PERFORMANCE OF MICROFINANCE: THE ROLE OF SUBSIDIES Ahmad Nawaz 04.02.20101Seminar Series, PIDE...

Seminar Series, PIDE 1

PERFORMANCE OF MICROFINANCE: THE ROLE OF SUBSIDIES

Ahmad Nawaz

04.02.2010

Pakistan Institute of Development Economics

Seminar Series, PIDE 204.02.2010

Objectives of the Study

Motivation

Estimating the performanceSubsidy Dependence Index (SDI)

Introduction --- Theoretical Framework --- Data Sources--- Descriptive AnalysisWith & without subsidy analysis

Conclusion



Objectives of the studyIn General:“To make the case for subsidy-adjustments when it comes to evaluation of the performance of microfinance”And in particular:• to calculate a decent measure of sustainability of microfinance taking into account the subsidies• calculate how much the subsidization of Microfinance costs to the society•How subsidization of microfinance relates to various organizational and institutional factors• To pin down the factors affecting the sustainability of microfinance



Motivation

Incorporation of role of subsidies in the performance evaluation of MFIs: a neglected area

Win-Win proposition?: the promise of Microfinance for strong social performance alongwith financial self sustainability remains unmet

The recent drive towards commercialization of Microfinance The importance of the impact of various strategic,

organisational and operational variables on the efficiency of Microfinance Institutions

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TYPE Notation Type of grant1. Direct Grant DG

Equity Grant (EG)2. Paid-up-capital PC

3. Revenue Grant RG

Profit Grant (PG)4. Discount on Public Debt A.(m-c)

5. Discount on Expenses DX

6. True Profit TP Equity Grant (EG)

Introduction : What constitutes subsidies?

These are subsidized/public funds from government or donors and come in six forms:

Total Subsidised funds consists of Equity Grants and Profit Grants.Equity Grants increases net worth but do not directly change the accounting profitProfit grants increases directly the accounting profit since they inflate revenues



• Role of Subsidies : Two strand of Thoughts Which justifies the positive role of subsidy

notwithstanding poverty alleviation (Hulme & Zeller) The others are skeptical of the long run role of subsidies:

the notion of smart subsidies (Hendricks, 2003; Aghion & Morduch, 2004; Morduch 2005)

• Yaron´s Subsidy Dependence Index (SDI) • Measures the social cost of subsidized Financial

Institution in short time frames such as year• It is the ratio of the (annual) subsidies against the

interest income of the Financial institution

Measuring the performanceInstitutionalist perspective : Outreach & Sustainability



SDI = subsidies (S) / revenues from lending (LP * i)= (E * m + A (m - c) + K – P) / (LP * i)

Where:• E = average annual equity• m = Market Interest rate or Interest rate the MFI is assumed to pay for

borrowed funds if access to concessional borrowed funds were eliminated • A = Average annual outstanding concessionary-borrowed funds or Average

public debt• c = actual interest rate paid on concessionary borrowed funds or interest

rate paid on Public debt • P = Reported annual profit or accounting profits• K = Other Subsidies received by the MFI (RG + DX) • LP = Average annual outstanding loan portfolio of the MFI• i = yield on lending or interest rate charged to borrowers

Theoretical Framework: The SDI Formula



The Choice of Opportunity cost of concessional borrowing Evidence from existing literature Deposit rate as proxy (Khandker, Khalily, and Khan, (1995) as Rate on three year

Deposit (Bangladesh) ; Hashemi and Schuler (1997) as Transaction costs (3%) + Bangladesh Bank deposit rate (IMF) ; Morduch, (1999b) as Bangladesh Bank deposit rate(IMF) + 3% transaction costs; Sacay, Randhawa, and Agabin, 1996 as deposit rate ; Yaron, Benjamin and Piprek (1997) as market deposit rate; Schreiner and Yaron (1999) as Deposit rate paid by MFI + 3% transaction costs)

Inflation rate (Rosenberg, Christen, and Helms, 1997; Holtmann and Mommartz, 1996; Christen et al., 1995; SEEP, 1995; IADB, 1994)

10% rule of thumb (Belli, 1996; Katz and Welch, 1993; Gittinger, 1982) Benjamin Formula Prime rate (lending rate) + Premium for RiskWhere, Premium for risk = premium for age + premium for profitability Commercial banks Lending rate

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An ExampleSDI = subsidies (S) / revenues from lending (LP * i)

= (E * m + A (m - c) + K – P) / (LP * i)

A value of 0.25 shows that the subject MFI is subsidy dependent. In order to be subsidy free, the interest rate has to be increased by 25%. In other words, it distorts public wealth.

A value of -0.10 shows that an MFI is subsidy-free and it will remain subsidy-free even if it deacreses interest rate by 10%. In other words, it creates public wealth.

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Year 2005 2006

SDI Value 0.25 -0.10

Type Subsidy dependent Subsidy free



• Audit Reports of 204 MFIs for SDI calculations taken from MIX Market Website for years 2005 & 2006

• MIX Market Website (www.mixmarket.org)• International Monetary Fund, International Financial

Statistics, Washington, D.C. 2005 & 2006• Respective MFIs Websites• Annual Reports of respective MFIs• Third Party Rating Reports of MFIs• World Development Indicators• Direct contact with MFIs

Sources of Data



• Region Africa (A), South Asia (SA), Latin America (LA), Middle East & North Africa (ME & NA), Central Asia & Eastern Europe (CA & EE), East Asia & Pacific (EA & P)

• Status Banks, Cooperatives, Non-Governmental Organizations (NGOs), Non-Banking Financial Institutions (NBFI), Rural Banks

• Lending Methodology Individual Lending (I), Solidarity or Groups (S), Individual & Solidarity Lending (IS), Village Banking (V)

• Saving Yes or No

• Regulated Yes or No

• Other Services Yes or No

Institutional Variables



Descriptive analysis of Data

32.35%

48.04%

13.24%

6.373%

I IS SV

LENDING METHODOLOGY*

23.04%

14.71%

9.314%

33.33%

5.392%

14.22%

Africa CA&EE EA&PLA ME&NA SA

REGION

14.71%

5.392%

29.41%

46.08%

4.412%

Bank Coop. NBFINGO R.Bank

STATUS

42.65%

57.35%

No Yes

REGULATED

59.8%

40.2%

No Yes

OTHER SERVICES

44.61%

55.39%

No Yes

SAVINGS



Camparison between using different interest rates

Year 2005 Year 2006SDI (Lending

rate)SDI (Benjamin,

1994)SDI (Lending

rate)SDI (Benjamin,

1994)No risk

premiumwith risk premium

No risk premium

with risk premium

Subsidy Dependent 153 179 122 155

Subsidy Free 51 25 57 24

Total 204 204 179 179

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The SDI in institutional setting

-.1

0

.1

.2

.3

SD

I

Bank Coop. NBFI NGO R.Bank

STATUS

0

.1

.2

.3

SD

I

I IS S V

Lending Methodology

0

.05

.1

.15

.2

.25

SD

I

No Yes

SAVINGS

0

.05

.1

.15

.2

.25

SD

I

No Yes

REGULATED

0

.05

.1

.15

.2

.25

SD

I

No Yes

Other Services

0

.1

.2

.3

.4

SD

I

Africa CA&EE EA&P LA ME&NA SA

REGION



Return on Asset (ROA) Vs Subsidy Adjusted ROA

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-.05

0.0

5.1

.15

Valu

e


by Region

ROA and SAROA

ROA SAROA0

.02

.04

.06

Va

lue

Bank Coop. NBFI NGO R.Bank

by Status ROA and SAROA

ROA SAROA

-.0

20

.02

.04

.06

Va

lue

I IS S V

by Lending Methodology

ROA and SAROA

ROA SAROA

0.0

1.0

2.0

3.0

4.0

5V

alu

e

No Yes

by Other Services ROA and SAROA

ROA SAROA

0.0

2.0

4.0

6.0

8V

alu

e

No Yes

by Regulated ROA and SAROA

ROA SAROA0

.02

.04

.06

.08

Va

lue

No Yes

by Saving ROA and SAROA

ROA SAROA



Return on Equity (ROE) Vs Subsidy Adjusted ROE

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-.4

-.2

0.2

.4V

alu

e


by Region

ROE and SAROE

ROE SAROE-1-1

-.5

-.5

00.5.5

Va

lue

Va

lue

BankBank Coop.Coop. NBFINBFI NGONGO R.BankR.Bank

by Status

ROE and SAROE

ROEROE SAROESAROE

-.2

-.1

0.1

.2V

alu

e

I IS S V


ROE and SAROE

ROE SAROE

-.1

-.0

50

.05

.1.1

5V

alu

e

No Yes

by Other Services

ROE and SAROE

ROE SAROE

-.1

-.0

50

.05

.1.1

5V

alu

e

No Yes

by Regulated

ROE and SAROE

ROE SAROE

-.0

50

.05

.1.1

5V

alu

e

No Yes

by Savings ROE and SAROE

ROE SAROE



Actual Vs Nominal Subsidy-free Yield

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0.1

.2.3

.4.5

Val

ue


by Region

Actual Yield (AY) and Subsidy Free Yield(SFY)

AY NSFY0

.1.2

.3.4

Val

ueBank Coop. NBFI NGO R.Bank

by Status


AY NSFY

0.2

.4.6

.8V

alue

I IS S V



AY NSFY

0.1

.2.3

.4V

alue

No Yes

by Other Services


AY NSFY

0.1

.2.3

.4V

alue

No Yes

by Regulated


AY NSFY

00.1.1

.2.2.3.3

.4.4V

alue

Val

ue

NoNo YesYes

By savings


AYAY NSFYNSFY



Important factors affecting the sustainability

For MFIs which become subsidy-free Increase in porfits results from• Increase in interest income from lending & investment• Decrease in market lending rate....borrowing cheap• Elimination of revenue grantsFor MFIs which become subsidy-dependent• Increase in market lending rate• Decrease in actual cost of borrowing• Decrease in interest income from lending• Increase in revenue grants

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Conclusion

• Microfinance sector is highly subsidized. • MFIs located in SA and Africa have relatively low performance and thus

are highly subsidized. LA MFIs perform better relative to the others.• MFIs with group lending features have relatively low perfromance while

those which only lend to individuals perfrom relatively better.• MFIs with NGO and Bank status perform relatively low while those

having NBFIs have perform better.• MFIs providing other services and regulated relatively perform low with

high subsidy dependence.• Conventional financial ratios do not depict the reality. The results show

that when adjusted for subsidies, the financial performance of MFIs decline substantially.

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Policy Implications

• For governments and donors, measurement of social cost of subsidization helps them taking informed policy decisions in making the best use of public funds earmarked for the poor

• for the microfinance practitioners, the essay not only puts a price tag on their institution in terms of costs to the society but also pins down the important factors which contribute towards financial sustainability by reducing subsidy dependence

• for social investors, it serves as a guide to the in evaluating their investment in projects which increase the public wealth of the society at large

• for microfinance clients, it is awareness towards the importance of transparent prices in microfinance particularly for those clients to whom MFIs charge exorbitant interest rates.

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Thanks for your attention

04.02.2010


PERFORMANCE OF MICROFINANCE: THE ROLE OF SUBSIDIES Ahmad Nawaz 04.02.20101Seminar Series, PIDE...

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