The Determinants of the Financial Performance of Microfinance Institutions: Impact of the Global Financial Crisis

• Published date: 01 March 2015
• Author: Erwan Le Saout,Lâma Daher
• DOI: http://doi.org/10.1002/jsc.2002
• Date: 01 March 2015

Strat. Change 24: 131–148 (2015)

Published online in Wiley Online Library

(wileyonlinelibrary.com) DOI: 10.1002/jsc.2002 RESEARCH ARTICLE

Copyright © 2015 John Wiley & Sons, Ltd.

Strategic Change: Brie ngs in Entrepreneurial Finance

Strategic Change

DOI: 10.1002/jsc.2002

The Determinants of the Financial Performance of

Micro nance Institutions: Impact of the Global

Financial Crisis

1

Lâma Daher

University Paris 1 Panthéon-Sorbonne (PRISM) , France

Erwan Le Saout

University Paris 1 Panthéon-Sorbonne (PRISM) , France

 e micro nance industry has encountered several local crises during the period

following the declaration by the United Nations of 2005 as the International Year

of Microcredit, including Morocco in 2007, Bosnia-Herzegovina, Nicaragua, and

Pakistan in 2008, India in 2005 and 2010. Eager to fully cover their costs, micro-

 nance institutions (MFIs) enjoy a much higher interest rate policy than conven-

tional commercial banks ( Fernando, 2006 ; Ashta, 2009 ; Rosenberg et al ., 2013 ).

 e relatively high prices of micro nance products, namely microcredit, have been

criticized regarding their fairness in the context of lending to the poor ( Hudon

and Ashta, 2013 ). Other criticisms have portrayed MFIs as exploitative ( Priya-

darshee and Ghalib, 2011 ; Ghosh, 2013 ; Mader, 2013 ). For instance, in India,

the Andhra Pradesh crisis has called attention to the predatory behavior of certain

Indian MFIs, which were accused of deploying harassing methods to extract loan

settlements from their clients.  e suicides committed by some of these resulted

in an investigation as to whether this act was motivated by local political and social

unrest or by the harsh behavior of the lenders ( Ashta et al ., 2011 ).

Moreover, the desire of MFIs to improve their  nancial performance is con-

sidered, by advocates of the welfarist approach, to be the reason behind the high

interest rates charged to clients and their high determination to enhance loan

repayment rates. Following this approach, the pro t-seeking goal of MFIs con icts

with the goal of poverty alleviation ( Hermes et al ., 2011 ) and contributes to the

The most pro table micro nance

institutions are well capitalized,

have a high portfolio quality, low

cost inef ciencies, a high volume

of assets, a high share of

microcredit portfolios, and offer

large loans.

Highly pro table micro nance

institutions are located in Latin

America, and in the least-

developed countries, with good

institutional quality.

The recent international  nancial

crisis has caused a decline in

pro tability of the global

micro nance sector, notably in

2009.

With the growing scarcity of funding and the increasing commercialization of

micro nance institutions, the latter should protect themselves particularly from

the credit default risk of their microcredit portfolios and the risks related to  nancial

market  uctuation in order to optimize their  nancial performance.

1 JEL classi cation codes: C33, G01, G21, G23, G32, L31, O16.

132 Lâma Daher and Erwan Le Saout

Copyright © 2015 John Wiley & Sons, Ltd. Strategic Change

DOI: 10.1002/jsc

Literature review and assumptions

 e  nancial performance of MFIs refers to the process

of measuring the results of their strategies, policies, and

operations in monetary terms. It includes aspects of prof-

itability and  nancial sustainability. Pro tability indicates

how well an institution uses its assets to generate returns.

It can be gauged by the ratio of return on assets (ROA),

calculated as the net income after taxes divided by the

average total assets.  e  nancial sustainability indicators,

expressing the ability of the MFI to survive over time,

include operational self-su ciency (OSS),  nancial self-

su ciency (FSS), and the self-su ciency index (SSI).

Although these indicators are largely used in micro nance

research ( Hartarska and Nadolnyak, 2007 ; Mersland and

Strøm, 2009 ; Ahlin et al ., 2011 ; Roberts, 2013 ), we

adhere to the recommendation of the guide on Micro -

nance Financial Reporting Standards (  e Seep Network,

2010 ), which favors the use of pro tability measures

rather than  nancial sustainability measures.  e guide

justi es the rejection of  nancial sustainability indicators

by the fact that they become less helpful as measures of

 nancial performance once an MFI exceeds the breakeven

point (i.e., 100% sustainability).  us, the ROA ratio is

better suited to analyzing an established MFI ’ s  nancial

performance.

We select the determinants mainly after examining

the existing literature, and consider  nancial performance

as a function of industry-speci c, internal, and external

factors. Many authors have indicated an interest in survey-

ing the literature related to the  nancial performance of

the micro nance industry; for instance, see Milana and

Ashta ( 2012 ) and Daher and Le Saout ( 2013 ).

Industry-speci c factors

We explore the in uence of the following industry-speci c

factors on pro tability: legal form, pro t status, experi-

ence, regulation scheme, and geographical location. We

cannot clearly predict the impact of these factors on MFI

pro tability; furthermore, the literature reported miti-

gates the results in this regard.

so-called mission drift of micro nance ( Christen and

Drake, 2002 ). However, the advocates of the opposing

approach, the institutionalists, argue that micro nance

will not be e cient in poverty reduction unless MFIs

improve their  nancial performance ( Christen, 2001 ). In

fact, with the increasing scarcity of free external  nancing

and subsidized loans, and ever more demanding investors,

the critiques of the pursuit of pro t maximization can be

reproached for being outdated and counter-strategic.

Funds from private and public investors, especially foreign

capital investments, as well as loans from commercial

banks, are applied to revenue-generating investments.  e

focus of these new market sources of funding is on pro t-

ability ( Ghosh and Van Tassel, 2011 ). MFIs should there-

fore concentrate on enhancing their  nancial performance

in order to carry on and grow.  e resulting high level of

MFI com mercialization might raise new risks though,

namely foreign exchange rate  uctuations and  nancial

market downturns.

 ese reasons prompt us to inspect the  nancial per-

formance of MFIs using one-way and two-way panel data

regressions.  is innovative econometric methodology

allows us to consider the heterogeneity among MFIs and

across years.  e present article has three main objectives.

First, we investigate the determinants of  nancial perfor-

mance from within the MFIs and their country-level

context. We test the e ect of some new variables that have

not been investigated so far, namely the devaluation of the

local currency. Second, we examine the existence of dif-

ferences in  nancial performance between MFIs based on

their industry-speci

c characteristics, such as experience,

legal form, geographical location, and so on.  ird, we

inspect the impact of the recent global monetary crisis of

late 2007–early 2008 on the  nancial performance of

MFIs.  is article is organized as follows. In the subse-

quent section, backed by a broad literature review, we set

out our assumptions regarding the determinants of  nan-

cial performance. Next we describe the data, after present-

ing the applied models, and discuss our empirical results.

Lastly, we conclude.