Preparing Fertile Ground: How Does the Business Environment Affect Outcomes From Microfinance?

Transformative effects on microfinance client business growth are expected in financial inclusion's traditional theory of change, yet have largely been unrealized in most randomized controlled trial studies on microcredit. While instructive, the broader policy relevance of individual studies may be limited by their localized geographic coverage and relative invariance of business environments in which respective client businesses operate. In this paper, we draw on longer-term nationwide administrative data from a leading Cambodian financial service provider and exploit a natural experiment to test if and to what extent differences in business environments affect clients’ business growth. Our main finding is that positive shocks to the business environment lead to significantly increased employment in exposed client enterprises compared to client enterprises in contextually similar districts but that are unexposed. The effect is particularly strong for small (rather than micro-) enterprises and clients located in districts with larger local economic markets. Furthermore, factors relating to enterprises’ business environment are more predictive for growth than those relating to business characteristics. To broaden our argument and policy relevance, we then pool data from past microcredit impact evaluations to demonstrate how a number of related business environment factors help explain the heterogeneity found in their results. In those data, we observe, for example, that subnational differences in levels of trust in formal institutions are particularly strongly related to greater levels of employment in client businesses, and that areas with access to better infrastructure and larger markets show signs of particularly higher client profits. Our results suggest that financial access in isolation is less likely to trigger the desired transformative effects, or may not be fulfilling its real potential, unless coupled with the right opportunities in the business environment. Policy implications are that microfinance clientele respond to opportunities provided by local business environments and that national and subnational governments can play more active roles in improving business framework conditions.