Does the efficiency wage reduce the credit risk of microfinance institutions? Global evidence

Abstract From a relational lending or banking perspective, offering higher than industry average wages, known as efficiency wages (EWs), can boost employee productivity and, specifically, improve loan recovery within microfinance institutions (MFIs). This underscores the significance of EWs in managing credit risk, a persistent challenge in the microfinance industry. Accordingly, this study investigates the relationship between EWs and credit risk in MFIs, an issue of growing interest to both policymakers and academics. We used data from the World Bank's MIX market database, covering 1258 unique MFIs across 101 countries from 2010 to 2018. Utilizing panel regression analysis, we found that implementing EWs tends to reduce credit risk within MFIs. Our results suggest that paying employees above industry standards incentivizes them to enhance their productivity and performance, thereby supporting loan recovery efforts. These findings remain robust even when employing alternative proxies and endogeneity‐corrected techniques.