Written by Joshua Zacharias, Glucksman Institute for Research in Securities Markets at The Leonard N. Stern School of Business, New York University, Faculty Advisor: David Backus, April 16, 2008, available at: http://archive.nyu.edu/handle/2451/25936.
‘Economies of scale’ refers to increased efficiency (lower average costs per unit produced) experienced by firms as they increase the overall size (total units produced) of their operations. For financial institutions, this measurement measures cost savings realized from increasing the size of its loan portfolio in terms of both number of loans and overall value of loan portfolios.
Zarcharias explains that this topic is especially important in microfinance because of recent debates over the for-profit microfinance institutions (MFIs) like Compartamos of Mexico (pg 2). Those in favor of for-profit microfinance believe that potential profit will fuel increased investment, leading to an increase in the size of microfinance institutions. If economies of scale do exist, then these larger institutions would be able to offer microfinance services at the lower costs (interest rate) to customers (pg 3). Those opposed to commercializing microfinance, like Nobel Prize Laureate Muhammad Yunus, argue that the desire to maximize profits and shareholder return will shift MFIs away from their original goal of alleviating poverty (pg 2).
In the first round of testing, Zacharias finds two major conclusions. The first is that an increase in gross loan portfolio (GLP) size does have a significant negative relationship with average cost (pg 14). This result implies that increasing the overall size of a gross loan portfolio does allow MFIs to offer lower interest rates to customers with loans of the same size.
The other major result from this first section was that there is a strong inverse relationship between average loan size and average costs (pg 14-15). In fact, this relationship had a magnitude three times that of the correlation between GLP and average costs. In microfinance, there is a tenuous balance between maximizing efficiency and fulfilling the original goal of assisting the poor. This finding implies that managers who strive to improve cost efficiency may do so by increasing loan sizing. This could potentially mean shifting away from the goal of serving those most in need (pg 16). This could create a dilemma for those MFI managers who want or need to improve efficiency but do not want to abandon to the original goals of their organization.
In the second portion of the study, which employs time-trend data, Zacharias finds further evidence of ‘economies of scale’ in MFIs (pg 17). Surprisingly, these effects seem even more pronounced in non-governmental organization (NGO) MFIs, which focus on social return, not profit, but often strive for self-sufficiency (pg 18). This could potentially be due to the fact that NGOs receive grants and subsidies, which could affect the ability to compare the costs of for-profit and NGO MFIs (pg 20).
Also in this second section, Zacharias finds vast differences in the effect of increasing sizes in MFIs across geographic regions with South & East Asia and the Middle East seeing significant reductions in cost with increased size (pg 18). These findings may have been influenced by widely variant sample sizes from different regions (19).
Overall, this study does provide evidence of ‘economies of scale’ in microfinance institutions. According to Zacharias, these results, however, become difficult to translate into policy and business plans because of the potential trade-off between efficiency and remaining in the microfinance field of operations (pg 20). Zacharias also believes that his findings support the growing body of evidence that managers cannot plan for a blanket ‘win-win’ scenario with increased efficiency and improved social effects (pg 22). This fact forces managers to seek balance when improving efficiency through ‘economies of scale’ without abandoning the original goals of their organizations (pg 22). All data for this study was taken from MIX Market, the Microfinance Information eXchange.
By Greg Casey, Research Assistant
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