MICROFINANCE PAPER WRAP-UP: Where Does Microfinance Flourish? Microfinance Institution Performance in Macroeconomic Context, by Christian Ahlin, Jocelyn Lin and Michael Maio

By Christian Ahlin, Jocelyn Lin and Michael Maio, published by the Journal of Development Economics, April 27, 2010, 16 pages, available at: http://news.msu.edu/media/documents/2010/06/8d6d8126-97dd-4569-b65b-736f700fc844.pdf

Mr Ahlin, Ms Lin and Mr Maio study whether and how the success or failure of microfinance institutions (MFIs) depends on the country-level context, particularly macroeconomic and macro-institutional features. In order to explore these questions, the authors reviewed data on 373 MFIs from 74 countries. The authors rely on two groups of MFI performance variables: operational self-sufficiency (the ratio of revenues to costs) and loan portfolio growth. Operational self-sufficiency is broken down into three components: financial revenues and costs, losses due to default and operating costs, so that, in some cases, the authors are able to identify the channel through which a given macroeconomic variable is correlated with the financial sustainability of a MFI. MFI portfolio growth is decomposed into two components: growth in number of borrowers (extensive growth) and growth in average loan size (intensive growth).

This data set is then merged with country-level economic and institutional data from the World Bank’s World Development Indicators (WDI) and the World Bank’s ‘Doing Business’ Indicators. The four main indicators of economic performance and structure are: growth in per capita GDP (Gross Domestic Product ? an approximation of the value of goods produced in the country), labor force participation rate, manufacturing’s share in GDP and private credit as a fraction of GDP. A number of additional variables including inflation and income inequality are also taken from WDI.

Using linear regression analysis, the authors find strong macroeconomic predictors of MFI performance. First, MFIs cover costs better when macroeconomic growth is higher, due in large part to lower default rates and operating costs. Financial depth, which is the a measurement of the strength and security of the country’s financial market, is also associated with lower default and operating costs. However, this generally translates into lower interest rates rather than greater MFI self-sufficiency, which suggests that financial market competition may be good for borrowers.

The authors also found that MFIs generally grow more successfully in countries with less of a manufacturing base likely because manufacturing jobs tend to crowd out the more entrepreneurial-related jobs generally supported by microloans. Similarly, MFIs perform better in countries with lower workforce participation rates.

The study also suggests that the structure of the economy impacts MFI performance. A large service sector predicts faster MFI growth, while a larger rural population and/or agricultural sector predicts lower default, operating costs and interest rates. This result is somewhat surprising as the common perception is that costs are higher in rural areas due to the lack of infrastructure and the larger transportation costs. The authors, however, hypothesize that there is greater social cohesion in rural contexts, which lowers monitoring, collection and default costs. It may also be that rural borrowers benefit more from and are more reliant on MFIs, which leads to greater repayment discipline. Although this does not result in higher profits for the MFI, it does lead to lower interest rates for borrowers.

Higher inequality, measured by the gini coefficient, is associated with higher default and operating costs, higher interest rates and lower MFI sustainability. The study also finds that better developed governing institutions can negatively impact MFIs by driving up costs, which may suggest that borrowers may benefit from a more hands-off regulatory approach. Again, this runs contrary to the idea that regulation protects borrowers from unfair practices, such as unreasonably high interest rates.

Overall, the study suggests that country context is an important determinant of MFI performance. Although the results may suggest that MFIs generally perform better in countries with faster growing economies, there are several other variables at work, such as the country?s manufacturing base, workforce participation rate, economic structure, inequality and regulation.

By Conner Brannen, Research Assistant

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