Strategic Behavior between a Bank and A Microfinance Institution: The Role of Psychological Distance and Education Level

The relationship between the banking and microfinance sectors is a critical element of financial inclusion in developing countries. Their interaction is supposed to improve the efficiency of the intermediation system as a whole, particularly access to credit for entrepreneurs. Competition is one of the most palpable aspects of this relationship, particularly in developing countries. This article aims to analyze spatial competition between a bank and an MFI. In the Hotelling fundamental model (1929), the geographical distance and high transportation costs grant firms some market power over local buyers in their neighborhoods. We start from this basic model and consider a linear city whose length is normalized at 1. In this city, customers are uniformly distributed, each of whom wants to acquire one unit of credit for financing an investment project. We assume that two types of intermediaries ensure the financing of projects in this market: a bank and an MFI. The bank is located at the left end of the segment and the MFI is on the right end. We investigate a non-cooperative game between the two institutions where competition occurs through price and each player determines its rate of interest by taking the other player's strategy into account. We introduce two additional factors of product differentiation to better account for the reality of the interaction between both sectors: 'psychological distance' and the client's level of education. Our model shows that the competition does not play out only based on transport costs, as in the Hotelling model. When the educational level is relatively high compared to psychological and physical distance, the clientele prefers the bank to the MFI. The bank serves the entire market. However, when the educational level is low compared to the mistrust and physical distance, the clientele will prefer to deal with the MFI rather than the bank. The MFI gets the entire market. The same results arise once the psychological distance dominates physical distance and level of education. However, when the clientele is at a psychological equidistance from both institutions and has an average educational level, the market share is determined by the transport costs and physical distance, as in the Hotelling model.