AN EMPIRICAL STUDY OF FINANCIAL REPORTING BY

MICROFINANCE INSTITUTIONS-THE CASE OF

BANGLADESH
 TABLE OF CONTENTS

Page

Table of Contents ii
List of Tables vii
List of Figures vii
List of Appendices vii
Abstract viii

Table of Contents

AN EMPIRICAL STUDY OF FINANCIAL REPORTING BY MICROFINANCE INSTITUTIONS-THE

CASE OF.................................................................................................................................................................1

Introduction............................................................................................................................................................5
1.0 Background and Motivation...................................................................................................................6
1.2 The Research Objectives........................................................................................................................9
1.3 Contribution and Importance of the Study...........................................................................................11
1.4 Organization of the Thesis....................................................................................................................12

Chapter 2...............................................................................................................................................................15
2.0 Introduction..........................................................................................................................................15
2.1 Accountability and Reporting of MFIs.................................................................................................15
2.2 Accountability and Reporting of MFIs in Bangladesh.........................................................................20
2.3 Importance of Financial Statement in Discharging MFI’s Accountability..........................................23
2.4 Summary...............................................................................................................................................25

Chapter 3...............................................................................................................................................................26
3.0 Introduction..........................................................................................................................................26

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 3.1 The History of Microfinance in Bangladesh........................................................................................26
3.2 The Socio-economic Environment.......................................................................................................27
3.3 Microfinance Providers........................................................................................................................28
Table 3.1 Development of Microfinance Sector in Bangladesh (Tk. in million).......................................29
3.3.1 Direct Fund Providers..................................................................................................................29
ASA (The Association for Social Advancement).......................................................................................30
The Grameen Bank.....................................................................................................................................31
Palli Daridra Bimochon Foundation (PDBF).............................................................................................32
Rural Development Scheme (RDS) of Islami Bank (IBBL)......................................................................32
3.3.2 Apex Fund Provider....................................................................................................................32
Table 3.2 A Component-wise Disbursement Breakup of PKSF’s Loan...................................................33
3.4 Sources of MFI Funds..........................................................................................................................34
Table 3.3 Sources of Microfinance and Revolving Loan Funds of MFIs..................................................35
3.5 Outreach of MFIs:................................................................................................................................36
3.6 Microfinance and Different Types of Collateral..................................................................................37
Table 3.4 Credit Delivery and Savings Mechanisms of MFIs...................................................................38
3.7 The Social Impact of Microfinance in Bangladesh..............................................................................39
Table 3.5 Impact of Microfinance (compared to non-participants)............................................................41

Chapter 4...............................................................................................................................................................43
4.0 Introduction..........................................................................................................................................43
4.1 Regulatory Framework of Microfinance Institutions...........................................................................43
4.2 Legal and Financial Reporting Requirements of MFIs in Emerging Countries...................................46
4.3. Legal Provisions for Formation and Reporting of MFIs in Bangladesh.....................................50
The Societies Registration Act 1860 (Act XXI of 1860)...........................................................................50
The Trust Act 1882.....................................................................................................................................51
Voluntary Social Welfare Agencies (VSWA) (Registration and Control) Ordinance 1961......................51
The Companies Act 1994...........................................................................................................................51
Cooperative Societies Act 2001.................................................................................................................52
4.3.1 Regulatory Bodies.......................................................................................................................52
PKSF (Palli Karma-Sahayak Foundation)..................................................................................................53
The NGO Affairs Bureau (NGOAB)..........................................................................................................54

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 Microcredit Regulatory Authority..............................................................................................................54
Registration requirements:..........................................................................................................................55
License requirements for MFIs:.................................................................................................................55
Reporting Requirements for MFIs:.............................................................................................................55
4.3.2 Financial Reporting Environment of MFIs in Bangladesh..........................................................56
4.4 Summary...............................................................................................................................................57

Chapter 5 Literature Review...............................................................................................................................58

5.0 Introduction..........................................................................................................................................58
5.1 Accountability Studies..........................................................................................................................58
5.2. Reporting and Disclosure Studies of NFPOs......................................................................................61
5.3 Governance Quality Studies.................................................................................................................64
5.4 Regulation Studies................................................................................................................................65
5.5 Summary...............................................................................................................................................68

Chapter 6...............................................................................................................................................................69
6.0 Introduction..........................................................................................................................................69
6.1 Hypotheses Development.....................................................................................................................69
6.2 Attributes of MFI Financial Statement.................................................................................................70
MFI’s Size..................................................................................................................................................72
MFI’s Debt level.........................................................................................................................................72
Rate Surplus of Revenue over Expenditure................................................................................................73
Size of Audit Firms.....................................................................................................................................73
Nature of Registration................................................................................................................................74
Hypothesized Relationships between Dependent and Independent variables............................................76
6.3 Hypotheses:..........................................................................................................................................76
6.4 Summary...............................................................................................................................................77

Chapter 7...............................................................................................................................................................79
7.0 Introduction..........................................................................................................................................79
7.1 Research Methodology.........................................................................................................................79
7.1.1 Questionnaire Survey Method.....................................................................................................79
7.1.2 Disclosure index Method.............................................................................................................81
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7.1.3 Construction of disclosure index.................................................................................................84
7.1.4 Scoring for the Disclosure Index.................................................................................................85
7.2 Data Collection.....................................................................................................................................88
7.2.1 Survey sample..............................................................................................................................88
7.2.2 Annual report (Financial Statement) Source...............................................................................89
7.3 Data Analysis tool................................................................................................................................90
7.3.1 Descriptive Analysis....................................................................................................................90
7.3.2 Preliminary Tests on Regression Assumptions...........................................................................91
7.3.2.1 Multicollinearity..........................................................................................................................91
7.3.2.2 Homoscedasticity.........................................................................................................................91
7.3.2.3 Linearity.......................................................................................................................................92
7.4 Hypothesis testing.................................................................................................................................92
7.4.1 Hypothesis 1:...............................................................................................................................92
7.4.2 Hypothesis 2:...............................................................................................................................93
7.4.3 Hypothesis 3:...............................................................................................................................93
7.4.4 Hypothesis 4:...............................................................................................................................94
7.4.5 Hypothesis 5:...............................................................................................................................94
Regression Model.......................................................................................................................................97
7.4 Summary...............................................................................................................................................97
8.0 Introduction..........................................................................................................................................99
8.1 Descriptive Statistics and Correlation Analysis...................................................................................99
Table 8.1: Descriptive Statistics of the Dependent and Independent Variables.......................................100
Correlation Analysis.................................................................................................................................101
Table 8.2 Pearson Correlation Coefficients between Variables...............................................................101
8.2 Analysis and Interpretation of the Results..........................................................................................102
8.3 The Degree of Consensus between Users and Preparers of MFIs......................................................102
• H1: There is no consensus between users and preparers regarding the importance attached to the
information items disclosed in MFI financial statement....................................................................102
Demographic Profile of the Respondents (Users and Preparers).............................................................103
Table 8.3 Users and Preparers’ Background............................................................................................103
Table 8.4 Users’ Information Needs and Preparers’ Perceptions.............................................................104
Table 8.5 Importance of Information items by Users and Preparers........................................................105
Table 8.6 Users and Preparers’ Information Needs/ Perceptions (Sectional)..........................................107
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 8.4 Disclosure practice and Users’ information needs.............................................................................108
• H2: There is no significant gap between the information needs of users and actual disclosure in
MFI financial statement......................................................................................................................108
Table 8.7 Distribution of Overall Disclosure Indices According to Number of MFIs in 2006...........109
Table 8.8 Disclosure Practice and Users’ Information Needs..................................................................110
8.5 Disclosure Practice and Preparers’ Perceptions.................................................................................111
H3: There is no significant gap between the perceptions of preparers and actual disclosure in MFI
financial statement..............................................................................................................................111
Table 8.9 Disclosure Practice and Preparers’ Perceptions.......................................................................112
H4: There has been no improvement in the quality of MFI disclosure since 2004..................................112
Table 8.10 Distribution of Average Sectional and Total Disclosure Index in 2004, 2005 and 2006.......113
Table 8.11 T value Showing the Significance of Differences in Disclosure Indices...............................114
8.7 MFI Characteristics and Disclosure Quality......................................................................................114
H5: There is no association between the total disclosure quality and the MFI’s characteristics such size,
debts levels, surplus of revenue over expenditure, size of audit firms, nature of registration, MFI’s
age, governance structure, frequency of board meetings and qualification of board members.........114
Table 8.12: Regression Results of Disclosure Index and MFI Attributes................................................116
8.8 Further Robustness Test.....................................................................................................................119
Table 8.13 Results of Random Effect Regression Model........................................................................119
8.9 Summary.............................................................................................................................................119

Chapter 9 Summary and Conclusion...............................................................................................................121

References............................................................................................................................................................127

5
 Introduction

1.0 Background and Motivation

In recent years, the world has witnessed a significant growth in Microfinance Institutions

(MFIs). These are specialised entities that provide a small amount of business credit

(popularly known as microcredit or microfinance) usually without collateral to very poor

people who lack steady employment and a verifiable credit history. MFIs are also called Non-

Government Organizations (NGOs) or Not-for-Profit Organizations (NFPOs) because of

similar nature of their operations and social objectives. In this thesis, NGOs, NFPOs and

MFIs are used interchangeably. In Bangladesh, MFIs are given not-for-profit status and are

not required to pay taxes on their income. They generate income by charging interests for

their services, however, their main purpose is still being social upliftment rather than profit

maximisation. MFIs are required to charge interests to operate their organizations efficiently,

to protect members’ savings and loan repayments.

Microcredit is not a new concept and has been practised at various times in modern history

(Cons & Paprocki, 2008). The provision of microcredit, initially operationalised by Dr.

Akhther Hamid Khan during the late sixties in Comilla, Bangladesh. Later through the

formation of Grameen (village) Bank in Chittagong, Bangladesh in 1972, Professor

Muhammad Younus (a Nobel laureate for his contribution to poverty alleviation) popularised

the concept, not only in emerging countries but also in many developed countries, including

the U.S.A where Grameen Bank started their operation in New York in 1999.

The objectives of MFIs are to build entrepreneurial capacity of borrowers (micro-

entrepreneurs) by providing small (micro) finance with a view to generating employment

6
opportunities and assisting them with training and education to sustain entrepreneurial

activities. It is estimated that the microfinance industry accounts for roughly USD. 15 billion-

17 billion in microfinance loans outstanding at the end of 2006, with a total of 3,552 MFIs of

which 1,727 are located in Asia, 935 are in Sub-Saharan Africa, 613 are in Latin America

and the Caribbean and the remainder 85 in the Middle East and North Africa (Harris-Daley,

2009). Because of significant growth, the United Nations declared 2005 as the ‘international

Year of Microfinance’. The Forbes (2009) ranked the world's top fifty microfinance

institutions based on scale, efficiency, portfolio risk and profitability, and found that most of

the MFI’s are located in Bangladesh, India and some Latin American countries.

Along with other emerging nations Bangladesh also witnessed exponential growth in MFIs in

terms of number, size, membership, and finance (Devine, 2006). Increasing availability of

donor funds and supportive policy environment under successive regimes since independence

of the country has further propelled the pace of their expansion (Lam, 2006). These

organizations are well known, more than anything else, for pioneering microcredit programs

as these now reach as many as 37 percent of all Bangladeshi households and around 60

percent of poor households (Siddiquee & Faroqi, 2009). For example, the World Bank alone

reached more than 6 million poor people in Bangladesh through microfinance projects worth

over USD.260 million since 1996 (World Bank, 2007).

Bangladesh is credited with microfinance innovation and has taken a leading role in

improving the reporting standards of MFIs. For example, the Consultative Group to Assist

the Poor (CGAP) of the World Bank in association with Palli Karma-Sahayak Foundation

7
(PKSF)1, has issued a set of disclosure guidelines on MFI financial reporting requirements

based on International Financial Reporting Standards (Rosenberg et al., 2003)2. These

disclosure guidelines were developed in consultation with microfinance practitioners and the

donor members of CGAP (the Consultative Group to Assist the Poor). CGAP is a consortium

of bilateral foreign aid agencies from 16 countries, 12 multi-lateral agencies, and 2 private

foundations. This final version (July 2003) is based on the results of field testing and input

from the Financial Services Working Group (FSWG) of the Small Enterprise and Education

and Promotion Network (SEEP). Further, the Government of Bangladesh promulgated a

‘Microcredit Regulatory Authority Act 2006’ and established the Microcredit Regulatory

Authority (MRA) in 2006 to improve financial reporting of microcredit organizations within

the country and this reporting regime is being adopted by many other emerging countries

where microcredit is getting momentum (MIX Market Report, 2009). However, the process

of monitoring and discharging accountability functions in the form of financial reporting is

mostly under-regulated and users and regulators get limited amount of information from

MFIs in Bangladesh despite the existence of legislation and regulatory bodies (Tazi, 2006).

With the significant growth in microfinance, the problem of accountability and governance of

these institutions have become very important issues and pose several challenges. These

challenges also include financial reporting of their performance not only to local depositors

(members) but also to regulators and international funding agencies such as the World Bank,

1
Palli Karma-Sahayak Foundation (PKSF) means Rural (Palli) Employment (Karma) Support
(Sahayak) Foundation (Foundation) in English.
2
These disclosure guidelines were developed in consultation with microfinance practitioners and the member
donors of CGAP (the Consultative Group to Assist the Poor). CGAP is a consortium of bilateral foreign aid
agencies from 16 countries, 12 multi-lateral agencies, and 2 private foundations. This final version (July 2003)
is based on the results of field testing and input from the Financial Services Working Group (FSWG) of the
Small Enterprise and Education and Promotion Network (SEEP).
Richard Rosenberg, Patricia Mwangi, Robert Peck Christen, and Mohamed Nasr were the principal drafters of
this document.

8
and the United Nations Capital Development Fund (UNCDF) (Ebrahim, 2003a&b; Khan,

2003; and Bala & Mir, 2006). However, to date academic research with respect to MFIs’

accountability and performance are mostly confined to assessing the effectiveness of

microfinance relating to loan repayment, utilization of funds, poverty alleviation and

empowerment of women (Hashemi et al., 1996; Khandaker, 1998 & 2003; Pitt, 1999;

Murdoch, 1999; BIDS, 2001; Khandaker & Cartwright, 2003). Some have examined the role

of their governance structure in outreach to the poor and their financial performance

(Mersland & Strøm, 2009).

Despite the recognition that quality financial reporting is necessary to improve MFIs

accountability to stakeholders, there has been no substantive empirical study to date to assess

how these organizations report to various parties using a general purpose financial reporting

framework. This study, in this regard, is the first substantive attempt to redress this gap in

our knowledge in the financial reporting quality of MFIs by using a large sample 435 firm-

year reports over a period of three years in Bangladesh, a country which is credited with

microfinance innovation and taken a leading role to improve reporting standards of MFIs.

1.2 The Research Objectives

In this study, three important disclosure issues have been focused: (1) a cross-sectional study

of the level of information disclosure by MFIs, (2) how MFIs governance, auditors and

internal factors are associated with the variation in disclosure and (3) users’ information

needs and preparers’ perception about disclosed items in MFI financial statement. The

disclosure of information of MFIs is analyzed by developing a disclosure index comprising

82 items appropriate for MFIs based on the recommendations of the World Bank, IASB, and

9
government and non-government bodies engaged in monitoring reporting performance of

these entities. Further, a questionnaire survey is administered to determine the information

needs of users and perceptions of preparers about the disclosed information and compared it

to the current disclosure practice of MFIs to identify if there is any expectation gap. Data

were collected by two sources: questionnaire survey and archival records such as annual

report (financial Statement). The perceptions of users and preparers about disclosed

information items in financial statement were collected through mail survey and annual

reports or financial reports are used to collect data on disclosure practice.

The specific research questions, address in this thesis, are as follows:

(1) What are the institutional and legal disclosure requirements or guidelines affecting

financial reports of microfinance institutions in Bangladesh?

(2) What are the current accounting and disclosure practices of microfinance institutions

in Bangladesh as reflected by the information disclosed in MFI financial reports?

(3) Is there any consensus between the preparers and users with respect to their perceived

information needs?

(4) What is the expectation gap between the level of disclosure and the users’ information

needs?

(5) What is the expectation gap between the level of disclosure and the preparers’

perceptions about disclosed items in MFI financial statement?

(6) Has there been any improvement in disclosure quality over three years since 2004?

(7) Is there any association between the quality or extent of actual disclosure and some

selected organization characteristics such as size, debts level, rate surplus of revenue

over expenditure, size of audit firms, nature of registration, organization’s age,

10
 governance structure, frequency of board meetings and qualification of board

members.

1.3 Contribution and Importance of the Study

This study will contribute significantly to our understanding of disclosure practices of MFIs

in Bangladesh and internationally, and will generate an increasing awareness among

regulators, donors, other stakeholders on policy making in improving their reporting

standards. The study may also help the other emerging countries which have similar

regulatory and reporting environment for MFIs.

The results of this study will assist accounting standard setters and regulators by determining

whether there is a gap between the expectations of users and MFI disclosure practices and if

so, the extent of the gap. They will also be benefited by knowing the perceptions of preparers

about disclosed items in MFI financial statement. The study will help them to understand the

degree of MFI disclosure compliance with the provisions of the existing guidelines and the

areas where non-compliance (if any) is higher.

Further, an examination of the impact of some selected organization attributes on disclosure

practice will enhance our knowledge by identifying the significant factors explaining the

variability of disclosure practice of MFIs in Bangladesh. This information will also assist the

regulators and policy makers in improving the quality of reporting of MFIs.

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1.4 Organization of the Thesis

The reminder of the thesis is organized as follows: chapter two presents the nature and

pattern of accountability of microfinance institutions. The chapter also focuses on how these

organizations are discharging their accountability via disclosure in financial statement.

Section one focuses on the accountability and reporting of MFIs along with the theories

underlined the framework. Second section outlines the accountability and reporting

framework of MFIs in Bangladesh. Section three discusses the importance of financial

statement of MFIs in discharging accountability along with the perceived information needs

of users and preparers of MFI financial statement.

Chapter three discusses microfinance and socio-economic activities by non-government

organizations (as mentioned earlier MFIs are one form of NGOs) in Bangladesh and beyond.

Section one to six outlines the microfinance activities in Bangladesh. Section seven discusses

the social impact of microfinance activities in Bangladesh. Section eight outlines the

expansion of microcredit organizations in the world along with the some criticisms of

microfinance activities. The last section discusses the international bodies which are involved

in expanding and regulating the microfinance activities.

Chapter four outlines the regulatory framework of microfinance institutions. Section one

presents the regulatory framework of microfinance institutions along with the legal and

financial reporting requirements of MFIs in emerging countries. The last section of the

chapter highlights the major provisions of the various Acts and institutional guidelines

governing financial reporting of microfinance institutions in Bangladesh.

12
Chapter five presents previous studies on the accountability, reporting and disclosure,

governance and regulation of micro finance institutions, not-for-profit organizations and

corporations. Sections one to five outline the previous studies on reporting and disclosure,

governance and regulations of micro finance and not-for-profit sector. Section six discusses

about the disclosure and governance studies of profit making organizations. The last section

presents the corporate perceptions studies of users and preparers.

In chapter six, the hypotheses are presented for empirical investigation in this study. Total

five hypotheses have been developed for testing: (1) There is no consensus between users and

preparers regarding the importance attached to the information items disclosed in MFI

financial statements (2)There is no significant gap between the information needs of users

and actual disclosure in MFI financial statements (3) There is no significant gap between the

information needs of preparers and actual disclosure in MFI financial statement (4) There has

been no improvement in the overall disclosure practice since 2004 and (5) There is no

association between the total disclosure quality and some selected organization

characteristics such as size, debts level, surplus of revenue over expenditure, size of audit

firms, nature of registration, organization’s age, governance structure, frequency of board

meetings and qualification of board members.

Chapter seven outlines the data collection methods and sources followed by the research

methodology and statistical techniques used for hypothesis testing.

Chapter eight presents the findings of this study. This chapter is organized into four sections:

Section one presents descriptive statistics and correlation analysis. Section two analyses and

13
interprets the results of univariate test and multiple regression models followed by discussion

of results on additional statistical analyses.

The final chapter summarises and concludes this thesis. Additionally, the policies on relevant

subject are also provided in this chapter.

14
 Chapter 2

Accountability and Reporting Framework for MFIs

2.0 Introduction

The purpose of this chapter is to present the nature and pattern of accountability of

microfinance institutions along with how these organizations are discharging their

accountability via disclosure in financial statement. Section one focuses on the accountability

and reporting of MFIs along with the theories underlined the framework. The second section

outlines the accountability and reporting framework of MFIs in Bangladesh. The third section

presents the importance of MFI financial statement along with the perceived information

needs of users and preparers of MFI financial statement.

2.1 Accountability and Reporting of MFIs

Generally, financial reporting by MFI is mostly explained by accountability framework.

Accountability is defined as ‘the means by which individuals and organizations report to a

recognized authority or authorities and are held responsible for their actions’ (Edwards &

Hulme, 1996). In the context of MFIs, it connotes an obligation on the part of MFIs to

provide accounts to a set of legitimate authorities and those mechanisms and strategies

through which MFI organizations are kept responsible for their actions. However, Lewis

(2001) and Clerk (1991) argue that the accountability framework is rarely so simple for MFIs

because they have multiple stakeholders and are accountable in different and complex ways

to a variety of different groups and interests. Edwards and Hulmes (1996) and Lewis (2001)

also argue that MFIs face demands for two principle types of accountability. They face the

functional accountability such as accounting for resources, resource use and its impact. They

15
also have to meet strategic accountability such as accounting for impacts that MFI actions

have more widely and on other organizations and society. However, reconciling functional

and social accountability may produce tensions, which might affect their upward

accountability with funders and regulators (Ebrahim, 2003a). This makes accountability a

complex challenge for MFIs.

Leat (1988) and Lewis (2001) also outline another three levels of NGO accountability, which

are: (a) full accountability, (b) explanatory accountability and (c) responsive accountability.

In the case of full accountability, there is a right to demand an account from an NGO and

then impose a penalty if is not forthcoming, such as withdrawal of funding. This type of

accountability has become a dominant feature of the NGO world because it has been

associated with the growing concerns of fund providers to ensure that NGOs use resources

efficiently. In the case of explanatory accountability, an NGO needs to respond to a call for

account with information and explanation. Sanctions for failure to meet this accountability

come in the way of disapproval but not as a penalty. In the case of responsive accountability,

there is no formal sanction at all but the system runs on trust and good faith.

MFI accountability has also been classified in many ways- micro level and macro-level,

formal and informal, short term and long-term, functional and strategic. Micro-level

accountability is concerned with the availability, reliability, cost and quality of services

provided while macro-level accountability deals with how public expenditures decisions are

taken, controlled and monitored through accounting systems, external audit and review

procedures (Robinson, 1994). Formal accountability takes into cognizance whether agreed

objectives in a program have been met while informal accountability includes ongoing

discussions between partners (Edwards & Hulme, 1996). Short term and long term

16
accountability are not merely determined by the time dimension but also by the nature of

organizational functioning and goals. In all these frameworks, the role of financial reporting

to stakeholders to discharge accountability function have been emphasised, through the

frequency, contents, format and the channels are differently addressed.

Although microfinance organizations do not have residual claims and the separation of

ownership and managers are not severe because of funding arrangements and organizational

structure, they nonetheless face agency conflicts (Behn et al., 2007). For example, donors

would like their funds to be used wisely and efficiently on the programs and missions, but the

managers could spend the fund on bigger bonuses, better offices, conferences and travel, or

increased benefits. So accountability can be conceptualised in the framework of principle

agent relationships whereby the principles e.g. donors, funders provide resources to agents

17
(MFI) to deliver specialized services and manage resources on their behalf. Such a separation

of ownership and control requires that a set of checks and balances are put in place that can

ensure that the agents discharge their roles and functions faithfully. It also ensures that agents

manage funds in a mechanism like auditing, reporting, monitoring and evaluation seeking to

keep close tabs on not only whether the fund have spent but also on how these have been

spent. This allows funders to assert both “financial control” (seeking accountability of

money) and “policy control” (seeking accountability for accomplishment of goals/missions).

Within this framework, Najam (1996) argues, like publicly available financial reports, not-

for-profit financial reports play an important informational role by mitigating the inherent

principle-agent conflict within the organization.

Some researchers use agency theory to define and measure accountability for NGOs on the

basis of contractual relationships between principal and agent (Laughlin, 1996; Yetman &

Yetman, 2004; Desai & Yetman, 2004). The focus of the theory is the contract governing the

relationship between principal and agent and determining how the contract can be made as

efficient as possible (Eisenhardt, 1989). Using this principal-agent model, Laughlin (1996)

studying religious organisations, talks about contractual accountability as a relationship

where expectations are formally recorded, which Roberts (1991) calls the relationship

hierarchical accountability based on subordinates accounting to their superiors. This

relationship is also known as “Hard accountability” (Leat, 1988; Stewart, 1984; Laughlin,

1996) and information disclosure about how resources being used via financial reporting

becomes an integral part of discharging accountability function.

Ebrahim (2003b) conceptualize accountability for NGOs in a broader and more inclusive

manner through the stakeholder framework. He identifies three primary groups which have

18
explicit or implicit contacts with NGOs: (1) Funders (2) Sectors Regulators and (3) Clients

and Communities. Under this framework, for an organization to continue to succeed, it

requires the support of all its stakeholders, and that in order to engender this support, it needs

to be accountable to all its stakeholder groups. This framework supports the traditional

decision usefulness framework in which all purpose financial reporting is issued by

organizations to discharge accountability, in addition to specific reports to meet the demand

from funds providers (Dhanani, 2009). This decision usefulness framework for reporting has

also been accepted as one way of discharging accountability not only in the private sector but

also in the public sector (Ryan et al., 2002).

Ebrahim (2003a) also identifies some important mechanisms of NGO accountability in

addition to reports and disclosure statements, which are performance evaluations,

participations, self-regulation and social audits. While the first two refer to accountability that

are prepared regularly, participation and self-regulation are generally more and multi-faceted

than tools emphasising certain courses of action rather than a distinct end result. Social

auditing overlaps the border of tools and process. Disclosure of statements and reports are

among the most widely used tools of accountability and frequently required by funding

bodies and regulatory authority. Such reports and legal disclosures are significant tools of

accountability in that they make available basic data on organizational operation. However,

the bulk of this reporting emphasizes upward reporting of financial data, with only limited

indication of the quality of MFIs work and almost no attention to downward accountability to

stakeholders.

Notwithstanding all this, academics remain doubtful about MFI’s ability to maintain

appropriate and effective level of accountability to a range of stakeholders. But all of them

19
mentioned about one type of accountability-conventional accountability for utilization of

resources (Edward & Hulme, 1996 and O’Dwyer & Unerman, 2005 (functional

accountability); Lewis, 2001 (full accountability); Nazam, 1996 (accountability to patrons);

Ebrahim, 2003a (principle-agent accountability). Even though this represents a narrower,

legal rule-bound perspective of accountability, nevertheless it sets forth the context of

broader understanding of the term, for it gives rise to the questions such as, why is reporting

necessary, who are legitimate authorities, what actions can be reported to and how? As a

result, like corporate financial report, MFI financial statements also play a very important

role for discharging their accountability. Various stakeholders especially funders and

regulators can also make more informed investing and regulating decisions by utilising

information in the MFI financial statement about the financial condition and performance of

an organization. Ebrahim (2003b) observes that NGOs discharge their financial

accountability through the financial reports in 95 percent cases.

2.2 Accountability and Reporting of MFIs in Bangladesh

The MFI accountability and reporting in Bangladesh is centred round three groups of

stakeholders- the funders/donors, the regulators and the beneficiaries. However, the

requirements of the existing MFI accountability framework in Bangladesh are skewed

towards the demands of the two influential groups- the donors and the regulators. Khan

(2003) and Mir and Bala (2006) also find that NGOs in Bangladesh are more interested to

discharge their upward functional accountability to their funders and regulators The MFIs

receiving funding are subject to the tight accountability and reporting requirements of the

respective donors. The Palli Karma Shayak Foundation (PKSF) sets some pre conditions for

providing funds, as required by the government of Bangladesh. Those in receipt of foreign

funds are subject to the Foreign Donations Regulation Ordinance, 1978 and Rules under the

20
ordinance, administered by the NGO Affairs Bureau. The Government’s regulatory

framework is mainly concerned with ensuring that MFIs activities are lawful and do not

conflict with government policies. On the other hand, the two apex bodies-the Association of

Development Agencies in Bangladesh (ADAB) and Federation of NGOs in Bangladesh

(FNB) set some self-regulatory code of ethics for their member NGOs. The code intends to

establish self-regulatory practices and norms for the member NGOs.

The Rules under the some of the Acts have specified the books of accounts to be kept by

MFIs. Annual accounts are required and audit is done by a qualified chartered accountant

(member of the Institute of Chartered Accountants of Bangladesh) selected by the MFIs,

from a list approved under the NGO Bureau (for foreign donations). The Ordinance

empowers the Government to inspect NGO books and to carry out its own audits if

necessary. Annual reports must also be submitted to the NGO Bureau. Although NGOs are

required to submit annual reports, the NGO Bureau is rarely concerned about the real

outcome of the project. On the other hand, donors demand project-based accounting but they

are more interested in knowing how their funds have been utilized (World Bank, 2006). Only

exception is the PKSF (Apex finance body). PKSF set some standards and reporting

guidelines for its partner NGOs. It strictly follows these guidelines before disbursing any

fund. All partner organizations are required to submit annual report and audited financial

statements every year to PKSF.

The financial reporting accountability of MFIs in Bangladesh can be explained by Ebrahim’s

Principle-Agent Framework. Ebrahim (2003b) identifies three primary groups which have

explicit or implicit contacts with NGOs: (1) Funders, (2) Sector Regulators and (3) clients

and communities.

21
 Financial Reporting Framework for MFIs in Bangladesh

FUNDERS
International Donors
Government
PKSF
World Bank

MFIs

SECTOR CLIENTS &

REGULATORS COMMUNITIES
Diff Authorities Members
CGAP Beneficiaries
NGO Bureau CDF
Central Bank Society
PKSF/ADAB/FNB

Figure 2.1

Source: Modified Ebrahim’s (2003b) Principle-Agent Accountability Framework

In Bangladesh, funders mainly PKSF, government and other donor agencies including World

Bank provide money to MFIs in exchange for regular reports and evaluations that confirm the

legitimate use of those funds. These reports and evaluations (which include financial

statements, narratives, performance assessments and monitoring systems) function to hold

NGOs accountable to their funders. In other words, the accountability mechanisms position

funders (PKSF, Government, International agencies) as principals and MFIs as agent.

NGOs are linked to sector regulators by accountability mechanisms that position them as

both agents of the public and of governments. Sector regulators (PKSF, Central Bank,

22
CGAP, different Authorities) impose some of the regulations and reporting requirements on

MFIs to follow. Laws governing not-for-profit status and their attendant requirements for

information disclosure are generally intended to ensure a minimum level of transparency in

NGOs, for purpose of ensuring public trust.

The third set of relationships involves clients and communities or beneficiaries. The service

providing MFIs has the powerful option of threatening to withdraw from current or future

funds in the event of non cooperation or non performance. At the same time, members

(depositors) are also concerned about their fund and demand financial reports from MFIs to

evaluate about their performances. Under such conditions, MFIs may be viewed both as

principal and agent.

In all these contractual relations, financial report can assist these groups to monitor their

contracts. However, the literature suggests that, in most of the cases, Bangladeshi MFIs are

discharging their upward functional accountability to their funders and regulators through

financial reports and neglecting downward accountability to their members.

2.3 Importance of Financial Statement in Discharging MFI’s Accountability

The disclosure of information contained in corporate annual reports is considered to be one of

the most important sources due to the availability of other sources, but it is not so for

microfinance institution because there is no alternative market for information generation

such as analysts and management forecasts, and financial news papers for such entities.

Therefore, discharging of accountability to stakeholders via annual reports or financial

statements remains the only sources though fund providers get some amount of information

through direct contacts and regulatory bodies.

23
The Statement of Financial Accounting Standards (SFAS No. 117) in USA states that the

primary purpose of financial statements for not-for-profit is to provide relevant information

to meet the common interest of donors, members, creditors and others who provide resources

to not-for-profit organizations. Like corporation, the external parties use MFI financial

statements in assessing (a) an organization’s services and its ability to provide those services

and (b) how managers discharge their stewardship responsibilities and other aspects of their

performance (FASB 1993). So the MFI annual report or financial statement should disclose

adequate and relevant information to satisfy the needs of users.

SFAS 117 identified donor/funder as the main user of non profit financial statement. PKSF is

the main fund provider for MFIs in Bangladesh as well as regulator However, in this study

auditors are treated as the main users as they are the most important parties to use the MFIs’

financial statements more frequently. They prepare management reports based on these

MFIs’ financial statements, which later on, utilized by PKSF. They also work as agents for

fund providers and regulators. PKSF appoint auditors every year to audit the MFIs’ financial

statements and to prepare management report in relation to the performance of MFIs.

Auditors examine different aspects of MFI’s performances i.e., debt collection, liquidity,

debt-coverage and rate of return by calculating some of the ratios (Prescribed by PKSF)

based on the financial statements. In this regard, their perceptions about disclosed

information in MFIs’ financial statement is important. According to Gibbins, et al. (1990),

auditors can also help to identify disclosure issues and related norms and opportunities. On

the other hand, views of MFI accountants as preparers can also be considered important for

the purpose of determining the adequacy of disclosures in MFI financial statements. MFI

accountants prepare financial statements based on some guidelines (CGAP 2003, PKSF and

Bangladesh bank) and some International Accounting Standards. They are well aware about

24
the disclosure need of which items are more important than others. The regulatory bodies

may also take into consideration the preparers’ perceptions for standard setting or

formulating regulations.

In the light of the above framework, this thesis will seek to understand and explain disclosure

pattern of informational items and the perceived gaps between users and preparers.

2.4 Summary

The chapter outlines the nature and pattern of accountability and reporting of microfinance

institutions along with how these organizations discharge their accountability via disclosure

in financial statements. The main finding of this chapter is that MFIs accountability and

reporting framework is skewed to two influential groups –funders and regulators. The

regulators are PKSF, central bank, government and CGAP. MFIs discharge their upward

functional accountability through financial reports in most of the cases. In Bangladesh, the

main fund provider, PKSF, also uses MFI financial statements to evaluate its member MFIs’

performances. The chapter also discusses the importance of users and preparers’ perceptions

about disclosed items in MFI financial statement.

25
 Chapter 3

Microfinance in Bangladesh and Beyond

3.0 Introduction

The purpose of this chapter is to discuss the microfinance activities in Bangladesh and other

emerging countries. Section one to six outlines the microfinance activities in Bangladesh.

Section seven and eight discuss the social impact of microfinance activities in Bangladesh

along with some of the criticisms of microfinance institutions. Section nine outlines

expansion of microcredit in other emerging countries. The last section discusses the

international bodies which support the microfinance activities.

3.1 The History of Microfinance in Bangladesh

It has been claimed that Bangladesh is the leader for microfinance activities in the world.

Though microcredit is not a new concept, Dr. Muhammad Yunus is credited with

operationalising the concept of microfinance in Bangladesh in 1976. While teaching

economics at the University of Chittagong, Dr. Yunus initiated a research program to design

a framework that would bring the poor within a viable banking network. (Gibbons,1999).

Through the Grameen Bank Project, he demonstrated that poor, asset-less and landless people

were creditworthy and that lending to the poor could be an economically viable activity. In

1983, the Grameen Bank Project was transformed into an independent commercial bank,

known as the Grameen Bank. In 2007, cumulative loan disbursement of Grameen Bank was

Tk. 356.89 (USD.5.10) billion, occupying 31.69 percent of the market share of the sector

(Microcredit Regulatory Authority (MRA) statistics 2008).

26
Following the success of the Grameen Bank, a number of existing Bangladeshi non-

government Organizations (NGOs), including the Bangladesh Rural Advancement

Committee (BRAC) and the Association for Social Advancement (ASA), developed their

own microfinance programs based on the Grameen model. According to MRA statistics

(2008), there are more than 4,000 MFIs in Bangladesh with outstanding loan of more than

Tk.115 (USD.1.65) billion in 2007. However, there are only 402 MFIs who procured the

license from Microcredit Regulatory Authority (MRA) and are required to prepare the

financial statements in accordance with regulatory provision of the authority.

3.2 The Socio-economic Environment

Bangladesh is one of the most densely populated and poorest countries in the world. In 2008,

the population of Bangladesh was over 140 million people and the population density was

1083 people per square kilometre. The average income per capita was approx. USD. 599 per

year and close to 40 percent (nearly 56 million) of the population lived below the poverty

line. The number of hard core poor was 35 million. The adult literacy rate was 56 percent and

unemployment rate was 4.5 percent (World Bank, 2009).

The above mentioned socio-economic factors that have contributed to the problem of poverty

have also encouraged microfinance to thrive in Bangladesh. Poverty creates demand for

microfinance loans in countries where there is a strong tradition of entrepreneurship, but

access to credit remains severely restricted for the asset-less poor (Squillance, 2004). Despite

the immense poverty in Bangladesh, the poor have managed to find many profitable income

generating projects in service-based businesses such as rickshaw transportation, delivery van,

tea stalls, embroidery works, handicrafts etc. These businesses are generally easy to start and

manage, provide services that are in always in demand (even by the poor) and generate a

27
profit in a short amount of time. These factors ensure the success of the business, full

repayment of the loan and the tendency of the borrower to renew or increase the size of

his/her next loan. High population density increases the demand for these business services,

which also contribute to the creation of a large microfinance market in Bangladesh. (Geeta et

al.,1998).

3.3 Microfinance Providers

Institutionally microfinance is provided at two stages: direct providers and apex lenders. At

present, the main direct providers are microfinance institutions (MFIs), Grameen Bank (GB),

Palli Daridra Bimochon Foundation (PDBF), Rural Development Scheme (RDS) of Islami

Bank (IBBL), among other. At the apex level the main fund provider is Palli Karma Shayak

Foundation (PKSF).

As per Credit Development Forum (CDF) microfinance survey 2007 (table 3.1), cumulative

disbursement of loans to the individual borrowers stood at Tk. 891.04 (USD. 12.70) billion

up to December 2006, while that reached Tk. 1,126.01 (USD. 16.10) billion up to December

2007. This shows that annual loan disbursement was 234.97 (USD.3.34) billion, an increase

in loan disbursement by 26.37 percent in 2007 from 2006. This growth is underestimated as

535 MFIs were surveyed in 2007 compared to 611 MFIs in 2006.

Among the direct service providing agencies, MFIs as a group was dominating with

cumulative disbursement of loans at Tk.555.68 (USD. 7.93) billion up to December 2006,

which was 62.36 percent and Tk.732.32 (USD. 10.46) billion up to December 2007, which

was 65.03 percent of the sector. The annual disbursement was Tk.176.65 (USD. 2.52) billion

of the reporting 535 MFIs in 2007. These reflect tremendous expansion of market outreach of

28
the MFI’s program. The sector was very much concentrated to a very few institutions, as only

8 percent institutions occupy over 80 percent of the market. The major share of the market

was captured by two very large institutions namely BRAC and ASA, who have provided

63.23 percent of total MFI loan outstanding and have collected 54 percent of total savings

(MRA statistics 2008).

Table 3.1 Development of Microfinance Sector in Bangladesh (Tk. in million)

Agencies Cumulative Loan Cumulative Loan Annual Change Growth

Disbursement up Disbursement up
to 2007 (N=535) to 2006 (N=6111)

Disbursement to 1,126,014.85 891,041.08 234,973.77 26.37

Borrowers

1.MFIs 732,323.56 555,676.68 176,646.88 31.79

2.Grameen Bank 356,798.20 306,368.60 50,429.60 16.46

3.PDBF 22,924.08 19,692.70 3,231.38 16.41

4.RDS (IBBL) 13,969.01 9,303.10 4,665.91 50.15

Wholesale Lending by 49,725.72 35,060.78 14,664.94 41.83

PKS

Source: CDF and Bangladesh Microfinance Statistics 2007

3.3.1 Direct Fund Providers

Bangladesh Rural Advancement Committee (BRAC)

BRAC is the largest national MFI in Bangladesh. It is also the largest development

organization in the private sector in the country. BRAC started its first small loan programs

29
in the mid-1970s, lending to groups of artisans and other poor village to finance income-

generating activities. It initiated its major credit activity in 1979, and has been involved in

microfinance ever since. Despite having one of the largest microfinance operations in the

world, BRAC is not exclusively a microfinance providing institution (MFI). It has equally

large programs in health, education, employment generation, human rights and development

of other capacities, which are part of its holistic development approach. It is now one of the

largest NGOs in the world.

BRAC’s microfinance activities are operated through its Rural Development Program or

RDP. The Nucleus of RDP is the village organization (VO). A VO comprises of 40-45 rural

poor as members. RDP lays importance on enterprise development of the borrowers, which is

supported by credit, training, input and extension support and often marketing assistance. At

the end of 2007, it had 7.05 million borrowers and a loan disbursement of Tk. 43.24

(USD. 0.62) billion (MRA Statistics 2008).

ASA (The Association for Social Advancement)

ASA was established as an NGO in 1978, with a focus on consciousness raising, group

development and training among the rural poor. In 1991, it started its microfinance

operations and recreated itself as a finance-only MFI. It is now the third largest MFI in

Bangladesh and offers a range of savings, credit and insurance facilities. At the end of 2007,

ASA had over 5.6 million active borrowers and a loan disbursement of Tk. 29.12 (USD.

0.42) billion (MRA Statistics 2008).

30
The Grameen Bank

The Grameen bank is a unique financial institution. It was created by a special Act of

Parliament, the Grameen Bank Ordinance 1983, as a commercial bank with the social

mission of providing credit, with or without collateral security, to assetless and landless

borrowers for any type of economic activity. The Grameen Bank was started with funds from

Bangladesh Bank, capital markets and concessional loans from international donors.

As a single loan provider, Grameen Bank, is the largest. In 2007, cumulative disbursement

of Grameen Bank was Tk. 356.89 (USD. 5.10) billion, occupying 31.69 percent of the market

share of the sector. The share declined from 34.38 percent in 2006 to 31.69 percent in 2007.

The annual loans disbursement was Tk. 50.43 (USD. 0.72) billion, which is around 22

percent of micro loans disbursement in 2007 (CDF & Bangladesh Microfinance Statistics

2007).

In 2001-2, all Grameen Bank branches began to operate the new, simpler and much more

flexible ‘Grameen Generalised System’ (also called ‘Grameen II’), which offers four types of

loan products : (a) basic, (b) housing, (c) higher education and (d) struggling members

(beggars) loans. There is also a facility for larger small enterprise loans, and a range of

companies (commercial and not-for-profit) in the ‘Grameen Family’. This includes Grameen

Shikka (GS), established in 1997 to promote the education of non-literate Grameen Bank

members. GS provides financial support in the form of loans and grants for education; and

use and promote new and innovative ideas and technologies for educational development.

31
Palli Daridra Bimochon Foundation (PDBF)

PDBF is a transformed public sector MFI in Bangladesh. This is the only public sector MFI

in Bangladesh. It was established in 1999 under an Act of Parliament. As an autonomous

body, the Foundation started functioning in 2000. PDBF’s Cumulative loan disbursement

increased to Tk.22.92 (USD. 0.32) billion in 2007 from Tk.19.92 (USD.0.28) billion in 2006.

Rural Development Scheme (RDS) of Islami Bank (IBBL)

The IBBL replicates Grameen model and directly implements RDS at the field level. The

IBBL is the only commercial bank that implements group-based microfinance program

directly. The cumulative loan disbursement of RDS (IBBL), still a small niche of the market,

was Tk.13.97 (USD. 0.20) billion in 2007.

3.3.2 Apex Fund Provider

Palli Karma Sahayak Foundation (PKSF)

PKSF, the single largest apex body of microfinance in the country, established in 1990 to

finance MFIs in order to broaden credit supply to poor households, provided Tk.50 (USD.

0.72) billion through its partner MFIs up to December 2007, while up to 2006 the figure was

Tk. 35 (USD. 0.50) billion. The annual loan disbursement in 2007 was Tk.15 (USD. 0.22)

billion.

The legal structure of PKSF allows flexibility, authority, and power to take programs and

implement them throughout the country while managing its affairs as an independent

organization. PKSF’s mandate authorizes its management to mobilize funds in the forms of

grants, loans at concession rates, and contributions from a wide variety of sources that

include Government of Bangladesh (GOB), private individual organizations, foreign

32
governments, international donors and lending agencies. PKSF receives funds from the

Government of Bangladesh, the International Development Agencies (IDA), The European

Union (EU), World Bank, USAID and the Asian Development Bank.

PKSF had 225 Partner organizations (POs) at the end of 2007 (PKSF, 2008). It charges

differential service charge for its two categories of POs: 7 percent for the big POs and 4.5

percent for the small and medium POs. It also operates a loan program for capacity

enhancement of POs at a subsidized rate of 1 percent. It provides customized training courses

and has a well-developed training strategy including outsourcing to private and public sector

institutes. On-site technical assistance is also offered during the intensive schedule of field

visits undertaken by PKSF personnel. Under the diversified mainstream credit program,

PKSF provided five categories of loans: (a) rural microcredit (b) urban microcredit (c) micro

enterprise (d) ultra poor program and (e) seasonal loan. A component-wise disbursement

breakup (table 3.2) showed that PKSF provided more loan in rural microcredit followed by

urban credit and micro enterprise loan.

Table 3.2 A Component-wise Disbursement Breakup of PKSF’s Loan

Products Cumulative Loan Five yrs Loan Number Of Number of

Disbursement Disbursement Members in Borrowers in
(Tk in mil.) (Tk. In mil.) 2007 2007
RMC 230,834.75 46,379.93 74,899,86 5,543,277

UMC 26,764.77 7,136.19 585,089 492,482

MEL 12,077.70 5,977.00 135,486 128,555

UP 7,790.31 3,748.83 833,064 708,062

Seasonal Loan 890.63 774.67 33,061 26,120

Source: PKSF Report 2007

PKSF continued to provide loans to the rural poor through its POs under five special

projects: 1) Participatory Livestock Development Project (PLDP-1) funded by the Asian

33
Development Bank b) Integrated Food Assisted Development Project (IFADEP) funded by

the European Commission; c) Training, Employment and Income Generation Program of

Jamuna Multipurpose Bridge Authority (JMBA); d) South-West Rehabilitation Loan

Program (SRLP); e) Financial Services for the poorest (FSP) and f) Micro Finance Technical

Support (MFTS) funded by the International Fund for Agricultural Development (IFAD).

3.4 Sources of MFI Funds

Initially foreign donation was the major sources of fund for the MFIs, contribution of which

stood to near 50 percent of the total fund before 1996. But after that, it had declined sharply

and became only 10 percent of the total fund in 2007 (CDF and micro finance statistics

2007). One of the reasons for this sharp decline is that international donors now prefer to

provide donation or loan to apex funding body PKSF instead of MFIs directly. At present, the

sources of funds of MFIs are varying as a result of differences in their access to various

sources of fund for covering operating expenses and for providing micro loans. According to

Credit Development Forum (2007), sources of funding for the revolving loan fund (RLF) of

the MFIs is surveyed, came from the internal sources 52 percent and external sources 48

percent.

Most MFIs had traditionally received heavy support from foreign donors. However, as

international donor funds are drying up and commercial sources of funds remain limited,

MFIs have been increasingly relying on funds from savings deposits and approaching Palli

Karma Sohayak Foundation (PKSF) for financial and technical support. As MFIs are legally

restricted by the Government from collecting savings deposits from the general public (with

the exception of Grameen Bank), several larger, more stable MFIs such as BRAC and ASA

have augmented their funding resources with members’ savings deposits. According to CDF

34
and Bangladesh Microfinance Statistics (2006 & 2007), member’s savings have exhibited an

overall growth of 24 percent in 2006 over 2005 and 15 percent in 2007 from 2005. In many

Grameen-type group-lending programs, the members are required to deposit forced or

compulsory savings (as little as Tk. 1-10) on a weekly basis. The regularity of savings

deposits and attendance of group meetings are additional preconditions for receiving credit.

Table 3.3 Sources of Microfinance and Revolving Loan Funds of MFIs

(As of December, 2007) (Fund in million Tk.) N=195

Sources Growth Growth Growth

2007 2006 2005 2007 over 2006 over 2007 over

2006 2005 2005

A. External 5340.14 5167.14 5053.83 3.35 2.24 5.67

Sources:

1. International 5071.28 5018.37 4887.79 1.05 2.67 3.75

Donors:

2. International 266.86 148.76 166.04 80.73 -10.41 61.92

NGOs

B. Internal Sources: 49,752.71 40,923.24 31940.70 21.57 28.12 56.77

1. Own Sources 28,729.57 28,041.62 22,009.46 2.45 27.41 30.53

1. Members’ 22605.89 24506.234 19752.45 -7.75 24.07 14.45

Savings

2. Own Fund 6123.68 3535.38 2257.01 73.21 56.64 171.32

C. Borrowing: 21,023.14 12,881.62 9,931.24 63.20 29.70 111.69

1. PKSF 13628.12 10853.26 8501.75 25.57 27.66 60.30

2. CDF 28.83 26.75 23.97 7.78 11.6 20.28

3. Others 6106.01 1756.67 1212.31 247.64 44.9 403.74

Total 55,092.85 46,090.38 36,994.53 19.53 24.59 48.92

Source: Bangladesh Microfinance Statistics 2007

35
Historically, MFIs do not allow members to withdraw any amount of their forced savings

except when members decide to permanently leave the organization, since most MFIs have

used the savings fund as an important source of their fund (Dewan,1999). The table 3.3

shows that the amount of revolving fund was Tk. 55.09 (USD. 0.79) billion in 2007 and in

2006 the fund was Tk. 46.09 (USD. 0.66) billion. The annual increase in the fund was Tk. 9

(USD. 0.13) billion in 2007 and the growth rate was 19.53 percent. Members’ savings was

the dominating source contributing to around 52 percent in 2007, although it declined from

61 percent in 2006. Floods and price hike in 2007 may have contributed to the decline in

members’ net savings. Grants and donations from international agencies have contributed

around 10 percent. It remained constant over time. PKSF has contributed substantially to

financing micro credit. Its contribution has increased from 23 percent to 25 percent in 2007.

Local MFIs, the big ones, also provide loans to small MFIs. In 2005, the amount of

contribution was Tk.0.19 (USD. 2.52 million) billion, it increased by more than five times to

Tk.1.20 (USD. 0.17) billion in 2007.

3.5 Outreach of MFIs:

The outreach of the MFIs may be seen through its institutional and financial strength such as

number of branches of the agencies, loan coverage, net savings and loans outstanding. The

total number of branches of the direct loan providing institutions was 14,937 as of December

2007 while that was 11,723 in 2006. The annual growth rate of branches in the sector was

27.42 percent in 2007. The MFIs together had the highest number of braches (12,096),

followed by single largest institution, Grameen Bank (2,481).

The total number of members mobilized by MFIs was 33,137,964 as at December 2007, it

was 29,008,795 in 2006. The MFIs occupied 72.29 percent of the sector’s total members in

36
2007, and in 2006, they together retained 70.71 percent of the total numbers. The Grameen

Bank’s share as a single agency was still very significant at 22.36 percent on 2007 and 23.82

percent in 2006.

Net savings mobilization by the MFIs at the end of 2007 was Tk.62.5 (USD. 0.87) billion,

higher by around 17 percent over 2006. The share of Grameen Bank was over 45 percent.

With the increase in member savings, loans outstanding, a reflection of higher loans

disbursement, increased at a rate of around 25 percent. In 2007, loans outstanding amount

was Tk.138.6 (USD. 1.98) billion. These reflect tremendous expansion of market outreach of

the MFIs’ program. The pattern of increase in the net savings and loans outstanding suggests

that the MFIs greatly emphasize mobilization of savings as a process of financing loan and

reducing dependency on external fund, as they use it in their revolving loan funds.

3.6 Microfinance and Different Types of Collateral

Many microfinance programs rely on group-based lending and other methods. Group-based

lending provides an incentive for borrowers to repay and help in avoiding adverse selection

of borrowers, thereby improving loan recovery rates. While group-based lending does not

always improve loan recovery, it constitutes a powerful incentive for repayment when it

helps to create “social collateral” that works against loan default (Miah, 2004). In Bangladesh

most microfinance programs have separate programs for men and women, in accordance with

socio-cultural norms. Membership is strictly limited to people who own less than half an acre

(approx. 2000 sqm) of land, are not members of the same household as another program

member, have similar economic resources and live in same village. The different methods of

credit delivery and savings mechanisms of four major MFIs are discussed in the following

table (table 3.4).

37
Table 3.4 Credit Delivery and Savings Mechanisms of MFIs

Credit Delivery Savings mobilization

Grameen Maximum land holding of half an acre of BD Tk.1.00 per week

Bank land 5% of each loan (non-refundable) goes to

No collateral, but group liabilities group fund

5 members form a group 0.5% of each loan used for group insurance

50-week instalment of loan Option to buy share worth BD Tk.100 per

Interest at the end of loan cycle member

20% interest rate for general loan

8% for housing loan

Maximum loan BD Tk.10,000

BRAC Maximum land holding of half an acre of BD Tk. 2.00 per week

land 4% of each loan (non-refundable) goes to

No collateral, but group liabilities group fund

30-40 members form a village 0.1% of each loan used for group insurance

organization 50-weeks instalment of loan

Interest at the end of loan cycle

20% interest rate for production loan

Maximum loan BD Tk. 10,000

ASA Maximum land holding half an acre of Weekly at a minimum rate of BD Tk. 10-25

land No collateral but group liability per member

Initial loan size is BD Tk.5000 for rural

areas and BD Tk.6000 for urban areas per

member with a BD Tk. 1,000-2000 annual

increase

Maximum loan size is BD Tk.9000

(US$184)

Loan duration 1 year

Source: (Miah 2004)

38
3.7 The Social Impact of Microfinance in Bangladesh

The literature broadly supports the hypothesis that access to microcredit contributes to

poverty reduction and social development in Bangladesh. Microfinance has had a positive

impact on several individual and household outcomes in Bangladesh, most clearly on

consumption smoothing and social indicators.

Hashemi et al. (1996) examines the relationship between microcredit programs and women’s

empowerment. 1,225 married women under the age of fifty-members of Grameen Bank,

BRAC, non-members in Grameen served villages, and a comparison group- have been

observed and interviewed over a period of three years. Eight indicators have been used as

proxies for empowerment: (1) mobility, (2) economic security, (3) ability to make small

purchases, (4) ability to make larger purchases, (5) involvement in major household

decisions, (6) relative freedom from domination from within the family, (7) political and

legal awareness and (8) participation in public protests and political campaign. Each of the

programs is shown to have a significant effect on four empowerment indicators (2,3,4,7) as

well as on the woman’s contribution to family support and to the composite empowerment

score. Grameen Bank alone significantly affects women’s involvement in major decisions (5)

and BRAC alone significantly affects mobility (1). Even those members with little or no

control over their loans and income generating activities are shown to be more empowered

than non-members.

Khandaker (1998), using 92-98 household data, estimates that for every Tk. 100 (about

USD. 1.33) lent to a woman, household consumption increases by Tk. 18 (USD. 0.26);

interestingly the figure is Tk. 11 (USD. 0.16) if the same amount was lent to a man.

Moderate poverty falls by around 15 percent and ultra-poverty by 25 percent for households

39
who have been BRAC members for up to three years controlling for other factors according

to the author. Similar results are found for Grameen Bank and Bangladesh Rural

Development Board (BRDB) members. Recent evidence from re-survey of the same

households suggests that microcredit has significantly contributed to reducing poverty

(Khandaker, 2003). Somewhat surprisingly, the impact appears to be greater for households

who started off extremely poor (18 percent point drop in extreme poverty in seven years)

compared to moderate poor households (8.5 percent point drop).

One comprehensive study is conducted by Alamgir (2000) among twenty Partner

Organizations (POs) of the Palli Karma Sahayak Foundation (PKSF) in Bangladesh. The

main purpose of this study was to determine whether PKSF had been able to reach the poor

through its partner organizations. The study collected data from 1194 respondents by using a

survey technique. The study concludes that 97.51 percent of borrowers had an improvement

in family income and expenditure, quality of food, housing condition, child education,

sanitation and social awareness.

The Bangladesh Institute of Development Studies (table 3.5) also carries out an extensive

study of the impact of PKSF Partner Organizations (POs) microcredit program using data of

3000 households between1997-2000. One of the key findings is that microcredit has a

positive and significant effect on poverty status of the program households (BIDS, 2001).

40
Table 3.5 Impact of Microfinance (compared to non-participants)

Broad Category Indicators Type of Cause of Change

change

Economic Income + self employment activities

Impact
Food Security + greater access to cultivable land through the rental

market

Wage (land poor) + Transport and other non-agri activities support by

microcredit

Employment (land + . better access to the land rental market . wage

poor) employment in non-agri sector

avg. low land size than non-participants

.larger operational holding

Asset (land poor) + .impact of MF(poultry livestock, bicycles,

rickshaw/van)

Social and other Fertility and + . program participation

development contraceptive use . female methods dominate

Impacts

Health and Nutrition + Program placement effect

Sanitation and + Program participation

drinking water

Literacy and school + Program participation

enrolment of children

Social mobility ? Do not vary significantly

Women participation + Participation in a microcredit program

and HH welfare Increasing women’s income

Source: Bangladesh Institute of Development Studies (BIDS) 2001

41
The study also finds that microcredit members are less vulnerable when struck by crisis.

Moreover improvements in other social indicators (child immunisation, use of sanitary

latrines, contraceptive prevalence) are also more noticeable for microcredit program

members compared to non-members.

Another study conducted at BRAC specifically examines the impact of microfinance on poor

women in respect of their mobility and social awareness. The findings reveal that mobility of

these women outside their home has increased. They have also gained some control on using

their own income. In many cases, the women have participated in decision making on

household issues. They are also found to be critically aware on issues relating to dowry,

family and inheritance laws, family planning and education of their children. (Abed, 2004).

The impact of microcredit on non-income indicators in Bangladesh is also broadly positive.

There is a convincing evidence based on a representative household survey, which takes into

account common methodological problems such as selecting bias, that access to microcredit

empowers female in Bangladesh (Pitt et al., 2003).

42
 Chapter 4

Legal Environment of Microfinance Institutions

4.0 Introduction

The chapter outlines the regulatory framework of microfinance institutions. Section one

presents the regulatory framework of microfinance institutions along with the legal and

financial reporting requirements of MFIs in emerging countries. The last section of the

chapter highlights the major provisions of the various Acts and institutional guidelines

governing financial reporting of microfinance institutions in Bangladesh.

4.1 Regulatory Framework of Microfinance Institutions

Microfinance has grown largely outside a regulatory framework (Jackson & Tazul, 2001).

However, in most emerging countries, microfinance activity has grown to the point where

financial regulators see the need to frame a policy and eventually to integrate some portion of

the microfinance spectrum into the framework of regulated financial services institutions

(Meagher, 2002). The need for regulation and supervision of MFIs arises from several

considerations, like protecting the interests of small savers, ensuring proper terms of credit,

financial stability and discipline and institutionalizing a proper reporting system for orderly

development.

The growing literature on the subject of microfinance regulation and supervision holds

varying views on the subject. Some are in favour of a market-directed approach, an open

banking system as it were, with the regulator simply setting the framework for the industry,

while others advocate a more government-directed stance with an active promotional role for

43
the regulator. (Jackson & Tazul, 2001). Some of them view that only deposit taking MFIs

should be regulated, whereas other groups think that both deposit taking and non-deposit

taking microfinance institutions should be regulated (Lianto, 2006). However without a

supportive regulatory framework, it is difficult for MFIs to expand and reach large of

numbers of the poor sustainably. The consequence of the lack of suitable regulatory

framework has also slowed growth of microfinance activities in many countries.

Regulators including government, international and local agencies are trying to develop

suitable regulatory framework in different emerging countries. Some surveys have been

conducted by academics and institutions on the development of regulatory framework of

microfinance mainly in the emerging countries.

Meghar (2002)) through IRIS Center, a university of Maryland, has conducted a survey on

the regulatory frameworks of 10 emerging countries. In his study, he discusses separate

examples (Bangladesh, Bolivia, Ethiopia, Ghana, Indonesia, Peru, the Philippines, South

Africa, Uganda and the West African Economic and Monetary Union) of microfinance

regulatory systems, from ten jurisdictions within the developing world. He examines

microfinance institutional forms that are in some way recognized, registered, regulated and

supervised – whether directly by the government or indirectly by private (or state owned but

non regulatory) institutions. In the study, he finds that most countries’ approaches to

microfinance regulation fall into one of four broad categories: (a) mandatory control under

banking law, (b) paternalistic support according to a charitable model, (c) a tiered structure

incorporating banks as well as MFIs and (d) neglected. The study also observes that

regulations and requirements vary from country to country due to different situation and

different microfinance development levels. The appropriate role for the central bank in

44
microfinance differs from country to country. Such difference reflects a variety of factors.

The financial system and the microfinance sector have evolved differently in different

countries and a variety of institutional structures have emerged. The stage of development of

the financial system, and of the microfinance sector also differs from country to country.

Other relevant factors include the degree of independence of each central bank and its

operational capacity is also another problem to take into consideration.

In 2004-2005, the Asian Productivity Organization (APO) commissioned microfinance

experts to conduct a survey of legal and regulatory framework in Ten Asian Countries

(Bangladesh, Japan, Lao PDR, Malaysia, Nepal, Pakistan, Sri Lanka and Vietnam). The

Survey report concludes that the regulatory authorities are still developing an understanding

of the microfinance phenomenon, making sincere attempts to flesh out an appropriate

regulatory framework and building the required capacity for effective regulation.

In 2007, the Asia Pacific Philanthropy Consortium (funded by Asia Foundation, Charities

Aid Foundation India and University of Iowa) conduct a survey on the recent developments

of regulatory framework of Not-for- Profit Sector in five South Asian Countries (Bangladesh,

India, Nepal, Pakistan and Sri Lanka).The report describes and analyses development of the

legal frameworks of NGOS (including MFIs) generally from about 2004 through mid 2007.

Some countries in this study found that government has shown a more welcoming,

cooperative, even facilitative attitude toward the non profit sector and philanthropy, while in

other countries conflict between the sector and the State has increased and in some countries,

elements of both increasing conflict and strengthened cooperation have been observed.

45
4.2 Legal and Financial Reporting Requirements of MFIs in Emerging Countries

As the regulatory framework for MFIs varies from country to country, it is not surprising that

the legal and financial reporting requirements of MFIs also differ among the countries.

In Tanzania, both regulated and unregulated microfinance service providers operate in the

same markets targeting the same clientele. The National Microfinance Policy (NMP)

stipulates that all MFIs be subjected to a best practice of (non-prudential) regulatory

framework. In the case of micro-lending NGOs, this is done through application of

regulations on accounting and auditing standards issued by the National Board of

Accountants and Auditors (NBAA) to ensure transparent disclosure. For NGOs, that receive

funding from donors and/or the domestic government, standards compliance monitoring is

done through the relevant regulatory measures issued under the Public Finance Law. The

Microfinance Companies and Microcredit Activities Regulation ACT 2005, relating

specifically to Microfinance Companies (MFCs) include conditions related to minimum core

capital and other licensing provisions, lending limits, capital adequacy, asset quality and

reporting requirements. Minimum core capital for MFCs has been set at TZD. 800 million

(Approx. USD. 800,000), in case of MFCs with a nation-wide branch network and

TZD. 200 million (Approx. USD. 200,000) in case of MFCs which do not have multiple

branches (Unit MFCs). The prescribed minimum capital is intended to ensure that MFCs

have the financial capacity to acquire the necessary infrastructure and technology. All MFCs

are required to prepare financial statements according to accounting and auditing standards

issued by the National Board of Accountants and Auditors (NBAA).

46
In Nigeria, there is no separate legal form specifically designated for microfinance

institutions (MFIs). MFIS may get license from Central Bank of Nigeria if they have paid up

capital ND. 3,000,000, liquidity ratio 40 percent and capital adequacy ratio 12 percent. Most

of the biggest ones have been duly registered and incorporated as companies limited by

guarantee and operate as secondary cooperative societies. Every MFI is also required to

submit its audited financial statements and the abridged version of the accounts to the

Director of Others Financial Institutions of the Central Bank of Nigeria.

In the Bolivian financial system, there is no special set of laws covering microfinance. Rather

financial regulations cover all types of institutions and activities. This is an important

distinction that is evident throughout the supervisory and regulatory framework. The

Superintendency of Banks and Financial Entities (SBEF), has not attempted to establish

softer rules for microfinance services or institutions at the expense of prudential regulations.

Instead, it has sought to create a set of rules that enables the financial system to serve all

market niches. Accordingly, the regulatory framework for microfinance activities including

financial reporting requirements lies within the general rules applied to financial activities,

particularly in Law 1488 and Supreme Decrees.

In 1995, Bolivia created the Private Financial Fund (PFF) by Presidential Decree. The

purpose of the PFF was to provide for a second –tier non-bank financial institution (NDFI),

to channel resources to small and micro enterprises. The Central Bank and Superintendency

of Banks and Financial Institutions have regulatory over PFFs. Some of the key features of

PFFs are (Meagher, 2002):

I) PFFs are required to be corporations and to have a minimum paid-up capital

equivalent to USD. 1 million
II) The minimum capital adequacy ratio is 10 percent

47
 III) The maximum portfolio allocation to loans is two times the value of equity
IV) PFFs are required to submit audited financial statement annually

In India, microfinance institutions that are registered as companies come under the regulatory

purview of Reserve Bank of India (RBI)). Non-Banking Financial Companies (NBFCs)

accepting public deposits are subjected to rigorous supervision by Reserve Bank of India

(RBI), there are, however, only a few MFIs in the country that are registered as NBFCs

(NABARD, 2002). Further, companies which are engaged in microfinancing activities,

licensed as not-for-profit companies and are not accepting public deposits, are exempted

from the key regulatory/statutory requirements such as registration, maintenance of liquid

assets (USD. 12,200) and transfer of minimum percentage of profits (15 percent) to the

Reserve Fund. However, all MFIs are required to submit annual financial statements.

The Micro Financial Sector (Development and Regulation) Bill, 2007 was introduced and

passed in the Lok Sabha (Parliament) in 2007. This bill seeks to promote the microfinance

sector and regulate micro-finance organizations.

Some of the features of the bill are:

I) The National Bank for Agriculture and Rural Development (NABARD) would
regulate the micro financial sector.
II) Every MFO that accepts deposits will need to be registered with NABARD
III) Conditions for registration include a) Net owned funds of at least Rs. 500,000
(Approx. USD. 12,200) and b) at least 3 years in existence as an MFO
IV) All MFOs, whether registered or not, shall submit annual financial statements to
NABARD.
V) Every MFO that accepts deposits will be required to establish a reserve fund
through transfer of a minimum of 15 percent of its net profit realized out of its
thrift and micro finance services every year

48
 VI) The central government may also establish a Microfinance Development Council
to advise NABARD on formulation of policies related to the micro financial
sector.

In Pakistan, The Microfinance institutions Ordinance, 2001 was issued to regulate the

establishment, business and operations of micro finance institutions by the State Bank of

Pakistan. The Ordinance provides for the establishment and regulated microfinance

institutions at three levels- district, provincial, and national-to integrate microfinance into the

broader financial system and to create possibilities for institutional diversity. Some of the

features of the Ordinance are:

I) Obtain license from the State Bank of Pakistan

II) Minimum Capital Requirements:

Country wide/national PKR 500 (USD. 6.25) million
Province-wide PKR 250 (USD. 3.12) million
District wide PKR 100 (USD. 1.25) million

III) At least 51 percent of the total paid up capital is required

IV) MF may contribute up to 50 percent of their capital in the form of their existing portfolio
and other assets
V) MFIs are required to maintain equity equivalent to at least 15 percent of the risk-weighted
assets
VI) All MFIs are required to submit Financial Statements.

The ordinance assigns the State Bank of Pakistan authority for licensing, supervising and

regulating reporting of microfinance institutions. A separate division has been created in the

Banking Supervision Department of State Bank of Pakistan to exclusively deal with

microfinance related matters including financial reporting and to monitor and supervise

licensed MFIs.

49
4.3. Legal Provisions for Formation and Reporting of MFIs in Bangladesh

Although there has been an unprecedented growth of microfinance institutions in

Bangladesh, the legal framework for Not-for-Profit organizations has not gone through a

major reform. At present, NGOs including MFIs can be registered under one or more Acts of

Parliament or Ordinances and the reporting requirements vary from no systematic accounts

keeping to submission of annual reports to fund providers. These provisions apply to Not-for-

Profit organizations in general and do not specifically address microfinance activities. The

following are the Acts that deal with the formation and accountability of MFIs within

Bangladesh:

The Societies Registration Act 1860 (Act XXI of 1860)

Under the provision of The Societies Registration Act 1860 (Act XXI of 1860), The Registrar

of Joint Stock Companies (RJSC) within the Ministry of Commerce is responsible for any

society formed for any “literary, science, or charitable purpose. (World Bank, 2006). A great

majority of not-for-profit organizations in Bangladesh are formed and registered under this

Act because of its wide scope and flexibility to permit a range of activities. Under this act,

each society must have a formal governing body which is responsible for managing the

society (Section 16). Societies must hold annual general meetings except where their rules

allow otherwise, and any person may inspect documents of a society filed with the registrar

(Section 19). However, the Act does not specify whether a society is required to maintain

accounts and audits.

50
The Trust Act 1882

A not- for- profit organisation can also be formed under The Trust Act 1882. A Board of

Trustees is responsible for the management of the Trust and is bound under the Act to

maintain clear and accurate accounts of the trust property. Whenever the beneficiary requests,

the trustee shall furnish him/her with detailed information of the amount and state of the trust

property, but it does not require submission of annual accounts or audit report to the

beneficiaries (Section 19).

Voluntary Social Welfare Agencies (VSWA) (Registration and Control) Ordinance 1961

Under the Registration and Control Ordinance 1961, mandatory registration of voluntary

associations is required. The Ordinance is administered by the Social Welfare Department

within the Ministry of Social welfare and it has broad power to suspend or dissolve an NGO

without recourse to judicial appeal. A large number of NGOs are registered under the

voluntary Social Welfare Agencies Ordinance 1961. Every agency registered under the

Registration and Control Ordinance 1961 shall maintain accounts as required by the

registration authority; submit annual reports and audited accounts; pay money into separate

accounts in approved banks; and furnish any other information required. The VSWA

registration authority may inspect books and records, including any financial information

(Section 7). In addition, any person may, on payment of a prescribed fee, inspect any

document relating to a registered agency or obtain a copy or extract thereof (Section 13).

The Companies Act 1994

Although the Companies Act 1994 deals mainly with private trading companies, it also

contains provisions that permit formation of a not-for-profit organization with limited

51
liability provided that the organization applies any income for promoting its objectives and

prohibits the payment of any dividends to its members. An entity wishing to register under

the Companies Act seeks approval from the Registrar of Joint Stock companies. Forming a

not-for-profit company under the Companies Act requires preparation of the Memorandum of

Association and the Articles of Association (Section 22).

Not-for-profit companies registered under this Act are required to maintain proper books of

accounts, in order to provide a free and fair view of the state of affairs (Section 18). Detailed

financial reports and reports on company activities must be made available to shareholders

before and at the annual general meeting (Section 183). However, the number of NGOs

registered under this law is significantly lower than any other laws, possibly due to its more

rigorous legal requirements (World Bank, 2006).

Cooperative Societies Act 2001

Cooperative societies can be formed under the Cooperative Societies Act 2001 with the

objective of producing and/or disposing of goods as collective property and performing

services for cooperative members. Under the Act, societies are permitted to receive savings

from the general public (members). The Registrar of cooperatives has little power, either

preventive or protective, and conducts minimal supervision. The Cooperative Societies Act

includes a requirement for an annual meeting, but does not require the submission of annual

accounts or external audits.

4.3.1 Regulatory Bodies

Besides the above Acts, Bangladesh Government established three Institutions: PKSF-a

wholesale financing company to finance and regulate its Partner Organizations (POs), NGO

52
Affairs Bureau-primarily to regulate NGOs which receive donations and grants from foreign

entities and MRA (Micro Credit Regulatory Authority) to supervise, control and monitor the

licensed MFIs.

PKSF (Palli Karma-Sahayak Foundation)

PKSF is the most important organisation for the regulation and financing of MFIs in

Bangladesh (Hulme & Moore 2006). PKSF itself was created in 1990 under the Companies

Act 1913 (amended in 1994) to support and assist, financially and institutionally, to its

eligible partner MFIs (POs) and monitors their performance, including financial reporting.

With regard to financial reporting by its POs, PKSF had developed guidelines for accountants

on how to prepare financial statements on accrual basis of accounting and information to be

contained within these statements; management of information systems; business planning

for POs; and internal and external audit procedures including their appointments (Miah,

2006). In collaboration with the World Bank, PKSF had introduced certain International

Accounting Standards for financial reporting of its partner organizations (POs) and switched

from cash basis of accounting to accrual basis of accounting (World Bank, 2006).

PKSF contributed significantly in the preparation of a user-friendly regulatory framework for

the microcredit sector in Bangladesh (PKSF, 2007). The Committee appointed by the

Government to prepare the regulatory framework for MFIs was headed by the Governor of

Bangladesh Bank, while the Technical Committee, which prepared detailed guidelines and

format for MFI financial reporting was headed by the Managing Director, PKSF.

53
The NGO Affairs Bureau (NGOAB)

The Government formed an agency (The NGO Affairs Bureau) to regulate the affairs of

nongovernmental organisations within the Ministry of Establishment in 1990. The NGOAB

requires all NGOs seeking or receiving foreign funds to register with it under the Foreign

Contributions (Regulation) Ordinance of 1982 and to renew that registration every five years.

The Bureau is concerned with receiving and utilization of foreign funds for projects, and

evaluating statements and reports submitted by NGOs including auditing incomes and

expenditure accounts by external auditors. However, unlike the PKSF, it has not developed

any guideline for financial reporting. Organizations are only required to submit the partial

report for utilization of their foreign donations/funds (World Bank, 2006).

Microcredit Regulatory Authority

The Government of Bangladesh promulgated ‘Microcredit Regulatory Authority Act 2006’

(Act number 32 of the year 2006) in August and later established the Microcredit Regulatory

Authority (MRA) to improve the institutional and regulatory framework for MFIs. Apart

from authorising operations, audit of accounts and policy formation, the MRA requires MFIs

(under Section 27 of the Act) to maintain their accounts in the manner prescribed by the

Authority, prepare annual budget for the next financial year and prepare the Balance Sheet,

the Profit and Loss Account annually, and submit it to the Authority. However, the

requirements of MFIs by MRA are still on trial stage and are not fully implemented yet. Most

of the licensed MFIs are still confused about the financial reporting format and are reluctant

to submit the financial statements annually (MRA, 2008).

54
Some of the features of Microcredit Regulatory Act 2006 are as follows:

Registration requirements:

All licensed MFIs should be registered by either one of the following Acts:

 The Societies Registration Act, 1860 (Act XXI of 1860);

 The Trust Act, 1882 (Act II of 1882);

 The Voluntary Social Welfare Agencies (Registration and Control) Ordinance, 1961

(Ordinance No. XLVI of 1961);

 The Companies Act, 1994 (Act XVIII of 1994).

The financial reporting provisions contained in each of the above Acts have been discussed in
the previous section.

License requirements for MFIs:

 Either 1,000 borrowers or Tk. 4 million (USD. 60,000).

Reporting Requirements for MFIs:

 MFIs (fulfilling the above criteria) are required to submit 8 pages (prescribed by

authority) half yearly reports and also required to submit audited annual reports

before 30th September each year

 One page reporting system is applicable for those MFIs which have not reached the

minimum level either 1000 borrowers or outstanding loan of Tk. 4 million.

55
4.3.2 Financial Reporting Environment of MFIs in Bangladesh

As there are several legislation and regulatory bodies, the process of monitoring and

discharge of accountability functions in the form of financial reporting is mostly under-

regulated and users and regulators get limited amount of information from MFIs in

Bangladesh (Tazi, 2006). Most of the small MFIs do not prepare annual reports, rather they

prepare management reports including financial highlights showing receipts and payments in

two pages. Some organizations prepare financial reports and their financial accounts are also

being audited, but these reports provide minimum information on assessing their financial

position. Some financial statements, for example, limit performance analysis by not

separating microfinance operations from the institution’s other activities, such as health or

training services. Audits are generally conducted to comply with donor requirements. To

satisfy the requirements of different donor organisation, MFIs sometimes undertake multiple

audits and in some cases, even close their books twice a year (Irish & Simon, 2005). The

production of multiple audited accounts creates an additional strain on limited resources and

results in showing a partial picture of the MFIs since donors usually ask for audited accounts

covering only the utilisation of their funds within the institution.

The Consultative Group to Assist the Poorest (CGAP), a consortium of public and private

development agencies hosted by the World Bank, has issued a set of disclosure guidelines on

MFI financial reporting requirements (Rosenberg et al., 2003). However, these guidelines are

not accounting policies and do not command any particular format for financial reporting.

Instead, they simply indicate the minimum information that should be included in MFI

financial reports. The CGAP encourages MFIs to adopt International Accounting Reporting

Standards (IAS 1, 30 and 32) issued by the International Accounting Standards Board (IASB)

and the industry-specific Consensus Guidelines on Disclosure for Financial Reporting.

56
PKSF, with support from the World Bank, has moved towards consolidated audited accounts

for the microfinance operations of its partner organizations. PKSF have also adopted certain

International Financial Reporting Standards (IFRS 1, 7 and 10) for financial reporting for its

POs, which resulted in fairly uniform financial reporting, audits and presentations (World

Bank, 2006). To improve the regulatory and reporting framework for MFIs, the Government

of Bangladesh also introduced ‘Microcredit Regulatory Act 2006’. However, as mentioned

earlier, these reporting requirements by MRA are still on trial stage and not fully applied yet.

4.4 Summary

The chapter outlines the regulatory framework of microfinance institutions along with the

legal and financial reporting requirements of MFIs in Bangladesh and beyond. The main

finding of the chapter is that the regulatory framework of MFIs is mainly under regulated and

it varies from country to country. In Bangladesh, even though, there are different Acts to

regulate and control MFIs, however, none of them (except Company Act) requires

submission of audited financial statement. PKSF is the only exception. PKSF, with support

from the World Bank, has moved towards consolidated audited accounts for the microfinance

operations of its partner organizations. PKSF have also adopted certain International

Financial Reporting Standards (IFRS 1, 7 and 10) for financial reporting for its partner

organizations.

57
 Chapter 5

Literature Review

5.0 Introduction

Because there is limited regulation on financial reporting by MFIs, not surprisingly limited

empirical research has been undertaken due to lack of data even then traditional financial

institutions are highly regulated with respect to disclosure of information (Nieto et al., 2008).

However, over the years several studies have been undertaken on Not- for- profit

organizations and their conclusion could be drawn on to improve reporting and accountability

of MFIs since the nature of operations and objectives are similar.

The chapter reviews related studies on NGOs/MFIs accountability, disclosure, regulation and

governance in order to develop a framework and hypotheses for empirical investigation in the

subsequent chapters. The review starts with accountability studies, followed by disclosure,

governance and regulation of microfinance and not- for -profit organizations. As the research

methods draw on some selected prior disclosure studies of corporations, this review will

include appropriate reference to them.

5.1 Accountability Studies

Most accountability studies have focused on the definitions and scope of not-for-profit

organizations with regard to accountability rather than financial reporting specifically. For

example, Brown et al. (2001) focused on developing the concept of international non-

governmental development and environment organizations (INGO) accountability, first as an

abstract concept and then as strategic idea with very different implications for different

58
INGO strategies. The study examines those implications for INGOs that emphasize delivery,

capacity-building and policy influence. They recommend that INGOs committed to service

delivery may owe more accountability to donors and service regulators; capacity building

INGOs may be particularly obligated to clients whose capacities are being enhanced; and

policy influence may be especially accountable to political constituencies and to influence

targets. INGOs that are expanding their activities to include new initiatives may need to

recognize their accountability systems to implement their strategies effectively.

Tilt (2006) outlines the need for a different conceptualization of accountability for NGOs,

than the one normally use when calling for greater accountability of corporations, and

demonstrates there already exists many effective accountability mechanisms. The study

points out that a major flaw in the argument for greater NGO accountability is that it is

usually presented from a perspective that ignores the conflict between control and the role

that NGOs play in civil society-a role that provides a voice for those unable to speak for

themselves and counters the views of more powerful groups. Tilt (2006) concludes that

NGOs play an important role in society and in the absence of profit motives, it may be

necessary to apply different criteria when judging their effectiveness. Similarly, Unerman

and O’Dwyer (2005) demonstrate that the mechanisms required for effective accountability

by the NGOs will usually be different to mechanisms suited to discharging the accountability

duties of other forms of organization. They conclude that flexible and informal accountability

mechanisms seem most suited to situations of closer relationships between an NGO and its

key stakeholders.

Goddard and Assad (2005) find that organizational culture resist accounting in NFPOs and its

use is more symbolic and in navigating legitimacy. They also find that organizations with

59
stronger accounting functions, better qualified accounting personnel and well documented

accounting systems were not necessarily perceived by stakeholders to be more accountable.

Superior accountability was seen to be associated with organizational accessibility to social

scrutiny and the transparency with which its affairs were conducted.

Prior to them, Ebrahim (2003a) and Khan (2003) find that accounting reports and disclosure

statements of MFIs, have emphasised “upward” and “external” accountability to donors

while “downward” and “internal” mechanisms remain comparatively underdeveloped.

Ebrahim (2003a) examines how accountability is practiced by nongovernmental

organizations (NGOs) in USA. The study reviews five broad mechanisms: reports and

disclosure statements, performance assessments and evaluations, participation, self-

regulation, and social audits. Each mechanism, distinguished as either a “tool” or a “process”,

is analysed along three dimensions of accountability: upward-downward, internal-external,

and functional-strategic. Ebrahim (2003a) observes that accountability in practice has

emphasised “upward” and “external” accountability to donors while “downward” and

“internal” mechanisms remain comparatively underdeveloped. He also finds that NGOs and

funders have focused primarily on short-term “functional” accountability responses at the

expense of long-term “strategic” processes necessary for lasting social and political change.

Khan (2003) examines the accountability of NGOs in Bangladesh to patrons, clients and

themselves by employing case studies. The study observes that NGO’s accountability to

patrons-donors and government-is in a near satisfactory state. Though accountability systems

to patrons are in place, accountability to clients and to themselves still suffers from a number

of deficiencies.

60
All these studies stated here focused on accountability with a view to develop a framework to

assess how the functional accountability has been discharged as these organizations are

different from other types of organizations with regard to objectives, functions and reporting

on key performance. The next section presents some studies on reporting and disclosure by

NFPOs.

5.2. Reporting and Disclosure Studies of NFPOs

Yetman and Yetman (2004) examine the effects of governance mechanisms on the financial

reporting quality of NFPOs in the USA. They categorize governance into market-based

(monitoring by lenders and investors) and regulatory (monitoring by Federal and State

Governments) and examined how these two monitoring mechanisms affect the quality of

financial reporting. They find that market-based governance measures have a more consistent

and beneficial effect on reporting quality than the regulatory based measures. Desai and

Yetman (2004) analyse the influence of state-varying legal and reporting rules on the

behaviour of public charities and foundations from 1987 to 2000 in the USA. They develop

state-level indices of the legal and reporting rules and examine how these rules shape

accounting behaviour of NFPOs. They find that stronger non-distribution constraints are

associated with greater charitable expenditures and foundation payouts while more stringent

reporting requirements are associated with lower insider compensation. They also find that

stronger governance measures are associated with intertemporal smoothing of resources and

greater activity in response to negative economic shocks. Prior to them, Krishnan et al.

(2002) examines how NFPOs manage their performance efficiency and effectiveness by

manipulating certain accounting ratios such as the program service ratio and the fund rising

ratio. The study finds that managers of these organizations have incentives to over-report the

expenses, classified as program services, and under report the expenses, classified as

61
administrative and fundraising, in order to improve these ratios. Behn et al. (2007) examine

the incentive for voluntary auditing of financial statements of 300 largest NFPOs in the USA

in 2001. They find that organizations with a high level of debts, a large contribution ratio and

compensation ratio, larger in size and with a low level of lobbying expenses are more likely

to provide audited financial statements voluntarily.

Outside the USA, Simnett (1987) examines the determinants of accounting information

disclosure for not-for-profit organizations (NFPOs) in Australia. Using a sample of 1,000

NFPOs, he finds that gross income, number of members, the presence of a professional

administrator, geographic dispersion of members, and auditors of the financial statements are

significant determinants of information disclosure. Whereas nature of the organizations,

accounting experience of the person preparing the financial statements and use of outside

credit facilities are found not to be significant determinants.

Nieto et al., (2008) is the only study to our knowledge that has focuses on financial reporting

of MFIs in different countries in the world from a database of MFI’s, known as MIX Market,

a web-based platform that compiles information on MFIs worldwide and whose membership

is voluntary. They examine the incidence of financial and social information disclosure on

the internet and the contents of these reporting. Using a sample of 273 MFIs, they find that

overall internet presence of MFIs is very limited and that large MFIs with a high degree of

public exposure on the internet disclose more information on their web sites than smaller

MFIs with a low degree public exposure. Countries with higher levels of GNP and improved

level of ICT infrastructure use more internet for reporting and MFIs located in Africa and

Latin America are less likely to reveal information than those located in Asia or Eastern

62
Europe. Since their study examined the incidence of reporting on the internet using a

secondary source whose membership is voluntary and the results lacked the depth in

explaining the entity specific determinants of disclosures.

In Bangladesh, Mahmood (2001) observes that MFIs typically present financial reports that

are less rigorous reflections of their financial performance. Some do not even produce annual

financial statements due to flexible regulations for MFIs. Most use cash accounting and do

not apply depreciation, provision for loan losses etc. The audited financial statements of

MFIs have significant differences in their presentation and disclosures. It is difficult to

ascertain to what extent accounting principles are homogeneous and it is problematic to have

meaningful analytical comparisons. The study suggests that MFI needs increased

transparency, accountability and reporting in dealings because an MFI with good governance

will perform better over time which will promote investor confidence, facilitates the flowing

of funds and encourage economic development.

Bala and Mir (2006), using a case study approach, find that accounting reports and disclosure

statements of NGOs in Bangladesh have emphasised “upward” and “external” accountability

to donors while “downward” and “internal” mechanisms remain comparatively

underdeveloped. They observe that the NGOs that are dependent on the external sources for

their funding are more dependent on their day-to-day policy-making including their

management control and reporting systems. These organizations spend more times to keep

their funding providers happy rather spending time to assess and evaluate the outcome of

their beneficiary level activities. Their management control and reporting systems are centred

around their funding providers and not centred around their beneficiaries. Bala and Mir

(2006) support the previous literature on Bangladeshi NGO accountability, which mainly

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criticised the NGOs for their failure to adopt a beneficiary-centred accountability system.

Their conclusion is hardly surprising because the bulk of funding for NGOs in emerging

countries come from developed countries and international funding bodies such as the World

Bank which requires a system that reports information more often than their local monitoring

bodies.

5.3 Governance Quality Studies

It has been pointed that the quality of governance has a beneficial effect on financial

reporting and performance of NGOs. For example, Hartarska (2005) presents the first

evidence on the impact of governance on outreach and sustainability of microfinance

institutions (MFIs) in Central and Eastern Europe and the newly independent states. He

examines the impact of management remuneration, board independence and diversity and

external mechanisms of control. He finds that performance-based compensation of managers

is not associated with better performing MFIs; lower wages suggested for mission-driven

organizations with worsen outreach, while managers’ experience improves performance. The

results also provide strong support for independent boards with limited employee

participation. The study also finds that region, external governance mechanisms seemed to

play a limited role.

Recently Mersland and Strom (2009) assess the relationship between firm performance and

corporate governance in microfinance institutions (MFI) using a self constructed database on

MFIs collected from third-party rating agencies. They examine the effects of board and CEO

characteristics, firm ownership type, customer-firm relationship, competition and regulation

on an MFI’s financial performance and outreach to poor clients. They find that financial

performance improves with local rather than international directors, an internal board auditor,

and a female CEO, the number of credit clients increased with CEO/chairman duality and

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outreach is lower in the case of lending to individuals than in the case of group lending.

Mersland and Storm (2009) find no difference between not-for-profit organizations and

shareholder firms in financial performance and outreach. They also observe that bank

regulation has no effect. However their study suffers from selection bias as the sample

represents commercial and professionally oriented institutions that have decided to be rated

to improve access to funding.

A similar type of study is conducted by Soltane in 2009. He examines the relation between

governance mechanisms and the performance of Euro-Mediterranean microfinance

institutions (MFIs) in terms of outreach and sustainability. He finds that performance based

compensation of managers is not associated with better performance of MFIs. The results

identify trade-offs between MFIs outreach and sustainability depending on larger board size,

and on higher proportion of unaffiliated directors. The study also shows that the more women

are on the board, the better the performance and reveals that external governance mechanisms

help MFIs to achieve better financial performance. Soltane (2009) also identifies other

factors leading to better sustainability such as regulation, and the use of individual lending

methodology.

5.4 Regulation Studies

Irish and Simon (2005) conduct a survey on legal environment in Bangladesh. They find a

lack of clear accountability and internal governance rules for NGOs in the current legal

framework in Bangladesh. There is a very little in the principal registration laws (except

Companies Act) which deals with internal governance and external accountability for Non

Government Organizations. NGOs in the survey report that they do follow certain established

accounting standards, but there is a wide variety of the standards used. The study suggests

65
that it may be useful to adopt a set of clear standards strictly for use by NGOs, as has been

done in India.

The World Bank (2006) also finds that laws relating to internal governance and financial

accountability of NGOs are inadequate. The reporting and accounting burdens placed on

NGOs are contradictory and weak. Capacity of NGOs and computerized accounting system

vary. The study observes that PKSF introduced some standardized financial management

practices for microfinance programs, but accounting and auditing practices are also

influenced by highly variable donor financial reporting requirements, that typically focus on

the donor-financial project rather than on the whole institution. The quality of audit reports

varies significantly and regulators rarely focus on the comprehensiveness and quality of these

reports. The report also finds that there is a little oversight over NGO audit standards within

the profession. Moreover, audit reports are rarely posted in public spaces (such as on relevant

websites). The study concludes that NGO Boards suffer from weakness common in for-profit

corporate sector and typically feature the founder director, family members and a number of

over-stretched individuals who rarely rotate their positions.

Abbey (2008) demonstrates how regulation can improve the effectiveness of development

intervention of NGOs in Bangladesh and Dominican Republic. The study finds that

regulation of NGOs themselves can legitimize their role, improve their professional standards

and assure accountability to the general public. Abbey (2008) concludes that simple

registration, self-help regulatory mechanisms and formal regulation can improve the

performance and accountability of microfinance NGOS.

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Overall, the above review suggests that the financial reporting quality of MFIs has been

under-researched and that there is a gap in our understanding of how they perform their

reporting function via provision of information in annual financial statements. Bala and Mir

(2006) also note that NGO literature in Bangladesh provides non-empirical recommendation-

type discussion on administration and activities and lacks substantive analysis of how they

discharge their accountability functions via financial reporting.

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5.5 Summary

The chapter reviews prior studies on the accountability, reporting and disclosure, governance

and regulation of microfinance institutions/ not- profit- organizations and corporations. Due

to limited regulation on financial reporting and lack of data, very few empirical researches

have been undertaken on micro finance sector. The MFI literature in Bangladesh provides

non-empirical recommendation-type discussion on administration and activities and also

lacks substantive analysis of how they discharge their accountability functions via financial

reporting. Overall, the above review suggests that the financial reporting quality of MFIs has

been under-researched and that there is a gap of how they perform their reporting function

via provision of information in annual financial statements. Further, corporate disclosure and

perception studies have been reviewed to identify the attributes of financial disclosure which

could be used for developing the model for the current study.

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 Chapter 6

Hypothesis Development and Attributes of Financial Disclosure

6.0 Introduction

The purpose of this chapter is to present the hypotheses. The first section outlines the

hypothesis development process along with identifying financial attributes affecting financial

disclosure of MFIs. In the last section, the research hypotheses have been developed for

testing.

6.1 Hypotheses Development

One striking feature in corporate reporting is that a company generally provides information

to discharge specific obligations to society, investor, supplier, creditors, and legal authorities.

Statement of Financial Accounting Standard (SFAS) 1 declares that investors, creditors, and

others may use reported earnings and information about the elements of financial statements

in various ways to assess the prospects for cash flows. Whereas, SFAS No. 117 states that

the primary purpose of financial statements for not-for-profit is to provide relevant

information to meet the common interest of donors, members, creditors and others who

provide resources to not-for-profit organization. Those external users of financial statements

have common interests in assessing (a) an organization’s services and its ability to provide

those services and (b) how managers discharge their stewardship responsibilities and other

aspects of their performance (FASB 1993).

There are significant similarities between these two SFASs. Creditor’s interests are basically

the same for a not –for- profit or profit making organization. Creditors are concerned about

the amounts, timing and uncertainty of perspective cash flows to assess the risks of providing

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loans to any enterprise. Not-for-profit organizations have no residual claimants or investors

as for-profit organizations have but prior research suggests that funders act as investors.

Additionally, while not-for- profit organizations are not publicly traded, they compete for

scarce resources, whether for funding, labour or managerial talent, so they have similar

economic incentives to publicly traded firms while not having the ownership structure of

publicly traded firms (i.e, no residual claimants). Stakeholders in both for-profit and not-for-

profit are interested in whether management is efficiently managing the organizations.

6.2 Attributes of MFI Financial Statement

As a result of these similarities of profit and not –for- profit entities, the existing profit and

not-for-profit theories, as well as previous research findings on profit and not-for- profit

organizations, have been drawn in identifying the attributes of financial disclosure. Agency

theory has become widely accepted in recent times and used in corporate disclosure studies to

provide a theoretical justification for identified determinants of financial disclosure. An

agency theory can apply to non profit organizations as agency problem also exists there. The

agency theory (Jensen & Meckling, 1976) suggests that the firm represents a “nexus of

contract,” implicit and explicit, between suppliers of various factors of production. The nexus

of contracts view has particular appeal for accounting because many of these contracts are

defined and monitored in terms of accounting numbers.

Ebrahim (2003b) identifies three primary groups which have explicit or implicit contracts

with NGOs : (1) Funders ( 2) Sector and (3) Clients and Communities. Funders provide fund

to not-for- profit organizations for regular reports and evaluations that confirm the legitimate

use of those funds. Laws governing not-profit status and ensure proper disclosure of not-for-

profits’ financial statements and a minimum level of transparency in not-for-profit

70
organizations, for the purpose of ensuring public trust. Members or clients are concerned

about their deposits and require financial statement to evaluate the organization’s

performance. In all these contractual relations, accounting information can assist these groups

to monitor their explicit or implicit contracts.

A number of studies examine the financial disclosure issues in the corporate literature.

Marston and Shrives (1991) reviewed disclosure studies undertaken before 1986. They

observe that corporate size, listing status, leverage, profitability, and size of the audit firm are

the most common characteristics examined with regard to disclosure level. The study find

that corporate size and stock exchange listing status are significantly associated with higher

disclosure levels, and results are inclusive regarding profitability, leverage and size of the

audit firm. Ahmed and Courtis (1999) conduct a meta analysis of 29 previous disclosure

studies. The study finds a significant and positive relationship between disclosure levels and

corporate size, listing status and leverage. The study does not find any significant association

between corporate profitability or size of the audit firm.

The above ideas have been used to identify the attributes of financial disclosure for not-for-

profit organizations (MFIs). A review of the accounting requirements that are imposed upon

not-for-profit organization as a result of their legal form and funding body requirements is

also considered. In this present study, MFI’s size, debt levels, rate surplus of revenue over

expenditure, size of audit firms, nature of registration, MFI’s age, governance structure,

frequency of board meetings and qualifications of board members have been identified to

examine the extent of disclosure.

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MFI’s Size

Firm size is expected to be positively associated with disclosure level because information

generation and dissemination are costly, and therefore, large organisations with more

resources and superior expertise are better placed to produce comprehensive and detailed

financial statements (Ahmed & Nicholls, 1994; Nieto et al., 2007). Chow and Wong-Boren

(1987) argues that agency costs increase with firm size, so large firms voluntarily disclose

more information in annual reports to reduce agency conflicts. Utilising legitimacy theory,

Cowen et al., (1987) and Hacskston and Milne (1996) argue that a larger company carries out

more activities, receives more attention from the general public who are concerned with its

social programs than a smaller company which affect disclosure practices. Utilising the same

logic for MFIs, it is expected that large MFIs would disclose more informational items. The

size of the MFI is measured by total asset and the variable is called as MFISIZE.

Alternatively, the size is also measured by the number of members within the MFI because

the demand for financial information is the sum of the individual demands. As the number of

members increase, the total demand for financial information increases hence it is expected

to find a positive association between total disclosure and number of members.

MFI’s Debt level

Prior studies on corporations argue that highly levered firms incur high level of monitoring

costs and these firms seek to reduce these by providing more information (Jensen &

Meckling, 1976). On the other hand, if the debt levels are high, firm might disclose

information to the lenders directly rather than to all stakeholders via annual reports,

suggesting that the extent of information disclosure will be lower for firm with more debts. In

the case of MFIs, funds are provided by PKSF for its POs and it is expected that it would

72
monitor more those entities which have more borrowings. The debt level of MFI is measured

by the total amount of borrowing, divided by total capital as shown in the balance sheet and

defines this variable as LEV. Given the inconsistent finding in prior studies concerning the

effect of debts/borrowing on disclosure, no direction is predicted.

Rate Surplus of Revenue over Expenditure

Signalling theory suggests that when a firm’s profitability is considered good by

management, they are likely to disclose more information so as to signal to investors and

other users of financial information (Singhvi & Desai 1971; Wallace et al., 1994). Profitable

MFIs have also resources to defray the costs associated with dissemination of information.

Hence, a positive association between disclosure and profitability is expected. For MFIs the

term profitability is not used because the objectives of these organisations are not to make

profits but use the resources for social upliftment. I measure the rate surplus of revenues

over expenditures scaled by total capital and call this variable SURPLUS. In the absence of

prior research on MFIs and inclusive findings regarding corporation, no direction between

disclosure and rate of surplus is predicted.

Size of Audit Firms

One of the aims of having financial statements audited to ensure that information which is

important to the financial statement users is disclosed. DeAngelo (1981) argues in the context

of corporations that the larger audit firms have incentives to provide high-quality audit

services in order to enhance their public reputation as a credible monitor. They will therefore

encourage their clients to disclose comprehensive information in their annual reports and

accounts. In the case of MFI in Bangladesh, auditors are employed by PKSF for its POs on

73
the basis of experience and pricing, so some variation in size within the audit firms is

expected. Although empirical support for a significant positive association between

disclosure standards and auditor quality is not conclusive, in emerging countries including

Bangladesh a significant association has been found (see for a review, Ahmed & Courtis,

1999).

It is difficult to segregate audit firms in Bangladesh along Big and non-Big categories

because none of the Big-4 firms operate in Bangladesh under their brand names due to

restrictions imposed by the local professional body – the Institute of Chartered Accountants

of Bangladesh (ICAB). Instead, reputed local firms represent international firms including

the Big 4 by way of obtaining independent affiliations of such firms. Two criteria were used

to group audit firms as large - firms that employ four or more chartered accountants and those

that have an affiliation with an international Big or non-Big 4 firm (Karim & Moizer, 1996).

The rating was then discussed with a couple of senior partners of practising accountants to

reduce biasness. A dummy variable is used, where if the audit firm is large then assign 1

otherwise 0 and call this variable AUDDUM. A positive association is expected between this

variable and disclosure.

Nature of Registration

As stated earlier different Acts exist to regulate and monitor MFIs in Bangladesh, some of the

provisions are common across the various Acts and some are distinct and require

organizations to disclose prescribed information to satisfy their different requirements. An

MFI registered under the Companies Act 1994 is expected to provide more information

because the Act, by focusing on profit making companies, requires a more rigorous

disclosure standard compared with other Acts that regulate MFIs within Bangladesh.1 is

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assigned if the MFI is registered under the Companies Act 1994 and 0 if the MFI is registered

under one or more of the other Acts: Social Welfare Act, NGO Bureau Act and Co-operative

Act. This variable is called LEGDUM and expects a positive association between this

variable and disclosure.

It is widely recognised that emerging countries suffer from skill shortages due to low level of

educational qualifications, and Bangladesh is not an exception where the rate of adult literacy

during 2000-2004 period was around 53 percent (World Bank, 2009).

Following prior research, it is suggested that if the senior management are highly educated,

that level of expertise will be reflected in performance and transparency of the organisation.

Therefore data have been collected about the educational levels of directors of MFIs and

found that their educational levels vary amongst them. A dummy variable 1 is assigned if a

director holds a master degree or equivalent and 0 otherwise. One of the reasons for

assigning 1 for master degree is that the degree is conferred by universities or university

colleges where the quality of educational standard and students are much higher than normal

colleges or vocational institutions. Further comparative accounting standards are covered in

university accounting programs. For empirical analysis, if the majority of the directors hold

master degree or above, 1 is assigned to that MFI, otherwise 0. For sensitivity tests, the

criteria has been changed and assigned 1 for bachelor degree including overseas trained (not

having a master degree) directors, otherwise 0. The variable is called QALBD and expects a

positive relation with disclosure.

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A Summary of the hypothesized relationships between each independent variables and the

dependent variable has been depicted in figure 6.2.

Hypothesized Relationships between Dependent and Independent variables

Dependent Variable Independent Variable predicted sign

MFSIZE +
LEV ?
SURPLUS ?
Overall Disclosure AUDDUM +
LEGDUM +
AGE ?
BDSIZE ?
FBM +
QALBD +

Figure 6.1

6.3 Hypotheses:

Based on the previous discussions and literature review, the following hypothesises have

been developed for this study. It is mentioned on page 19 that like corporation, the external

parties use MFI financial statements in assessing (a) an organization’s services and its ability

to provide those services (b) how managers discharge their stewardship responsibilities and

other aspects of their performance (FASB 1993). So the MFI annual report or financial

statement should disclose adequate and relevant information to satisfy the perceived

information needs of users. On the other hand, it is mentioned on page 76 that preparers of

corporate annual reports are willing to provide users with information they need, but they

may not be aware of the importance of some type of information for external users (Firth,

1979). Preparers ‘ perceptions are also important as they prepare MFI financial statements

and are well aware about the disclosure need of which items are more important than others.

(page 18). Based on these discussions, the first 4 hypotheses have been developed. The fifth

hypothesis has been developed based on the literature review in the thesis (pages 62-74).

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See for example, Prior empirical studies on disclosure level have recognized the relationship

between the extent of disclosure and some firm-specific characteristics . (Singhvi & Desai,

1971; Buzby, 1975; Firth, 1979; McNally et al., 1982; Cook, 1989, Ahmed & Nicholls, 1994;

Wallace & Naser, 1995).

 H1: There is no consensus between preparers and users regarding the importance

attached to the information items disclosed in MFs’ financial statements

 H2: There is no significant gap between the information needs of users and actual

disclosure in MFIs’ financial statements

 H3: There is no significant gap between the perceptions of preparers and actual

disclosure in MFIs’ financial statements

 H4: There has been no improvement in the quality of overall disclosure since 2003

 H5: There is no association between the total disclosure quality and MFI

characteristics such as size, debts levels, rate surplus of revenue over expenditure,

size of audit firms, nature of registration, MFI’s age, governance structure, frequency

of board meetings and qualification of board members.

6.4 Summary

The chapter outlines the hypothesis development process along with the identification of

attributes of financial disclosure. Because of similarities between profit and not-for-profit

organizations, a review of corporate disclosure studies have been undertaken to identify the

attributes of disclosure. Agency theory is used to provide a theoretical justification for

identified attributes of financial disclosure. A review of the accounting requirements that are

imposed upon not-for- profit organizations as a result of their legal form and funding body

requirements is also considered. In this present study, the attributes of financial disclosure

77
such as MFI’s size, MFIs debt levels, rate surplus of revenue over expenditure, size of audit

firms, nature of registration, MFI’s age, governance structure, frequency of board meetings

and qualifications of board members, have been identified to examine the extent of

disclosure. Finally five hypotheses have been developed for testing.

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 Chapter 7

Research Methodology and Data Collection

7.0 Introduction

The purpose of this chapter is to discuss the research method used. The first section of this

chapter discusses the research methodology. The next section outlines the data collection

methods and sources followed by statistical techniques used for hypothesis testing.

7.1 Research Methodology

A questionnaire survey method was used to determine the perceived needs of users (auditors,

donors and regulators) and preparers (MFI accountants) for information items to be disclosed

in the financial statements of MFIs in Bangladesh. Disclosure practices of 165 MFIs

(Partners of PKSF) were then be measured by developing an unweighted disclosure index

and then compared with the information needs of users and preparers mentioned above.

Further, the disclosure index of 165 MFIs over a period of 3 years beginning in 2004 was

constructed to assess whether there has been any improvement during this period. Finally, a

regression procedure was used to determine the effect of the MFI’s characteristics such as

MFI’s size, MFIs debt levels, rate surplus of revenue over expenditure, size of audit firms,

nature of registration, MFI’s age, governance structure, frequency of board meetings and

qualifications of board members on MFI disclosure practice.

7.1.1 Questionnaire Survey Method

Conventional accounting theory emphasises that the corporate reports should disclose

adequate and relevant information to users to assist them in making economic decisions.

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However, disclosure adequacy is an abstract term and there is a lack of generally agreed

theory of disclosure adequacy. According to Buzby (1974), adequate disclosure will vary in

different situations, depending upon the audience for whom the disclosure is made, the

purpose for which the disclosed information will be used, the quality of information required

by users, the manner in which the disclosure is made, and the timing of disclosure.

Two approaches may be used to assess disclosure adequacy: (a) using a decision model

(methods mostly taken from psychology) to examine whether items disclosed in corporate

annual reports constitute an important part of the users’ decision process and (b) employing

survey techniques to determine users’ perceived importance for information items to be

disclosed in corporate annual reports. According to Cooke (1989), decision models may be

categorised into perspective and descriptive. For example, the Lens model tells us what

should be done. Alternatively, a descriptive decision model describes the steps involved in

making a decision from among a variety of course of action.

Methods using users’ decision model require the specification of users, their needs for

information items, the kind of decisions they make and the decision model they employ in

deciding the usefulness of information. There are some problems with the decision model

approach: (a) the identification of the users’ decision processes, (b) the methods of resolving

differences with respect to disclosure items and (c) the method of selecting between two or

more equally important information items which are relevant to users’ decision model

(Wallace, 1987). Where it is not feasible to determine users’ decision process and preference

for information items using the decision model approach, the perceived importance of

information items to be disclosed in corporate annual reports for decision making can be

determined by employing the questionnaire survey method. (Libby, 1981). Several

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researchers have applied the survey method to determine the perceptions of users concerning

the usefulness of accounting information. The present study also adopted the questionnaire

survey method to determine the perceived needs of practicing users and preparers concerning

information to be disclosed in MFI financial reports.

7.1.2 Disclosure index Method

There are different ways for companies to disclose information. Annual reports are

considered as the main source of information (Shohaieb, 1990; Knutson, 1992), although

Marston and Shrives (1991), Epstein and Palepu (1999) and Hope (2002) argue that annual

reports should be considered a useful but not sufficient disclosure vehicle. Moreover, Lang

and Lundholm (1993, 1996) find a high and significant positive correlation between annual

report disclosures and other forms of disclosure. Therefore, it is not surprising that most prior

research uses annual reports to investigate the disclosure level of companies.

Quality of accounting information disclosure appears to be an important attribute of corporate

financial reports. However, quality is neither a readily measurable nor a generally agreed

characteristic of a firm (Imhoff, 1992). According to Cooke and Wallace (1989), quality of

accounting information disclosure can not be measured directly because it does not possess

inherent characteristics by which one can determine its intensity or quality like the capacity

of a car. Despite this problem, some authors define disclosure quality as the extent of

disclosure of information in financial statements by reporting entities and attempted to

develop an approximate measure of its quality by investigating whether some predetermined

information items, generally held to be useful to one group or several groups of users, are

disclosed (Cerf, 1967; Singhvi & Deshai, 1968; Zimmerman, 1977; Copeland & Ingram

1983). This method was developed by Cerf and is called disclosure index method. In the

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literature, the extent of disclosure and quality of disclosure has been used interchangeably

and several authors modified disclosure index according to their research objectives (Singhvi

& Desai 1971; Buzby, 1974; Firth, 1979; Wallace 1988; Cooke, 1989).

The literature on disclosure provides a number of proxies to the amount of information

disclosed: the number of data items, the frequency of disclosure releases, financial analysts’

perceptions about the disclosure practices, and the disclosure index. The amount of

information disclosed can be measured per category or per company by counting the data

items, i.e, the number of words and numbers shown in the accounts, the number of sentences,

and the number of pages (Marston & Shrives, 1991; Hacskton & Milne, 1996). This approach

has been referred to as content analysis. This method is very popular in disclosure studies.

However, it might present problems due to, for instance, the repetitions of some items of

information in the annual reports. Moreover, numbers cannot be explained without words.

The frequency of disclosure releases is also used around an information event such as

earnings announcements and equity offering (Lang & Lundholm, 1993; Botosan & Harris,

2000). However, MFIs do not announce any earnings or offer equity. Perceptions of financial

analysts about the firm disclosure practice such as disclosure ratings from the Financial

Analysts Federation (FAF), the Association for Investment Management and Research have

been used by researchers as proxies for disclosure quantity and quality (Lang & Lundholm,

1996; Healy & Palepu, 2001). However, disclosure scores reflect analysts’ perceptions of

firms’ disclosure rather than the disclosure policies themselves and cover only a limited

number of large firms, creating perhaps the possibility of sample bias. Moreover, Lang

(1999) questioned the objectivity of these ratings given that no can know the incentives of

analysts to report their ratings and what kind of biases could be concluded.

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In the present study, the disclosure index method is used. This method has been extensively

used in prior research (Wallace et al., 1994; Meek et el., 1995; Inchausti, 1997; Ahmed &

Courtis, 1999; Depoers, 2000; Hope, 2002). A disclosure index is a measure (a proxy) of the

level of information disclosed by a particular company according to an extensive list of

selected items of information in the company reports (such as annual reports, financial

statements). Marston and Shrives (1991) in a review paper conclude that in spite of validity

and reliability problems, the disclosure index is a useful research tool for assessing disclosure

quality. According to them, the usefulness of a research tool should be assessed by the extent

to which it is used by researchers and the consistency of research findings across many

studies. They observe that the disclosure index method has been used by several researchers

over a period of more than 30 years and in most cases provided consistent results across

several studies.

Disclosure information in annual reports can be divided into two broad categories, mandatory

or compulsory and voluntary. The mandatory disclosure is information revealed in the

fulfilment of the requirements of statute in the form of laws, professional regulations in the

form of standards and the listing rules of stock exchanges. Voluntary disclosure is any

information in excess of mandated disclosure. Moreover, disclosure measurement may be

either weighted or unweighted. Weights are usually determined by seeking out the views of a

user group regarding the relative importance of various items of information (Buzby, 1975;

Firth, 1979). Alternatively, the unweighted approach gives equal weight to each item in the

list of items of information according to its existence. An item takes 1 if it exists in the

investigated report and 0 if not (Cooke, 1992; Inchausti, 1997; Meek et al., 1995; Depoers,

2000). However, some studies have used two approaches as robustness check (Chow &

Wong-Boren, 1987; Botosan, 1997).

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As mentioned earlier, disclosure index was used heavily in the accounting literature during

1970s’ to 2000s’ to investigate various aspects of corporate financial reporting such as; (a)

the association between firm characteristics and disclosure levels, (b) the economic benefits

of increased disclosure, and (c) the compliance with regulations or accounting standards.

Many prior studies use a country-relevant disclosure index either self-constructed or provided

externally as a measure of the disclosure level. Since there is no agreed theory (Wallace et

al., 1994) on either among the numbers (among 11 to 224) or the selection of informational

items (mandatory or overall disclosure), different disclosure indices have been used in

different studies.

In light of the above review, it can be noticed that several different approaches have been

adopted to measure disclosure quality and quantity, but there is no general theory that offers

guidance on the selection of items to measure the extent of voluntary disclosure (Marstom &

Shrives, 1991). Disclosure, by its very nature, is an abstract construct that does not possess

inherent characteristics by which one can determine its intensity or quality (Wallace &

Naser, 1995).

7.1.3 Construction of disclosure index

As there is no alternative market for information generation such as analysts and

management forecasts for MFIs, the discharging of accountability to stakeholders via annual

reports or financial statements remains the only source for microfinance sector. Though fund

providers get some amount of information through direct contacts and regulatory bodies.

In this study, the number of informational items has been used to measure the extent of

disclosure, though this approach has limitations including the measurement errors and

reliability. To mitigate such problems, the well accepted methods such as counting and

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cross-checking several annual reports by an independent rater have been applied. In the

event of variation between the researchers and the independent rater, further discussion was

held to find out the sources of errors to improve the process of construction of the index.

As mentioned earlier, disclosure information in annual reports can be divided into two broad

categories, mandatory or compulsory and voluntary. Due to lack of regulations and

requirements for disclosure for MFIs, the index in this study is based on total informational

items, both mandatory and voluntary, that a MFI would disclose.

An unweighted approach is employed to index construction following recent research and

debate on the pros and cons of using weighted versus unweighted index including

subjectivity, lack of insights of users and no difference in results (Marston & Shrives, 1991;

Ahmed & Courtis, 1999). The index is based on 82 items comprising 5 items for financial

statements; 9 for revenue items; 16 items for expenses; 11 items for assets; 11 items for

liabilities; 5 items for other statements; 12 items for accounting policies; and 13 items for

other information.

7.1.4 Scoring for the Disclosure Index

Robbins and Austin (1986) developed a scheme for scoring the disclosure index in which

items of the disclosures were rated according to their degree of specificity. This scheme

establishes a dichotomous scaling of the disclosure as being either 0 or 1. The contents of

each annual report are compared to the discretionary items on the list and coded as 1 if

disclosed or else 0. The disclosures coded as 1 are then added to ensure arrival at a total score

applicable to that company. In contrast, if it is apparent that an item of disclosure of

information is relevant but not disclosed then it will be assigned as 0. It is acknowledged that

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this introduces an element of subjectivity into the dichotomous procedure. However, failure

to adopt such a procedure would mean that more diversified enterprises would be able and

likely to disclose more information.

As mentioned earlier, an unweighted dichotomous disclosure index is employed in this study.

The score is unweighted in that each disclosure is assigned only a score of 1, if applicable,

regardless of what is being measured. In other words, no relative importance is attributed to

any disclosure area over another. The assumption is that each item is equally important.

Spero (1979) argues that the use of weights derived from the preference of user groups is

irrelevant because enterprises which disclose “important items” also disclose “unimportant

items”, that is, firms are consistent in their disclosure policies. On the other hand, Buzby

(1974b) argues that for measuring the adequacy of disclosure practices, it is usual to

introduce the weighted disclosure index to reflect the differing opinions of user groups

regarding the perceived importance of different disclosure items. However, empirical results

showed that the results derived from these different methods are not significantly different

(Firth, 1980; McNally et al., 1982; Robbins & Austin, 1986; Chow & Wong-Boren, 1987).

Support for using an unweighted disclosure index may be found in (Spero, 1979; Robbins &

Austin, 1986; Wallace, 1988b; Cooke, 1989a; 1992). It is argued that, in general purpose

financial reporting, it is difficult to determine whose preference should be reflected and given

priority, as not all user groups’ perceived information requirements can be sought at one

time.

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Each item of information is disclosed in the annual reports of the sampled MFIs, 1 is

assigned and 0 otherwise (see Appendix 2). The overall disclosure index is calculated by the

following formula (TDI):

nj

x y
i1
Ij 
nj
Where

nj = number of relevant items for j the firm, nj ≤ 82

X ¡j = 1 if ¡ the (relevant) item is disclosed

X ¡j = 0 if ¡ the (relevant) item is not disclosed

So that 0 ≤ Ij ≤ 1.

In this form the expression for TDI allows for the fact that it has been assumed that if a

particular item was not mentioned in the financial report, it would be treated as not

applicable. For example, if no mention was made in respect of grant received, it was assumed

that the item was not applicable for the MFI in that year. However, If it was disclosed

without mentioning the amount, then the score would be 0. Cooke (1989a) acknowledged

that this procedure would introduce an element of subjectivity. To overcome this potential

bias, he suggested that the whole annual report should be read first and a judgment made

about whether a particular item was applicable. This approach is adopted in this study.

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7.2 Data Collection

Data were collected by two sources: questionnaire survey and archival records such as annual

report (financial Statement). The perceptions of users and preparers about disclosed

information items in financial statement were collected through mail survey and annual

reports or financial reports are used to collect data on disclosure practice.

7.2.1 Survey sample

The research was conducted by a questionnaire survey. The selection of information for

inclusion in the questionnaire was made on the basis of the following criteria:

1) The items which were suggested to be disclosed according to the provisions of the

guidelines of CGAP, PKSF and Bangladesh Bank.

2) Literature suggested that the information should be disclosed

3) The items which have particular importance for microfinance sector

In the final questionnaire, 82 items were included. The questionnaire was pilot-tested and

minor modifications were made in the light of users’ comments. During the testing, it became

apparent that some respondents did not understand all the terminologies used in the

questionnaires and the differences in interpretation were occurring. To overcome this

problem, a list of definitions of those terms which appeared to be leading to difficulty, was

provided with the questionnaire.

The questionnaire was separated into two parts. The first part sought general information on

respondents’ education background, experience and training. The second part of the

questionnaire was related to the respondents’ opinion about different aspects of the financial

statements. The second part was classified into eight categories: financial statements (5

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items), revenue (9 items), expenses (16 items), asset (10 items), liabilities (12 items), other

statements (5 items), accounting policy (11 items) and other information (14 items). The

questionnaire covered 6 pages.

The questionnaires were distributed in January 2007 among users (PKSF enlisted Audit

firms) and preparers (accountants of PKSF partner organizations). The respondents were

requested to indicate their opinions on a 5 point likhert scale in terms of “less important” (1)

to “very important” (5). Respondents were told that individual replies would remain

confidential. Second mailings were made to those who did not reply within two weeks. 160

Questionnaires were sent to MFI accountants and responses were received from 72, which

was about 45 percent. Questionnaires were also sent to 70 PKSF enlisted audit firms and

senior personnel from donors and regulatory agencies and responses were received from 32,

with a response rate of about 40 percent. The response rate is consistent with the previous

perception studies in corporate sector (Firth, 1978; 36 percent for finance director, Firer &

Meth, 1986; 24 percent, Abu-Naser & Rutherford, 1995; 74 percent and Mohammad &

Soheila, 2009; 20.8 percent for preparer).

7.2.2 Annual report (Financial Statement) Source

As stated earlier, most of the MFIs in Bangladesh are very small and do not publish any

financial statements, it is nearly impossible to obtain financial statements of MFIs which are

not members of PKSF. Since PKSF requires all of its partners to submit audit financial

statements, the Deputy Managing Director of PKSF was contacted in 2007 and sought the

permission to photocopy the annual reports from its library since it does not allow audited

financial statements of its POs to be taken outside its premise. Through this process the

audited financial statements of 435 MFIs comprising 160 (2006), 136(2005) and 139 (2004)

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were collected and their contents were analysed using the index developed specifically for

MFIs. It should be noted that the audited financial statements of MFIs were obtained rather

than annual reports, because these only contains management reports with information about

their activities and do not contain financial statements which form the basis of all prior

studies on corporations.

7.3 Data Analysis tool

This section describes the statistical model employed to test the proposed hypotheses in

previous chapter. Prior to testing these hypotheses, descriptive statistical techniques were

applied to determine the basic characteristics of the data. Simple descriptive statistics were

initially adopted for data summarization and pattern detection. Then both bivariate (Pearson’s

Correlation and Variance Inflation Factor) and regression models (OLS and Rank) were

conducted to test the relationship between various disclosure attributes such as firm size, rate

surplus etc and disclosure scores. For sensitivity analysis, the Random Effect Regression

Model has employed. All the statistical tasks for this study were performed using SPSS

version 17.

7.3.1 Descriptive Analysis

The first part of the data analysis is concerned with descriptive analysis of the dependent and

independent variables. This involves looking at the mean, mode, median, standard deviation,

maximum and minimum disclosure. The next part of the analysis is concerned with

hypotheses testing and multivariate tests were undertaken. However, before conducting any

further tests, it is important to check the underlying distribution of the data set as this may

help in the choice of whether the statistical methods to be employed are parametric or non-

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parametric. Since the statistical methods, to be adopted, depend on the nature of the data and

distribution, it is important to first undertake a normality test of the data. Hence, in this study,

normality tests based on skewness and Kurtosis for all the dependent and independent

variables were conducted (Cooke, 1989b).

7.3.2 Preliminary Tests on Regression Assumptions

Prior to any regression analysis, several assumptions need to be satisfied. These include no

significant multicollinearity between the explanatory variables, the relationship between the

dependent and independent variable must be linear (linearity), the distribution of the values

of the dependent variable for each value of the independent variable must be normal

(normality) and there should be no errors related to measurement and specification. Tests of

each of these assumptions and possible ways to overcome them are discussed in the next

section.

7.3.2.1 Multicollinearity

Several multicollinearity tests were conducted in this study. The first involved examining the

correlation matrix to determine whether the explanatory variables are significantly correlated.

The rule of thumb for checking problems of multicollinearity is when correlation is > 0.800

(Gujarati, 2006). Besides the correlation matrix, another test for the potential effect of

multicollinearity on regression can be evaluated by computing the variance inflation factor

(VIF), where a VF exceeding 10 indicates a potential problem of collinearity.

7.3.2.2 Homoscedasticity

To satisfy the assumption of homoscedasticity, an analysis of residual was conducted. This

involved visual inspection of the scatter plot of studentised residuals against the predicted

values. If the residuals appear to be randomly scattered around a horizontal line through 0,

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then the equal variance assumption is satisfied. If results indicate otherwise, this may be

corrected by transforming data.

7.3.2.3 Linearity

The linearity assumption was checked by plotting the studentised residuals against the

predicted values. If a crescent or funnel pattern is observed, then the linearity assumption is

violated and one way of overcoming this problem is to transform data. The use of rank

regression, for transforming data, has recently been quite popular in a number of accounting

disclosure studies (Lang & Lundholm, 1993; Wallace et al., 1994; Wallace & Naser, 1995;

Cooke, 1998. Lang and Lundholm (1993) suggest that rank regression is useful when the

relationship between variable is not known and also when the relationship between the

dependent and independent variables is not strictly linear (Cooke, 1998)

7.4 Hypothesis testing

This section outlines the statistical models used for hypothesis testing. Both parametric and

nonparametric tests were used for analysing the results.

7.4.1 Hypothesis 1:

There is no consensus between users and preparers regarding the importance attached

to the information items disclosed in MFI financial statement.

In the Random House College Dictionary (1988), consensus is defined as “general agreement

or accord”. Consensus is defined here as “agreement among users and preparers on the

degree of importance of a set of selected disclosure items that should be disclosed in financial

statement of MFIs in Bangladesh“. It was assessed at three levels of observation: (1) the

aggregate level, (2) groups of items categorized according to various sections of the financial

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statement, and 3) each item-by-item basis. Users’ information needs and preparers’

perceptions about disclosed information were obtained through questionnaire survey. Man

Whitney U test is employed to measure the degree of consensus between users and preparers.

The test is carried out to identify which group (users or preparers) provides a different

opinion about various segments of the financial statements covered in this study. It is one of

the best known non-parametric significance tests, which is popular in users’ and preparers’

perception studies (Naser & Nuseibeh, 2003).

7.4.2 Hypothesis 2:

There is no significant gap between the information needs of users and actual disclosure

in MFI financial statements.

The hypothesis is tested by comparing the average MFI disclosure scores with the mean

ranks for each of the segment of the financial statements by the users. The disclosure score is

calculated by using disclosure index method. The questionnaires were sent to the users

(auditors, donors and regulatory agencies) and asking them to indicate their opinions on a 5

point likhert scale in terms of “less important” (1) to “very important” (5). The level of

significance is assessed by using Mann Whitney test.

7.4.3 Hypothesis 3:

There is no significant gap between the information needs of preparers and actual

disclosure in financial statement.

Like previous hypothesis, this hypothesis is also tested by comparing the average MFI

disclosure scores with the mean ranks for each of the segment of the financial statements by

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the preparers. The disclosure score is calculated by using disclosure index method. The

questionnaires were sent to the preparers (MFI accountants) and asking them to indicate their

opinions on a 5 point likhert scale in terms of “less important” (1) to “very important” (5).

The level of significance is assessed by using Mann Whitney test.

7.4.4 Hypothesis 4:

There has been no improvement in the overall disclosure practice since 2004.

The Student t-test is applied to test the hypothesis that there has been no improvement in the

disclosure quality of Bangladeshi MFIs over three year period beginning in 2003. The overall

disclosure indexes for each section of the financial reports were calculated and compared to

examine whether there is any improvement on overall and sectional disclosure practices of

MFIs over the years.

7.4.5 Hypothesis 5:

There is no association between the overall disclosure practice and MFI”s

characteristics such as MFI’s size, debt levels, rate surplus of revenue over

expenditure, size of audit firms, nature of registration, organization’s age, governance

structure, frequency of board meetings and qualifications of board members.

The purpose of the hypothesis is to determine the impact of the MFI explanatory variables on

the overall disclosure practice. Disclosure index is the dependent variable in the multiple

regression models. The explanatory variables are:

MFI size- Size can be measured in a number of different ways and there is no overriding

theoretical reason to select one variable rather than another. In this study, size is measured by

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total asset. Alternatively, size is also measured by the number of members within the MFI.

This information is gathered from the financial reports of the MFI sampled.

Leverage - The debt levels of MFIs are measured by the total amounts of borrowing divided

by total capital as shown in the balance sheet.

Profitability- Profitability is replaced by revenue over expenditure in MFI sector. The rate of

surplus of revenues over expenditures is calculated by excess of revenue over expenditure by

total capital shown in balance sheet.

Size of the audit firm- Two criteria are used to group audit firms as large - firms that employ

four or more chartered accountants and those that have an affiliation with an international Big

or non-Big 4 firm. The information is collected from the Institute of Chartered Accounts of

Bangladesh (ICAB).

Legal requirements- This variable is measured by their registration status.

Age- Age is measured by the difference between the reporting period and the year of

establishment.

Governance Structure – This variable is measured by the number of members in the board.

Frequency of board meeting- Frequency of board meeting is measured by the number of

board meetings per year.

Qualifications of board members – This variable is measured by the academic

qualifications of the board members.

In this study, multivariate analysis technique Ordinary Least Squares (OLS) regression is

used to estimate the association between the disclosure index and MFI explanatory variables.

Lang and Lundholm, (1993) suggest that it is advisable to transform both independent and

dependent variables into ranks before applying the OLS regression. They argue that Rank

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(OLS) regression is a "powerful" procedure for analysing a data set with "relations [that are]

nonlinear but monotonic." As a parametric test, it is more powerful than non-parametric

techniques. OLS regression has been widely used in previous research (Cooke 1989; Lang &

Lundholm, 1993; Wallace et al., 1994; Wallace & Naser 1995). For further test, Random

Effect Regression Model (RRM) has been used. There are several features of RRM that make

this method useful in longitude research: (a) It is assumed that all subjects have been

measured on the same number of time points, thus, in particular, subjects with incomplete

data across time are not excluded from the analysis and (b) Time is treated as a continuous

variable in RRM, so that subjects do not have to measure at the same time points (Hedeker &

Gibbons, 1997).

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Regression Model

Based on the previous discussion, the following Ordinary Least Squares (OLS) regression

model is developed to estimate the association between the disclosure index and the firm

specific variables as follows:

TDI = MFISIZE +2 LEV +3 SURPLUS +4 AUDDUM +5 LEGDUM +6 AGE +
7 BDSIZE+  FBM + QALBD + Yr DUM+ 

Where: TDI is total disclosure index

MFISIZE= Size of the MFI measured by total assets and log of total assets at the end of the financial year

MEMBERS= total number of registered members within each MFI

LEV= measures the debt levels by the total amounts of borrowing as shown in the balance sheet

SURPLUS= total amount of surplus of revenue over total expenses divided by total capital employed

AUDDUM= an indicator variable if the audit firm is large 1, otherwise 0.

LEGDUM= an indicator variable if the MFI is listed under Companies Act 1, otherwise 0.

AGE = difference between the reporting period and the year of establishment.

BDSIZE= size of governing body by the number of directors on the MFI board.

FBM= frequency of board meetings during the year under consideration

QALBD= an indicator variable when the majority of the board members have master degrees and above is 1,

otherwise 0

Yr Dum is a dummy that assumes the value of 1 if the data pertain to year t and 0 otherwise between 2004 and

2006.

7.4 Summary

This chapter explains the research design and methodology applied in this empirical study. It

provides details about the sample of the study and data collection process. Data were

collected from two sources: archival records such as annual reports or financial statements

and the questionnaire survey. The computer program package SPSS 17 is used to analyse

data. An unweighted disclosure method is used to measure the dependent variable. The

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independent variables were collected from MFIs’ financial statements and auditors’

management report. Finally, a regression model is developed to determine the effect of MFI

characteristics such as MFI’s size, MFIs debt levels, rate surplus of revenue over expenditure,

size of audit firms, nature of registration, MFI’s age, governance structure, frequency of

board meetings and qualifications of board members on MFI disclosure practice. For

sensitivity analysis, Random Effect Regression Model has been employed.

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 Chapter 8

Research Findings

8.0 Introduction

The purpose of this chapter is to present the findings of the study. This chapter is organized

into four sections: Section one discusses the descriptive statistics and correlation analysis.

Section two analyse and interpret the results by using regression models and Mann Whitney

U test. Sections three and four outline additional statistical analysis.

8.1 Descriptive Statistics and Correlation Analysis

Descriptive statistics as reported in table 8.1 show that the average total assets of the firms

are 17.36 million with a median value of 17.29 million. The board size of the firms varies

between 4 members to 25 members on the board, with the frequency of the board meetings

ranging from 1 to 28 meetings per year. It shows that the average age of the firms were 17

years, with a maximum of 44 years, suggesting that some firms have been undertaking

microfinance operations from the late sixties.

The table also reveals that the total disclosure index is normally distributed because both

skewness and kurtosis coefficients are not significantly different from zero at the 0.05 level.

However, there is some concern about the normality of the explanatory variables. The

skewness and kurtosis of the total assets indicate that the variable is not distributed normally.

Logarithm of this variable is used to reduce the effects of skewness. The skewness and

kurtosis values of the transformed variable reveal that the data is distributed normally. This

approach is also used by Ashton et al., 1989 and Charles et al., 1991. For other explanatory

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variables, MEMBERS, LEGDUM, AGE, QALDUM are normally distributed because both

skewness and kurtosis coefficients ere not significantly different from zero at the 0.05 level.

Table 8.1: Descriptive Statistics of the Dependent and Independent Variables

Mean Median St. deviation Minimum Maximum Skewness Kurtosis

TDI 0.69 0.69 0.04 0.53 0.80 -0.303 1.251

MFSIZE (Ln) 17.36 17.29 1.32 13.49 21.74 0.286 0.185

MFSIZE (Tk Mill) 93.50 32.50 228.25 0.72 2759.38 7.069 64.090

MEMBERS 18203.10 7049.00 43157.99 42.00 436121.00 0.270 0.753

LEV 10.06 4.90 4.47 0.42 3.06 4.590 24.361

SURPLUS 0.04 0.04 0.05 -0.19 0.22 1.1.43 8.179

AUDUM 0.49 0.00 0.50 0.00 1.00 0.060 -2.006

LEGDUM 0.06 0.00 0.49 0.00 1.00 -1.086 -0.825

AGE 17.27 1.00 6.73 1.00 44.00 0.619 1.120

BDSIZE 7.75 7.00 1.82 4.00 25.00 3.546 24.852

FBM 7.61 7.00 1.92 1.00 28.00 1.689 5.324

QALBD 0.78 1.00 0.41 0.00 1.00 -1.598 0.557

Where: TDI is total disclosure index

MFISIZE= Size of the MFI measured by total assets and log of total assets at the end of the financial year
MEMBERS= total number of registered members within each MFI
LEV=measures the debt levels by the total amounts of borrowing by total capital as shown in the balance sheet
SURPLUS= total amount of surplus of revenue over total expenses divided by total capital employed
AUDDUM= an indicator variable if the audit firm is large 1, otherwise 0.
LEGDUM= an indicator variable if the MFI is listed under Company Act 1, otherwise 0.
AGE= difference between the reporting period and the year of establishment.
BDSIZE= is size of governing body by the number of directors on the MFI board.
FBM= frequency of board meetings during the year under consideration
QALBD= an indicator variable when the majority of the board members have master degrees and above is 1,
otherwise 0

However, the skewness and kurtosis values of LEV, SURPLUS, AUDDUM, BDSIZE and

FBM indicate that the variables are not distributed normally. One way of overcoming this

problem is by transforming data. The use of Rank regression, for transforming data, has

recently been quite popular in a number of accounting disclosure studies (Lang & Lundholm,

1993); Wallace et al., 1994; Wallace & Naser, 1995; Cooke, 1998). Lang and Lundholm

(1993) suggest that rank regression is useful when the relationship between variable is not

100
known and also when the relationship between the dependent and independent variables is

not strictly linear. (Cooke,1998). In addition, being a non-parametric test statistic

(distribution free), it is especially useful when the accounting data sets reveal non-linear

monotonic relationship (unidirectional) between the independent and dependent variables

(Iman & Conover, 1979).

Correlation Analysis

As mentioned in the methodology chapter, to measure the association between the dependent

variable (TDI) and explanatory variables, Pearson correlation Coefficients are computed as

exhibited in Table 8.2.

Table 8.2 Pearson Correlation Coefficients between Variables

TDI MFSIZE LEV SURPLUS AUDUM LEGDM AGE BDSIZE FBM QLBD

TDI 1.000
MFISIZE 0.353** 1.000
LEV -0.094 -0.166** 1.000
SURPLUS 0.048 0.135** -0.323** 1.000
AUDDUM -0.046 -0.017 -0.085 0.044 1.000
LEGDUM -0.013 0.0100 -0.023 0.025 0.040 1.000
AGE 0.055 0.251** -0.022 -0.087 0.042 -0.047 1.000
BDSIZE 0.005 0.126** 0.044 -0.014 0.010 -0.060 0.235** 1.000
FBM 0.121* 0.027 0.038 -.146** -0.013 -0.074 -0.022 0.049 1.000
QALBD 0.049 -0.049 -0.008 -0.015 -0.014 -0.047 -0.005 0.110* -0.098* 1.OOO

** Correlation is significant at the 0.01 level (2 tailed).

* Correlation is significant at the 0.05 level (2 tailed).

Correlations between the independent variables indicate that the highest coefficient is -0.323

between LEV and SURPLUS, suggesting that there is no multicollinearity problem. The rule

of thumb for checking problems of multicollinearity is when the correlation is > 0.800

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(Gujarati, 2006). Further tests such as the Variance Inflation Factor (VIF) also find no

multicollinearity problem between these two explanatory variables. Other than this case, all

other coefficients are not above 0.251. The outliers within the dataset have been checked and

did not find any outlier problem.

8.2 Analysis and Interpretation of the Results

The purpose of this section is to present and analyse the results of the hypotheses stated in

chapter 6. These results were based on the survey of the perceived information needs of the

users and preparers and disclosure indices for 435 MFIs over a three year period beginning in

2004.

8.3 The Degree of Consensus between Users and Preparers of MFIs

In this study, the extent of agreement of some selected information items (82) between users

and preparers are determined based on the perceived importance placed by users (auditors,

donors and regulators) and preparers (MFI accountants) on disclosure items included in the

questionnaire. The hypothesis to be tested here is:

• H1: There is no consensus between users and preparers regarding the

importance attached to the information items disclosed in MFI financial

statement.

Results of most of the prior corporate studies have revealed that there is still a considerable

gap between the actual disclosure and the expected level of disclosure indicated by users.

One of the main reasons, suggested in prior literature, is that preparers of corporate annual

reports are willing to provide users with information they need, but they may not be aware of

the importance of some type of information for external users (Firth, 1979). In this regard, it

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is important to examine the consensus between users’ information needs and perceptions of

preparers about disclosed information in the MFI financial statement.

Demographic Profile of the Respondents (Users and Preparers)

As users and preparers of MFIs financial reports differ in their characteristics (including

education, training and accounting experience), their needs for information/perceptions and

their ability to use and understand such accounting information, are expected to vary. Table

8.3 presents a comparison of level of education, accounting qualifications and accounting

experience of the participants.

Table 8.3 Users and Preparers’ Background

Users Preparers
Education

Professional Accountant 100% -

Masters 100% 79%

Bachelor 21%
Training
Overseas 34% 6%
Local 66% 53%
Without training - 41%

Work Experience
Over 10 years 62% 36%
Between 5-10- years 19% 33%
Between 1-5 years 19% 31%

Table 8.3 reveals that the sample as a whole can be considered well-educated, with 100

percent holding Professional accounting (qualified Chartered Accountant) and masters

degree for users and 79 percent holding Masters degree for preparers). Thirty four percent of

the users have overseas training and 62 percent of them have work experience for more than

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10 years. In case of preparers, 6 percent of them have overseas training and 53 percent of

them have local training and 36 percent of them have more than 10 years work experience.

Results from the following table 8.4, show that, in all categories (education, training and

work experience) users’ information needs are more than the preparers’ perceptions about

disclosed items in MFI financial statement. It also reveals that users with more work

experience, higher education background and overseas training perceive more information to

be disclosed in MFI financial statement.

Table 8.4 Users’ Information Needs and Preparers’ Perceptions

Users (Mean) Preparers (Mean)

Education
Professional Accountant 4.447 -
Masters 4.447 4.21
Bachelor - 3.993
Training
Overseas 4.580 4.252
Local 4.343 4.20
Without training - 3.901

Work Experience
Over 10 years 4.549 4.315
Between 5-10- years 4.459 4.047
Between 1-5 years 4.334 3.972

The Importance of Information items

The purpose of the section is to determine the perception of the users and preparers regarding

the extent to which information are present in MFI financial reports. In order to accomplish

this objective, it is necessary to determine the importance of all possible items rated by users

and preparers on a five-point scale signifying 1 for less important and 5 for very important.

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An item by item examination is carried out to calculate mean scores of 82 information items.

This examination (item by item) measures the average preferences of the information item to

users and preparers. This examination could give the preparer a better insight about the

information needs of the users.

Table 8.5 Importance of Information items by Users and Preparers

Mean Users Preparers

5.0 2 -
4.5-5.0 35 22
4.0-4.5 22 21
3.5-4.0 13 17
3.0-3.5 2 12
2.5-3.0 - 2

Highest 5.0 4.847

Lowest 3.218 2.847
Average 4.419 3.3460
Standards deviation 0.8436 1.1083

The results from the above table 8.5 reveals that 37 items of information (with a mean of 4.5-

5.0) are considered to be great important, 35 items of moderate important (with a mean value

of 3.5 to 4.5) and 2 items (with a mean value of 3 to 3.5) are considered as less or slight

important by users. Whereas preparers perceive 22 items as greater importance (with a mean

of 4.5-5.0), 35 items as moderate importance (with a mean value of 3.5 to 4.5) and 14 items

as slight or less importance . Users perceive financial statement under the historical cost

convention and balance sheet includes financial information for two years as the highest

importance (with a mean value of 5) and cumulative amount of all prior years’

donation/grants and guarantee mechanism to obtain loan as the lowest importance (with a

mean value of 3.218 and 3.375 respectively. Whereas preparers perceive current and fixed

assets and amount of members/beneficiaries loan as the highest importance with a mean

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value of 4.819 and policy related to foreign exchange fluctuation and renegotiated members’

loan as the lowest importance with mean value of 2.847 and 2.944 respectively. The above

results reveal that there is an expectation gap between users and preparers about the

perceived importance of individual information items.

The sectional examination (mean score of different sections of financial statements) indicates

a set of information which were categorized in the questionnaire under different sections of

the financial statement. Part II of the questionnaires was divided into 8 sections which users

and preparers were asked to rank on a 5 point scale. Therefore, to obtain a sectional analysis

of financial statement, one column was allocated to each section of the financial statement

and the mean score of those sections were calculated by computer for each preparer and user

separately. The table 8.6 reveals that users perceive financial statement item as the most

important section followed by revenue, assets, expense, accounting policy, other statements,

liability and other information. Whereas preparers perceive expense as the most important

section followed by financial statement item section, other statements, expense, revenue,

assets, accounting policy and other information. The results are similar with previous

corporate studies where users and preparers rank the income statement and balance sheet

items are the most items in financial statement. The results also show that overall user’s

perceived information needs (mean average of 4.447) is more than the preparers’ perceived

information (mean average 4.1190) disclosed.

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Table 8.6 Users and Preparers’ Information Needs/ Perceptions (Sectional)

Users Preparers Difference Mann Whitney U test

Z Value Significance

Financial Statement 4.795 4.375 0.42 -3.693 .000

Revenue 4.690 4.158 0.532 -4.096 .000

Expense 4.450 4.397 0.053 -0.198 .843

Asset 4.455 3.903 0.552 -4.106 .000

Liability 4.380 4.278 0.102 -0.726 .468

Other Statements 4.405 4.317 .088 -0.583 .560

Accounting Policy 4.430 3.848 0.582 -3.943 .000

Other Information 3.975 3.606 0.369 -2.493 .013

Over all 4.447 4.110 0.337 -3.702 .000

The Man-Whitney test is carried out to identify whether groups provided a different opinion

about various aspects of financial statements covered in this study. The test reveals that

users’ opinion is significantly different in ranking the items of financial statement, revenue,

asset, accounting policy and other information whereas there is no significant difference for

expense, liabilities and other statements. The test also reveals that there is a significant

difference in their opinions for overall information disclosed. On the basis of the above

results, the null hypothesis, that there is no consensus between preparers and users regarding

the importance attached to the information items disclosed in MFI financial statement is

accepted.

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8.4 Disclosure practice and Users’ information needs

In this section, current disclosure practices of MFIs are compared with the users’ information

needs about disclosed information in MFI financial statement to find out if there is any

significant gap. The hypothesis to be tested here is:

• H2: There is no significant gap between the information needs of users and

actual disclosure in MFI financial statement.

The table 8.7 presents the distribution of disclosure indices according to number of MFIs in

2006. It shows that out of 160 firms only 65 firms have a score above 90 percent and 90

firms scored more than 60 percent for financial statement items. Scores for the other items

are quite low. The next levels of disclosure are on revenue, expenses and liabilities items,

with 66, 66 and 137 firms have disclosure indices above 80 percent. These results indicate

that microfinance firms prepare and disclose traditional financial statements such as the

balance sheet and income statement more than other items which are voluntary.

160 MFI’s financial statements were also extensively examined to identify weather each of

the 82 disclosure items were disclosed by scoring 1 if an item was disclosed, 0 if otherwise

and * for not applicable. The table 8.8 provides a summary of the results of the index scores

as a ratio for the 160 MFIs. The ratio of the total number of items disclosed by a company to

the total number of items that the company is expected to disclose. The average mean value

of users and preparers perceptions has been converted from 5 to 1 in order to compare it with

the disclosure practice.

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Table 8.7 Distribution of Overall Disclosure Indices According to Number of MFIs in
2006

Disclosure Financial Revenue Expenses Assets Liabilities Other Accounting Other

Index Statement Statement Policy Information

91-100 65 36 81 - 20 - - -

81-90 - 66 66 1 137 - - -

71-80 2 20 8 79 3 - - 2

61-70 90 29 2 78 - - 66 -

51-60 - - 3 2 - 160 93 80

41-50 3 8 - - - - 1 77

31-40 - 1 - - - - - 1

21-30 - - - - - - - -

11-20 - - - - - - - -

0-10 - - - - - - - -

Total 160 160 160 160 160 160 160 160

Lowest(%) 40 40 58.3 60 77.8 60 45.45 37.5

Highest(%) 100 100 100 90 100 60 63.6 71.4

Average(%) 76.4 81.6 87 74.8 89.8 60.0 58.2 53.5

St Dev. 0.310 0.345 0.320 0.453 0.300 0.548 0.515 0.533

The results reveal that overall disclosure practice with a mean value of 0.73 is obtained for

the entire sample firms. A further examination shows that the extent of disclosure of the 82

items varies within the firms in the sample. The mean value varies from 0.641 to 0.775. The

item by item analysis also reveals that mean value of compliance with the index of the 82

information items among MFIs varies from 0 to a high of 1.

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The table 8.8 shows that overall user’s information need is 0.889 compared to MFIs’ actual

disclosure score of 0.727 in 2006. MFIs disclose more information in liability, expenses and

revenue items whereas less information is disclosed in other information, accounting policy

and other statements information.

Table 8.8 Disclosure Practice and Users’ Information Needs

Disclosure Index Users’ Information Difference Mann Whitney U Test
Needs Z Value Significance
Financial 0.764 0.959 0.195 -4.414 .002
Statement
Revenue 0.816 0.938 0.122 -4.794 .000
Expense 0.87 0.89 0.02 -1.653 .098
Asset 0.748 0.891 0.143 -7.716 .000
Liability 0.898 0.876 (0.02) -1.550 .121
Other Statements 0.6 .881 0.281 -13.493 .000
Accounting 0.582 0.886 0.304 -9.680 .000
Policy
Other 0.535 0.795 0.26 -8.884 .000
Information
Overall 0.727 0.889 0.162 -8.320 .000

The sectional comparison shows that there is a gap between actual disclosure practice and

users’ expected information needs. The results reveal that more expectation gaps are in

accounting policy, other statements and other information items whereas less gap in revenue,

expense, assets and liabilities item. Mann-Whitney U test also confirms it. The test reveals

that there is a significant difference between actual disclosure practice and users’ expected

information needs in every sections of the financial statement except expenses and liability

items. MFIs disclose more information in expenses and liability items because of their

conservative accounting policies. The Mann Whitney U test also reveals that there is a

significant gap between users’ overall information needs and MFIs’ disclosure practice. So,

110
the hypothesis: “there is no significant gap between users’ information needs and MFIs’

disclosure practice” is rejected here.

8.5 Disclosure Practice and Preparers’ Perceptions

As mentioned earlier, the perceptions of preparers about the disclosed information item in

MFI financial statement are very important as they are well aware about the disclosure need

of items that are more important than others. In this regard, views of preparers can be

considered vital for the purpose of determining the adequacy of disclosures in MFI financial

statements. The hypothesis to be tested here is:

H3: There is no significant gap between the perceptions of preparers and actual

disclosure in MFI financial statement.

The table 8.9 reveals that the overall actual disclosure practice is 0.727 where as the

preparers’ perception about those disclosed information is 0.766. The sectional comparisons

show that more gap in other statements, accounting policy and other information whereas less

gap in revenue, expense, assets and liabilities.

MFIs disclose more information in assets and liabilities than the preparers’ perceptions.

Mann-Whitney test also confirms that there is a significant difference between actual

disclosure practice and preparers’ perceptions about disclosed information in all sections of

the financial statements except revenue, expense and liability items . The test also reveals that

there is a significant gap between preparers’ overall perceptions and MFIs’ actual disclosure.

So, the null hypothesis: there is no significant gap between preparers’ perceptions and MFIs’

disclosure practice is rejected here.

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Table 8.9 Disclosure Practice and Preparers’ Perceptions

Disclosure Index Preparers’ Difference Mann Whitney U Test

perception Z Value Significance
Financial 0.764 0.817 0.053 -3.080 .002
Statement
Revenue 0.816 0.771 0.045 -1.464 .143
Expense 0.87 0.819 0.051 -1.859 .063
Asset 0.748 0.726 (0.022) -2.977 .003
Liability 0.898 0.796 (0.102) -.105 .917
Other 0.6 0.805 .205 -13.753 .000
Statements
Accounting 0.582 0.716 0.134 -10.457 .000
Policy
Other 0.535 0.674 0.139 -8.885 .000
Information
Overall 0.727 0.766 0.039 -9.725 .000

8.6 Improvement in Disclosure Levels

The improvement in the quality of financial reporting in a country has been one of the

principle objectives of the regulatory bodies. A number of steps have been taken in

Bangladesh to improve the standard of financial reporting of MFIs including promulgation of

the Microcredit Regulatory Act 2006.

To assess whether the quality of financial reports has improved over time, the financial

reports of 435 MFIs over a period of three years beginning in 2004 were obtained. Disclosure

indices for each sections of MFIs’ financial reports and overall are computed. The hypothesis

to be tested is:

H4: There has been no improvement in the quality of MFI disclosure since 2004.

The table 8.10 reveals that the sectional and overall disclosure indexes have increased during

the three-year period. The results show that the overall disclosure index in 2004 was 69.3

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percent and increased to 72.7 percent in 2006. The disclosure levels are relatively high for

expense and liabilities items (around 80-90 percent), while low for other informational items

(around 40-54 percent). It is noted that while the disclosure index for other statements has

remained steady at 60 percent, the index has declined for financial statement items. To assess

whether these changes are statistically significants, the parametric t-tests are used.

Table 8.10 Distribution of Average Sectional and Total Disclosure Index in 2004, 2005

and 2006

2004 2005 2006

Financial Statement 0.776 0.786 0.764

Revenue 0.763 0.807 0.816

Expense 0.809 0.844 0.870

Asset 0.747 0.741 0.748

Liability 0.886 0.896 0.898

Other Statement 0.596 0.599 0.603

Accounting Policy 0.56 0.582 0.582

Other Information 0.404 0.538 0.535

Overall 0.693 0.724 0.727

Th table 8.11 reveals that the differences in the sectional disclosure indices (except few)

during the period (2004-2006) are not statistically significant. The overall indices show that

the differences are also not significant for all the years under study. On the basis of these

results, the null hypothesis that the quality of disclosure in Bangladesh has not improved

during 2004-2006 is accepted.

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Table 8.11 T value Showing the Significance of Differences in Disclosure Indices

Difference Financial Revenue Expenses Asset Liability Other Accounting Other Overall

Statement Statement Policy Information

2004-2005 -.233 -2.481* -2.274* 1.828 -1.138 1.007 -3.055* -3.466** -1.014

2005-2006 .959 -.604 -2.492* -1.149 -.409 -1.085 .070 .792 1.081

2004-2006 0.724 -3.061* -5.231** 0.717 -1.346 9.393** -3.243** -2.82** -.930

** Significant at 0.01 level

* Significant at 0.05 level

8.7 MFI Characteristics and Disclosure Quality

The purpose of this section is to assess whether the overall disclosure quality are associated

with the selected internal key characteristics of MFIs in Bangladesh. The MFI characteristics

for this study are: MFISIZE (assets or members), Lev (debt capital ratio), SURPLUS (Rate of

surplus of revenue over expenditure), AUDDUM (size of audit firms), LEGDUM (nature of

registration), AGE (organization age), BDSIZE (governance structure), FBM (frequency of

Board meetings) and QALBD (qualification of board members). The null hypotheses to be

tested here:

H5: There is no association between the total disclosure quality and the MFI’s

characteristics such size, debts levels, surplus of revenue over expenditure, size of audit

firms, nature of registration, MFI’s age, governance structure, frequency of board

meetings and qualification of board members.

In this study, multivariate analysis technique Ordinary Least Squares (OLS) regression model

is used to estimate the association between the disclosure index and the MFI specific

variables.

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Table 8.12 (Panel A) presents the regression results on disclosure indices and the MFI

specific attributes. The table shows that size of the organization (MFSIZE) (coeff= 0.373,

P<0.00) and frequency of the board meetings (coeff=0.091, p<0.05) are positively and

significantly associated with disclosure levels.

The finding of this study, size of the organization is positively associated with disclosure

level, is consistent with previous studies. Nieto et al. (2007) find a positive relation between

size of the firm and internet reporting of MFIs. Besides this, most of the corporate studies

have also persistently found large firms to be significant and positively associated with

disclosure (mentioned in literature review chapter). In this study, size is alternatively

measured by the number of members within the MFI and also finds a positive and significant

association with disclosure levels of MFIs.

The finding of the study, frequency of board meeting is positively associated with MFI

disclosure is consistent with the previous studies. The literature suggests that a board is more

effective in discharging its monitoring role when it meets more frequently (Vafeas, 1999). If

the board members meet frequently, they might have more queries and need more

information to satisfy their queries. Thus the frequency of board meetings would ensure

better monitoring, which in turn lead to better disclosure standard.

The regression results in table 8.12 (Panel A) also show that the qualification of the board

members variable is significant and positively associated with disclosure levels at the 10 per

cent level, consistent with expectation. This implies that qualified board members have some

influence on the overall disclosure level in the financial statements of MFIs, although their

influences are not that dominant as size of MFIs or frequency of board meetings variables

115
Table 8.12: Regression Results of Disclosure Index and MFI Attributes
Panel A: OLS regression
Variable predicted beta-coefficient t-value significance
sign
Constant 0.527 22.971 0.000
MFSIZE + 0.373 7.686 0.000
LEV ? -0.037 -0.797 0.213
SURPLUS ? 0.030 0.649 0.253
AUDUM + -0.020 -0.448 0.329
LEGDUM + -0.019 -0.409 0.683
AGE ? -0.033 -0.684 0.495
BDSIZE ? -0.092 -1.981 0.048
FBM + 0.094 2.053 0.041
QALBD + 0.090 1.896 0.059
Yr2005 0.026 0.491 0.624
Yr2006 0.012 0.207 0.836
Model’s significance 0.000
F value= 7.245
Adjusted R2=13.9%

Panel B: Ranked regression

Variable predicted beta-coefficient t-value significance
sign
Constant 145.400 4.655 0.000
MFSIZE + 0.342 6.986 0.000
LEV ? -0.065 -1.268 0.206
SURPLUS ? 0.017 0.336 0.737
AUDUM + -0.024 -0.527 0.598
LEGDUM + -0.003 -0.061 0.952
AGE ? 0.015 -0.300 0.764
BDSIZE ? -0.064 -1.367 0.172
FBM + 0.103 2.210 0.028
QALBD + 0.072 1.513 0.131
Yr2005 0.009 0.170 0.865
Yr2006 -0.006 -0.110 0.913
Model’s significance= 0.000
F value= 5.975
Adjusted R2 = 11.4

Where: TDI is total disclosure index

MFISIZE= Size of the MFI measured by total assets and log of total assets at the end of the financial year
MEMBERS= total number of registered members within each MFI
LEV=measures the debt levels by the total amounts of borrowing divided by capital as shown in the balance
sheet
SURPLUS= total amount of surplus of revenue over total expenses divided by total capital employed
AUDDUM= an indicator variable if the audit firm is large 1, otherwise 0.
LEGDUM= an indicator variable if the MFI is listed under company Act 1, otherwise 0.
AGE= difference between the reporting period and the year of establishment.
BDSIZE= is size of governing body by the number of directors on the MFI board.
FBM= frequency of board meetings during the year under consideration
QALBD= an indicator variable when the majority of the board members have master degrees and above is 1,
otherwise 0
Yr Dum is a dummy that assumes the value of 1 if the data pertain to year t and 0 otherwise between 2004 and
2006;

116
On the other hand, board size (BDSIZE) is negatively associated with disclosure levels at 5

percent level, which indicates that when the board size gets large the disclosure levels

decrease. The corporate governance literature (board size as a component of board structure)

suggests that small corporate boards are more effective monitors than are large boards

because they have a high degree of membership coordination, fewer communication

difficulties, and a lower incidence of severe free-ride problems (Jensen, 1993; Yermack,

1996).

The study finds no significant relationships between leverage, rate of revenue over

expenditure, size of the audit firm, registration status and age variables with disclosure levels

of MFIs.

The finding of the study, leverage is not significant with MFI disclosure is consistent with

some of the previous studies. Some find significant relationship between leverage and

disclosure level (Courtis, 1979; Malone et al., 1993; Hossain et al., 1994) while others have

not found any significant associations (Chow & Wong-Boren, 1987; Ahmed & Nicholls,

1994; Wallace et al., 1994; Wallace & Naser, 1995; Hossain et al., 1995; Raffournier, 1995)

Many studies examine the association between profitability and corporate disclosure. A

positive relationship is found in some studies (Singhvi, 1968; Singhvi & Desai 1971; Wallace

et al., 1994) while other studies find no such relationships (McNalley et al., 1982; Lau, 1992;

Raffournier, 1995). So the finding of the study, no significant relationship between rate of

revenue over expenditure and disclosure level of MFIs, is consistent with findings of the

prior studies.

117
The empirical evidence of association between size of audit firm and corporate disclosure

provides mixed results. Some studies find that large audit firms show a significant association

with higher disclosure levels (Singhvi & Desai, 1971; Ahmed & Nicholls; 1994, Hossain et

al, 1994; Ahmed, 1996; Patton & Zelenka, 1997) while other studies do not find any

significant relationships (Singhvi 1968; Courtis, 1979; Tong et al., 1990; Wallace et al,

1994). The finding of the study, there is no significant relationship between size of audit firm

and MFI disclosure level, is consistent with the findings of prior literature. The result of this

study indicates that audit firms have no influence on disclosure levels in MFI financial

statement in Bangladesh.

The study does not find any significant associations between registration status and age

variables which is also consistent with other previous studies (Curtis, 1979; Akhtaruddin,

2005; Moreland and Storm 2009).

Table 8.12 (Panel B) presents Rank regression results. Rank regression is employed to

supplement the OLS results because some independent variables are highly skewed for which

rank regression is a better alternative since it does not require a normal distribution of the

data. The table shows that results are generally consistent, with firm size (p<0.01) and

frequency of board meetings (p<0.05) significant and positive. Similar to Panel A,

registration status, auditor size, leverage, age and profitability are not significant

determinants. However, board size and qualification of board members are not significant

any more. Both models are significant and the adjusted R 2s are 14 percent and 11.4 percent in

the OLS and Rank regression models.

118
8.8 Further Robustness Test

For sensitivity analysis, a Random Effect Regression Model (RRM) has been employed.

Since annual observations of the financial variables are available for three consecutive years

and the governance variables are often assumed to be constant over the whole period, the

panel data are structured to estimate coefficients using the random effects method to check

how reliable the reported coefficients are (Greene, 2003). This approach was adopted by

Mersland and Strøm (2009) in their study of performance and governance of MFIs.

Table 8.13 Results of Random Effect Regression Model

Variable Predicted Beta-coefficient z-value significance

Sign
Constant 0.522 19.25 0.000
MFSIZE + 0.107 7.02 0.000
LEV ? -0.000 -0.36 0.722
SURPLUS ? 0.011 0.25 0.801
AUDUM + -0.003 -0.90 0.366
LEGDUM + -0.002 -0.26 0.795
AGE ? -0.003 -0.57 0.566
BDSIZE ? -0.002 -1.48 0.139
FBM + 0.001 1.52 0.129
QALBD + 0.008 2.00 0.045

The table 8.13 shows that the results of the Random Effect Regression Model are partially

same as OLS as reported in Table 8.12 (Panel A) with MFI size and board qualifications,

significantly positive at the 5 percent level. However, frequency of board meetings and

board size are not significantly associated with disclosure level.

8.9 Summary

The chapter discusses the findings of the study. In this study, multivariate analysis technique

Ordinary Least Squares (OLS) regression model is used to estimate the association between

the disclosure index and the MFI specific variables. Non parametric technique Mann

119
Whitney U test has also employed to assess users and preparers’ perceptions about the
disclosed items in MFI financial statement. For sensitivity analysis, Random Effect
Regression model has been used. The summary of the significant findings are depicted in the
following table:
Table 8.14 Summary of the Significant Findings
Hypothesis
H1: There is no consensus between users and
preparers regarding the importance attached to
the information items disclosed in MFI’s
financial statement.
H2: There is no expectation gap between the
information needs of users and actual disclosure
practice of MFIs
H3: There is no expectation gap between
preparers’ perception about disclosed information
and actual disclosure practice of MFIs.
H4: There has been no improvement in the
quality of the MFI’s disclosure since 2004.
H5: There is no association between the total
disclosure quality and some organization’s
characteristics such as size of the organization,
leverage, rate of surplus over expenditure, size of
the audit firm, registration status, governance
structure (board size), frequency of board
meetings and qualification of board members.
Findings
Mann Whitney U test reveals that there is a
significant difference between users and
preparers’ perceptions regarding the importance
attached to the information items disclosed in
MFI’s financial statement.
Mann Whitney U test confirms that there is a
significant gap between users’ information needs
and actual disclosure practice of MFIs.
Mann Whitney U test shows that there is a
significant difference between preparers’
perception about disclosed information and
actual disclosure practice.
Parametric t-test confirms that there is no
improvement in the quality of MFI’s disclosure
since 2004.
The OLS regression reveals that size of the
organization (MFSIZE) and frequency of the
board meetings (FBM) are positively and
significantly associated with disclosure levels.
Board size (BDSIZE) is negatively associated
with disclosure levels. The qualification of the
board members (QALBD) variable is also
significant and positively associated with
disclosure levels at the 10 per cent level. The
registration status, auditor size, leverage, age and
rate of revenue over expenditure are not
significant determinants.
120
 Chapter 9

Summary and Conclusion

This thesis examines the nature and pattern of discharging accountability via disclosure in

financial statements of microfinance institutions in Bangladesh, an emerging country, where

the concept of microfinance has been popularised over the last 50 years. This country has

provided leadership in microfinance regulations and performance evaluation across the globe.

The world has experienced significant growth in microfinance institutions in recent years

which provide small (micro) credit to the poor who are unable to borrow funds from

traditional financial institutions such as banks. With this growth, in credit and borrowing

from international development agencies and local lenders, and number of clients

(borrowers), the discharging of accountability via reporting to the various stakeholders

assumes a significant role for accounting and reporting.

Although several studies have examined financial performance and accountability of

microfinance institutions across the globe, no substantial empirical research on financial

reporting of MFIs, particularly dealing with what these organizations disclose, understanding

of the current regulatory regime and the role of organizational characteristics and governance

structure in information disclosure has been undertaken. In this regard, this study is the first

of its kind and should help the regulators of not-for-profit organizations and various

stakeholders including international donors and domestic lenders of MFIs in understanding

their reporting performance. Further, this study will contribute to the limited international

literature of MFIs by providing a detailed description of current financial reporting practices

of MFIs in Bangladesh. Financial reporting framework of MFIs (Ebrahim’s modified

121
accountability framework) of this study could also be used by other researchers to understand

the reporting pattern of MFIs in different countries.

The purpose of the thesis is to undertake a comprehensive study of financial reporting by

MFIs in Bangladesh. The study assesses MFI disclosure quality, and examines the impact of

the MFI characteristics on the disclosure quality of MFI financial reports in Bangladesh. Five

research hypotheses are formulated and tested in this thesis.

The research methods involve a questionnaire survey and content analysis of the financial

reports of PKSF partner organization (MFIs). One hundred and sixty questionnaires were

sent to MFI accountants and received responses from 72 which are about 45 percent.

Questionnaires were also sent to 70 PKSF enlisted audit firms and received response from 32

with a response rate of about 40 percent. This response rate is consistent with prior

perception studies in corporate sector. The 82 disclosure items are classified into eight

categories: financial statements (5 items), revenue (9 items), expenses (16 items), asset (10

items), liabilities (12 items), other statements (5 items), accounting policy (11 items) and

other information (14 items). The content analysis involved assessing the quality of

disclosure of the 2006 financial statements of MFIs cross-sectionally and the financial reports

of 435 MFIs over a period of three years beginning in 2004. The quality of disclosure is

measured by overall disclosure index. An unweighted disclosure model is used.

The hypothesis one examines the consensus between users and preparers regarding the

importance attached to the items disclosed in MFI financial statement. The analysis shows

that overall user’s perceived information needs is more than the preparers’ perceived

122
information disclosure. Users perceive financial statement under the historical cost

convention and balance sheet includes financial information for two years as the highest

importance and cumulative amount of all prior years’ donation/grants and guarantee

mechanism to obtain loan as the lowest importance. Whereas preparers perceive current and

fixed assets and amount of members/beneficiaries loan as the highest importance and policy

related to foreign exchange fluctuation and renegotiated members’ loan as the lowest

importance. The sectional analysis reveals that users perceive financial statement item as the

most important section followed by revenue, assets, expense, accounting policy, other

statements, liability and other information. Whereas preparers perceive expense as the most

important section followed by financial statement item section, other statements, expense,

revenue, assets, accounting policy and other information. Mann Whitney U test confirms that

there is no consensus between users and preparers regarding the importance attached to the

items disclosed in MFI financial statement.

The second hypothesis assesses the information needs of users and actual disclosure in MFI

financial statement. The analysis reveals that overall user’s information need is 0.889

compared to MFIs’ actual disclosure practice of 0.727 in 2006. MFIs disclose more

information in liability, expenses and revenue items whereas less information is disclosed in

other information, accounting policy and other statements information. The sectional

comparison shows that there is gap between actual disclosure practice and users’ expected

information needs. Mann Whitney U test also confirms that there is a significant difference

between actual disclosure practice and users’ expected information needs in every sections of

the financial statement except expenses and liability items.

123
The third hypothesis concerns with prepares’ perceptions about disclosed information items

in MFI financial statement. The analysis reveals that the overall actual disclosure practice is

0.727 compared to the preparers’ perception about those disclosed information is 0.766. The

sectional comparison shows that more gap in other statements, accounting policy and other

information whereas less gap in revenue, expense, assets and liabilities. MFIs disclose more

information in assets and liabilities than the preparers’ perceptions. Mann-Whitney test also

confirms that there is a significant difference between actual disclosure practice and

preparers’ perceptions about disclosed information in all sections of the financial statements

except revenue, expense and liability items.

The hypothesis four deals with the improvement of quality of MFI disclosure practice since

2004. The analysis reveals that the sectional and overall disclosure indices have increased

during the three-year period. The results show that the overall disclosure index in 2004 was

69.3 percent and increased to 72.7 percent in 2006. The disclosure levels are relatively high

for expense and liabilities items, while low for other informational items. It is noted that

while the disclosure index for other statements has remained steady at 60 percent, the index

has declined for financial statement items. However, t test confirms that these changes in

disclosure levels are not statistically significant.

The hypothesis five examines the association between the total disclosure practice and the

MFI characteristics such a size, debts level, rate of surplus of revenue over expenditure, size

of audit firms, nature of registration, MFI’s age, governance structure, frequency of board

meetings and qualification of board members. The OLS regression results show that size of

the organization (MFSIZE) and frequency of the board meetings are positively and

124
significantly associated with disclosure levels at the 5 percent level. Board size (BDSIZE) is

negatively associated with disclosure levels, which indicates that when the board size gets

large the disclosure levels decrease. The qualification of the board members variable is also

significant and positively associated with disclosure levels at the 10 percent level, consistent

with expectation. The registration status, auditor size, leverage, age and profitability are not

significant determinants. The level of disclosure is low in the area of accounting policy

choice, statements on other issue and further information items. The results of Rank

Regression and Random Effect Regression model are also generally consistent with the

results of Ordinary Least Square Regression.

The CGAP considers the lack of strong MFIs to be a major constraint on the further

development of the microfinance industry and has prepared guidelines for minimum

information that should be included in MFI financial reports based on certain International

Financial Reporting Standards (IFRS). Through establishment of Microcredit Regulatory

Authority (MRA), the Government of Bangladesh is also trying to improve the transparency

and reporting of microfinance organizations in Bangladesh, but it is not yet successful.

Several MFIs have not disclosed adequately and only large firms have disclosed more. So

disclosure standards of large firms should be used as a model for small firms and regulatory

agencies such as PKSF should pay more attention. Also PKSF should examine whether

information required in accordance with IFRS has been disclosed and comply with. The lack

of any association between auditor quality and reporting suggests that the selection criteria of

auditors by PKSF should be made more transparent. The accounting and regulatory bodies in

Bangladesh may take into consideration the users’ information needs and preparers’

perceptions about disclosed information items in MFI financial statement for standard setting

or policy formulation. The regulatory bodies should also examine the disclosure standards of

125
other emerging countries within Asia and Latin America so that MFIs in those countries can

be used as a model for improving the disclosure standards of Bangladesh. Limitations of the

study include the use of only PKSF’s partner organisations which do not necessarily

represent all MFIs in Bangladesh. However, this is unavoidable because obtaining annual

reports from NGO Bureau was not possible; because of non submission of report and other

regulatory bodies do not require proper financial reports based on internationally accepted

accounting standards.

126
 References

Abbey, M. (2008). Constructive regulation of non-government organizations. The Quarterly

Review of Economics and Finance, 48(2), 370-376.

Abed, H. F. (2000). Microfinance NGOs in Bangladesh-growth, impact and challenges. BRAC

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