The Multitask Problem Poverty Reduction versus Profitability

The problem in designing incentives for microfinance is made more challenging by the multiple tasks that managers expect their staffs to perform. For simplicity, think of the principal as being the manager of a microfinance institution with the twin objectives of reducing poverty and achieving financial self-sufficiency. Mosley (1996b) investigates these two objectives and finds that, rather than being complementary, the objectives often conflict.10 His arguments draw on evidence from BancoSol in the early 1990s. Consider figure 10.1: Poverty reduction is on the vertical axis and loan size on the horizontal axis. The downward sloping "poverty reduction" curve indicates that the impact on poverty reduction decreases with loan size. On the other hand, financial performance improves with loan size as economies of scale are reaped. (This is seen in the upward sloping "profitability" curve). Mosley estimates that in the particular case of BancoSol in the early 1990s, loans larger than $400 improved financial bottom lines but had a negligible effect on poverty.11 Incentive schemes could push loan officers to make larger loans or, if designed differently, to focus on the low-end; the answer hinges on which objectives managers choose as priorities.

The extent to which the two objectives can be obtained also depends on employees' constraints. So, how should managers design a contract to maximize the possibility of attaining their goals, subject to employ-

Reduction in poverty

Profitability

100 200 300 400 500 600 700 800 900 Average Loan Size ($)

Figure 10.1

The trade-off between poverty reduction and profitability: The case of Bolivia's BancoSol. Source: Mosley 1996b, 27.

Reduction in poverty

Profitability

100 200 300 400 500 600 700 800 900 Average Loan Size ($)

Figure 10.1

The trade-off between poverty reduction and profitability: The case of Bolivia's BancoSol. Source: Mosley 1996b, 27.

ees' participation and incentive constraints? The bonus schemes attempted by Corposol satisfied the participation constraints, but they rewarded the wrong targets. By rewarding loan volume, the Corposol managers gave employees little incentive to spend effort training and screening borrowers, and the contracts pushed the portfolio upmarket toward better-off customers. If managers had instead only rewarded the number of loans made, it might have pushed downmarket, but again would not have addressed loan quality. Suppose that instead the Corposol managers had offered bonuses to employees that were a function of repayment rates only. Employees might then have favored borrowers that are less poor or live in economically affluent areas (so that they have alternative resources to cover loan losses). But this would have gone against the objective of poverty reduction.

A potential way to resolve this trade-off is by offering bonuses to loan officers based on both high repayment rates and a large number of clients.12 This strategy has been followed by most microfinance institutions, a small sample of which is shown in table 10.2. In particular, by following such a strategy, lenders like ASA of Bangladesh have attained a high degree of financial sustainability while working with very poor clients, producing financial outcomes that compare favorably to that of BTTF of Kyrgysztan, which offers large and collateral-ized loans to relatively well-off borrowers.

This is a start, but in thinking about optimal incentives in microfinance, concerns go beyond risk versus incentives and beyond loan volume versus quality. There is also concern with enhancing teamwork, balancing short-term versus long-term objectives, discouraging fraud, and (holistically) creating an organizational culture of trust. The story of Corposol shows that each of these concerns can be undermined by incentive schemes that are too high-powered and inconsistently administered. The rest of this section takes up these concerns in greater detail.

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