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Efficiency and Sustainability of Micro FinanceInstitutions in South AsiaIntroductionPoverty is pervasive in South Asia. Rather it.s on the rise in some countries ofthe region, which in turn further worsening the access of the poor to the economicopportunities through which they could buildup their assets and enhance income inorder to come out of poverty cycle. The potential to avail such economic opportunitiesmainly depends on the degree of access to financial services. The commercial bankingsector does not consider the poor bankable owning mainly to their inability to meetthe eligibility criteria, including collateral. Thus, the poor people in most countriesvirtually have had no access to formal financial services [Littlefield, Murduch andHashemi (2003)]. The informal financial alternatives such as family loans,moneylenders, and traders are usually limited in amount, often rigidly administered,and in most of the cases involve very high implicit and explicit costs forcing thedestitute stuck in poverty cycle for generations. The more rational way to help thepoor could be the provision of sustainable economic opportunities at gross root levelespecially provision of required financial services at competitive rates to support theirinvestments including viable business activities.Microfinance emerged as a noble substitute for informal credit and aneffective and powerful instrument for poverty reduction among people who areeconomically active but financially constrained and vulnerable in various countries[Japonica Intersectoral (2003); Morduch and Haley (2002)]. It covers a broad range offinancial services including loans, deposits and payment services, and insurance to thepoor and low-income households and their micro-enterprises. Convincing researchevidence exists showing significant role of MFIs in improving the lives of thedeprived communities in various countries.1 Persuaded with the potential role of

1 There is no dearth of literature dealing with assessment of impact of microfinancing institutionsworking in various countries on poverty status. A large number of empirical studies has led the policymakers and analysts to believe that the microfinance programs in various countries are playingsignificant role in changing the lives of the very poor people by smoothing their consumption3microfinancing in alleviating poverty, the South Asian countries have been activelypursuing the policy of setting up formal network of microfinance institutions. Theseinstitutions include NGOs and government sponsored programs.Some leading MFIs, e.g. Grameen Bank, have created financial modes thatserve increasing number of poor. They also lead to repayment rates positivelycomparable with the performance of many commercial banks. These approaches havehelped many MFIs in achieving a reasonable level of sustainability, and have evenproduced profits without government subsidies and support from donor (Hulme,1999). Nonetheless, some of the MFIs especially the NGOs are facing serioussustainability problems indicating lapse in their financial procedures, organizationaldesign and governance. Moreover, most of the MFIs do not provide deposit servicesto their clients. In contrast, some of the successful MFIs like Grameen Bank inBangladesh and BancoSol in Bolivia have incorporated the provision of depositservices in their operations. Appropriately managing the deposit service and microand small savings help MFIs to reach financial self-sufficiency through generatingtheir own internal flow of funds that in turn reduce their dependency on externalsources (Bass, Henderson and WA, Inc., 2000; cited in Morduch and Haley, 2002).The MFIs exclusively dependent on external sources of funding usually are not

sustainable and efficient (Rhyne, 1998).The primary objective of this study is to identify the most efficient/bestpractice MFI(s) that would in turn help improve functioning of the other MFIs in theSouth Asian region, which comprises of 20% of the World poor and also the birth ofthe first MFI . the Grameen Bank started in 1976. Scores of studies are found on

expenditures, increasing incomes and savings, and diversify their income sources [Dichter (1999;Panjaitan-Drioadisuryo, Rositan and Cloud (1999); Remenyi and Quinones Jr., (2000); Mustafa (1996);Morduch (1998); Zaman (2000); Khandker (1998 and 2003); McKernan (2002); Simonwtz (2002);Hossain (1988)]. Some studies have also shown that these programs have significant positive effects onhuman resource development among the participants [Chowdhury and Bhuiya (2001); Khandker(1998); Marcus, et. al (1999); Barnes, Gaile and Kimbombo (2001); Barnes (2001); Chen andSnodgrass (2001)]. Evidence is also found in empirical literature that participation in microfinanceprograms positively affected the woman.s empowerment and welfare [Amin et. al. (1994); Naved(1994); and Hashemi et. al. (1996)]. The studies have also shown positive effects of these programs onschool enrollment and spending on schooling of children of benefiting families [Pitt and Khandker(1996); Marcus et. al. (1999); Barnes et. al. (2001); Foster (1995); and Jacoby (1994)]. The members ofthe participating household, particularly women and children, also benefit significantly from betternutrition, and health practices/services [MkNelly and Dunford (1999); Barnes (2001)].4analyzing the efficiency and its determinants in commercial banking sectors ofvarious countries.2 The MFIs are also financial institutions with a primary objective ofmaking credit available to that segment of the population which has been ignored bythe commercial banking system for not having collateral requirements. The efficientfunctioning of these MFIs on sustainable basis is important also for persistentfinancial access of the poor segment of the society. There is dearth of literatureregarding efficiency analysis of MFIs in South Asia. However, a few examples arefound in literature such as Nghiem (2004) Nieto, Cinca and Molinero (2004) andLeon (2003) using data from Vietnam, Latin America and Peru, respectively.

Performance analysis of a sample microfinanceinstitutions of Ethiopia

INTRODUCTIONMicrofinance is the provision of financial serves to thepoor people with very small business or business projects(Marzys, 2006). Only a small fraction of the world populationhas access to financial instruments, essentially becausecommercial banks consider the poor people as unbankabledue to their lack of collateral and informationasymmetries.There are a number of studies in the MF industry becauseit has got the attention of academicians and practitionersas an innovative method of fighting poverty. Thestudies mostly concentrate on three key areas. The firstone is impact assessment of the MF programs on thelives of the poor. It is to mean that whether the provisionof financial service mostly of credit and saving hasimproved the lives of the poor in terms of economic,social and political indicators of poverty. Using much typeof quasi experimental designs the studies about theimpact of the microfinance in changing the lives of thepoor have shown mixed results (Hishigsuren, 2004).

Sebstand and Chen, 1996 cited in Hishigsuren, 2004summarized the key findings from thirty two impact studiesand revealed varying degree of positive impact onprogram participants notably increase in household andenterprise income and assets. Mixed effects were foundin employment, children schooling and women’s empowerment.So the evidence on whether Microfinance canalleviate poverty is of highly debated issue.The second hot area in the MF industry amongInt.NGO.J. 288researchers is whether MF reaches the poorest of thepoor who is in need of financial services. There are studiesthat show that MF doesn’t reach the poorest of thepoor. Rather they are reaching the marginally poor ornon-poor. Besides most MFIs have no clear rules and criterionto target the poorest of the poor (Hishigsuren,2004). This indicates that the MFIs are drifting away fromtheir original mission of reaching and serving the poor.The third area that got the attention in the MF industryis the issue of financial sustainability of MFIs. HistoricallyMF has started operation with donor funds and now theindustry has almost aged around 30 years. There is anintense debate on whether MFIs should continue to bedonor supported or get relived from donation and standon their own leg. There are one school of thought whichsay MF should can be sustainable with donor funds(called welfarists) and the others say the MF should generateenough revenue to cover their own costs as donorsfunds are unpredictable (called institutionist) (Basuand Woller, 2004). Hence the issue of building a sustainableMF industry that can operate without a donorfunds is of an empirical enquiry.The purpose of this specific research is to assess theperformance of a sample of MFIs in Ethiopia. There is noenough research done in Ethiopian MF industry. Some ofthem such as (Kereta, 2006; Kidane, 2007) are also poorin terms of statistical analysis. Hence this study, by usingstatistical test of significance, will try to appraise the performanceof these institutions using many indicators suchas capital structure, asset allocation, breadth of outreach,depth of outreach, profitability and sustainability, revenueperformance, expense management, efficiency, productivityand portfolio quality. However it has to be noted thatthe performance analysis of MFIs don’t include impactstudies as there are not available data about the impactof MFIs on the lives of the poor from the data source Iused. More about the data source will be explained insection three.The rest of the study is organized as follows: sectiontwo discuss the relevant literature, section three will lookat data and methodology; section four is devoted to thediscussion of empirical findings and the last section sixconcludes.

IS MICROFINANCE AN EFFECTIVE STRATEGY TO REACH THEMILLENNIUM DEVELOPMENT GOALS?

IntroductionThe United Nations’ Millennium Development Goals (MDGs) have galvanized the development

community with an urgent challenge to improve the welfare of the world’sneediest people. Donor agencies are orienting their programming around the attainmentof the MDGs and are mobilizing new resources to reduce hunger and poverty, eliminateHIV/AIDS and infectious diseases, empower women and improve their health, educateall children, and lower child mortality.1

The MDGs are framed as concrete outcomes in the areas of nutrition, education,health, gender equity, and environment. Thus work in these specific areas will be a largepart of any development strategy driven by the MDGs. But decades of experience hasshown that progress in these areas is powerfully affected by other factors in the broadercontext, such as a functioning government, physical security, economic growth, andbasic infrastructure (for example, transportation). This paper reviews the mounting bodyof evidence showing that the availability of financial services for poor households(“microfinance”) is a critical contextual factor with strong impact on the achievement ofthe MDGs.Microfinance, and the impact it produces, go beyond just business loans. The poor usefinancial services not only for business investment in their microenterprises but also toinvest in health and education, to manage household emergencies, and to meet the widevariety of other cash needs that they encounter. The range of services includes loans, savingsfacilities, insurance, transfer payments, and even micro-pensions. Evidence from themillions of microfinance clients around the world demonstrates that access to financialservices enables poor people to increase their household incomes, build assets, and reducetheir vulnerability to the crises that are so much a part of their daily lives. Access tofinancial services also translates into better nutrition and improved health outcomes, suchas higher immunization rates. It allows poor people to plan for their future and send more1 The Millennium Development Goals are: (1) eradicate extreme poverty and hunger; (2) achieve universal primary education;(3) promote gender equality and empower women; (4) reduce child mortality; (5) improve maternal health; (6) combat HIV/AIDS,malaria, and other diseases; (7) ensure environmental sustainability; and (8) develop a global partnership for development.

IS MICROFINANCE AN EFFECTIVE STRATEGY TO REACH THEMILLENNIUM DEVELOPMENT GOALS?BY ELIZABETH LITTLEFIELD, JONATHAN MORDUCH, AND SYED HASHEMIBuilding financial systems that work for the poor2of their children to school for longer. It has madewomen clients more confident and assertive and thusbetter able to confront gender inequities.Microfinance clients manage their cash flows andapply them to whatever household priority they judgemost important for their own welfare. Thus microfinanceis an especially participatory and non-paternalistic

development input. Access to flexible, convenient,and affordable financial services empowers and equipsthe poor to make their own choices and build theirway out of poverty in a sustained and self-determinedway.Microfinance is unique among development interventions:it can deliver these social benefits on anongoing, permanent basis and on a large scale. Manywell-managed microfinance institutions throughoutthe world provide financial services in a sustainableway, free of donor support. Microfinance thus offersthe potential for a self-propelling cycle of sustainabilityand massive growth, while providing a powerful impacton the lives of the poor, even the extremely poor.Evidence shows that this impact intensifies the longerclients stay with a given program, thus deepening thepower of this virtuous cycle.Unfortunately poor people in most countries havevirtually no access to formal financial services. Theirinformal alternatives, such as family loans, savingsclubs, or moneylenders, are usually limited by amount,rigidly administered, or available only at exorbitant interestrates. The challenge ahead is to ensure access tofinancial services for the poor majority.This note reviews the evidence on the impact of microfinanceas it relates to the attainment of theMDGs.2 Specifically it assesses impact in the areas oferadicating poverty, promoting children’s education,improving health outcomes for women and children,and empowering women. Finally, the note addressesthe feasibility of reaching significant numbers of theabsolute poor with financial services on a sustainablebasis and on a massive scale.

MICROFINANCE IN INDIA: A DETAILED STUDY

Microfinance is defined as any activity that includes the provision of financial services such as credit, savings, and insurance to low income individuals which fall just above the nationally defined poverty line, and poor individuals which fall below that poverty line, with the goal of creating social value. The creation of social value includes poverty alleviation and the broader impact of improving livelihood opportunities through the provision of capital for micro enterprise, and insurance and savings for risk mitigation and consumption smoothing. A large variety of actors provide microfinance in India, using a range of microfinance delivery methods. Since the founding of the Grameen Bank in Bangladesh, various actors have endeavored to provide access to financial services to the poor in creative ways. Governments have piloted national programs, NGOs have undertaken the activity of raising donor funds for on-lending, and some banks have partnered with public organizations or made small inroads themselves in providing such services. This has resulted in a rather broad definition of microfinance as any activity that targets poor and low-income

individuals for the provision of financial services. The range of activities undertaken in microfinance include group lending, individual lending, the provision of savings and insurance, capacity building, and agricultural business development services. Whatever the form of activity however, the overarching goal that unifies all actors in the provision of microfinance is the creation of social value.

2. Activities in Microfinance

Micro credit: It is a small amount of money loaned to a client by a bank or other institution. Micro credit can be offered, often without collateral, to an individual or through group lending.

Micro savings: These are deposit services that allow one to save small amounts of money for future use. Often without minimum balance requirements, these savings accounts allow households to save in order to meet unexpected expenses and plan for future expenses.

Micro insurance: It is a system by which people, businesses and other organizations make a payment to share risk. Access to insurance enables entrepreneurs to concentrate more on developing their businesses while mitigating other risks affecting property, health or the ability to work.

Remittances: These are transfer of funds from people in one place to people in another, usually across borders to family and

Friends. Compared with other sources of capital that can fluctuate depending on the political or economic climate, remittances are a relatively steady source of funds.

3. Legal Regulations

Banks in India are regulated and supervised by the Reserve Bank of India (RBI) under the RBI Act of 1934, Banking Regulation Act, Regional Rural Banks Act, and the Cooperative Societies Acts of the respective state governments for cooperative banks.

NBFCs are registered under the Companies Act, 1956 and are governed under the RBI Act. There is no specific law catering to NGOs although they can be registered under the Societies Registration Act, 1860, the Indian Trust Act, 1882, or the relevant state acts. There has been a strong reliance on self-regulation for NGO MFIs and as this applies to NGO MFIs mobilizing deposits from clients who also borrow. This tendency is a concern due to enforcement problems that tend to arise with self-regulatory organizations. In January 2000, the RBI essentially created a new legal form for providing microfinance services for NBFCs registered under the Companies Act so that they are not subject to any capital or liquidity requirements if they do not go into the deposit taking business. Absence of liquidity requirements is concern to the safety of the sector.

4. Microfinance in India

At present lending to the economically active poor both rural and urban is pegged at around Rs 7000 crores in the Indian banks’ credit outstanding. As against this, according to even the most conservative estimates, the total demand for credit requirements for this part of Indian society is somewhere around Rs 2,00,000 crores.

Deprived of the basic banking facilities, the rural and semi urban Indian masses are still relying on informal financing intermediaries like money lenders, family members, friends etc.