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Efficiency and Sustainability of Micro Finance

Institutions in South Asia
Introduction
Poverty is pervasive in South Asia. Rather it.s on the rise in some countries of
the region, which in turn further worsening the access of the poor to the economic
opportunities through which they could buildup their assets and enhance income in
order to come out of poverty cycle. The potential to avail such economic opportunities
mainly depends on the degree of access to financial services. The commercial banking
sector does not consider the poor bankable owning mainly to their inability to meet
the eligibility criteria, including collateral. Thus, the poor people in most countries
virtually have had no access to formal financial services [Littlefield, Murduch and
Hashemi (2003)]. The informal financial alternatives such as family loans,
moneylenders, and traders are usually limited in amount, often rigidly administered,
and in most of the cases involve very high implicit and explicit costs forcing the
destitute stuck in poverty cycle for generations. The more rational way to help the
poor could be the provision of sustainable economic opportunities at gross root level
especially provision of required financial services at competitive rates to support their
investments including viable business activities.
Microfinance emerged as a noble substitute for informal credit and an
effective and powerful instrument for poverty reduction among people who are
economically active but financially constrained and vulnerable in various countries
[Japonica Intersectoral (2003); Morduch and Haley (2002)]. It covers a broad range of
financial services including loans, deposits and payment services, and insurance to the
poor and low-income households and their micro-enterprises. Convincing research
evidence exists showing significant role of MFIs in improving the lives of the
deprived communities in various countries. 1 Persuaded with the potential role of
1 There

is no dearth of literature dealing with assessment of impact of microfinancing institutions

working in various countries on poverty status. A large number of empirical studies has led the policy
makers and analysts to believe that the microfinance programs in various countries are playing
significant role in changing the lives of the very poor people by smoothing their consumption

3
microfinancing in alleviating poverty, the South Asian countries have been actively
pursuing the policy of setting up formal network of microfinance institutions. These
institutions include NGOs and government sponsored programs.
Some leading MFIs, e.g. Grameen Bank, have created financial modes that
serve increasing number of poor. They also lead to repayment rates positively
comparable with the performance of many commercial banks. These approaches have
helped many MFIs in achieving a reasonable level of sustainability, and have even
produced profits without government subsidies and support from donor (Hulme,
1999). Nonetheless, some of the MFIs especially the NGOs are facing serious
sustainability problems indicating lapse in their financial procedures, organizational
design and governance. Moreover, most of the MFIs do not provide deposit services
to their clients. In contrast, some of the successful MFIs like Grameen Bank in
Bangladesh and BancoSol in Bolivia have incorporated the provision of deposit
services in their operations. Appropriately managing the deposit service and micro
and small savings help MFIs to reach financial self-sufficiency through generating
their own internal flow of funds that in turn reduce their dependency on external
sources (Bass, Henderson and WA, Inc., 2000; cited in Morduch and Haley, 2002).
The MFIs exclusively dependent on external sources of funding usually are not

sustainable and efficient (Rhyne, 1998).

The primary objective of this study is to identify the most efficient/best
practice MFI(s) that would in turn help improve functioning of the other MFIs in the
South Asian region, which comprises of 20% of the World poor and also the birth of
the first MFI . the Grameen Bank started in 1976. Scores of studies are found on
expenditures, increasing incomes and savings, and diversify their income sources [Dichter (1999;
Panjaitan-Drioadisuryo, Rositan and Cloud (1999); Remenyi and Quinones Jr., (2000); Mustafa (1996);
Morduch (1998); Zaman (2000); Khandker (1998 and 2003); McKernan (2002); Simonwtz (2002);
Hossain (1988)]. Some studies have also shown that these programs have significant positive effects on
human resource development among the participants [Chowdhury and Bhuiya (2001); Khandker
(1998); Marcus, et. al (1999); Barnes, Gaile and Kimbombo (2001); Barnes (2001); Chen and
Snodgrass (2001)]. Evidence is also found in empirical literature that participation in microfinance
programs positively affected the woman.s empowerment and welfare [Amin et. al. (1994); Naved
(1994); and Hashemi et. al. (1996)]. The studies have also shown positive effects of these programs on
school enrollment and spending on schooling of children of benefiting families [Pitt and Khandker
(1996); Marcus et. al. (1999); Barnes et. al. (2001); Foster (1995); and Jacoby (1994)]. The members of
the participating household, particularly women and children, also benefit significantly from better
nutrition, and health practices/services [MkNelly and Dunford (1999); Barnes (2001)].

4
analyzing the efficiency and its determinants in commercial banking sectors of
various countries.2 The MFIs are also financial institutions with a primary objective of
making credit available to that segment of the population which has been ignored by
the commercial banking system for not having collateral requirements. The efficient
functioning of these MFIs on sustainable basis is important also for persistent
financial access of the poor segment of the society. There is dearth of literature
regarding efficiency analysis of MFIs in South Asia. However, a few examples are
found in literature such as Nghiem (2004) Nieto, Cinca and Molinero (2004) and
Leon (2003) using data from Vietnam, Latin America and Peru, respectively.

Performance analysis of a sample

microfinance
institutions of Ethiopia
INTRODUCTION
Microfinance is the provision of financial serves to the
poor people with very small business or business projects
(Marzys, 2006). Only a small fraction of the world population
has access to financial instruments, essentially because
commercial banks consider the poor people as unbankable
due to their lack of collateral and information
asymmetries.
There are a number of studies in the MF industry because
it has got the attention of academicians and practitioners
as an innovative method of fighting poverty. The
studies mostly concentrate on three key areas. The first
one is impact assessment of the MF programs on the
lives of the poor. It is to mean that whether the provision
of financial service mostly of credit and saving has
improved the lives of the poor in terms of economic,

social and political indicators of poverty. Using much type

of quasi experimental designs the studies about the
impact of the microfinance in changing the lives of the
poor have shown mixed results (Hishigsuren, 2004).
Sebstand and Chen, 1996 cited in Hishigsuren, 2004
summarized the key findings from thirty two impact studies
and revealed varying degree of positive impact on
program participants notably increase in household and
enterprise income and assets. Mixed effects were found
in employment, children schooling and womens empowerment.
So the evidence on whether Microfinance can
alleviate poverty is of highly debated issue.
The second hot area in the MF industry among
Int.NGO.J. 288
researchers is whether MF reaches the poorest of the
poor who is in need of financial services. There are studies
that show that MF doesnt reach the poorest of the
poor. Rather they are reaching the marginally poor or
non-poor. Besides most MFIs have no clear rules and criterion
to target the poorest of the poor (Hishigsuren,
2004). This indicates that the MFIs are drifting away from
their original mission of reaching and serving the poor.
The third area that got the attention in the MF industry
is the issue of financial sustainability of MFIs. Historically
MF has started operation with donor funds and now the
industry has almost aged around 30 years. There is an
intense debate on whether MFIs should continue to be
donor supported or get relived from donation and stand
on their own leg. There are one school of thought which
say MF should can be sustainable with donor funds
(called welfarists) and the others say the MF should generate
enough revenue to cover their own costs as donors
funds are unpredictable (called institutionist) (Basu
and Woller, 2004). Hence the issue of building a sustainable
MF industry that can operate without a donor
funds is of an empirical enquiry.
The purpose of this specific research is to assess the
performance of a sample of MFIs in Ethiopia. There is no
enough research done in Ethiopian MF industry. Some of
them such as (Kereta, 2006; Kidane, 2007) are also poor
in terms of statistical analysis. Hence this study, by using
statistical test of significance, will try to appraise the performance
of these institutions using many indicators such
as capital structure, asset allocation, breadth of outreach,
depth of outreach, profitability and sustainability, revenue
performance, expense management, efficiency, productivity
and portfolio quality. However it has to be noted that
the performance analysis of MFIs dont include impact

studies as there are not available data about the impact

of MFIs on the lives of the poor from the data source I
used. More about the data source will be explained in
section three.
The rest of the study is organized as follows: section
two discuss the relevant literature, section three will look
at data and methodology; section four is devoted to the
discussion of empirical findings and the last section six
concludes.

IS MICROFINANCE AN EFFECTIVE STRATEGY TO REACH THE

MILLENNIUM DEVELOPMENT GOALS?
Introduction

The United Nations Millennium Development Goals (MDGs) have galvanized the
development
community with an urgent challenge to improve the welfare of the worlds
neediest people. Donor agencies are orienting their programming around the
attainment
of the MDGs and are mobilizing new resources to reduce hunger and poverty,
eliminate
HIV/AIDS and infectious diseases, empower women and improve their health,
educate
all children, and lower child mortality.1
The MDGs are framed as concrete outcomes in the areas of nutrition, education,
health, gender equity, and environment. Thus work in these specific areas will be a
large
part of any development strategy driven by the MDGs. But decades of experience
has
shown that progress in these areas is powerfully affected by other factors in the
broader
context, such as a functioning government, physical security, economic growth, and
basic infrastructure (for example, transportation). This paper reviews the mounting
body
of evidence showing that the availability of financial services for poor households
(microfinance) is a critical contextual factor with strong impact on the achievement
of
the MDGs.
Microfinance, and the impact it produces, go beyond just business loans. The poor
use
financial services not only for business investment in their microenterprises but also
to
invest in health and education, to manage household emergencies, and to meet the
wide
variety of other cash needs that they encounter. The range of services includes
loans, savings
facilities, insurance, transfer payments, and even micro-pensions. Evidence from the
millions of microfinance clients around the world demonstrates that access to
financial
services enables poor people to increase their household incomes, build assets, and
reduce
their vulnerability to the crises that are so much a part of their daily lives. Access to
financial services also translates into better nutrition and improved health outcomes,
such

as higher immunization rates. It allows poor people to plan for their future and send
more
The Millennium Development Goals are: (1) eradicate extreme poverty and hunger; (2) achieve universal primary
education;
(3) promote gender equality and empower women; (4) reduce child mortality; (5) improve maternal health; (6) combat
HIV/AIDS,
malaria, and other diseases; (7) ensure environmental sustainability; and (8) develop a global partnership for
development.
1

IS MICROFINANCE AN EFFECTIVE STRATEGY TO REACH THE

MILLENNIUM DEVELOPMENT GOALS?
BY ELIZABETH LITTLEFIELD, JONATHAN MORDUCH, AND SYED HASHEMI

Building financial systems that work for the poor

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of their children to school for longer. It has made

women clients more confident and assertive and thus
better able to confront gender inequities.
Microfinance clients manage their cash flows and
apply them to whatever household priority they judge
most important for their own welfare. Thus microfinance
is an especially participatory and non-paternalistic
development input. Access to flexible, convenient,
and affordable financial services empowers and equips
the poor to make their own choices and build their
way out of poverty in a sustained and self-determined
way.
Microfinance is unique among development interventions:
it can deliver these social benefits on an
ongoing, permanent basis and on a large scale. Many
well-managed microfinance institutions throughout
the world provide financial services in a sustainable
way, free of donor support. Microfinance thus offers
the potential for a self-propelling cycle of sustainability
and massive growth, while providing a powerful impact
on the lives of the poor, even the extremely poor.
Evidence shows that this impact intensifies the longer
clients stay with a given program, thus deepening the
power of this virtuous cycle.
Unfortunately poor people in most countries have
virtually no access to formal financial services. Their
informal alternatives, such as family loans, savings
clubs, or moneylenders, are usually limited by amount,
rigidly administered, or available only at exorbitant interest
rates. The challenge ahead is to ensure access to
financial services for the poor majority.
This note reviews the evidence on the impact of microfinance
as it relates to the attainment of the
MDGs.2 Specifically it assesses impact in the areas of
eradicating poverty, promoting childrens education,
improving health outcomes for women and children,
and empowering women. Finally, the note addresses
the feasibility of reaching significant numbers of the
absolute poor with financial services on a sustainable
basis and on a massive scale.

MICROFINANCE IN INDIA: A DETAILED STUDY

Microfinance is defined as any activity that includes the provision of financial services
such as credit, savings, and insurance to low income individuals which fall just above the
nationally defined poverty line, and poor individuals which fall below that poverty line,
with the goal of creating social value. The creation of social value includes poverty
alleviation and the broader impact of improving livelihood opportunities through the
provision of capital for micro enterprise, and insurance and savings for risk mitigation
and consumption smoothing. A large variety of actors provide microfinance in India,
using a range of microfinance delivery methods. Since the founding of the Grameen Bank
in Bangladesh, various actors have endeavored to provide access to financial services to
the poor in creative ways. Governments have piloted national programs, NGOs have
undertaken the activity of raising donor funds for on-lending, and some banks have
partnered with public organizations or made small inroads themselves in providing such
services. This has resulted in a rather broad definition of microfinance as any activity that
targets poor and low-income

individuals for the provision of financial services. The range of activities undertaken in
microfinance include group lending, individual lending, the provision of savings and
insurance, capacity building, and agricultural business development services. Whatever
the form of activity however, the overarching goal that unifies all actors in the provision
of microfinance is the creation of social value.
2. Activities in Microfinance
Micro credit: It is a small amount of money loaned to a client by a bank or other
institution. Micro credit can be offered, often without collateral, to an individual or
through group lending.
Micro savings: These are deposit services that allow one to save small amounts of money
for future use. Often without minimum balance requirements, these savings accounts
allow households to save in order to meet unexpected expenses and plan for future
expenses.
Micro insurance: It is a system by which people, businesses and other organizations
make a payment to share risk. Access to insurance enables entrepreneurs to concentrate
more on developing their businesses while mitigating other risks affecting property,
health or the ability to work.
Remittances: These are transfer of funds from people in one place to people in another,
usually across borders to family and
Friends. Compared with other sources of capital that can fluctuate depending on the
political or economic climate, remittances are a relatively steady source of funds.
3. Legal Regulations
Banks in India are regulated and supervised by the Reserve Bank of India (RBI) under the
RBI Act of 1934, Banking Regulation Act, Regional Rural Banks Act, and the
Cooperative Societies Acts of the respective state governments for cooperative banks.

NBFCs are registered under the Companies Act, 1956 and are governed under the RBI
Act. There is no specific law catering to NGOs although they can be registered under the
Societies Registration Act, 1860, the Indian Trust Act, 1882, or the relevant state acts.
There has been a strong reliance on self-regulation for NGO MFIs and as this applies to
NGO MFIs mobilizing deposits from clients who also borrow. This tendency is a concern
due to enforcement problems that tend to arise with self-regulatory organizations. In
January 2000, the RBI essentially created a new legal form for providing microfinance
services for NBFCs registered under the Companies Act so that they are not subject to
any capital or liquidity requirements if they do not go into the deposit taking business.
Absence of liquidity requirements is concern to the safety of the sector.
4. Microfinance in India
At present lending to the economically active poor both rural and urban is pegged at
around Rs 7000 crores in the Indian banks credit outstanding. As against this, according
to even the most conservative estimates, the total demand for credit requirements for this
part of Indian society is somewhere around Rs 2,00,000 crores.
Deprived of the basic banking facilities, the rural and semi urban Indian
masses are still relying on informal financing intermediaries like money
lenders, family members, friends etc.