performance of microfinance: the role of subsidies ahmad nawaz 04.02.20101seminar series, pide...
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Seminar Series, PIDE 1
PERFORMANCE OF MICROFINANCE: THE ROLE OF SUBSIDIES
Ahmad Nawaz
04.02.2010
Pakistan Institute of Development Economics
Seminar Series, PIDE 204.02.2010
Objectives of the Study
Motivation
Estimating the performanceSubsidy Dependence Index (SDI)
Introduction --- Theoretical Framework --- Data Sources--- Descriptive AnalysisWith & without subsidy analysis
Conclusion
Pakistan Institute of Development Economics
Seminar Series, PIDE 304.02.2010
Objectives of the studyIn General:“To make the case for subsidy-adjustments when it comes to evaluation of the performance of microfinance”And in particular:• to calculate a decent measure of sustainability of microfinance taking into account the subsidies• calculate how much the subsidization of Microfinance costs to the society•How subsidization of microfinance relates to various organizational and institutional factors• To pin down the factors affecting the sustainability of microfinance
Pakistan Institute of Development Economics
Seminar Series, PIDE 4
Motivation
Incorporation of role of subsidies in the performance evaluation of MFIs: a neglected area
Win-Win proposition?: the promise of Microfinance for strong social performance alongwith financial self sustainability remains unmet
The recent drive towards commercialization of Microfinance The importance of the impact of various strategic,
organisational and operational variables on the efficiency of Microfinance Institutions
04.02.2010
Pakistan Institute of Development Economics
Seminar Series, PIDE 504.02.2010
TYPE Notation Type of grant1. Direct Grant DG
Equity Grant (EG)2. Paid-up-capital PC
3. Revenue Grant RG
Profit Grant (PG)4. Discount on Public Debt A.(m-c)
5. Discount on Expenses DX
6. True Profit TP Equity Grant (EG)
Introduction : What constitutes subsidies?
These are subsidized/public funds from government or donors and come in six forms:
Total Subsidised funds consists of Equity Grants and Profit Grants.Equity Grants increases net worth but do not directly change the accounting profitProfit grants increases directly the accounting profit since they inflate revenues
Pakistan Institute of Development Economics
Seminar Series, PIDE 604.02.2010
• Role of Subsidies : Two strand of Thoughts Which justifies the positive role of subsidy
notwithstanding poverty alleviation (Hulme & Zeller) The others are skeptical of the long run role of subsidies:
the notion of smart subsidies (Hendricks, 2003; Aghion & Morduch, 2004; Morduch 2005)
• Yaron´s Subsidy Dependence Index (SDI) • Measures the social cost of subsidized Financial
Institution in short time frames such as year• It is the ratio of the (annual) subsidies against the
interest income of the Financial institution
Measuring the performanceInstitutionalist perspective : Outreach & Sustainability
Pakistan Institute of Development Economics
Seminar Series, PIDE 704.02.2010
SDI = subsidies (S) / revenues from lending (LP * i)= (E * m + A (m - c) + K – P) / (LP * i)
Where:• E = average annual equity• m = Market Interest rate or Interest rate the MFI is assumed to pay for
borrowed funds if access to concessional borrowed funds were eliminated • A = Average annual outstanding concessionary-borrowed funds or Average
public debt• c = actual interest rate paid on concessionary borrowed funds or interest
rate paid on Public debt • P = Reported annual profit or accounting profits• K = Other Subsidies received by the MFI (RG + DX) • LP = Average annual outstanding loan portfolio of the MFI• i = yield on lending or interest rate charged to borrowers
Theoretical Framework: The SDI Formula
Pakistan Institute of Development Economics
Seminar Series, PIDE 8
The Choice of Opportunity cost of concessional borrowing Evidence from existing literature Deposit rate as proxy (Khandker, Khalily, and Khan, (1995) as Rate on three year
Deposit (Bangladesh) ; Hashemi and Schuler (1997) as Transaction costs (3%) + Bangladesh Bank deposit rate (IMF) ; Morduch, (1999b) as Bangladesh Bank deposit rate(IMF) + 3% transaction costs; Sacay, Randhawa, and Agabin, 1996 as deposit rate ; Yaron, Benjamin and Piprek (1997) as market deposit rate; Schreiner and Yaron (1999) as Deposit rate paid by MFI + 3% transaction costs)
Inflation rate (Rosenberg, Christen, and Helms, 1997; Holtmann and Mommartz, 1996; Christen et al., 1995; SEEP, 1995; IADB, 1994)
10% rule of thumb (Belli, 1996; Katz and Welch, 1993; Gittinger, 1982) Benjamin Formula Prime rate (lending rate) + Premium for RiskWhere, Premium for risk = premium for age + premium for profitability Commercial banks Lending rate
04.02.2010
Pakistan Institute of Development Economics
Seminar Series, PIDE 9
An ExampleSDI = subsidies (S) / revenues from lending (LP * i)
= (E * m + A (m - c) + K – P) / (LP * i)
A value of 0.25 shows that the subject MFI is subsidy dependent. In order to be subsidy free, the interest rate has to be increased by 25%. In other words, it distorts public wealth.
A value of -0.10 shows that an MFI is subsidy-free and it will remain subsidy-free even if it deacreses interest rate by 10%. In other words, it creates public wealth.
04.02.2010
Year 2005 2006
SDI Value 0.25 -0.10
Type Subsidy dependent Subsidy free
Pakistan Institute of Development Economics
Seminar Series, PIDE 1004.02.2010
• Audit Reports of 204 MFIs for SDI calculations taken from MIX Market Website for years 2005 & 2006
• MIX Market Website (www.mixmarket.org)• International Monetary Fund, International Financial
Statistics, Washington, D.C. 2005 & 2006• Respective MFIs Websites• Annual Reports of respective MFIs• Third Party Rating Reports of MFIs• World Development Indicators• Direct contact with MFIs
Sources of Data
Pakistan Institute of Development Economics
Seminar Series, PIDE 1104.02.2010
• Region Africa (A), South Asia (SA), Latin America (LA), Middle East & North Africa (ME & NA), Central Asia & Eastern Europe (CA & EE), East Asia & Pacific (EA & P)
• Status Banks, Cooperatives, Non-Governmental Organizations (NGOs), Non-Banking Financial Institutions (NBFI), Rural Banks
• Lending Methodology Individual Lending (I), Solidarity or Groups (S), Individual & Solidarity Lending (IS), Village Banking (V)
• Saving Yes or No
• Regulated Yes or No
• Other Services Yes or No
Institutional Variables
Pakistan Institute of Development Economics
Seminar Series, PIDE 1204.02.2010
Descriptive analysis of Data
32.35%
48.04%
13.24%
6.373%
I IS SV
LENDING METHODOLOGY*
23.04%
14.71%
9.314%
33.33%
5.392%
14.22%
Africa CA&EE EA&PLA ME&NA SA
REGION
14.71%
5.392%
29.41%
46.08%
4.412%
Bank Coop. NBFINGO R.Bank
STATUS
42.65%
57.35%
No Yes
REGULATED
59.8%
40.2%
No Yes
OTHER SERVICES
44.61%
55.39%
No Yes
SAVINGS
Pakistan Institute of Development Economics
Seminar Series, PIDE 13
Camparison between using different interest rates
Year 2005 Year 2006SDI (Lending
rate)SDI (Benjamin,
1994)SDI (Lending
rate)SDI (Benjamin,
1994)No risk
premiumwith risk premium
No risk premium
with risk premium
Subsidy Dependent 153 179 122 155
Subsidy Free 51 25 57 24
Total 204 204 179 179
04.02.2010
Pakistan Institute of Development Economics
Seminar Series, PIDE 1404.02.2010
The SDI in institutional setting
-.1
0
.1
.2
.3
SD
I
Bank Coop. NBFI NGO R.Bank
STATUS
0
.1
.2
.3
SD
I
I IS S V
Lending Methodology
0
.05
.1
.15
.2
.25
SD
I
No Yes
SAVINGS
0
.05
.1
.15
.2
.25
SD
I
No Yes
REGULATED
0
.05
.1
.15
.2
.25
SD
I
No Yes
Other Services
0
.1
.2
.3
.4
SD
I
Africa CA&EE EA&P LA ME&NA SA
REGION
Pakistan Institute of Development Economics
Seminar Series, PIDE 15
Return on Asset (ROA) Vs Subsidy Adjusted ROA
04.02.2010
-.05
0.0
5.1
.15
Valu
e
Africa CA&EE EA&P LA ME&NA SA
by Region
ROA and SAROA
ROA SAROA0
.02
.04
.06
Va
lue
Bank Coop. NBFI NGO R.Bank
by Status ROA and SAROA
ROA SAROA
-.0
20
.02
.04
.06
Va
lue
I IS S V
by Lending Methodology
ROA and SAROA
ROA SAROA
0.0
1.0
2.0
3.0
4.0
5V
alu
e
No Yes
by Other Services ROA and SAROA
ROA SAROA
0.0
2.0
4.0
6.0
8V
alu
e
No Yes
by Regulated ROA and SAROA
ROA SAROA0
.02
.04
.06
.08
Va
lue
No Yes
by Saving ROA and SAROA
ROA SAROA
Pakistan Institute of Development Economics
Seminar Series, PIDE 16
Return on Equity (ROE) Vs Subsidy Adjusted ROE
04.02.2010
-.4
-.2
0.2
.4V
alu
e
Africa CA&EE EA&P LA ME&NA SA
by Region
ROE and SAROE
ROE SAROE-1-1
-.5
-.5
00.5.5
Va
lue
Va
lue
BankBank Coop.Coop. NBFINBFI NGONGO R.BankR.Bank
by Status
ROE and SAROE
ROEROE SAROESAROE
-.2
-.1
0.1
.2V
alu
e
I IS S V
by Lending Methodology
ROE and SAROE
ROE SAROE
-.1
-.0
50
.05
.1.1
5V
alu
e
No Yes
by Other Services
ROE and SAROE
ROE SAROE
-.1
-.0
50
.05
.1.1
5V
alu
e
No Yes
by Regulated
ROE and SAROE
ROE SAROE
-.0
50
.05
.1.1
5V
alu
e
No Yes
by Savings ROE and SAROE
ROE SAROE
Pakistan Institute of Development Economics
Seminar Series, PIDE 17
Actual Vs Nominal Subsidy-free Yield
04.02.2010
0.1
.2.3
.4.5
Val
ue
Africa CA&EE EA&P LA ME&NA SA
by Region
Actual Yield (AY) and Subsidy Free Yield(SFY)
AY NSFY0
.1.2
.3.4
Val
ueBank Coop. NBFI NGO R.Bank
by Status
Actual Yield (AY) and Subsidy Free Yield(SFY)
AY NSFY
0.2
.4.6
.8V
alue
I IS S V
by Lending Methodology
Actual Yield (AY) and Subsidy Free Yield(SFY)
AY NSFY
0.1
.2.3
.4V
alue
No Yes
by Other Services
Actual Yield (AY) and Subsidy Free Yield(SFY)
AY NSFY
0.1
.2.3
.4V
alue
No Yes
by Regulated
Actual Yield (AY) and Subsidy Free Yield(SFY)
AY NSFY
00.1.1
.2.2.3.3
.4.4V
alue
Val
ue
NoNo YesYes
By savings
Actual Yield (AY) and Subsidy Free Yield(SFY)
AYAY NSFYNSFY
Pakistan Institute of Development Economics
Seminar Series, PIDE 18
Important factors affecting the sustainability
For MFIs which become subsidy-free Increase in porfits results from• Increase in interest income from lending & investment• Decrease in market lending rate....borrowing cheap• Elimination of revenue grantsFor MFIs which become subsidy-dependent• Increase in market lending rate• Decrease in actual cost of borrowing• Decrease in interest income from lending• Increase in revenue grants
04.02.2010
Pakistan Institute of Development Economics
Seminar Series, PIDE 19
Conclusion
• Microfinance sector is highly subsidized. • MFIs located in SA and Africa have relatively low performance and thus
are highly subsidized. LA MFIs perform better relative to the others.• MFIs with group lending features have relatively low perfromance while
those which only lend to individuals perfrom relatively better.• MFIs with NGO and Bank status perform relatively low while those
having NBFIs have perform better.• MFIs providing other services and regulated relatively perform low with
high subsidy dependence.• Conventional financial ratios do not depict the reality. The results show
that when adjusted for subsidies, the financial performance of MFIs decline substantially.
04.02.2010
Pakistan Institute of Development Economics
Seminar Series, PIDE 20
Policy Implications
• For governments and donors, measurement of social cost of subsidization helps them taking informed policy decisions in making the best use of public funds earmarked for the poor
• for the microfinance practitioners, the essay not only puts a price tag on their institution in terms of costs to the society but also pins down the important factors which contribute towards financial sustainability by reducing subsidy dependence
• for social investors, it serves as a guide to the in evaluating their investment in projects which increase the public wealth of the society at large
• for microfinance clients, it is awareness towards the importance of transparent prices in microfinance particularly for those clients to whom MFIs charge exorbitant interest rates.
04.02.2010
Pakistan Institute of Development Economics
Seminar Series, PIDE 21
Thanks for your attention
04.02.2010
Pakistan Institute of Development Economics