credit risk, whereas the opposite occurs among their conventional counterparts. Donations are associated with an improvement in the depth of outreach of Islamic MFIs, allowing them to serve a poorer client base, despite a simultaneous decline in the breadth of their outreach. On the other hand, donations improve both the depth and breadth of conventional MFIs outreach. Donations also exhibit a positive relation with productivity, efficiency and sustainability in conventional MFIs. Practical implications - This paper addresses a gap in the literature on Islamic MFIs and their use of donor funds by examining how donations contribute to the quality of their credit portfolios, financial performance and social outreach. This study used Ahmed’s (2012, 2017, 2020, 2021) total factor productivity model to capture the impact of donations on the performance of MFIs. Social implications - Donations are found to contribute to positive financial inclusion outcomes for both Islamic and conventional MFIs, a promising implication for society and donors alike. Originality/value - This paper addresses a gap in the academic literature on Islamic MFIs and their use of donor funds by examining how donations contribute to the quality of their credit portfolios, financial performance and social outreach.