Client protection principles in the lending process and credit risk of microfinance institutions

This study investigates whether the implementation of client protection principles (CPPs) in microfinance lending reduces the credit risk of microfinance institutions (MFIs). We base our hypothesis on the application of game theory within instrumental stakeholder theory. This framework suggests that, when MFIs treat their clients with respect, fairness, and professionalism, they tend to respond with cooperative behaviour. This, in turn, leads to proper and timely credit repayment, ultimately reducing the credit risk for MFIs. Using a panel dataset of 984 MFIs across 88 countries from 2007 to 2018, we find evidence in favour of this hypothesis. We find that the impact of CPPs on credit risk is more pronounced among the MFIs that primarily use individual lending as opposed to group lending methods and those that operate with commercial motives rather than non-profit motives.