Relationship lending in microfinance: How does it impact client dropout?

• DOI: http://doi.org/10.1002/jsc.2271
• Author: Cécile Godfroid
• Published date: 01 July 2019
• Date: 01 July 2019

RESEARCH ARTICLE

Relationship lending in microfinance: How does it impact client

dropout?

Cécile Godfroid

Business and Management Department,

UMONS-CERMi, Mons, Belgium

Correspondence

Cécile Godfroid, Centre for European

Research in Microfinance (CERMi), Université

de Mons, Warcoqué 17, 7000 Mons, Belgium.

Email: cecile.godfroid@umons.ac.be

Abstract

A close relationship between microfinance loan officers and their clients is essential

to avoid the phenomenon of client dropout. Client retention has been identified as a

critical factor for both the social performance and the financial sustainability of

microfinance institutions. Relationship lending in microfinance decreases the proba-

bility of clients dropping out, showing the importance of close contacts between loan

officers and their clients. We recommend that microfinance practitioners avoid the

rotation of loan officers through different branches when the risk of fraud from loan

officers is low.

1|INTRODUCTION

In September 2015, the United Nations adopted a collection of

17 goals covering numerous global social and economic development

issues, as part of the 2030 Agenda for Sustainable Development.

Microfinance, by favoring financial inclusion, appears as a useful tool

to contribute to several of these goals such as eliminating extreme

poverty, reducing hunger and promoting food security, achieving good

health and well-being, fostering good quality education, and promot-

ing gender equality (Klapper, El-Zoghbi, & Hess, 2016).

To favor the development of microfinance, client retention has

been identified as a critical factor as it relates to both the social per-

formance and the financial sustainability of microfinance institutions

(MFIs). Undeniably, by retaining clients, MFIs are able to reduce

administrative costs and loan defaults. Moreover, client retention is

considered as a social indicator by the United States Agency for Inter-

national Development and by the microfinance industry's Social Per-

formance Task Force because it shows that clients are satisfied with

the services and products offered.

Given the advantages offered by client retention and knowing that

“for most poor microentrepreneurs the cessation of a microfinance

relationship constitutes an exit from formal credit markets altogether,

as graduation rates to larger formal lenders tend to be low”(Pearlman,

2014, page 302), it seems essential to analyze the factors that can

explain the phenomenon of client dropout in the microfinance sector.

However, this field remains poorly documented in the literature.

Among the few studies on this topic, some have shown that clients

exit MFIs mainly because of attributes related to themselves or to

their businesses, of attributes related to the services offered by the

MFI, of loan officers' attributes, of group issues or external shocks

(Bardsley, Gray, & Gash, 2015).

This study focuses on factors linked to the relationship between cli-

ents and their loan officer in order to analyze client dropout. We argue

that without a close relationship between both actors, microfinance may

lose its raison d'être, and clients may be negativelyaffected.Tobetter

explain this point of view, we build on the literature on relationship lend-

ing and relationship marketing.

Relationship marketing relates to activities that consist in “attracting,

maintaining and—in multiservice organizations—enhancing customer rela-

tionships”(Berry, 1983, page 25). As argued by Taleghani et al. (2011,

page 155), this marketing strategy represents “an excellent way for banks

to establish a unique long-term relationship with their customers.”Based

on this marketing strategy, banks have developed a specific lending tech-

nique called relationship lending.

Relationship lending presents several advantages for both the bor-

rower and the lender. For the lender, it can reduce information asym-

metry problems as banks obtain private information about borrowers'

repayment history (Diamond, 1991). As information asymmetry may

be particularly problematic when dealing with poor people who are

active in the informal economy and often lack collateral, reducing this

barrier through relationship lending appears to be essential for the

financial inclusion of those poor people.

Studies on relationship lending often consider the relationship

between banks and their clients without taking the role of loan officer

DOI: 10.1002/jsc.2271

Strategic Change. 2019;28:289–300. wileyonlinelibrary.com/journal/jsc © 2019 John Wiley & Sons, Ltd. 289