Microfinance in Ghana: A Comparative Study of Performance of the Formal versus Informal Rural Financial Institutions

Abstract

A growing number of formal commercial banks are increasingly showing interest in financing the vast underserved and untapped market of microenterprises in Ghana. However, the greater majority are still on the fence and are hesitant to venture into microlending. Using field survey data from a wide range of rural financial institutions and tracing the evolution of microfinance in Ghana, the study analyzes the performance in microlending (both in terms of non-performing loans (NPLs) and managers’ perception of growth performance) of formal banks, compared to the traditional MFIs while emphasising the incentives and disincentives, as well as risk mitigation strategies. The study finds that while the main incentives driving banks into microlending were profitability and changing market conditions, disincentives ranged from high cost of transactions to perceived high risks associated with microentrepreneurs. Further, while asset-based collateral was found not to affect the performance of FIs, we find evidence to support the hypothesis that collateral leads to a reduction of NPLs. However, informal FIs were found to perform better in reducing default rates than the formal FIs. On depth of outreach, whereas FIs with clients dominated by women were more likely to perform better, those located in rural areas were more inclined to have higher NPLs. Finally, while a higher scope of outreach was found to be significant for performance, high lending rates charged by FIs led to higher levels of default rates.