Market power, social welfare, and efficiency in the Peruvian microfinance

This study quantifies the social welfare loss caused by market power in Peru’s regulated microfinance industry and analyzes its effect on microfinance institutions’ (MFIs) efficiency from 2003 to 2019. We estimate the efficiency-adjusted Lerner index as a measure of market power and obtain efficiency scores via cost and profit stochastic frontiers estimation using data from a wide panel of MFIs. Additionally, to analyze the effect of market power on the MFI’s efficiency, we estimate a fixed effects model with instrumental variables to correct the endogeneity problem. The results show that the welfare loss due to market power in Peru’s regulated microfinance industry has increased from 0.12% of GDP in 2003 to 0.27% in 2019. It is also found that market power positively affects Peruvian MFIs’ efficiency. Therefore, reducing market power leads to a welfare gain by lowering the social welfare loss (Harberger’s triangle) and a welfare loss due to decreased efficiency in MFIs. However, we find that reducing market power leads to a positive net effect on social welfare due to greater welfare gain than loss.