Rural Lending and Microfinance Sustainability -- Is Small Beautiful?

Lending to rural borrowers is a key element of pursuing the poverty alleviation mission of microfinance. However, a strong focus on rural areas is said to hamper the sustainability of microfinance institutions (MFIs). We analyze this potential trade-off based on data covering 802 microfinance institutions over the period 2008-2013. We find that increasing the share of rural borrowers over time has only limited impact on MFI sustainability. By contrast, there are substantial cross-MFI effects. A higher share of rural borrowers is associated with better sustainability prospects, in particular when institutions are newly established. However, we also find evidence suggesting that a stronger focus on rural borrowers has a negative impact on sustainability when MFIs either become larger or more productive. Thus, transaction cost disadvantages of rural lending seem to weaken economies of scale and productivity effects that contribute to MFI sustainability in urban areas. Overall, our results provide some support for the view that small is beautiful when MFIs predominantly serving rural borrowers want to achieve sustainability