Are microfinance institutions resilient to economic slowdown? Evidence from their capital ratio adjustment over the business cycle

Prior studies using pre-crisis data concluded that microfinance institutions are resilient to economic crises. However, some recent studies indicate that the microfinance sector is becoming part of the global financial system and microfinance lending activities are now vulnerable to economic and financial crises. Capital being a key resource to support lending, this paper analyzes the cyclical behaviour of capital ratio using an international sample of microfinance institutions from 2001 to 2014. We uncover a negative relationship between their capital-to-assets ratios and business cycle indicators. This relationship mainly concerns regulated institutions, comprised mostly of profit-oriented MFIs, and is driven by both asset-side and capital level adjustments. We identify the lending channel (loan-to-assets ratio) as the main mechanism to explain these cyclical variations. Our findings are consistent with the “procyclicality” of capital regulation documented extensively in the banking literature. Hence, macro-prudential regulation for MFIs should target regulated and profit-oriented MFIs. •MFIs’ capital ratios comove negatively with the business cycle.•This cyclical behaviour concerns mainly commercialized (regulated and profit-oriented) MFIs.•Lending is the main transmission channel of the cyclical variations of MFIs’ capital ratios.•MFIs with higher lending tend to adjust their capital ratio downwards in response to business cycle shocks.•Macroprudential regulation should target regulated and profit-oriented MFIs.