Academic journal article American Journal of Entrepreneurship

Microfinance Institutions: A Profitable Investment Alternative?

Academic journal article American Journal of Entrepreneurship

Microfinance Institutions: A Profitable Investment Alternative?

Article excerpt

INTRODUCTION

The Microfinance Institution (MFI) literature in recent years has seen an increased focus on financial sustainability as the MFIs continue to grow and develop. Microfinance is thought to be important to development because of the social benefits it brings (Armendáriz and Morduch 2010, Yunus 2003, and Karlen and Appel 2011). It helps the poorest of the poor escape of poverty. It helps people escape debt bondage. Moreover, microfinance can increase womens' empowerment in two important ways. Microfinance gives women more money and that alone seems to bring empowerment, but unlike other types of aid, microfinance does not bring aid dependency. Many hope that attitudes towards women will change when women support themselves with their own businesses.

However, in order to achieve its full potential, an MFI needs to be self-sufficient in a financial context so that it no longer has to rely on donors, subsidized grants or loans, NGOs, or government programs for its continued operations. There is a growing literature focusing on this need for sustainability which has used measures such as operational sustainability, financial sustainability and return on assets as measures of MFI performance (Ayayi and Sene, 2010, Hasan, Hassan, and Uddin, 2009, Crabb, 2008, Hartarska, and Nadolnyak, 2007, Morduch, 1999). However, to this point no one has examined MFI return on equity (ROE) as a measure of performance.

The reason for the lack of emphasis on return on equity as a measure of performance makes sense if the MFI operates as a non-profit entity. However, more and more MFIs are organizing as banks, non-bank financial institutions, or rural banks. These organizational forms allow for the MFI to enter the capital markets in search of funds. Indeed, in August 2010 Indian microlender SKS Microfinance Ltd. saw strong demand for its initial public offering (Wall Street Journal 2010). The Grameen Foundation and Standard Chartered Bank hosted a conference in February 2010 for MFIs in East Africa where attendees could learn about "best practices for structuring their operations to attract and manage commercial financing, including advice on securing equity financing and managing debt financing" (PRNewswire 2010). As early as October 2008, AIG announced plans to invest equity in Blue Intercontinental Micro Finance Bank through AIG Global Emerging Markets Fund II, L.P. (Investment Business Weekly 2008). Compartamos went public in April 2007 and sold $468 million in shares on the Mexican stock market (Malkin 2008). As can be seen from these examples, MFIs are moving into the capital and private equity markets. According to the Microfinance Information Exchange (MIX) market database, of 1084 MFIs reporting data, 38 percent declared themselves as for-profit organizations. This represents a substantial increase from the 1999 benchmark data series where, of 57 MFIs reporting data, only 23 percent designated themselves as for-profit. Given this significant emerging market trend, it makes sense to examine what factors drive profitability for equity investors in MFIs. Therefore, studying ROE as a measure of MFI performance is increasingly valid and relevant.

Sustainability for commercial banks and bank-like institutions requires a competitive return on equity. Whether as banks, non-bank financial institutions (NBFIs), or rural banks, MFIs will require equity investors to achieve sustainability. Attracting those investors will require MFIs to offer competitive ROE. On the other side of that coin, investors searching for new investment vehicles are increasingly considering adding MFI investments to their portfolios. To date relatively few MFIs have become fully operationally self-sufficient, including a sufficient ROE. However, potential investors would have an interest in analysis which helps investors to predict which MFIs might offer sufficient ROE in the future. Accordingly, for this study, our focus is on what factors influence the return on equity reported by MFIs to the MIX market database. …

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