Professional Documents
Culture Documents
Submitted by
Business School
University of Huddersfield
Supervisors
Prof. Hussein Abdou
Prof. Collins Ntim
Table of Contents
CHAPTER 1: INTRODUCTION........................................................................4
1.0. Introduction.....................................................................................4
CHAPTER 2: BACKGROUND TO THE RESEARCH..........................................6
2.0. Background to the Research............................................................6
2.1. Historical Background......................................................................6
2.1.1. Money Lenders...........................................................................6
2.1.2. ROSCAS......................................................................................7
2.1.3. Cooperatives..............................................................................9
2.2. Microfinance in Developing Countries............................................11
2.2.1. Rural Banks, Government Efforts and Policies.........................11
2.2.2. Commercial Banks...................................................................12
2.2.3. NGOs........................................................................................13
2.2.4. Microfinance Banks..................................................................14
CHAPTER 3: THEORETICAL LITERATURE....................................................16
3.0. Introduction...................................................................................16
3.1. The Theory of Microfinance............................................................16
3.2. Mission Drift Theory.......................................................................17
3.3. Neo-Institutional Theory................................................................21
CHAPTER
4:
EMPIRICAL
LITERATURE
REVIEW
AND
HYPOTHESES
DEVELOPMENT..........................................................................................22
4.0. Introduction...................................................................................22
4.1. Default and Repayment Rates.......................................................22
4.2. Mission Drift...................................................................................23
4.3. Factors Affecting Outreach.............................................................25
CHAPTER 5: RESEARCH DESIGN AND METHODOLOGY..............................27
Next Step.......................................................................................33
REFERENCES.............................................................................................34
CHAPTER 1: INTRODUCTION
1.0.
Introduction
Secondly, it has been shown that a lot of MFIs do not reach very far down
the poverty spectrum, either in absolute terms or relative to other income
categories (Hulme, 1999; Cohen and Sebstad, 2000). Instead, customers
in these MFIs tend to be clustered around the poverty line, being as Woller
(2002) described them, predominately moderately poor (top 50th
percentile of households below the poverty line) or vulnerable non-poor
(households above the poverty line but vulnerable to slipping back into
poverty).
Thirdly, the question of mission drift is also becoming a popular topic in
Microfinance Literature (Mersland & Strm, 2010; Casselman & Sama,
2013) and the term refers to the shifting focus of MFIs from reaching the
abject poor to the wealthier poor in order to maintain financial profitability
and sustainability (Cull, Demirgu-Kunt, & Morduch, 2007). On one side of
the
argument
there
are
the
institutionalists
who
argue
that
touched lightly on outreach was that of Hermes et al. (2011) that looked
at the trade-off between efficiency and outreach and found them
negatively correlated.
1.2.
Contribution to Literature
The current study offers a more in-depth look at factors that affect the
ability of microenterprises to access credit by looking at the role of
ownership structure of
small and medium scale enterprises, respectively. The study will also
introduce variables that have hitherto havent been explored empirically
in relation to microfinance.
Introduction
Historical Background
2.1.1. Money Lenders
Moneylending is very old and has been traced as far back as ancient
Babylon where Hammurabis Code allowed for moneylenders and
permitted their charging of interest for loans. In the Middle Ages,
canonical laws were against moneylending but made exceptions for the
Jews while in India, moneylenders were allowed, but with interest rates
recommended by the early Hindu scriptures. These interest rates varied
according to the loaners caste- from 2% annually for Brahmins, 3% for
Kshatriya , 4% for Vaishya, 5% for Shudra all the way up to 60% for
traders (Reddy, 2000). One key problem with moneylenders was that
there were limited in the amount of funds they could raise, as such not
everyone could get a loan when they needed one and amounts
(Armendariz & Morduch, 2010). Another problem with money lenders were
the high interest rates they charged and this is still a major issue when
dealing with moneylenders today. In the Punjab area of India for instance,
interest rates were found to range from 134-159% (Singh, 1983), in
Thailand the rates were 60-120% with the higher rates found in the
remote areas (Mingmaneenakin & Tubpun, 1993); in Pakistan interests
8
ranged from 18-200% with an average rate just below 70% (Aleem, 1990)
while in some West African countries the rates were found to be 50%
higher than what is charged in the formal sectors.
However, money lenders have continued to thrive and offer services to
the poor because they have rich information on borrowers and the ability
to enforce contracts two areas commercial banks struggle with and this
has kept them out of this market segment (Armendariz & Morduch, 2010)
What modern day Microfinance has done is learn from the key success
and failure points of the previous attempts at mobilizing funds for the poor
and combines local informational and cost advantages of neighbours and
moneylenders with modern bankings resources (Armendariz & Morduch,
2010)
2.1.2. ROSCAS
10
of the cycle from any amount left over. Usually an attempt is made to find
a replacement for the defaulting member (Nurmakhanova et al., 2015).
There is no overhead costs in running a ROSCA as members either bring
their contributions to their group head or the heads go and collect it from
those under them. However, in some unrestricted ROSCAs the members
willingly contribute an extra round at the end of the cycle which is divided
among the heads and subheads. There are also professional ROSCA
groups created by people who run it as a business. They tend to insist on
the extra round as professional fees (Nurmakhanova et al., 2015).
There are two types: the conventional type, found all over the world, in
which the full amount contributed (apart from minor deductions) is
allocated to one member at a time, either by lot, demonstrated need or in
an agreed-upon sequence; and an advanced type found in a number of
Asian countries including China, Vietnam and Nepal where the amount
collected is allocated by auction to the lowest bidder and the balance
returned to the members, or by tender (Seibel, 2005).
Risk management usually occurs in either of two ways. In the first
method, payments are split amongst two or more members to reduce the
likelihood of a member defaulting after they might have collected their
entire contributed sum. In the second, a reserve fund is held to reduce
the loss exposure should a member default (Nurmakhanova et al., 2015).
Methods
of
enforcement
include
banning
participants
who
create
could
only
save
but
with
the
modified
structures
of
deposit rates three times higher than what the commercial banks were
offering (and with higher interest rates on loans) and financed solely on
deposits and profits, their outreach eventually
covered 20%
of Irish
households. The Irish commercial banks felt threatened and in 1843, they
induced the government to cap on interest rates and taking away the
Loan Funds competitive advantage. This then led to the gradual decline of
the loan funds by 1950, they had disappeared. Often cited in literature
regarding cooperatives is its strong German roots. In Germany the
microfinance sector is divided into two networks:
community savings
when
Schulze-Delitzschs
started
the
first
urban
credit
cooperatives grew to more than 15, 000 till they were all brought under
the banking law and became universal banks. By this time, the concepts
of cooperatives had spread to Ireland, Italy, and Japan and from there it
went on to Korea, Taiwan, Canada, the United States, and parts of Latin
America (Armendariz & Morduch, 2010). As of 1997 the two microfinance
networks
in
Germany
encompassed
39,000
branches,
75
million
responsible for 53% of all retail loans to private individuals and 57% of all
loans to small and medium enterprises. In comparison to the top four
commercial banks in Germany, these savings and cooperative banks are
more profitable. In 2002 their pre-tax return on equity was 8.2% among
savings banks, 9.2% among cooperative banks and 3.1% among the four
big commercial banks (Seibel, 2003).
2.2.
include South Africas Khula Enterprise Finance Ltd which was established
in 1996. Khuala Enterprise funded SMMEs through Retail Financial
Intermediaries (RFIs), which are SMME departments of commercial banks
or accredited NGOs. RFIs apply their own minimum lending criteria (the
most basic is the provision of a business plan). The average rate of
successful applicants were four out of every three hundred (Berry et al.,
2002). Another example was the Nigerian governments efforts through
the Central Bank of Nigeria (CBN) which established a N200 billion Small
and Medium Enterprises
Credit Guarantee
Scheme
(SMECGS), for
15
role in banks decisions to lend to this sector. None of this research looked
at microenterprises.
Armendariz and Morduch (2010) explains that there are several reasons
why commercial banks shun lending to the poor. The first issue is that of
adverse selection which is when banks cannot determine which customers
are riskier than others. Moral hazard is the second challenge which arises
because banks are incapable of ensuring that their loans are being
maximized and because customers can try and make off with the banks
money. These problems are exacerbated by challenges in contract
enforcement in places that have weak judicial systems. Finally, the cost of
gathering information that would enable banks solve the aforementioned
problems is relatively high. This transactions cost is higher when dealing
with the poor as conducting a lot of small transactions for the poor is far
more expensive than conducting one large transaction for a richer
customer. These problems are further compounded by the lack of assets
that could serve as collateral by the poor. These factors have led to the
shutting out of the poor from accessing credit from formal banking
sources.
2.2.3. NGOs
As stated earlier, there were several key elements that made lending to
the poor unattractive. These were the issues of adverse selection, moral
hazard, auditing costs and contract enforcement. Adverse selection is the
challenge in ascertaining the level of risk attached to a potential borrower,
moral hazard is the challenge of determining whether the potential
borrower will use the loan, once made, for the purpose stated to ensure
repayment;
auditing
costs
challenges
are
those
associated
with
ascertaining how the project really did in case of the borrowers inability to
17
18
19
Introduction
Microfinance
Institutions
have
been
able
through
various
20
progress toward sustainability validating the theory that the poor can pay
back their loans.
3.2.
The mission drift theory states that when microfinance institutions begin
to focus more on making profits, they tend to move away from their
original mission of providing financial services to the poor.
The theoretical representation of the Mission drift theory was put forward
by Mersland and Strm (2010) and based on the assumption that in order
to remain in business, that all Microfinance Institutions have to be
financially sustainable and this is the key driver in their choice of market
segments.
Focusing on the profit function alone and disregarding governance issues,
they assumed that the MFIs risk averse with an exponential utility
function
u ( )=e
Where
Where
21
u (P)
customers. Then the MFI is able to control its own risk level (Freixas &
Rochet, 2008, pp. 8991). Furthermore, relationship banking is a
characteristic of microfinance. In such a setting, the customer becomes
locked in with the bank (Mersland, 2009; Rajan, 1992; Sharpe, 1990). The
MFI has some power to fix deposit and lending rates, and is therefore able
to neutralize changing rates on the interbank market. Second, because
MFIs management cost is primarily related to labour, it should be
predictable and as such possess very little risk. Thirdly, repayment costs
are likely to be risky even though microfinance observers find that the
poor repay their loans. MFIs try to minimize their losses by making small
loans with short maturity terms; by making group loans, so that peers
control each other; and by differentiating between individuals based on
their reputations as their individual credit histories accumulate (Ghatak &
Guinnane, 1999). However, repayment seems to be the chief risk element
in microfinance, since an MFI is often unable to differentiate between good
and bad risks and to monitor a clients performance (Armendariz de
Aghion & Morduch, 2005). The outcome is that the only risk remaining is
the repayment risk which now gives:
1
P=( r L r ) L+ ( r ( 1a )r D ) DC ( D, L ) 2 (L)
2
Where
1 P r ( 1 )r D D
1 C ( D , L) 1 2
+
+ (L)
r L r CC
r L r
CC r L r CC
2
credit client would go up. If coefficients differ but the signs are equal, the
average profit or the average cost will be the more significant variable.
The prediction for risk indicates that higher risk per customer may lead to
mission drift, since the bank may then favour higher loans to members of
society who are better off. This is a mission drift hypothesis. However, a
risk exposure argument would result in the opposite prediction. When risk
per customer increases, one would expect MFIs to reduce the average
loan size. After all, this is one of the ways any bank uses to limit risk
exposure to particular customers. This is a risk exposure hypothesis. Thus,
the risk prediction in the last equation is not clear-cut. In addition to the
model variables, an MFIs time in business may induce it to accept smaller
loan sizes. This time variable is important, since the mission drift
argument implies that the older an MFI, the more it will drift toward higher
income segments. The data of Mersland and Strm (2010) showed that the
average loan size for all MFIs does not increase with MFI age. Two effects
pulling in the same direction may be at work here. The first is a cost effect
in which operating costs may drop over time as an MFI expends less effort
to promote microloans and to ensure their repayment. The second effect
stems from the fact that a repeat relationship with the same customer
segment reveals its typical creditworthiness. An MFI may be willing to
increase loans and move deeper into a segment with a good record. The
initial low-risk customers in a given segment may establish a good
reputation, which benefits followers with lower loan demands. An
experienced MFI is more likely than a novice to obtain such customer
information and to risk lending to smaller customers. Thus the older and
more experienced the MFI, the more likely it will be to go down the
poverty spectrum, thus annulling the theory that pursuance of profits
negatively affects outreach.
24
3.3.
Neo-Institutional Theory
and
help
Institutionalization
in
categorizing
describes
how
and
social
classifying
processes,
phenomena.
obligations,
or
actualities become rules and norms in social thought and action (John W.
Meyer & Rowan, 1977).
Neo-institutional theory emphasizes the role of socio-cultural factors in
legitimizing and defining what ideas and behaviours become acceptable
to an organization, particularly deeply engrained ones (John W. Meyer &
Rowan, 1977). The social context within which an organization finds itself
exerts influence on the organization. That context contains strong
institutional rules that will shape and define what would become
appropriate and acceptable forms of behaviour for the organization. As
such, to understand why an organization behaves in a certain way, the
influence of this institutional context must be taken under consideration.
Granovetter (1985) shows that markets are rooted in their local cultures
and are a reflection of the value systems and historical background of
these
societies.
This
research
is
based
on
the
assumption
that
25
26
Introduction
This chapter will look at empirical evidence of the theories on which this
research is based. It will look at evidence evaluating the poors ability to
repay their loans, look at whether a microfinance institutions inclination
towards profits implies neglect of the bottom of the pyramid and finally
look at what work has been done with regards to factors affecting
outreach.
4.1.
McKenzie and Woodruff (2006) using data from the Mexican National
Survey of Microenterprises (ENAMIN) estimated returns to capital among
the smallest urban microenterprises in Mexico. They found that those with
less than US$200 invested had returns of around 10-15% per month, or an
uncompounded rate of 180% per year. For those with capital stock above
$500, the returns fall to around 40%60% per year. De Mel, McKenzie, and
Woodruff (2008) used randomized grants to generate shocks to capital
stock for a set of Sri Lankan microenterprises. They found that the
average real return to capital in these enterprises came to about 4.6%
5.3% per month (55%63% per year), amounts they found to be
substantially higher than the prevalent market interest rates at that time.
McKenzie and Woodruff (2008) repeated their 2006 research but with a
smaller sample of enterprises in Mexico with less than US$900 of capital
stock and still find return on capital, this time returns are in the range of
250%360% per year, higher than the cross-sectional estimates in their
earlier work. Udry and Anagol (2006) estimate the average rate of returns
in a sample of small-scale agricultural farmers in Ghana. Their sample
data comprised of inputs and outputs collected over two years at the plot
level for 1,659 plots cultivated by 435 farmers in four village clusters. The
data was collected at six-week intervals over the survey period to increase
the accuracy of recall by the farmers especially in the area of the use of
household labour and continual harvest of staple crops. Their results show
the returns to be 50% per year among those producing traditional crops
27
on a median-sized plot and 250% per year among those producing nontraditional crops on median-sized plots.
In spite of the research showing that the poor are able to engage in
entrepreneurial and are able to pay back their loans and (very high
interest rates) it has been shown that many MFIs do not reach very far
down the poverty spectrum, either in absolute terms or relative to other
income categories and as such the poor are still excluded. Woller (2002)
noted that this exclusion of the very poor appears to be a widespread
phenomenon. This exclusion could either be by self-selection, by
microfinance programmes and loan officers, or by peer loan groups. This
widespread exclusion of the very poor from MFI client rolls contradicts the
image of microfinance as a tool of global poverty alleviation
4.2.
Mission Drift
30
4.3.
variables
used
spanned
three
major
areas:
Policy,
Geographical and Institutional. The policy variables he used were- GNI per
capita, level of inflation, amount of international aid per capita (to proxy
the international support), level of industry value added (to proxy the level
of industrialization). The geographical variable was population density
while the institutional variables were literacy rates (to approach the level
of education) and colonial background dummies. As his control variables
he used the level of political stability and a corruption.
His major data source used to assess the number of MFIs and the number
of clients served by these institutions was the CGAP database in the time
up 2003. This dataset was augmented with data from the following
agencies the Microfinance Information Exchange (MIX) and three other
microfinance rating agencies listed by the Rating Fund- MicroRate, PlaNet
Rating and Microfinanza. This brought the data set to 2677 serving
278,243,699 clients.
His results indicate that the microfinance sector is more present in the
richer countries of the developing world, that microfinance reaches more
clients
population density has a positive influence, which might explain why the
sector is still underdeveloped in rural areas and that the level of
industrialisation and inflation do not seem to influence microfinance
outreach, while regional dummies do.
Hartarska and Nadolnyak (2007) in a cross country survey using data for
114 MFIs from 62 countries looked at the impact of regulation on MFI
performance. They used an empirical model specifying performance as a
function of MFI-specific, regulatory, macroeconomic and institutional
31
variables. Their result does not find any direct link with regulation to
outreach. In other words, a MFIs being regulated or not does not affect its
outreach.
Mersland and ystein Strm (2009) look at governance and its effects on
outreach. Arguing that the function of governance is to achieve corporate
goals and that for most MFIs there is a duality of goals- to contribute to
development (and lend to the poorer population) and to do this in a
financially sustainable manner, independent of donors. The data they
used came from five microlender rating agencies; all approved as official
rating agencies by the Ratingfund of the C-GAP. The agencies are
MicroRate, Microfinanza, Planet Rating, Crisil, and M-Cril.
Average loan size and the number of credit clients (used as a proxy for
outreach)
were
regressed
over
variables
representing
board
are
shareholder
owned
Microfinance
Institutions
more
Rural
Banks,
Non
Bank
32
Financial
Institutions
and
Credit
33
According to Burrell and Morgan (1979) there are four different paradigms
within which a researcher could locate their research. The objectivistsubjectivist objectivist approaches the social world as an external,
objective and looks for universal laws to explain this reality while the
subjectivists focuses on understanding the way in which people interact
with the world around them and their personal definition of their
experiences. R esearchers w h o p l a c e t h e m s e l v e s i n t h e radical
school of thought see modern society as characterized by radical changes
and structural conflict while researchers in the regulatory zone view the
world as cohesive and look for explanations to phenomenons that support
this. My research adopts the functionalist-objective framework because
my research aims to provide explanations for social occurrences that are
rational and provide practical solutions to practical problems. By adopting
34
The
There are three major sources for cross country research data on
microfinance. These are:
Data
for
this
research
will
come
from
private
organization
self-reporting
website-
dedicated
to
the
promotion
of
balance or whether ratios levels are abnormally high or low for an MFI.
Although participation in the Mix Market database is voluntary, many MFIs
choose to consistently provide their financial and outreach information to
the database, and the information provided is believed to be fairly
reliable. All the variables used in the study are based on financial
statements outreach information reported as of 2006, and all monetary
values are expressed in current United Sates dollars.
Mixmarket was chosen as a data source for the following reasons. First of
all is that it makes the distinction between Rural banks, NGOs, Non- Bank
Financial Institutions and Credit Unions/Cooperatives. Secondly it also
makes a distinction between the various loan sizes which this research
uses as a proxy for type of business- Micro- small or medium enterprise.
Table 5.2: #of Current MFIs reporting to wwww.mixmarket.org1
REGION
Africa
Asia
Eastern Europe & Central Asia (ECA)
Latin America & Caribbeans (LAC)
Middle East/North Africa (MENA)
TOTAL
5.2.
# of MFIs
195
283
217
333
56
1084
the
regression
model
has
three
dependent
variables-(1)
36
37
MFI CHARACTERISTICS
Ownership type/Legal Status: The four options are coded from 0-4 to be
able to fit into the regression. Rural Banks are coded as 0, NGOs are coded
as 1, Non Bank Financial Institutions are coded as 2, and Credit
Unions/Cooperatives are coded as 3
Scale of Operation and Age of MFI
GOVERNANCE FACTORS
Developed by the World Bank and taken from www.govindicators.org, The
Worldwide Governance Indicators (WGI) are a set of collective and
individual governance indicators for the period 19962013 and for 215
countries. They represent six dimensions of governance and are described
in the table 5.3:
Table 5.3: World Governance Indicators2
Variable
Voice and
Accountability:
Description
Captures perceptions of the extent to which a country's citizens are
able to participate in selecting their government, as well as freedom
Political Stability
and Absence of
Violence
This variable captures perceptions of the quality of public services, the
Government
Effectiveness
quality of the civil service and the degree of its independence from
political
pressures,
the
quality
of
policy
formulation
and
Regulatory Quality
Rule of Law
Control of
Corruption
public power is exercised for private gain, including both petty and
2 Source: http://info.worldbank.org/governance/wgi/index.aspx#doc
38
Model specification
i= + X i
39
Pi
= + X i
1Pi
( )
{ }
Where
40
6.1
Next Step
With respect to this research, over the next 12 months, I will review and
update this report, begin cleaning my data and start the initial testscorrelation and test for normal distribution. This will be done while I attend
skills classes in econometrics and either of E-Views, Gretel or Statistical
Package for the Social Sciences (SPSS), dependent on discussions with my
supervisor. Within this period, I will also begin work on my first paper for
publication based on initial observations and/or the framework for this
study.
The timeline (in months for these activities are given below)
1
2
3
4
5
6
Activity
Review & Update Interim
Report
Data Cleansing
Econometrics Classes
Initial Tests
Paper Write Up
Analyses
41
10
11
12
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