Written by Niels Hermes, Associate Professor of International Finance at the University of Groningen, Robert Lensink, Professor of Finance and Financial Markets at the University of Groningen and Aljar Meesters, Faculty at the University of Groningen, this report is based on a study of MFIs over a 11 year period to examine the trade-off (if any) between outreach to the poor and efficiency of microfinance institutions (MFIs). The 29 page document was published by the University of Groningen in June 2008 and the full text of the report is available here.
What follows is a summary of the report:
In the recent past, there has been an increased focus on the ability of MFIs to cover their operational expenses out of the income generated from outstanding loans and also the need for MFIs to reduce their cost of lending money. This shift from subsidizing MFIs to a focus on financial sustainability and efficiency is due to increased competition among MFIs, the commercialization of microfinance (i.e. the interest of commercial banks and other investors to finance MFIs) and the regulation policies of the government. In view of this change, the report examines the extent to which this shift in focus has impacted the outreach of MFIs. As a preliminary hypothesis, the report states that owing to the high cost involved in lending to the very poor, the goals of outreach and sustainability of the MFIs may be conflicting.
The report references earlier studies by other researchers in this regard which are mostly suggestive of the fact that there is a negative relationship between outreach and efficiency of MFIs. However, as per the report, these earlier studies which provided limited experimental evidence used mostly small datasets and/ or simple analysis.
The study by the University of Groningen uses a dataset of 435 MFIs observed over a period of eleven years from1997 to 2007, with the total number of observations equaling 1,318. The MFIs were spread across the regions of Africa, Asia, Latin America, Caribbean and the Pacific. Four types of MFIs were observed for the study:
1. Individual MFIs which provide loans to individuals
2. Solidarity or Group MFIs providing loans to groups
3. Village lending organizations
4. Mixed lending organizations which do not focus on any one specific method.
Some of the key indicators gathered on these MFIs over the 11 year period include loan balance per borrower, loans below USD 300, number of women borrowers, clients below poverty line and savings balance per saver.
The results obtained by analyzing the key indicators show evidence that outreach is negatively related to efficiency of MFIs. Specifically, MFIs that have lower average loan balances, which is a measure of the depth of outreach of MFIs, are less efficient. Further, the study shows that MFIs which have more women borrowers as clients – as a measure of the depth of outreach – are less efficient from a sustainability perspective. Thus, increase in competition reduces the scope for the more traditional aim of the MFIs, which is lending to the poor. MFIs change their outreach strategy such that only the less poor and more productive borrowers are offered loan contracts. This move by the MFIs to reduce defaults – and thereby increase their efficiency and sustainability – leads to less access to credit for the poorest (i.e. less outreach). The data also shows that in comparison with MFIs that focus on individual lending, MFIs that focus on group lending and village banking are more likely to have a higher percentage of female borrowers and clients below poverty line.
The study concludes that with more commercial banks and other financial players entering the market to finance MFIs, the emphasis for efficiency would only be stronger. It suggests that improving efficiency may only be achieved if MFIs increase their average loan balance and focus more on the less poor and more productive borrowers (i.e. reduce their outreach). The report does however point that the demand for efficiency is to a major extant reliant on the aim of the commercial parties. Investors interested in diversifying their portfolios rather than profit maximization might not necessarily be interested in just the most efficient MFIs. The report calls for more research to better understand the reasons why commercial parties invest in MFIs and also their impact on the efficiency and outreach of MFIs.
By Bharathi Ram, Research Assistant
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