Do microfinance institutions accomplish their mission? Evidence from the relationship between traditional financial sector development and microfinance institutions’ outreach and performance

Abstract

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

Keywords:

• financial sector development; microfinance; financial performance; outreach; mission drift

JEL Classification::

• O16
• O50
• G21

Acknowledgements

Begoña Guttiérrez-Nieto, Valentina Hartarska, Niels Hermes, Marek Hudon, Marc Jegers, Marc Labie, Robert Lensink, Kim Oosterlinck, Ariane Szafarz and Leo Van Hove are gratefully acknowledged for their comments on earlier versions. Also the participants of the First European Research Conference on Microfinance at CERMi, Brussels, the ATINER Conference in Athens, the VVE-Research Day in Hasselt and the Nordic Conference on Development Economics in Helsinki are thanked for their useful suggestions. Didier Toussaint is thanked for language corrections.

Notes

¹ The terms traditional banking sector, traditional financial sector, (commercial) banking sector and a country's financial sector development are used interchangeably. All point towards the traditional banking sector in a country, that by assumption does not comprise MFIs.

² Cull et al. (2007) define commercial MFIs as institutions that operate as legal for-profit entities with the possibility of profit-sharing by investors. By commercially-oriented they mean that institutions strive to make profits.

³ Cull et al. (2009) argue that self-sustainability is a better socially accepted term that covers the fact that institutions strive to make profits.

⁴ Atlhough every MFI may have its specific mission, here Armendáriz and Morduch (2010) are followed, who claim that MFIs were first set up in a logic to increase access for the unbanked poor.

⁵ In comparison, Ahlin et al. (2011) use only data from 373 MFIs.

⁶ See, http://www.mixmarket.org/ (accessed January 2011).

⁷ See, for example Barr (2005).

⁸ Furthermore, MFI data to the MIX is mainly self-reported and in a lot of countries no specific financial reporting for MFIs towards national regulatory institutions is organized. This is especially true for the NGOs.

⁹ Hereby they assume that serving clients has a positive impact. Average loan size has also been criticized by the sector (Dunford, 2002), but until now no other measures seem to be available. More recently, the number of women borrowers is increasingly recognized as an alternative poverty indicator, but unfortunately we have no data on that. Copestake (2007) argues for the implementation of a social performance management system in order to assess the impact on the clients.

¹⁰ Note that we look at operational self sustainability (OSS) instead of the financial sustainability (FSS) indicator because we do not have enough data about the last one. The difference between OSS and FSS is that FSS also takes into account the ability of the MFI to grow with internally generated funds, while OSS only looks at the ability to cover costs. The MIX calculates OSS as: Operating Revenue/(Financial Expense + Loan Loss Provision Expense + Operating Expense). Since not all institutions report FSS, looking at FSS would seriously reduce our sample size.

¹¹ In the estimations, the natural logarithm of ATMs/cap, Branches/cap and Branches/km² are used.

¹² In the estimations, the natural logarithm of aid per capita and Gross National Income (GNI) per capita is used.

¹³ Age squared is here introduced because the assumption is that the older the MFI, the better it performs, but this effect reduces with age (Hartarska and Nadolnyak, 2007).

¹⁴ Total labour force is defined as the number of people aged 15 and older who meet the International Labour Organization definition of the economically active population. These are all people who supply labour for the production of goods and services during a specified period. It includes both employed and unemployed (http://data.worldbank.org/indicator/SL.TLF.TOTL.IN (accessed January 2011)).

¹⁵ They argue that a specific type of manager may be attracted by a specific type of institution.

¹⁶ Note that putting the three variables measuring financial sector development together in the regression, none of them is significant, which is most probably due to multi-collinearity plaguing the analysis.

¹⁷ Note that Ahlin et al. (2011) find no significant effect of private credit on sustainability. They show that lower default and operating costs are associated with more financial depth, but that this results in lower interest rates MFIs charge, rather than greater MFI self-sufficiency. However, Ahlin et al. do find a negative sign, they just do not find significance.

¹⁸ Although the estimation here could be plagued by multi-collinearity.

¹⁹ We only report the result for ATMs, but the results are similar for the other explanatory variables. The additional tables are available upon request.

²⁰ Note that a higher corruption index means that the country is perceived to be better-off and, therefore, to have lower corruption.