Does financing startups impact the profitability of microfinancing institutions?

Abstract

PurposeFunding startups is usually perceived as a risky investment for money lenders and investors due to the high failure rate of such early-stage firms. Therefore, funding startups may negatively impact the profitability of the lending institutions. The current study aims to test how financing startups (the percentage of financed enterprises that are startups) affects the profitability of microfinancing institutions (MFIs). It also attempts to determine the conditions that allow MFIs to limit the negative effects of such risky investments on their profitability.Design/methodology/approachThe study considers panel data of 2,694 global MFIs hosted on the Microfinance Information Exchange Market on the World Bank website. Dynamic panel data methodology (generalized methods of moment) is applied to conduct the econometric analysis. In addition to regression analysis, to test the main and interaction effects, interaction graphs are plotted to elaborate on the findings.FindingsDirect evidence implies that financing startups negatively impacts the profitability of MFIs. Therefore, MFIs should act per two necessary conditions to reduce risks associated with startups financing. First, MFIs should optimize their risk cover and use these funds to finance startups. Second, an increased use of non-earning liquid funds to finance startups is recommended to maintain profitability.Practical implicationsThe findings of our study will help MFIs continue lending to startups while protecting their profitability.Originality/valueThe findings contribute to the institutionalization approach of MFIs while providing favorable conditions for financing startups and protecting profitability at the same time.