Shifting goals in microfinance: from social performance to financial performance

By Lâma DAHER 1 and Erwan LE SAOUT 2

1 Lâma DAHER is a PhD student in Finance at University of Paris 1 Panthéon-Sorbonne. Her subject deals about the financial performances and risks of Microfinance. She’s member of PRISM and participant at the Convergences 2015 World Forum. E-mail address : lama.m.daher@gmail.com

2 Erwan LE SAOUT is a Professor of financial markets and risk management at ESCEM Business School and University of Paris 1 Panthéon-Sorbonne. He’s head of both Masters programs Corporate Finance and Cash Management, and member of PRISM and CRESCEM. E-mail address : erwan@lesaout.com

Abstract

Microfinance has evolved from providing high interest rate microcredits to respond to the furthermost financial and non-financial needs of the bottom of the pyramid category. Its original objective is to eradicate poverty and increase financial inclusion. Yet, the rapid growth of the sector during the last decades shifted the goals of microfinance institutions and a new target was set: to become financially sustainable, self-sufficient and subsidy-free. Achieving the double bottom line of social mission and profitability is the challenge of successful microfinance institutions.

Introduction

The term “poor” refers to low-income persons excluded from the traditional financial system, and who need to have access to a variety of financial products and services - practical, flexible, and at a reasonable price. Microfinance is defined1 as a powerful tool to fight poverty, through the provision of basic financial services, including credit, savings, insurance and transfer of funds. These financial products and services are delivered by microfinance institutions, which cover a range of service providers differing by their legal structure, mission, and methodology.

The demand of microfinance services consists of two types: in the one hand, the income generating activities, and in the other hand, the small enterprises. The income generating activities are defined as non-permanent activities, like an individual owning a retail shop or a micro-service provider. The small enterprises are of two types: microenterprises, composed of one entrepreneur assisted or not by his family members, and small enterprises, composed of a few number of employees supervised by an entrepreneur.

On the supply side, the microfinance offer has evolved to take into account the growing demand. MFIs have expanded their offer from providing only microcredit – grouplending and individual lending – and savings, to include additional services and reach a wider market of unbanked and under-banked clients. The new offer embraces financial and non-financial services. Financial services involve micro-insurance, housing credits, transfer of funds, and remote financial services. Non-financial services include development support services, such as technical trainings, trainings in marketing and in management, and social services, such as education, healthcare, nutrition, and illiteracy eradication. According to Brau and Woller

1 Definition by the Consultative Group to Assist the Poor (CGAP).

1

(2004), MFIs providing non-financial services, in addition to their financial offer, have a better performance in comparison with microfinance organizations that provide only financial services, also known as minimalists.

This paper is organized as follows. First, we trace the historical development of microfinance; we reveal its principal players and its central social mission. Second, we exhibit some results of academic papers on financial and market performances of microfinance institutions. And finally, we identify three financial performance indicators and apply them to our study.

1. Microfinance: a fast-moving sector

Microfinance, has been, for a long time, approximated to microcredit. Yet, these two words do not hold the same denotation. This topic will be clarified in the following section, where we highlight the beginnings of microfinance, its current framework, social objectives and key players.

1.1. Microfinance 1.0

1.1.1. History of microfinance at a glance

The idea of providing the poor the possibility to have access to financial services is longstanding. Informal credit and savings mechanisms have existed long ago. Researchers remind the establishment of a charitable institution, in 1462, to fight against usury. It was the Monte di Pietà, founded by the Italian monk Barnabé de Terni. Two hundred years later, Lorenzo Tonti, a Neapolitan banker, created the Tontine in 1653. The tontine is described as an investment plan, in which each subscriber invest a specific sum of money in a common fund and receive an annuity that increases every time a subscriber dies, until the last survivor or those who survive after a specified time take the entire fund. The tontine system did not vanish. It inspires, nowadays, the system of mutual life insurance, which compels the procurement of benefits solely by those participants who survive and maintain their policies throughout a stipulated period. Many other informal financial services have existed and still exist today, particularly in the developing countries.

Starting the 19th Century, new formal forms of financial services have emerged. In 1849, in Rhineland, the Prussian mayor Friedrich-Wilhem Raiffeisen established the first credit and savings co-operative company. Its purpose was to offer for labor populations, excluded from the traditional banking system, the basic banking services of credit and savings. In 1853, the French brothers Pereire suggested to Napoleon III to create the Credit Unions. In France again, Father Ludovic de Besse founded in 1880 the Crédit Mutuel et Populaire, which is the antecedent of the Banques Populaires. Later, the French government launched the Crédit Agricole, based on the Raiffeinsen model, trying to restructure and support the national agriculture sector.

In the 1960s and 1970s, this model of financial organization reached the developing countries. A large number of public banks and credit and savings unions have been settled in Asia and Latin America. And the “modern” microfinance sprang in the mid-1970s, remarkably in these two regions. The star model was the Bangladeshi Grameen Bank micro-financing model, created in 1976 by Professor Muhammad Yunus. The whole project started in this same year, when Yunus decided to help 42 women in the village of Jobra near Chittagong University - where he used to teach - by lending them the equivalent of USD 27 in local currency. This first loan made to the poorest households of the village was totally repaid, which demonstrates that the poor are able to borrow and pay back their loans. These small loans have permitted

2

the women to work, make business, feed their families and survive, and at the same time, interest payments made this experience profitable to Yunus as well. Inspired by Dr Akhtar Hameed Khan, founder of the Pakistani Academy for Rural Development, he decided then to create the “village bank” or Grameen Bank, based on a grouplending system addressed at first exclusively to women. Small loans were made to small groups of persons, called solidarity groups. The advantage of this system is that all group members act as co-guarantors of repayment and support one another's efforts at economic self-advancement. This model has developed and has been copied in several countries around the word taking into account the specification of each society. The Grameen Bank, alongside with its founder Professor Yunus, have received the Peace Nobel Prize in 2006 rewarding their efforts in fighting poverty in Bangladesh. By this initiative, Yunus has made microcredit a formal financial product – microcredit being the “supply of small loans to individuals usually within groups as capital investment to enable income-generation or for self employment” (Weber, 2004). Though, the industry of microfinance involves more than microcredits.

Until the beginning of the 1990s, microfinance institutions of the urban and rural areas in developing countries were still very reliant on subsidies, donations and grants from development agencies and public and private donors. Since that time, MFIs began seeking self-sufficiency and financial sustainability. Later, profitable ones started restructuring their business and their organization, in order to attract and raise commercial investments from both public and private sectors. Their argument was that bankers and investors would not accept to lend money to operationally non-sustainable, subsidy-dependent and financially unprofitable MFIs. Hence, MFIs have to concentrate their efforts on improving their financial situation, in order to grow and have access to new sources of funding. Besides borrowing from banks, such new funding can come through opening their capital to outside investors or even to the public throughout an IPO. Four IPOs in the recent history of microfinance are worth to be recalled: Bank Rakayat of Indonesia (BRI) was listed in 2003 on the Jakarta Stock Exchange, Equity Bank in Kenya went IPO in 2006, Banco Compartamos in Mexico went public in 2007 and SKS Microfinance Ltd made a stock offering in 2010 becoming the first and only India’s listed micro-lender. Banco Compartamos and SKS differ from the first two MFIs by the fact that, at their early stages, at the beginning of the 1990s, they entered the business as nonprofit organizations offering microcredit and funded by public donations. And later in the beginnings of 2000s, these two NGOs have been shifted to become for-profit enterprises and given the right to collect savings as formal banking institutions.

1.1.2. Microfinance schism

This organizational transformation from not-for-profit to for-profit was strongly criticized by the welfarists, and even by Grameen Bank’s founder, Professor Muhammad Yunus. The welfarists’s argument is that this financially highly rewarding strategy has a detrimental social impact on the poor. Actually, Banco Compartamos charged its clients interest rates as high as 100% and its investors have been earning an average return on equity of 53%.

The welfarists support the poverty lending approach (Robinson, 2001) that “concentrates on using credit to help overcome poverty, primarily by providing credit with subsidized interest rates”. Subsidizing interest rates is fundamental in this approach. The welfarists’ view stresses the importance of social impact and outreach and the threat of focusing too much on efficiency and financial sustainability (Hermes et al., 2009). Outreach is defined by Conning (1999) as the effort by MFIs to extend loans and financial services to an ever-wider audience (breadth of outreach) and especially toward the poorest of the poor (depth of outreach). Consequently, impact is the extent to which the incomes and welfare of those reached is raised. Welfarists are opposed to institutionists, for whom financial sustainability and

3

efficiency are more important than outreach (Christen, 2001; Rhyne, 1998). Their approach exhorts microfinance providers to aggressively pursue sustainability through raising interest rates and lowering costs. Sustainability, according to Conning (1999), refers to full cost recovery or profit making, without the need to government subsidies or donor funds.

Beyond the controversial microfinance schism, the sector of microfinance continues to grow allowing more unbanked and excluded people to profit from the products and services they provide. At the time, this growth allows new players to enter this market and widen the microfinance offer.

1.2. Microfinance 2.0

A growing number of microfinance institutions are using the Internet to raise funds. The development of new technologies and particularly the Internet played a catalytic role in the expansion of the microfinance sector. To date, we count around 10,000 MFIs operating in the five continents. In this section, we present the main types of existing MFIs and the dilemma about their intentions.

1.2.1. Current typology of the sector

About 30 years ago, the microfinance industry was represented by a dozen of NGOs. Currently, alongside with the development of the sector, the number of stakeholders has raised. On the one hand, a variety of formal and semi-formal microfinance institutions are sharing the market (non formal lenders still exist): cooperatives, credit unions, non-governmental organizations (NGO), non-banking financial institutions (NBFI), rural banks, postal banks, and commercial banks. And on the other hand, players of different kinds and intents are contributing in the market: government agencies, public donors, insurance companies, investment funds, individual investors, rating agencies, money transfer companies, and mobile network carriers.

Out of the above-mentioned types of microfinance institutions, 34% are NGOs, 28% are NBFIs, 19% are credit unions or cooperatives, 6% are banks, and 6% are rural banks (figure1).

Figure 1Typology of MFIs

NGOs34%

NBFIs28%

Credit unions19%

Banks6%

Rural banks6%

Other7%

Source: Mix Market (2,000 MFIs worldwide – 12/31/2011)

4

NGOs are created and run with donations from private foundations, governments, international aid agencies and even individuals donors. Usually, they are registered as non-profit for tax purposes, and do not take deposits. NGOs are typically not regulated by a banking supervisory agency, and face two major problems: a risk of dependency towards external donors, and fragile governance. Originally, this type of organizations do not seek to make profits, but as with the development of the microfinance sector, many NGOs are in the process of institutionalization, i.e. to turn into profit corporations. NBFIs are non-banking financial intermediaries that do not have direct access to central bank reserves, since they are not licensed under the same category as banks. Though, these micro-loan organizations provide similar services to those of banks. NBFIs differ from banks over three things: supervision under a different state agency, limitations on financial service offerings, and lower capital requirements.Credit unions and cooperatives are non-profit member-based financial intermediaries, i.e. they are owned and managed by their members. These organizations collect savings from their members, and then use these deposits to grant them loans. Credit unions are not regulated by a state banking supervisory agency, but may come under the supervision of regional or national cooperative council.Banks are licensed financial institutions regulated by a state banking supervisory agency. They are owned by outside stockholders whose main objective is making profit. Banks provide the wider range of financial services among the three other types of institutions. Their offer includes: lending, deposit taking, payment services, and money transfers.Rural banks are banking intermediaries that target micro-entrepreneurs who live and work in non-urban areas and who are generally involved in agricultural-related activities, such as farmers, fishermen and traders. Rural banks provide customer-tailored financial services, including micro-loans and savings.

Intentions of MFIs vary according to their type. Consistent with Bédécarrats et al. (2010), non-for-profit MFIs have better social ratings than for-profit MFIs. Actually, NGOs are supposed to be the most socially oriented institutions since they do not have a lucrative drive. They follow a social agenda, are accountable towards the donors and care about the outcomes and the impact of their projects. At the second place, credit unions and cooperatives are highly concerned about improving the living of their members and do not target profit making. And then, NBFIs, rural banks and banks are commercially oriented, more or less depending on their ownership structure and are likely to care to maintain a sound financial status.

1.2.2. Social performance of MFIs

Social performance is defined by the “Social Performance Task Force” (SPTF) as "the effective translation of an institution's social mission into practice in line with accepted social values that relate to serving larger numbers of poor and excluded people; improving the quality and appropriateness of financial services; creating benefits for clients; and improving social responsibility of an MFI". It is not only based on studying the impact of microfinance programs, it also evaluates social objectives set by the MFI and practices and measures taken by the MFI to meet its objectives.Accordingly, a social performance assessment (SPA) enables an institution to measure its social performance relative to its social mission and objectives. It includes analyses of the social performance of an MFI at different levels (Figure 2):

Process: Institutional process and internal systems. Analysis of the declared social objectives of an MFI, an evaluation of the effectiveness of its system and services in meeting these objectives.

5

Results: Client condition. An assessment of social performance at the client level to determine related outputs and success in effecting positive changes in the lives of clients.

Figure 2Dimensions of Social Performance

Source: SPTF, 2012.

Microfinance institutions concerned with improving their social performance examine the whole process of translating MFIs mission into social impact, and analyze several dimensions of the social performance pathway. However, there is a difference between social impact and social performance. The evaluation of social impact – assessing the impact on beneficiaries and analyzing the breadth, the depth, the scope, the cost and the worth of outreach – comes only after the assessment of the outputs and outcomes of the MFI. Karlan and Zinman (2008, 2011) and Copestake (2007) have conducted impact studies. Table 1 shows some results of academic studies on microfinance social performance.

Table 1Academic results on social performance of MFIs

Authors (year) Sample Period

Results

Cull et al. (2006)

124 MFIs worldwide

1999-2002

The most profitable category of lenders (individual-based MFIs) serves the poor to the least extent.The lenders most sharply focused on reaching the poor and facing the highest average costs (village banks and group-based lenders) are the most subsidy-reliant.Financially self-sustaining individual-based lenders tend to have smaller average loan size and lend more to women, suggesting that pursuit of profit and outreach to the poor can go hand in hand.Larger individual-based lenders and group-based lenders tend to extend larger loans and lend less frequently to women.Older individual-based lenders also do worse on outreach measures than younger ones.

Marr and Awaworyi (2012)

878 MFIs worldwide

2000-2010

Older MFIs as well as regulated ones tend to perform less socially as compared to younger and non-regulated MFIs.MFIs with more assets and higher ratios for loans per loan officer have the tendency of performing more socially.

Evaluating the social impact of microfinance remains the main subject of most of microfinance surveys. The difference between measuring social impact and social performance was recently emphasized, enabling practitioners to establish a new framework for social performance management and assessment, as well as identifying social performance indicators. However, since about 15 years the focus of microfinance institutions has shifted to assessing and improving their financial performance. This is the subject of the following section.

But before exploring microfinance financial performance, we would like to underline that many institutions try to find a compromise between social performance and financial performance, though only few are likely to succeed achieving this goal. This dilemma leads

Intent and Design

Internal Systems/ Activities

Outputs Outcomes Impact

6

us to the paradox of sustainable microfinance institutions, mentioned by Tucker and Miles (2004). It features the trade-off between poverty alleviation and financial self-sufficiency. The researchers point out that, with the purpose of attaining sustainability, MFIs try to gain economies of scale by concentrating their efforts in servicing better-off clients. This strategy results in reducing expenses per loan and increasing the probability of repayment. Another way to attain sustainability, consistent with Tucker and Miles (2004), is to increase profits by raising interest rates, fees, or both. The risk of this option is that it expands the costs for clients and consequently raises default rates. In both cases, the very poor are marginalized and could not benefit from microfinance services. Yet, concentrating efforts on microfinance institutions sustainability and profitability is strengthened by two evidences: first, financially self-sufficient MFIs can broaden their financing possibilities by borrowing from banks and in private capital markets (Gibbons and Meehan, 1999), and second, without sustainability MFIs cannot reach the goal of poverty alleviation (Otero, 1999). In addition, CGAP emphasizes the necessity to insure the financial sustainability of the operations of MFIs in order to cover a large number of poor people.

2. Financial performance

According to Hermes and Lensink (2007), the financial systems approach, which “emphasizes the importance of financial sustainable microfinance programs”, is likely to prevail the poverty lending approach. The argument is that microfinance institutions have to be financially sustainable in order to guarantee a large-scale outreach to the poor on a long-term basis. In this section, we exhibit a review of some studies’ results on financial and market performances of MFIs, and then we do our own survey using a dataset from the MixMarket.

2.1. A review of the literature

2.1.1. Financial performance of MFIs

Today, microfinance institutions are seeking financial sustainability. Many MFIs were restructured in order to achieve financial sustainability and finance their growth. Sustainability is defined as the capacity of a program to stay financially viable even if subsidies and financial aids are cut off (Woolcock, 1999). It embraces “generating sufficient profit to cover expenses while eliminating all subsidies, even those less-obvious subsidies, such as loans made in hard currency with repayment in local currency” (Tucker and Miles, 2004).

Tucker and Miles (2004) studied three data series for the period between March 1999 and March 2001 and found that self-sufficient MFIs are profitable and perform better, on return on equity (ROE) and return on assets (ROA), than developing-world commercial banks and MFIs that have not attained self-sufficiency. However, aggregate data of all MFIs in the sample show that MFIs are unprofitable and perform bad compared to their geographic commercial peers. In order to optimize their performance, MFIs are seeking to become more commercially oriented and stress more on improving their profitability; therefore self-sustainable MFIs are not likely to be servicing the smallest and costliest loans to the poor. Yet, the authors emphasize on the fact that most of MFIs will continue to require subsidies, and thus not to be self-sustainable, because their mission is not only to provide financial services and earn interest, they provide also non financial services without requiring any gains in order to help their clients to better manage their living and their business. Tucker and Miles (2004) recalled the use of the Accion CAMEL rating system (a modification of the CAMELS

7

system used by U.S. commercial lenders) by the microfinance industry to report financial measures, such as capital adequacy, asset quality, management, earnings, liquidity management and sensitivity to market risk (see table 2). The adoption of the Accion CAMEL rating model made the comparisons between MFIs possible based on standard accounting practices.

Table 2 CAMELS Performance indicators for banks

Capital adequacy Asset quality Management

efficiencyEarnings quality or Profitability Liquidity Sensitivity to

market risk

CARNon performing

loans to total loans ratio

Profit per bank branch ratio ROA Liquidity

indicator

Market value of stocks to equity ratio

Capital to asset ratio (CA)

Profit per employee ratio ROE

Non interest income to non interest expense ratio

NIM

Source: Teker et al., 2011

Luzzi and Weber (2006) used a data set composed of 45 MFIs for the period 1999-2003. Their objective is to measure MFIs’ performance, including financial performance. In their study, they retained one only variable referring to sustainability or financial performance (factor 2), and five variables to assess outreach or social performance (factor 1). Luzzi and Weber (2006) used factor analysis methodology to construct synthetic indices of both outreach and sustainability. They estimated a seemingly unrelated regressions model (SUR) to assess the determinants of the performance. Their results for the year 2003 are represented in table 3. The four most significant determinants of financial performance are: interest rate ceiling (the higher the interest rate, the higher is the MFI financial return), number of clients per loan officer (the higher the number, the higher the financial return), competitiveness (more competitors, less profits), and number of days for processing a first loan (the shorter the processing time, the more profitable for the MFI).

Table 3 Determinants of multidimensional MFIs Performance

Determinants of Social performance(factor 1)

Financial performance(factor 2)

Processing time for a first loan No Yes / positiveCompetitors No Yes / negative

Number of clients per loan officer No Yes / positivePercentage of rural clients Yes / positive No

Number of loan officers by branch Yes / positive NoInterest rate ceiling No Yes / negative

Number of financial services offered by the MFI Yes / negative No

Scale of operation (size of portfolio) Yes / negative Yes / positiveNumber of active clients Yes / positive Yes / negative

Source: Luzzi & Weber, 2006

Bartual Sanfeliu et al. (2011) made an interesting statement about the fact that “there has been a lot of literature dealing with aspects like sustainability/profitability, asset/liability management, and/or portfolio quality, whereas there is little literature on the efficiency/productivity of these institutions”. In their paper, Bartual Sanfeliu et al. (2011) chose to measure the performance of MFIs that have a banking side and a social side, using a goal programming based multicriterion methodology. The global business performance

8

ranking combines all the twelve used variables (table 4), assuming that the higher the value of any of the criteria, the higher the perception of the performance, except for the following aspects: FEA, PEA, CPB and PA, which had a negative effect. Accordingly, for these four variables: the higher the value of these criteria, the lower perception of the performance. The authors found that the two categories representative of the general performance tendency are OFP and R&L, followed by IC, which represent the size of the company, then by E. Bartual Sanfeliu et al. (2011) completed their work by carrying out a spearman correlation analysis in order to analyze the correlation between each of the single-criterion measurements and the final performance. They found only two variables that have highly significant correlations with multicriterion performance: ROE and PTA are the two key factors for improving MFIs’ performance.

Table 4 Variables representing business performance categories

Factors Business Performance CategoriesO: offices (number of branches) IC: institutional characteristicsP: personnel (number of employees) IC: institutional characteristicsPTA: portfolio to assets (gross loan portfolio/total assets) FS: financial structureROE: return on equity (net income/shareholder’s equity) OFP: overall financial performanceFEA: financial expense/total assets E: expensesPEA: personnel expense/total assets E: expensesCPB: cost per borrower (operating expense/average number of active borrowers) E&P: efficiency and productivity

LPLO: loans per loan officer (number of loans outstanding/number of loan officers) E&P: efficiency and productivity

PA: personnel allocation ratio (loan officers/personnel) E&P: efficiency and productivityPR90: portfolio at risk > 90 days (value of loans outstanding /gross loan portfolio) R&L: risk and liquidity

LL: loan loss rate ((write-offs – value of loans recovered)/average gross loan portfolio) R&L: risk and liquidity

RC: risk coverage (impairment loss/average assets) R&L: risk and liquiditySource: Bartual Sanfeliu et al., 2011

Tucker (2001) studies the importance of benchmarking and competition in improving MFIs’ financial performance. He states that the rise of competition and the emergence of the possibility to compare the financial performance of MFIs with each other and to benchmarks. He used the results of a study made by Jansson and Taborga (2000) with a database composed of 17 MFIs, 9 regulated and 8 unregulated, including BancoSol Bolivia and FINCA Nicaragua. He selected three benchmark ratios and used their adjusted measures, obtained after adjusting the data by removing subsidies. These ratios are gross financial margin (GFM), ROA and ROE, and the target benchmark ratios were calculated based upon the measures of the better performing MFIs. ROA and ROE are higher in unadjusted measures than in adjusted measures (AROA and AROE) due to the high level of subsidies disbursed in the MFIs. GFM adjusted and unadjusted measures are high for MFIs and well above that obtained by the commercial banks. Commercial banks have lower GFM because they benefit from economies of scale and lower operating expenses to assets. Regulated MFIs achieve better economies of scale than unregulated MFIs, and have a better Debt to equity (D/E) ratio than unregulated MFIs but still lower than commercial banks. Tucker (2001) concludes that using benchmark measures improves business practices. The author also stress on the importance of having benchmarks in order to be able to compare MFIs with each other, particularly on the basis of financial performance.

9

Hudon (2010) analyzes the relationship between financial performance of MFIs and their management mechanisms. 83 MFIs of three types (non-profit institutions and NGOs, non-banking financial institutions, for-profit institutions and cooperatives), from Latin America, Africa, Central Asia and NIS, North Africa and the Middle East, and Asia, constitute the dataset provided by PlaNet Rating. All these MFIs are evaluated based on three financial indicators (ROA; AROA; Financial self-sufficiency FSS) and four management dimensions (Decision making: board governance competencies; Accounting and control: planning budgeting and reporting competences, competencies; Top management: competencies of the top managers; Human resources: competencies of HR management). The results of Hudon (2010)’s analysis show that management ratings influence drastically the MFI financial performances. However, except for the cooperatives where the management variable (specifically HR human resources management) has a negative impact on the ROA, no organizational structure exhibits better results for the three financial indicators. The author underscores that regulated MFIs have significantly better management ratings than non-regulated ones. It is also the case for larger MFIs, in terms of loan portfolio, total assets or borrowers. Conversely, younger MFIs may be more financially profitable, as suggested by Stephens (2005), but not particularly better managed. According to this study, the top management is a key indicator of financial success among the four management dimensions, and seems to have also a positive influence on the amount of received subsidies.

Cull et al. (2006) studied the possibility for MFIs to earn profits while serving the poor. They used a data set of 124 MFIs (village banks, individual-based lenders, and group-based lenders) from 49 developing countries for the period, between 1999 and 2002, to search patterns of the relationship between financial performance and outreach of MFIs. Cull et al. (2006) used three dependent variables: FSS, unadjusted measure of OSS and ROA. The evidence demonstrates that raising interest rates to very high levels does not ensure greater profitability, nor does cost minimization. This evidence is coherent with Stiglitz and Weiss (1981)’s assumption, which says that raising interest rates will undermine portfolio quality due to adverse selection and moral hazard. The researchers found that individual-based lenders that charge higher interest rates are more profitable than others, but only up to a point. Beyond threshold interest rates, profitability tends to be lower. In contrast, for solidarity group-lenders, financial performance tends not to improve as yields increase. Consistent with the economics of information, they also found that individual-based lenders with higher labor costs (as a fraction of total assets) are in fact more profitable. For solidarity groups, who exploit local information to select and monitor customers, they found no significant relationship between labor costs and profitability. Moreover, Cull et al. (2006) found that institutions that make smaller loans are not necessarily less profitable. Larger loan sizes are associated with lower average costs for both individual-based lenders and solidarity group lenders.

Tchakoute-Tchuigoua (2010) studied the relationship between the performance of MFI and their legal status. For that, he compared the performance of 202 MFIs between 2001 and 2006. Three forms of ownership were chosen: cooperatives, private microfinance cooperatives and non-profit making organizations (NGOs). He analyzed five types of performance: financial performance, social performance, and organizational efficiency, quality of portfolio and size and solvency. To assess financial performance of microfinance institutions, the author chose to measure the following ratios: ROA, OSS and profit margin (PM). Regarding sustainability, Tchakoute-Tchuigoua (2010) found no significant difference between NGOs and cooperatives, and that private microfinance corporations have better financial performance than NGOs and better portfolio quality than cooperatives and NGOs.

2.1.2. Market performance of listed MFIs

10

In 2006, a new component was added to the CAMEL rating system in order to take into consideration the sensitivity of the MFI performance towards market risk (see section 2.1.1). The market performance of a listed microfinance institution is an important factor impacting its overall performance. Therefore, we decided to include this section in our paper.

To date, there are two types of public investments in microfinance: Microfinance Investment Vehicles (MIVs) and Listed microfinance institutions. Up to 2010, ten microfinance institutions went public. They are displayed in table 5.

Table 5Listed MFIs and their IPO year

Microfinance institution Market Year of IPOAfrican bank South Africa 1990Dananmon Indonesia 1990

Capitec Bank South Africa 2002Bank Rakyat Indonesia Indonesia 2003

Equity Bank Kenya 2006Blue Financial Services South Africa 2006

Compartamos Banco Mexico / NYSE 2007BRAC Bank Bangladesh 2007

Financiera Independencia Mexico 2007SKS Microfinance India 2010

Microfinance investment funds mobilize funding for microfinance institutions from foundations, individual and institutional investors and development agencies. Estimations show that a variety of around 74 different MIVs existed at year-end 2006 (Dieckmann, 2007). MIVs are funding structures of three types differentiated according to their respective degree of commercialization. Commercially-oriented MIVs include debt and sub-debt instruments but rarely equity investments, because equity stakes are perceived as more risky by investors and exit strategies are difficult, thus these instruments are not easily placed at a reasonable price.

The first category of MIVs is composed by microfinance development funds, which are non-profit entities or cooperatives providing funding usually below market rates and often complemented by technical assistance, and without necessarily seeking a financial return. Investors are development agencies, corporations or private donors (individuals and foundations) and target microfinance institutions approaching financial sustainability. Investors in these microfinance development funds focus on social returns but are more commercially minded than other socially minded investor groups; they usually refrain from providing grants and donations.

The second category is composed of dual-objective microfinance or commercially oriented microfinance investment vehicles, which seek to realize a financial return eventually and are satisfied of that return being below market-based returns. Investors in these dual-objective microfinance vehicles are private donors, development agencies and socially responsible investors.

The third category includes commercial funds, which have a predetermined financial target rate of return while social returns play a secondary role. Investors in this category are individual and institutional investors, and with the development of the microfinance sector, commercial funds are expected to raise their proportion of sub-debt and equity stakes over the medium term and to become open also to investing in riskier parts of MIVs such as equity pieces.

11

Brière and Szafarz (2011) evaluate the profitability of investing in microfinance via stock markets. The authors build microfinance indices: one microfinance index per country and one global microfinance index. These indices differ from the LIFI index developed by JP Morgan that includes microfinance institutions and other financial institutions serving the same public. The authors choose to analyze only listed microfinance institutions, thus the results of their study should be analyzed with precaution. Brière and Szafarz (2011) found that investing in microfinance is very profitable, since as at December 31, 2010, the majority of listed microfinance institutions have high returns (profitability), except a few MFIs like Blue Financial Services in South Africa. Volatilities of MFIs in the Emerging markets are very excessive, ranging from 39.41% to 106.87%, while the average volatility on these markets is of 28%. The authors found that starting 2001, the correlation between financial markets and listed MFIs is getting stronger. This suggests that MFIs, especially those listed on a stock market, are becoming more like commercial banks.

Nevertheless, according to a study by JP Morgan (2010), microfinance institutions listed or their equivalents have a discount of between 13 and 23% compared to traditional commercial banks according to the multiple capitalization retained. In 2010, price earnings ratios were estimated 16,2 for commercial banks while investors 12.4 times earnings for MFIs. Moreover, although the return on equity displayed by them is higher than traditional banks (22% vs 19%), the ratio of market value to book value was 2.6 times for MFIs against 3 times for traditional banks.

In terms of risk analysis based on the CAPM leads to a higher sensitivity of MFIs. In contrast, exposure to currency risk is similar for both types of assets. Brière and Szafarz (2011) conclude that a reduction of the effect of MFI diversifier. Simulations generate different portfolios consisting of 10 to 30% of MFI after risk aversion of the investor.

2.2. Survey on financial performance

2.2.1. Dataset and indicators

In this section, we undertake a statistical analysis on financial performance using a dataset of MFIs referenced by Mix Market. Mix Market is the primary source for microfinance data and analysis. Nearly 2,000 MFIs around the world publish their financial and organizational information on the online platform. As of 12/31/2011, the Mix Market covers 92 million borrowers and more than 1,900 MFIs around the globe, out of which 23% are in Latin America and the Caribbean, 23% are in Africa, 21% are in Eastern Europe and Central Asia, 13% are in East Asia and the Pacific, and 4% are in the Middle East and North Africa. Almost 51% of the MFIs are regulated and 40% are not.

We retained 1,956 MFIs and calculated, over the period 2005-2010, three indicators of performance and risk: return on assets, yield on gross portfolio and portfolio at risk.

Return on assets ratio (ROA) is an indicator of how well an institution uses its total assets to generate returns. It’s calculated as follows:

Net Operating Income−TaxesAverage Assets

Yield on gross loan portfolio, or portfolio yield ratio, measures income from the loan portfolio as well as the average interest rate charged to borrowers by the MFI (including loan-related fees). It’s calculated as follows:

12

Cash Financial Revenue ¿Loan Portfolio ¿AverageGross Loan Portfolio

Portfolio at risk (PAR) measures the value of all loans outstanding that have one or more installments of principal overdue more than a certain number of days. The ratio gives the percentage of loans outstanding that are at substantial risk of default as signaled by difficulties that have already emerged. The PAR 30 days is calculated as follows:

Portfolio at risk (after 30 days)Gross Loan Portfolio

The aim of this study is to support the review of the literature by examining the three most representative financial indicators for microfinance.

2.2.2. Results

We excluded the extreme values, both the positive and negative ones. Therefore, our statistical analysis is done on deciles 2 to 9. Although we have excluded two deciles, we find that the indicators do not follow a normal distribution. Figure 3 shows the distributions of computed performance and risk indicators. Additionally, we notice that these distributions are asymmetric: there is a bigger proportion of MFIs with a higher performance and a lower risk than the average.

Figure 3 Distribution of performance and risk indicators

Return on Asset (%) Yield on gross portfolio (%)

13

Portfolio at risk 30 days (%)

We report in tables 6 and 7 performance and risk indicators measured depending on the type and the location of MFIs. We find that, out of all types of MFIs, rural banks have the higher profitability - assessed by the ROA ratio, and the higher level of risk. It implies a positive relationship between risk and return, as stipulated in the modern portfolio theory. Yet, the yield on gross portfolio for rural banks is lower than the other types of MFIs, such as NGOs. NGOs generally rely more on subsidies than banks do, which cover almost all its costs. The reason of the low yield on gross portfolio can be explained by the fact that rural banks do not diversify their investments as other MFIs – since they fund specifically agricultural projects- or because they invest in lower amounts per project compared to other types of MFIs, subsidized institutions in particular.

In addition, we find that investing in Africa is currently the least profitable and the riskiest. This is due to many reasons, including the lack of financial infrastructures, the high level of insecurity and instability, the precariousness healthcare and sanitation, and the very high level of poverty. Moreover, the yield on gross portfolio scores the highest level, featuring the fact that interest rates charged by MFIs in Africa are the highest. In fact, the risk of default is more important in this region due to the lack of maturity of the microcredit activity on the continent. As for South Asia, we can point out that the level of yield on gross portfolio is the less important compared to other regions. This may come from the fact that the sector is much more developed in this region, unlike Africa. Accordingly, South-Asian MFIs benefit from economies of scale and experience and can charge less their borrowers. Besides, there are no statistically significant differences to highlight between the other groups of regions.

Table 6 MFIs performance and risk according their type

NGOsCredit unions NBFIs Rural banks Banks Other

Return on assets1,722%(4,651%)2,170%

1,611%(2,381%)1,495%

1,994%(3,830%)2,080%

2,905%(1,575%)2,720%

1,283%(2,326%)1,360%

4,971%(3,949%)3,710%

Portfolio at risk 30 days 4,292%(3,723%)

5,591%(3,998%)

3,895%(3,393%)

9,060%(6,262%)

4,104%(3,325%)

2,543%(2,890%)

14

3,370% 4,740% 3,030% 8,530% 3,040% 1,930%

Yield on gross portfolio33,11%(10,95%)30,62%

22,76%(7,08%)20,94%

34,19%(11,32%)31,99%

29,40%(7,19%)28,42%

26,83%(7,54%)25,84%

33,35%(11,92%)35,37%

Average – (Standard deviation) - Median

Table 7 MFIs performance and risk according region

Africa

East Asia and the Pacific South Asia

Latin America and

The Caribbean

Middle East and North

Africa

Eastern Europe and Central Asia

Return on assets-0,591%(5,575%)0,680%

2,996%(2,447%)2,720%

0,751%(3,009%)1,095%

2,330%(3,203%)2,165%

3,634%(4,281%)3,835%

3,315%(3,706%)2,700%

Portfolio at risk 30 days6,895%(5,218%)5,490%

5,304%(5,177%)3,465%

2,974%(3,203%)1,765%

5,368%(3,170%)4,655%

3,418%(3,518%)2,235%

3,031%(2,978%)1,990%

Yield on gross portfolio35,67%(14,94%)31,74%

33,23%(10,52%)31,43%

23,48%(5,03%)23,26%

33,79%(11,54%)31,16%

30,59%(6,77%)31,29%

30,03%(9,55%)28,84%

Average – (Standard deviation) - Median

Conclusion

This article aims to present the microfinance sector and to relate the results of early research on the analysis of financial performance. We undertook a statistical study that allow us to say that rural banks have the highest risk/return position, and that African MFIs are the most risky and the less profitable of all. Analysis of financial performance should not overshadow the objective of microfinance: improving social performance. It will be necessary to build robust social performance indicators and highlight a positive relationship with financial performance. The lack of relationship could jeopardize the future of microfinance.

References

Bartual Sanfeliu, C., Cervella Royo, R., Moya Clemente, I., 2011. Measuring performance of social and non-profit Microfinance Institutions (MFIs): An application of multicriterion methodology. Mathematical and Computer Modelling. Bédécarrats, F., Lapenu C., Tchala, R.Z., 2010. Social Audits in Microfinance: What have we learned about social performance?. SPI3 Discussion Paper 25. CERISE.Brau, J.C., Woller, G.M., 2004. Microfinance: A comprehensive review of the existing literature. Journal of Entrepreneurial Finance and Business Ventures, 9(1), pp.1-26.Brière, M., Szafarz, A., 2011. Investment in Microfinance Equity: Risk , Return , and Diversification Benefits. Working papers CEB.Christen, R.P., 2001. Commercialization and mission drift: the transformation of microfinance in Latin America. Occasional Paper No. 5, CGAP.Conning, J., 1999. Outreach, sustainability and leverage in monitored and peer-monitored lending. Journal of Development Economics, 60(1), pp.51-77.

15

Copestake, J., 2007. Mainstreaming microfinance: social performance management or mission drift?. World Development, 35 (10), pp. 1721-1738.Cull, R., Demirgüç-Kunt, A., Morduch, J., 2006. Financial Performance and Out- reach: A Global Analysis of Leading Microbanks, World Bank Policy Research Working Paper, 3827.Deutsche Bank Research, Microfinance: An emerging investment opportunity, Frankfurt am Main: Deutsche Bank, December 19, 2007.Luzzi, G., Weber, S., 2006. Measuring the Performance of Microfinance Institutions. Applied Sciences, pp.1-17.Gibbons, D. S., Meehan, J.W., 1999. The microcredit summit's challenge: Working toward institutional financial self-sufficiency while maintaining a commitment to serving the poorest families. Journal of Microfinance, 1 (1, Fall) 131–192.Hermes, N., Lensink, R., 2007. The Economic Journal, 117 (February), F1-F10.Hermes, N., Lensink, R., Meesters, A., 2009. Financial Development and the Efficiency of Microfinance Institutions. SSRN Electronic Journal, pp.1-29.Hudon, M., 2010. Management of microfinance institutions: do subsidies matter? Journal of International Development, Volume 905 (November 2009), pp.890-905.Karlan, D., Zinman, J., 2011. Microcredit in Theory and Practice: Using Randomized Credit Scoring for Impact Evaluation. June 2011, Science, 332(6035), pp. 1278-1284.Karlan, D., Zinman, J., 2008. Expanding Credit Access: Using Randomized Supply Decisions to Estimate the Impacts. Innovations for Poverty Action, January.Marr, A., Awaworyi, S., 2012. Microfinance social performance: a global empirical study. Applied econometrics and international development, 12 (2), pp. 51-68.Otero, M., 1999. Bringing development back, into microfinance. Journal of Microfinance, 1(1), 8–19.Rhyne, E., 1998. The yin and yang of microfinance: reaching the poor and sustainability. The Microbanking Bulletin, Vol. II. The Economics Institute, Boulder, 1.Robinson, M., 2001. The microfinance revolution: sustainable banking for the Poor, Washington DC, World Bank.Stephens, B., 2005. Sustainability in sight: an analysis of MFIs that become sustainable. MicroBanking Bulletin 10: 23–29.Tchakoute-Tchuigoua, H., 2010. Is there a difference in performance by the legal status of microfinance institutions? The Quarterly Review of Economics and Finance, 50(4), pp.436-442.Tucker, M., Miles, G., 2004. Financial performance of microfinance institutions: a comparison to performance of regional commercial banks by geographic regions. Journal of Microfinance/ESR Review, 6(1), pp.41-54.Tucker, M., 2001. Financial Performance of Selected Microfinance Institutions: Benchmarking Progress to Sustainability. Journal of Microfinance, 3(2), pp.107-123.Weber, H., 2004. The new economy and social risk: banking on the poor?. Review of International Political Economy, 11:2 May 2004, pp. 356-386.Woolcock, M. J. V., 1999. Learning from failures in microfinance: What unsuccessful cases tell us how group based programs work. American Journal of Economics and Sociology, 58(1), 17–42.

16