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The effect of subsidies on the performance and sustainability of microfinance institutions in sub-Saharan Africa

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  • Dlamini, Menzie S.
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    Abstract

    Microfinance Institutions (MFIs) in sub-Saharan Africa (SSA) and the developing world have over the years attracted and received billions of US dollars (valued at over US$4 billion annually worldwide) in subsidies and concessionary funds. These subsidies are used to capitalize, promote growth, and help improve efficiency, operations and performance of newly established MFIs. At face value these interventions seem positive, yet studies have shown that they can be counterproductive in terms of their effect on the performance, efficiency and self-sustainability of the MFIs. This research addresses this issue by identifying four determinants of MFI’s performance and analysing the effect that subsidies have on them. A quantitative approach was used in the analysis in which the financial data of 92 MFIs were estimated using panel data estimation. The method of variable selection was based on the procedure used by Nawaz (2010). This method of determining the relationship between selected performance and sustainability indicators and subsidy was modelled on the Subsidy Dependant Index (SDI) method of analysis developed by Yaron (1992a) and the Return on Asset (ROA), Operational Self-Sufficiency (OSS) and Financial Self-Sufficiency (FSS) methods of analysis developed by the SEEP Network (2005). The summary results of the analysis showed that the majority of MFIs (90.22%) were not sustainable nor were they found to be profitable. However, the results show that all the institutions were operationally self-sufficient and that, on average, MFIs in SSA charged higher interest rates than MFIs in other parts of the world. The average OSS was 136.01% showing that MFIs are operationally self-sufficient. However, the average FSS value was ix 74.32% reflecting that the MFIs are not able to raise enough revenue to cover their capital and indirect costs which would ultimately result in them running out of equity funds. The inclusion of subsidies in the sustainability regressions resulted in a decline in the ability of the MFIs to attain operational and financial self-sufficiency, thus showing the negative effect subsidies have on the sustainability of MFIs. Inflation and interest rates charged on loans also had a negative effect on sustainability as they resulted in an increase in costs and a decline in the number of low income clients. MFIs located in wealthier countries were found to be more efficient because of the lower costs associated with having wealthier clients who have larger loan sizes. MFIs in lower income countries have to overcome limitations of weak infrastructures, low population densities and rural markets which increase operating costs. Older institutions were found to more likely be sustainable than new and young MFIs as expected because of their improved efficiency and productivity and also because they have more experience and are therefore better equipped to overcome challenges. However, by adding subsidy in the analysis the results show that the level of efficiency of MFIs is reduced. The results also show that with increased maturity MFIs are found to be more productive, however, when subsidies are included in the finances the levels of productivity will decline as costs increase. NBFIs are the most suitable business model to practice in MFIs in Africa according to the findings which reflect that NBFIs are more profitable and efficient than any of the other business models in the sample. However, cooperatives were found to be the most productive business model as they have a stronger borrower to staff ratio than the other institutional types. Furthermore, cooperatives and NBFIs tend to have clients who are better off and therefore can afford to take larger sized loans, unlike clients of NGOs who are poor who struggle to have a stable income.

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    Bibliographic Info

    Paper provided by Collaborative Masters Program in Agricultural and Applied Economics in its series Research Theses with number 134487.

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    Date of creation: May 2012
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    Handle: RePEc:ags:cmpart:134487

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    Web page: http://www.agriculturaleconomics.net

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    Keywords: Agricultural Finance;

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    References

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    1. Roy Mersland & Reidar Øystein Str�m, 2008. "Performance and trade-offs in Microfinance Organisations-does ownership matter?," Journal of International Development, John Wiley & Sons, Ltd., vol. 20(5), pages 598-612.
    2. Cull, Robert & Demirguc-Kunt, Asli & Morduch, Jonathan, 2006. "Financial performance and outreach : a global analysis of leading microbanks," Policy Research Working Paper Series 3827, The World Bank.
    3. Mark Schreiner, 2002. "Aspects of outreach: a framework for discussion of the social benefits of microfinance," Journal of International Development, John Wiley & Sons, Ltd., vol. 14(5), pages 591-603.
    4. Suman Ghosh & Eric Van Tassel, 2008. "A Model of Mission Drift in Microfinance Institutions," Working Papers 08003, Department of Economics, College of Business, Florida Atlantic University.
    5. Morduch, Jonathan, 1999. "The role of subsidies in microfinance: evidence from the Grameen Bank," Journal of Development Economics, Elsevier, vol. 60(1), pages 229-248, October.
    6. Schreiner, Mark, 1997. "Ways Donors Can Help The Evolution Of Sustainable Microfinance Organizations," Economics and Sociology Occasional Papers 28327, Ohio State University, Department of Agricultural, Environmental and Development Economics.
    7. Marek Hudon & Daniel Traca, 2006. "On the efficiency effects of subsidies in microfinance: an empirical inquiry," Working Papers CEB 06-020.RS, ULB -- Universite Libre de Bruxelles.
    8. Mosley, Paul & Hulme, David, 1998. "Microenterprise finance: Is there a conflict between growth and poverty alleviation?," World Development, Elsevier, vol. 26(5), pages 783-790, May.
    9. Ahmad Nawaz, 2010. "Issues in Subsidies and Sustainability of Microfinance: An Empirical Investigation," Working Papers CEB 10-010.RS, ULB -- Universite Libre de Bruxelles.
    10. Marek Hudon, 2010. "Management of microfinance institutions: Do subsidies matter?," Journal of International Development, John Wiley & Sons, Ltd., vol. 22(7), pages 890-905.
    11. Beatriz Armendariz & Bert D'Espallier & Marek Hudon & Ariane Szafarz, 2011. "Subsidy Uncertainty and Microfinance Mission Drift," Working Papers CEB 11-014, ULB -- Universite Libre de Bruxelles.
    12. Hartarska, Valentina M., 2005. "Governance and Performance of Microfinance Institutions in Central and Eastern Europe and the Newly Independent States," 2005 International Congress, August 23-27, 2005, Copenhagen, Denmark 24568, European Association of Agricultural Economists.
    13. Yaron, J., 1992. "Assessing Development Finance Institutions; A Public Interest Analysis," World Bank - Discussion Papers 174, World Bank.
    14. Annabel Vanroose, 2008. "What macro factors make microfinance institutions reach out?," Working Papers CEB 08-036.RS, ULB -- Universite Libre de Bruxelles.
    15. Yaron, J., 1992. "Successful Rural Finance Institutions," World Bank - Discussion Papers 150, World Bank.
    16. Hartarska, Valentina, 2005. "Governance and performance of microfinance institutions in Central and Eastern Europe and the Newly Independent States," World Development, Elsevier, vol. 33(10), pages 1627-1643, October.
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