Profitability is at the heart of the promise that microfinance can deliver meaningful poverty reduction while reaching global scale. Microfinance contracts have proven able to secure high rates of loan repayment in the face of limited liability and information asymmetries, but high repayment rates have not translated easily into profits for most microbanks. We examine why this promise remains unmet. Using a data set with unusually high-quality financial information on 124 institutions in 49 countries, we explore patterns of profitability, loan repayment, and cost reduction. The evidence demonstrates the possibility of earning profits while serving the poor. The most profitable category of lenders serves the poor to the least extent, however, and the lenders most sharply focused on reaching the poor are the most subsidy-reliant. Raising interest rates to very high levels does not ensure greater profitability, nor does cost minimization.

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We jointly analyze the static, selection, and dynamic effects of domestic, foreign, and state ownership on bank performance. We argue that it is important to include indicators of all the relevant governance effects in the same model. "Nonrobustness" checks (which purposely exclude some indicators) support this argument. Using data from Argentina in the 1990s, our strongest and most robust results concern state ownership. State-owned banks have poor long-term performance (static effect), those undergoing privatization had particularly poor performance beforehand (selection effect), and these banks dramatically improved following privatization (dynamic effect). However, much of the measured improvement is likely due to placing nonperforming loans into residual entities, leaving "good" privatized banks.

The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.

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