Academic journal article Journal of Money, Credit & Banking

Which Microfinance Institutions Are Becoming More Cost Effective with Time? Evidence from a Mixture Model

Academic journal article Journal of Money, Credit & Banking

Which Microfinance Institutions Are Becoming More Cost Effective with Time? Evidence from a Mixture Model

Article excerpt

MICROFINANCE INSTITUTIONS, OR MFIs, serve as important providers of credit to poorer borrowers and thus can play a significant role in programs to alleviate poverty and promote economic opportunity in nations around the world (Morduch 1999a, Zohir and Matin 2004). These institutions make loans to borrowers who seek relatively small amounts and who may be viewed as too risky by larger conventional lenders. Quite often, MFIs operate with subsidies from charitable or governmental agencies. There appears to be considerable heterogeneity in the microfinance industry in terms of institution size, sustainability, and clientele served. Worldwide, the leading 10% of MFIs (about 150 institutions) serve approximately 75% of all microfinance clients, with the remainder served by thousands of small and heterogeneous institutions with varying degrees of sustainability ( Given their important role in providing credit to underserved individuals and the use of subsidies from various sources to support them, MFI operations should be well understood. One important question is whether MFIs are becoming more cost effective over time, particularly if any improvements can reduce or eliminate the need for subsidies. We are particularly interested in whether all MFIs appear to improve at the same rate, and whether there are identifiable factors associated with any detected differences.

There are several novel features of our study to answer these key questions. First, we have access to a unique database on MFIs operating in the Eastern Europe and Central Asia (ECA) region for 2003 and 2004. Second, we are among the first to estimate a statistical cost function using data on MFIs, although the practice is commonly applied to banking institutions. Finally, we are among the first to provide an analysis of the operations of nongovernmental organizations (NGOs) in the ECA region.

In general, it would be expected that firm operating performance should improve with time, ceteris paribus. In the case of MFIs, this is both an understatement and an oversimplification. For MFIs, time is vitally important to offset the information asymmetries present. Both the lenders and the clientele learn over time.

To illustrate the importance of time in the microfinance production process and to highlight some of the time-related effects, we consider what might be the case of a typical microfinance lender. An MFI may begin lending operations as an NGO or some other form of nonprofit entity. They are in the business of making small loans to customers who are not generally serviceable by the commercial banking sector. The MFI clientele typically lacks either credit histories, or collateral, or both. Given time, successful borrowers, whether individuals or members of a borrowing group, will exhibit responsible behavior and generate credit histories, thus providing some of the information absent when the MFI began operations. If these borrowers are very successful they may also generate collateral.

While the situation is changing on the clientele side with the passage of time, improvements in the productivity of the MFI itself are also likely to occur. Navajas, Conning, and Gonzalez-Vega (2003) and Gonzalez-Vega et al. (1996), when discussing Bolivia, describe the evolution of an MFI from an NGO to a for-profit bank. In their studies, they detail several advantages in the form of various types of capital passed from the NGO to the bank. While they deal with individual cases, generalizing some or all of the detailed advantages to maturing MFIs is not far fetched, particularly as one considers how the passage of time should affect an MFI.

Several possible benefits of the passage of time on microfinance performance are pointed out by Gonzalez-Vega et al. (1996): (i) the lending technology is proven and improved through several years of experimentation, development, and adjustment; (ii) the MFI accumulates a stock of information capital about the clientele and the environment; (iii) the MFI develops client relationships and identifies well-performing clients; (iv) the MFI accumulates the human capital embodied in an experienced staff; (v) the MFI acquires a reputation as a serious organization capable of sustaining relationships with clients; and (vi) the MFI has likely established connections with international networks and enjoys the resulting technology transfers. …

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