Does Efficiency Lead to Lower Prices? A New Perspective from Microfinance Interest Rates

Kar A.K., Swain R.B.

Recent controversies regarding the high interest rates being charged by microfinance institutions (MFIs) have been justified in the name of financial sustainability. This article investigates whether MFIs’ high interest rates improve profitability, reduce repayment rates and lead to mission drift. Within an agency theoretic framework, instrumental variables (IV) estimations have been employed to account for the endogeneity issues using a comprehensive global panel database consisting of 379 MFIs in 71 countries for 6 years – from 2003 to 2008. Results show that real yield on loan portfolio – a frequently used proxy for interest rates – has a positive and highly significant impact on MFIs’ financial performance and loan repayment rates. We further find that loan delivery methods have a significant impact on financial performance. Individual-based lenders tend to show a greater profitability but only up to a certain level. We also find that individual-based lenders are prone to mission drift as compared to village banks.

Dorfleitner G., Leidl M., Priberny C., von Mosch J.

High microcredit interest rates cause fierce debates among practitioners, scholars and even the general public. To objectify these discussions, this article investigates determinants of microcredit interest rates by using a worldwide data set of 712 microfinance institutions (MFIs). We examine how cost factors, gender, regulation, lending methodology and organizational type affect microcredit interest rates. Controlling for other microfinance- and country-specific factors, we identify the operating expenses as the main factor influencing microcredit interest rates. Furthermore, our findings show that MFIs tend to subsidize interest rates charged with income from investments not related to their lending activities.

Hudon M., Ashta A.

This paper addresses the fairness of microcredit interest rates. Since microfinance institutions provide credit for the poor at relatively high prices, the fairness of their interest rates has been repeatedly debated. We first apply Rawls' principles of justice to the case of microcredit interest rates and suggest some limitations related to the hypothesis of rationality of the borrowers and the level of inequality. We then suggest another framework based on the analysis of the distribution of the benefits generated by the transaction to assess the fairness of interest rates. We conceptualize this as the distribution of the bargaining range between the borrowers' and the institutions' reservation price and discuss what these reservation prices could be in the context of microfinance.

Vanroose A., D’Espallier B.

This article analyses the relationship between outreach and performance of Microfinance Institutions (MFIs) on the one hand and traditional financial sector development on the other. The results indicate that MFIs reach more clients and are more profitable in countries where access to the traditional financial system is low. This finding is in line with the market-failure hypothesis: MFIs respond to a need that banks do not fulfill and MFIs flourish where the formal financial sector fails. Along the same line, the results demonstrate that MFIs serve poorer people in countries with well-developed financial systems. The results suggest that in countries with well-developed financial systems, the two sectors stand in more direct competition with each other. This competition pushes MFIs down the market and makes mission drift by MFIs less likely.

Singh S., Goyal S.K., Sharma S.K.

Périlleux A.

Cooperatives actively pursuing financial inclusion in West Africa could potentially benefit from a closer look at the historical Raiffeisen model, which may help them provide long-term loans in rural areas through specific strategic changes.

Bédécarrats F., Lapenu C.

Microfinance was designed as a development tool, but remains firmly anchored in the market economy, creating an ambivalence that blurs the traditional distinction between the political and economic, the public and private, the commercial and social. Its hybrid nature makes it unique among development tools: microfinance benefits from financial, fiscal and regulatory support, while maintaining relative independence from governments and donors and their fluctuating agendas. The result is a heterogeneous and complex sector that articulates different scales: the local, given it is microfinance, and the national, as states closely supervise retail-banking activities. But it is also a global field, involving various transnational actors: NGOs, cooperation agencies, investors, private entrepreneurs, multilateral agencies, and so on.

Milana C., Ashta A.

Most contributions in the fast-growing literature on microfinance seem to agree that all the stakeholders (borrowers, lenders, communities, government and regulators, interested third parties) should become fully aware of the potentiality of the joint value creation achieved through cooperation.

Milana C., Wu H.X.

Recent studies confirm that financial support for innovative entrepreneurial firms is important for sustainable productivity growth in China and for a rebalanced global economy.

Hermes N., Lensink R., Meesters A.

This paper uses stochastic frontier analysis to examine whether there is a trade-off between outreach to the poor and efficiency of microfinance institutions (MFIs). We find convincing evidence that outreach is negatively related to efficiency of MFIs. More specifically, we find that MFIs that have a lower average loan balance (a measure of the depth of outreach) are also less efficient. Moreover, we find evidence showing that MFIs that have more women borrowers as clients (again a measure of the depth of outreach) are less efficient. These results remain robustly significant after having added a number of control variables.

Hudon M., Traca D.

Summary Using an original database of rating agencies, this paper gives empirical evidence on the impact of subsidy intensity on the efficiency of Microfinance Institutions (MFIs). We find that subsidies have had a positive impact on efficiency, in the sense that MFIs that received subsidies are more efficient than those that do not. However, we find also that subsidization beyond a certain threshold renders the marginal effect on efficiency negative. In our sample, 26% of MFIs receive levels of subsidization higher than that threshold, which implies that a marginal cut on subsidy intensity would increase their efficiency.

Périlleux A., Hudon M., Bloy E.

How do microfinance institutions (MFIs) allocate their surplus to stakeholders? This article shows that this allocation process varies depending on the MFI ownership structure. Nonprofit organizations and shareholders-held MFIs exhibit a tendency to largely keep their surplus within the MFI as a self-financing margin (reserve accounts, future investments, and capital increase) rather than transferring it to their clients (interest rate decrease) and their employees (salary increase). The surplus distribution in COOPs is more in favor of providers and employees. Finally, the article discusses the importance of these findings for the evaluation of MFIs by policy makers.

Armendáriz B., Szafarz A.

Briere M., Szafarz A.

This paper takes full advantage of daily quoted prices of microfinance stocks from their issuance, and draws a global picture of worldwide microfinance equity from the viewpoint of a profit-oriented investor. We construct microfinance country equity indices and an international global microfinance index. We analyse the changes in these indices, which we assess in reference to comparable indices for the financial sector and also to national indices. Our findings show that microfinance has resumed its close correlation with the financial sector since 2001. In terms of risk exposure, estimations of the Capital Asset Pricing Model demonstrate that microfinance shares exhibit higher market beta than conventional financial institutions, and have equivalent currency exposure. We also examine whether adding microfinance to international asset portfolios improves the investor's risk-return performance. While the inclusion of microfinance equity has indeed been a major source of diversification in the 1990s, its impact has diminished in recent years. Still, optimal portfolios invested in countries where microfinance equity is available may contain up to 20% of stocks from MFIs.

Tchakoute-Tchuigoua H.

Based on some cases of notable successes in Latin America, some microfinance practitioners advocate a transformation of non-profit microfinance organizations into private and regulated companies. The performance of the latter is supposed to be higher than those of non-profit organizations. From this point of view, there is a relationship between the legal status of MFIs and their performance. This article's main objective is to test this relationship from the comparison of performance of 202 MFIs in the period from 2001 to 2006. Rather than restricting the comparison to NGOs and private companies, cooperatives have also been taken into account to compare the performance by the dominant legal forms of MFIs. The results show that the performance of private corporations is better than that of NGOs only when portfolio quality is used as an indicator for measuring performance. Also, our results show that for profit MFIs are more socially efficient than not-for-profit MFIs. The commercial approach of microfinance does not seem inconsistent with the social mission of MFIs.

Rüter L., Schienle M.

Abstract We propose an adaption of the multiple imputation random lasso procedure tailored to longitudinal data with unobserved fixed effects which provides robust variable selection in the presence of complex missingness, high-dimensionality, and multicollinearity. We apply it to identify social and financial success factors of microfinance institutions (MFIs) in a data-driven way from a comprehensive, balanced, and global panel with 136 characteristics for 213 MFIs over a 6-year period. We discover the importance of staff structure for MFI success and find that profitability is the most important determinant of financial success. Our results indicate that financial sustainability and breadth of outreach can be increased simultaneously while the relationship with depth of outreach is more mixed.

Park K., Jun H.

AbstractImpact investing plays a critical role in financing enterprises that have the potential to tackle social problems through business means, particularly in developing countries. However, concerns about over‐indebtedness of microfinance institutions have fueled questions regarding potential trade‐offs between financial and social efficiency of impact investing and demand further investigation. Using the case of Cambodia's microfinance industry, this paper first examines whether the microfinance industry outperforms from the perspective of both social and financial returns. In addition, as impact investments by Development Finance Institutions (DFIs) form the backbone of the microfinance sector, a related objective is to investigate whether social or financial returns are more important for DFIs when making impact investment decisions. Using Data Envelopment Analysis (DEA) and Tobit regression, our research finds that while Cambodian MFIs excel in financial efficiency, social efficiency is considerably lower. The analysis also finds that DFIs' investments are predominantly driven by financial efficiency rather than an approach that considers both social and financial outcomes. Our analysis suggests the need for enhanced impact measurement frameworks and a reevaluation of DFIs impact investing strategies to ensure a more equitable focus on both financial and social impacts.

Serrano-Cinca C., Cuellar-Fernández B., Fuertes-Callén Y.

We used latent class growth analysis to study the trajectories followed by microfinance institutions for 10 years. This technique can detect groups of firms that follow different patterns of change over time. We identified groups of institutions that followed the same strategy and iso-performance groups of institutions with the same outcome trajectory. The trajectories were analyzed with categorical regression and decision trees, which constitutes a novel approach to latent class growth analysis. Lending money to the poorest while making a profit is not straightforward and it is challenging for microfinance institutions to be self-sufficient. We found that the most useful strategy was to improve efficiency by lowering operating costs, followed by the control of credit risk. Deviating from the mission also had a positive effect on self-sufficiency, but was a strategy followed by few institutions. Rarely did changes in interest rates or not lending to women prove valuable. The findings are useful for the stakeholders of these institutions and particularly for managers.

Zheng C., Cheung A.(., Zhang J., Haider I.

Parmeter C.F., Hartarska V.

This review covers current issues that applied researchers assessing the performance of MFIs are likely to encounter and should be cognizant of.

Al-Azzam M., Mimouni K., Smaoui H., Temimi A.

• We evaluate the impact of subsidies and deposits on cost inefficiency in microfinance. • Endogeneity concerns are addressed using two alternative approaches. • The results show that subsidies worsen cost inefficiency while deposits reduce it. • However, combining subsidies and deposits together aggravates cost inefficiency. • The results imply clear policy recommendations on the use of subsidies and deposits. Lending tiny loans to poor clients lacking credit history and enough collateral is an expensive business for microfinance institutions (MFIs). Minimizing cost inefficiency is important if MFIs are to meet their dual mission – outreach and sustainability. This paper evaluates how subsidies and deposit mobilization affect the cost inefficiency of MFIs. We use a rich data set from the Microfinance Information Exchange (MIX) Market consisting of information on 1,582 MFIs in 92 countries for the period 2003 – 2018 and employ a baseline cost stochastic frontier approach, two-step system GMM, and a recently developed test to address endogeneity concerns. The results of our study suggest that subsidies worsen cost inefficiency while deposit-taking reduce it. Deposit-taking, however, may worsen cost inefficiency if an MFI welcomes subsidies and deposits together. Our findings draw a clear policy recommendation for governments and donors regarding the sources of funds and cost inefficiency in microfinance. In light of these results, governments’ adjustments of regulatory framework that allow MFIs to mobilize deposits and donors’ awareness that subsidizing MFIs can be counterproductive seem necessary for the sustainability of the microfinance industry.

Dang T.T., Nguyen H.T., Tran N.D.

The research focuses on the impact of lending interest rate on financial performance in Vietnamese microfinance institutions (MFIs) in the period of 2014–2019. The data of 28 MFIs is collected through Microfinance Information Exchange (Mix market), State Bank of Vietnam and Vietnam Microfinance Working Group (VMFWG). Based on Bayesian approach in our research is more reliable and effective statistical inference than p-value hypothesis testing—traditional method. The research’s results show that lending interest rate has positive impact on financial performance in Vietnamese MFIs.

Wondirad H.A.

This paper analyses how much is fair interest rate when lending to the poor. Empirical works of literature on microfinance interest rates are investigated to explain the basis of the exigent ethical debates. To further understand the fairness of an interest rate in microfinance, theoretical investigations were also conducted. The findings suggest that providing financial services to the bottom of the pyramid is costly, but feasible. A fair interest rate is affordable to the poor, and, at the same time, could enable microfinance institutions to be sustainable and allow them to provide a permanent financial service to low-income households. The findings also suggest that microfinance institutions are charging a high interest rate to cover operational costs rather than a profit orientation. The studies reviewed in this paper also show that a high interest rate has both a positive and a negative significant effect on microfinance institutions’ financial performance and social mission respectively. However, there is an interest rate threshold level that would balance the interests of all stakeholders in the microfinance industry. Indeed, looking for an optimal interest rate that makes microfinance institutions self-sufficient and sustainable, at the same time affordable to borrowers’ requires stakeholders’ collaboration.

Bharti N., Malik S.

Purpose The purpose of this study is to evaluate whether focus on social output affects the efficiency of MFIs. Inclusive growth is the key developmental aim for many developing countries, including India. The role of microfinance institutions (MFIs) in promoting financial inclusion is widely applauded. However, to achieve financial sustainability, MFIs have become highly commercialised and are seen to have drifted away from their social mission. Various studies have shown the efficiency of MFIs on financial parameters. MFIs being a social enterprise, it is important to include social output among the efficiency parameters. Design/methodology/approach This study attempts to compare the efficiency of MFIs with and without social performances across the various size of MFIs based on their asset, i.e. large, medium and small. This study uses Data Envelopment Analysis (DEA) for assessing an MFI’s efficiency. For calculating the social output score, the Gutman Scale is used. Efficiency is calculated with and without social output, and the resulting scores are compared to assess the impact of social performance on the efficiency of MFIs. Findings The results of this study allow us to conclude that with the inclusion of social output, the efficiency of MFIs improves across various categories. In terms of social performances, it is concluded that MFIs are targeting women and mostly working in rural areas but have neglected issues like health and education. Originality/value The findings of this study will help MFIs in formulating their mission and vision statements and in achieving the objective of financial inclusion without experiencing mission drift.

Ashraf D., Rizwan M.S., L’Huillier B.

Microfinance institutions (MFIs) contribute greatly to sustainable development through microlending. This paper establishes a bridge between political stakeholder theory, social responsive theory, and institutional theory as applied to the functioning of MFIs. By establishing a nexus between these theoretical concepts, we investigate whether country-level socio-economic freedom, human development, and environmental issues affect the engagement and integration of environmental, social, and governance (ESG) activities by MFIs. Using a sample of 2,064 MFIs from 94 countries for the period 2007 to 2018, we find that MFIs from countries with higher socio-economic freedom, coupled with higher human development, may adhere to superior ESG policies. We posit that this is due to pressure from stakeholders to incorporate the triple bottom line objectives of ‘profit, people, and the planet’. ESG integration is in line with institutional theory and enriched by political stakeholder theory.

Parmeter C.F., Hartarska V.

This review covers current issues that applied researchers assessing the performance of MFIs are likely to encounter and should be cognizant of.

López-Penabad M., Maside-Sanfiz J.M., Torrelles-Manent J., López-Andión C.

Social enterprise pursues both social and economic goals and is recognized as a formula for achieving sustainable development. Sheltered workshops (SWs) are a manifestation of this phenomenon, their main objective being the labor market integration of disabled people. In this paper, the efficiency of SWs has been studied taking into account the operational and the core social aspects, as well as their distinct nature, namely for-profit or non-profit status. Additionally, we have analyzed the relationship between the social efficiency and the economic returns of these entities. To do this, a semiparametric methodology, combining different data envelopment analysis (DEA) models with truncated regression estimation has been used. It is the non-profit and top-performing SWs that achieve the best social and economic efficiency. For-profit and low-performing SWs show further reductions in social efficiency as a result of the economic crisis and uncertainty in subsidy-related public policies. Their extensive social proactiveness and high economic strength in the crisis period positively influenced their social and economic efficiency. We have also proven that it is the most profitable SWs that have the greatest social efficiency. We consider that our results constitute a useful complement to other evaluation models for social enterprise.

Zheng C., Zhang J.

This study investigates the effect of the COVID-19-induced decline in economic activities on the financial and social efficiency of microfinance institutions (MFIs). We find that the pandemic-induced impact decreases the financial efficiency of MFIs; however, the social efficiency of MFIs is increased under the impact of COVID-19. To explore potential channels through which efficiency is influenced by the COVID-19 outbreak, we examine the supply and demand side of MFIs’ funding. We find that the lending rate mediates the relationship between the impact of COVID-19 and MFI efficiency, whereas the mediating role of the funding rate is negligible.

López-Penabad M., Maside-Sanfiz J.M., Torrelles Manent J., Iglesias-Casal A.

Sheltered workshops (SW), as social enterprises, need to be efficient and maintain a balance between social aspects and economic prosperity. An important part of research on the subject has been focused on measuring the economic value created by these entities. In this study, we analyzed performance of SWs in Galicia (Spain), from the point of view of efficiency, combining social and economic aspects and investigating its key determinants. Using panel data from 609 entities from 2008 to 2017, we followed Simar and Wilson’s two-stage approach (2007). Specifically, we used data envelopment analysis (DEA) at the first stage to estimate efficiency scores and then used truncated regression estimation with double-bootstrap to test the significance of explanatory variables. Our results show that SWs have high levels of performance, higher in economic than in social terms, and we found that several factors, such as size and age, positively influence total, economic and social efficiency individually. We also found a positive, significant relationship between social efficiency and economic profitability.

Milana C., Ashta A.