Microfinance and Cooperative M5056

Article Review
Si’eki Tefatu
School of Global Masters of Business Administration in Finance, National Taipei University

Case Study
Financial Performance and Outreach:
A Global Analysis of Leading Micro Banks

By Robert Cull, Asli Demirgu ¨c¸-Kunt and Jonathan Morduch

Economic Journal, (Online). Vol. 117, No. 517, 02.2007, p. F107-F133.
https://doi.org/10.1111/j.1468-0297.2007.02017.x

1. PURPOSE

The focus of the article is to try examine why meeting the full promise of microfinance of reduce poverty
through innovative contracts and by employing profit-making banking practices in low-income communities
a challenge that remains for most microbanks with so far, relatively few yield the fruit of a profitable means
of serving the poorest.

The study examine why this promise remains unmet for most institutions, secured high loan repayment rates
does not ensure greater profitability, and the benefits of cost-cutting diminish when serving better-off
customers, but a trade-off emerges between profitability and serving the poorest.

“Microfinance would be a grand failure if securing high repayment rates was all there was to it.”

2. MAIN IDEA

Based on a high-quality survey of 124 microfinance institutions in 49 countries with strong commitments to
achieving financial self-sufficiency underlines the best hopes for achieving poverty reduction with profitable
practices. The articles perception is to explore the patterns of profitability, loan repayment, and cost
reduction divergences in a cross-country data analysis. Provide the underlying ample disparity in contractual
types, prices, institutional sizes and locations, and target markets. The means to describe the nature and trade-
offs of lending relationships and illuminate other important questions. The paper wish to address three
questions.
1. Does raising interest rates exacerbate agency problems as detected by lower repayment
rates and less profitability?
2. Is there evidence of a trade-off between the depth of outreach to the poor and the pursuit
of profitability?
3. Has “mission drift” occurred – i.e., have micro banks moved away from serving their
poorer clients in pursuit of commercial viability?
The cross-country analyses, aim is to describe patterns in the data and identify variation in key variables to
reliably estimate causal impacts, focus on associations that can help illuminate and frame key debates, while
bearing in mind that the institutions in the survey are more focused on financial performance than typical
micro banks.
3. METHODOLOGY

Empirical Approach
To shed light on the topic the authors had to conduct a cross-country data analyses on 124 microfinance
institutions (MFIs) in 49 developing countries. The data was collected by the Microfinance Information
Exchange (MIX), a private NGO organization that aims to promote information exchange in the microfinance
industry.

The database contains one observation per institution from 1999 to 2002 with 70% stems from 2002.The
institutions were selected based on the quality and extent of their data. The data set thus, not representative of
all microfinance institutions. However, do collectively serve a large fraction of microfinance customers
worldwide. The study focus on three main institutional categories.

i. “Individual-based lenders:” institutions method that use standard bilateral lending contracts
relationship between the bank and customer. (traditional banking practices)

ii. “Solidarity group lenders:” institutions method that uses self-formed groups of customers that assume
joint liability for the repayment of loans given to group members. (popularize by MFI Grameen Bank)

iii. “Village banks,” institution method based on larger groups with joint liability and a degree of self-
governance (pioneered by FINCA).

Regression approach
The aim of the target regressions is to understand why some micro banks are profitable while others have relied
on subsidy. The base regressions thus describe the correlates of profitability, focusing particularly on costs
and interest rates on loans. The study allows these factors to vary by lending type using a reduced-form of
mathematical equation to explain causal variances.

4. CONCLUSION
The article concludes that the answers to their questions depend on an institution’s lending method.
The results show that raising interest rates is associated with improved financial performance for individual
based lenders only. The factor for real gross portfolio yield is positive and significant across all three
profitability indicators;

1. financial self-sufficiency,
2. operational sustainability, and
3. return on assets),

Indicating that individual-based lenders tend to be more profitable when their average interest rates are
higher. But the same result does not hold for village banks or solidarity group lenders. Thus, for both types
of group lenders there is not a significant relationship between interest rates and profitability, even after
controlling for costs.

On the other hand, institutional design and orientation matters importantly in considering trade-offs in
microfinance. The trade-offs can be blatant: village banks, focus on the poorest borrowers, face the highest
average costs and the highest subsidy levels. By the same nominal, individual-based lenders earn the highest
average profits but do least well on indicators of outreach to the very poor.
 The summary statistics show, little evidence of agency problems, outreach-profit trade-offs, or mission drift
for example, that a reason that costs are so much higher for village banks and group lenders (relative to
individual-based lenders) is that they make smaller-sized loans and serve poorer populations.

5. SIGNIFICANCE
The significance of the study reflects pattern differences in social mission, target customers, and location as
much as management strategies. Consistent with the article findings, this article contributes to the topic by;

First, proving over half of the institutions in the survey were profitable after accounting adjustments were
made soon achieve financial self-sufficiency.

Second, uncover simple correlations show little evidence of agency problems, outreach-profit trade-offs, or
mission drift to achieving both profit and substantial outreach to poorer populations, and to staying true to
initial social missions even when aggressively pursuing commercial goals.

The study finds that institutional design and orientation matter substantially. Lenders that do not use group-
based methods to overcome incentive problems experience weaker portfolio quality and lower profit rates
when interest rates are raised substantially.
6. STREANGTH

The strength of this document rests in the article essential data qualitative information on the lending style
employed by the MFI, the range of the services it offers, its profit status, ownership structure, and sources of
funds. These detailed data enable the study to offer a more complete analysis of MFI performance by lending
type than has been possible before.

7. WEAKNESS

The article acknowledges that their data set is not a representative of all microfinance institutions worldwide.
However, collectively serve a large fraction of microfinance customers thus the viability of the data analysis
is questionable and might not be applicable to other MFI in a different setting.

The institutions in the survey are more focused on financial performance than typical micro banks. Thus the
trade-offs defined in the study can be even unambiguous for institutions that did not participate in the survey.
Insufficient exogenous variation in key variables to reliably estimate causal impacts.