Expand or avoid: Microfinance credit risk and climate vulnerability

This study investigates the association between climate vulnerability, geographic expansion, and credit risk in microfinance institutions (MFIs) loan portfolios. It is motivated by inconclusive evidence concerning the climate vulnerability-bank risk nexus and the geographic expansion-bank risk nexus. Applying system generalized method of moments (GMM) to a sample of global MFIs over the period 1999–2019, we report evidence that climate vulnerability and geographic expansion increase MFI credit risk. Our results indicate that MFIs operating in climate-vulnerable countries or undergoing geographical expansion tend to maintain higher financial buffers to absorb potential losses. Furthermore, we also report evidence of increased institutional credit risk for MFIs with wider geographical expansion and larger loan portfolios. The risk is more pronounced for non-shareholder-owned MFIs compared to shareholder-owned MFIs. This suggests MFI expansion into climate prone regions is curtailed in the case of shareholder-owned MFIs to minimize credit risk, overshadowing the microfinance mission to provide banking services to the poorest and the most vulnerable. In addition, we report evidence that climate vulnerability moderates the consequences of geographic diversification in the microfinance industry. • Climate vulnerability increases credit risk in microfinance loan portfolios. • Geographic expansion increases credit risk in microfinance loan portfolios. • Non-shareholder-owned MFIs face greater credit risk from climate vulnerability. • Climate vulnerability moderates the effect of geographic expansion on MFI credit risk.