Written by Roy Mersland of Agder University and R. Oystein Strom of Ostfold University College, this report analyzes the relationship between firm performance and corporate governance in Microfinance Institutions (MFIs). It studies the effects of ownership type, competition and regulation using a global data set on MFIs, collected from third-party rating agencies. The 36 page document was published by the University Library of Munich, Germany in June 2007 and the full text of the report is available here.
What follows is a summary of the report:
MFIs typically have two goals i.e. to increase outreach and to achieve financial sustainability and independence from donors. To measure financial performance, the study uses return on assets (ROA), operational costs and portfolio yield of the MFIs which were surveyed. Outreach is measured by the MFI’s average outstanding loan (measure of depth) and the number of credit clients served (measure of breadth).
The study identifies two kinds of governance mechanisms – 1) internal which comprise the functions of the CEO/ board and the ownership type and 2) external which include product market competition and regulation. With regard to internal governance, the primary hypothesis is that ownership type (whether Non Profit Organizations (NPOs) or Share Holder Firms (SHFs)) does not matter in case of financial performance and outreach of MFIs. From an external governance perspective, the study hypothesizes that increased competition will increase outreach and efficiency levels (thereby acting as a substitute mechanism for internal governance) and lower the return on assets (ROA).
The dataset for the study contained information from risk assessment reports made by five rating agencies: MicroRate, Microfinanza, Planet Rating, Crisil and M-Cril. The rating reports of a total of 226 MFIs were analyzed for the period 2000-2006 with a vast majority of data analyzed for the years 2004, 2005 and 2006.
The results of the study show that ownership type of MFIs is not a key determinant for financial performance. Ownerless MFIs such as NPOs are as capable of producing a favorable or unfavorable financial performance as a shareholder owned MFIs (SHFs). Further, the results show no significant difference in the depth and breadth of outreach of SHFs and NPOs. The study infers that SHFs are not just focused on satisfactory financial results but also equally committed to reaching out to poor clients. Likewise, NPOs sometimes curtail the depth of their outreach in order to perform well financially and sustain lending. Additionally, MFIs which combined the roles of CEO and Chairman were found to have a lower return on assets than MFIs which split the two roles. MFIs with female CEOs had higher return on assets (ROA) and lower operational costs.
The results show that increase in competition lowers interest rates to clients and return on assets. Increase in competition force MFIs to become more efficient and this indirectly substitutes the need for specific internal governance mechanisms by the owners of the MFIs. The lack of such internal governance mechanisms may weaken MFI-customer long-time relationships and when relationships are undermined through competition, the MFI’s financial performance is weakened. MFIs which focus on group lending as opposed to individual lending reach poorer fractions of the population and thereby have greater depth of outreach. However, group lending did not contribute positively to the financial performance of the MFIs. MFIs which concentrated more on individual loans than group loans fared better financially.
The report concludes that some ‘assumed’ truths of microfinance need rethinking, specifically the following:
– The call for transformation of NPOs into shareholder firms for better performance. The study instead states that NPOs may work better than SHFs for certain clients.
– The emphasis on group lending in order to keep up and strengthen close ties with customers. The study reveals strengthening customer ties need not necessarily be done through group lending as this approach increased costs.
The report raises one pertinent question – “Are MFIs becoming less concerned about outreach and more about financial performance?” – and calls for more investigation into the reasons behind the almost performance of NPOs and SHFs both in terms of outreach and financial stability.
By Bharathi Ram, Research Assistant
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[…] The study identifies two kinds of governance mechanisms – 1) internal which comprise the functions of the CEO/ board and the ownership type and 2) external which include product market competition and regulation. With regard to internal governance, the primary hypothesis is that ownership type (whether Non Profit Organizations (NPOs) or Share Holder Firms (SHFs)) does not matter in case of financial performance and outreach of MFIs. From an external governance perspective, the study hypothesizes that increased competition will increase outreach and efficiency levels (thereby acting as a substitute mechanism for internal governance) and lower the return on assets (ROA)… [click here to read the rest of this article…] […]