Prior research suggests that long-term relationships with microfinance institutions (MFIs) are necessary for sustained growth of microcredit-initiated small businesses. However, we present robust evidence that long-term lending relationships may worsen the credit risk of MFIs. Based on information on 1087 MFIs from 69 countries over the period of 2003–2014, we show that, at the initial stage, credit risk declines as an MFI makes more relationship-based loans, but after a certain level, default and delinquencies increase with the magnitude of relationships. We further show that the non-linear, U-shaped, association between relationship lending and credit risk is stronger (a) among small MFIs compared to that among large MFIs and (b) among MFIs that make individual loans compared to those making joint liability-based loans. We discuss policy implications of these findings.
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