When Pro-poor Microcredit Institutions Favor Richer Borrowers - A Moral Hazard Story

We suggest an explanation for the existence of “mission drift”, the tendency for MFIs to lend money to wealthier borrower rather than to the very poor. We focus on the relationship between Microfinance Institutions (MFIs) and external funding institutions. We assume that both the MFIs and the funding institutions are pro-poor oriented and agree on the optimal proportion granted to the poorer borrower. However, asymmetric information on the effort level chosen by the MFI to identify higher quality projects may increase the share of loans attributed to wealthier borrowers because funding institutions build incentives for MFIs with a tradeoff between the quality of the funded projects and the attribution of loans to poorer borrowers.