The Financial Sustainability of Micro-Finance Institutions in Sub-Saharan Africa

Master's Thesis, 2018

103 Pages, Grade: 90.0


Table of Contents

1 Introduction
1.1 Relevance
1.1.1 In Terms of Poverty Alleviation
1.1.2 In Terms of Subsidization
1.1.3 In Terms of Trade-Offs
1.2 Region of Focus: Sub-Saharan Africa
1.2.1 The Situation in Sub-Saharan Africa
1.2.2 Financial Inclusion in Sub-Saharan Africa
1.2.3 Microfinance in Sub-Saharan Africa

2. Literature Review
2.1 Microfinance Industry Overview
2.1.1 Defining Microfinance
2.1.2 Informal Lending as a Type of Microfinance
2.1.3 History of Microfinance
2.1.4 Current Developments in Microfinance
2.1.5 Greenfield Microfinance
2.2 Financial Sustainability
2.2.1 Financial Systems Approach
2.2.2 Indicators for Financial Sustainability
2.2.3 Results from Previous Studies
2.2.4 Financial Sustainability and Interest Rates
2.3 Outreach
2.3.1 Poverty Lending Approach
2.3.2 Findings from Previous Research
2.3.3 Outreach and Operating Costs
2.4 Business Models
2.4.1 Internal Business Practices for Financial Sustainability
2.4.2 Non-Financial Services
2.4.3 Operating Methodology
2.4.4 Benefits of Group Lending
2.5 Challenges for Microfinance
2.5.1 Inadequate Regulation
2.5.2 Over-Indebted Borrowers and Multiple Borrowing
2.5.3 Regional Challenges
2.6 Theories on MFI Funding Processes
2.6.1 Life Cycle Theory
2.6.2 Profit Incentive Theory
2.7 Case Studies of Sustainable MFIs
2.7.1 HSBC India
2.7.2 Triodos Bank
2.7.3 Opportunity International

3. Approach
3.1 Hypothesis
3.2 Methodology
3.3 Framework

4. Data
4.1 Source – Mix Market
4.2 Definitions for Indicators
4.2.1 Basic Information
4.2.2 Operational Self Sufficiency
4.2.3 Outreach
4.2.4 Other Indicators

5. Analysis
5.1 Data Selection
5.2 Descriptive Statistics
5.3 Basic Data Analysis
5.4 Correlation Analysis
5.5 Regression Analysis
5.6 Findings

6 Specific MFI Analysis
6.1 Data Selection
6.2 Correlation Analysis
6.3 Findings

7 Implications for Business Models

8 Concluding Remarks
8.1 Interpretation of Findings and Discussion
8.2 Limitations
8.2.1. Bias
8.2.2 Faulty Data
8.2.3 Regression Limitations
8.3 Recommendations for Future Research

9. References

10 Appendix
10.1 Ethics Statement (Affidavit)
10.2 Data from Research

11 Glossary

I. Abstract


Hanna Kattilakoski

Microfinance institutions exist to provide small scale loans to those who otherwise do not have access to financial resources as a means for poverty alleviation. Recently, the topic of financial sustainability in MFIs has become more important as an increasing number of institutions seek operational self-sufficiency. In the past, many MFIs have been mostly funded through subsidies, which is not a sustainable funding method for MFIs. The aim of this study is to understand the factors that drive financial sustainability in microfinance institutions. To accomplish this, several indicators for operational self-sufficiency (OSS) were investigated through correlation and regression analysis. The results indicate that the drivers for operational self-sufficiency include return on assets, number of active borrowers and profit margin. The analysis also showed that in terms of OSS and profitability, there is little difference between for-profit and non-profit organizations. To increase operational self-sufficiency institutions should increase return on asserts, the number of active borrowers and their profit margin. The results support the profit-incentive theory and the financial systems approach. These results indicate that to achieve financial sustainability MFIs should focus on covering operating expenses through earned revenues. Therefore, MFI structure should encourage cost-oriented management. Additionally, findings from this study revealed that there may not be a large tradeoff in efficiency and outreach. Results showed that operationally self-sufficient MFIs actually have a larger outreach than non-self-sufficient organizations. Limitations for this study include that the regression only explains the variables affecting OSS with 26% certainty and other variables not tested may also be factors.

Key words: microfinance, operational self-sufficiency, financial sustainability

II. Personal Statement

Since my first visit to Uganda in May of 2014, poverty alleviation efforts have been close to my heart. I went to Uganda as an undergraduate at Baylor University with the accounting department for an Accounting Mission Trip. For the first time in my life, I saw what poverty looked like. The aim of the mission trip was to lead a business conference in conjunction with the Pastor’s Discipleship Network in Uganda to teach Ugandan pastors and their wives about basic business practices (and of course, accounting). Specifically, my team worked with a small group of 10 entrepreneurs in a business development seminar. Firsthand, I had the chance to listen to the problems they faced as entrepreneurs and hear about how they conduct business within their communities. At the end of the week, a small loan was given to two of the entrepreneurs for them to further develop their businesses. This sparked my interest in microfinance and has since been a topic I have been passionate about.

Since 2014, I have visited Uganda twice more. Each visit brings me joy as I see how much the country has developed. During my other visits, I have worked together with Global Hands of Hope to end generational poverty within a community in the town of Bukeka.

To read more about how Global Hands of Hope and the Pastor’s Discipleship Network are working in Uganda, please visit: and

III. Acknowledgements

I would like to thank my parents for their continued support for all of my endeavors – even when it meant moving to the other side of the world for a master’s degree.

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I would like to thank Dr. John Ssozi for encouraging me to continue writing and researching microfinance. As he stated, “there is still more work to be done.”

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I would like to thank Dr. Laxmi Remer for being my advisor for this thesis and for providing me with guidance and encouragement.

Table of Figures

Figure 1: Region of Focus: Sub-Saharan Africa

Figure 2: Population in Poverty (as % of total population) in Sub-Saharan Africa

Figure 3: Population with an Account at a Financial Institution in Sub-Saharan Africa

Figure 4: Triodos Bank Financed MFI Financial Information (2016 or Most Recent)

Figure 5: Descriptive Statistics of Entire Data Set

Figure 6: Descriptive Statistics for Specific Data

Figure 7: Comparison of Operational Self-Sufficiency

Figure 8: Comparison of Legal Status

Figure 9: Comparison of Outreach (For-Profit vs Non-Profit)

Figure 10: Comparison of Outreach (OSS vs Non-OSS)

Figure 11: Operational Self-Sufficiency in Non-Profit vs For-Profit Organizations

Figure 12: Regression Analysis

Figure 13: Correlation with OSS Results

1 Introduction

Microfinance institutions exist to provide small scale loans to those who otherwise do not have access to financial resources, which associates microfinance with poverty alleviation efforts. However, many microfinance institutions (MFIs) are financially unsustainable and financed mostly through donations or subsidies, creating an impasse for the long-term sustainability of these institutions. The research question for this thesis is how microfinance institutions’ business models are structured in order to facilitate financial sustainability in Sub-Saharan Africa?

With a majority of MFIs financially unsustainable, the growing industry faces challenges in continuing to serve poor populations. Many MFIs depend on donors to provide a steady flow of subsidies in order for them to continue operations (Quayes, 2012). Financial sustainability would allow an MFI independence from subsidies and the opportunity to continue outreach to populations with unmet needs. Non-self-sufficient MFIs, however, may not be able to continue operations due to lack of funding, thus diminishing their ability to aid in poverty alleviation. Therefore, financial sustainability is important for aiding in poverty alleviation as well as for the long-term operations for an MFI.

Microfinance has already reached approximately 130 million clients, indicating that the market is already fairly established. However, microfinance has only reached less than 20% of its potential market of the 3 billion impoverished people in the world (International Finance Corporation, n.d.). Although many MFIs have shown great success in outreach, “millions of low income individuals in developing countries still lack access to financial services” (Bogan, 2012). With an estimated CAGR of more than 15% by 2020, Microfinance is a rapidly growing industry (Technavio, 2016). The challenge, however, remains in reducing an MFI’s dependence on subsidies.

When a majority of MFIs are financed through subsidies, governments or donations, is it possible for microfinance to be a profitable industry? If so, what sort of business model is required? What characteristics do sustainable institutions have in common with one another?

Is outreach compromised with financial sustainability? These questions and more will be further investigated.

The aim of this research paper is to understand what factors influence financial sustainability in MFIs. The structure for the research will be to first discuss the relevance of the topic, followed by an analysis of current literature. The literature review will first investigate microfinance in general, with a focus on the definition, the history as well as current developments within the industry. The rest of the literature review will cover different areas of microfinance institutions, including theories on financial sustainability, outreach and business models. Challenges the industry is facing will also be discussed, and the section will end with some case studies discussing actual MFIs in practice, and how they approach financial self-sustainability. The methodology of this paper will be mostly a quantitative analysis, with an inductive approach. The data used is from the Microfinance Information Exchange (MIX Market), which is one of the leading providers of data for microfinance research. The data will then be analyzed using statistical processes, and the paper will end with conclusions and a brief discussion.

1.1 Relevance

Financial sustainability in microfinance organizations is paramount because it enables an MFI to achieve both their long-term and short-term goals. According to Bayar (2013), the total demand in microfinance markets is about 500 million people, indicating a large unmet demand and potential for further growth within the microfinance industry. Overall, penetration rates are low, ranging from 0.5 percent in Eastern Europe and Central Asia to about 2.5 percent in South Asia (Gonzalez & Rosenberg, 2006). To meet this need, MFIs are promoting financial inclusion through financial services to the poor (Chikalipah, 2017). Unfortunately, the industry situation is that there is an overwhelming number of unprofitable MFIs, which serve about 56 percent of all micro-borrowers. However, this number does not even include the extremely small MFIs, which are likely to be unprofitable, that do not report financial information (Gonzalez & Rosenberg, 2006).

MFIs remain subsidized because of their importance to poverty alleviation. There is a well acknowledged tradeoff in the industry between sustainability and outreach. The tradeoff assumes that if an MFI focuses on financial sustainability, their outreach will be compromised, since they will likely have to increase interest rates to compensate for higher operating expenses. Likewise, if an MFI focuses solely on financial inclusion and outreach, they are likely to be unprofitable because they are unable to cover the excessive costs of reaching the extremely poor.

However, financial sustainability has recently become more important for the microfinance industry. Thus, MFIs have seen improving results in profitability over time. With this increasing profitability within the microfinance industry, new players are emerging and entering the market. The expansion of the microfinance industry will continue to meet the demand for about 250 million customers in the future (Bayar, 2013). Additionally, there is a business need for MFIs to be financially sustainable, because financially self-sufficient MFIs are able to use a wider array of financial resources, such as borrowing from banks or through capital markets (Gibbons & Meehan, 1999). Therefore, financial sustainability is an ongoing, relevant issue within the microfinance industry.

There are three main points to be discussed when it comes to the relevance of financial sustainability to microfinance institutions. Those are in terms of poverty alleviation, in terms of subsidization and in terms of the tradeoff between sustainability and outreach.

1.1.1 In Terms of Poverty Alleviation

In terms of poverty alleviation, financial sustainability is critical for the long-term success of microfinance organizations in aiding the transformation of communities through financial inclusion. While normal financial institutions would not provide loans to these poor individuals, these are exactly the clients that MFIs are targeting. Impoverished individuals struggle to obtain any financial help from traditional banks because of the lack of collateral or assets under their name. This is where microfinance organizations fill the gap; they are able to offer loans or other financial services to the impoverished people, which in turn aids in poverty alleviation. When these individuals receive loans, they are given an opportunity.

Often, loans are used to establish a business that provides income for their families, or even to purchase assets that can be used in entrepreneurial activities. Therefore, MFIs are actively helping in poverty alleviation and are critical in meeting the needs of an underserved market.

However, meeting the needs of this underserved market is rather costly. Many organizations are unable to fund these types of ventures. Especially in the rural areas of Sub-Saharan Africa, operating costs can run high and capital constraints limit the outreach MFIs can have (Bogan, 2012). These costs and capital constraints have prevented MFIs from meeting the demand for their services. Thus, the need to continue aiding in poverty alleviation makes financial sustainability an important topic for MFIs. Without financial sustainability, reaching the long-term goal of aiding in poverty alleviation is more difficult since MFIs are constantly depending on third parties for funding (Daher & Le Saout, 2013; Otero, 1999). Ultimately, several researchers have concluded that financial sustainability is a pre-requisite for achieving higher rates of outreach and having the most impact on poverty alleviation.

1.1.2 In Terms of Subsidization

In terms of subsidization, subsidies are important in that they allow a MFI to conduct business regardless of whether they are financially self-sufficient or not. However, subsidization is also a root cause of MFIs not achieving financial sustainability. Research has found that the intensity of subsidies is associated with lower sustainability (Hudon & Traca, 2010). As MFIs receive more funding, they are less dependent on the success of their own operations. Financial performance of MFIs is seen to significantly decline without the use of subsidies (Nawaz, 2010). However, the use of subsidies remains extremely common within the microfinance industry and institutions are rarely created without support from donors.

Subsidization occurs in microfinance because of how important these institutions are for the communities and for poverty alleviation efforts. Subsidies help cover the cost of funds and administrative costs, which in turn increases the outreach an organization can have (Hudon & Traca, 2010). Additionally, MFIs can offer borrowers with lower interest rates that they are more likely to be able to afford. Subsidies are particularly important in more remote areas, where individuals are harder to reach, and thus, administrative costs of loaning and doing business are higher. There are several players that work to sustain microfinance institutions, including government agencies, public donors, insurance companies, investment funds, individual investors, rating agencies, money transfer companies, and mobile network carriers (Daher & Le Saout, 2013).

There has been concern within the industry that there is an excessive amount of subsidization occurring. Although MFIs may claim that they are profitable, they may still use subsidies to cover costs in their operations (De Aghion & Morduch, 2004; Hudon & Traca, 2010). Excessive subsidization can also distort the market, which hurts the microfinance industry as a whole and can prevent commercial institutions from entering the market (Hudon & Traca, 2010). While subsidization can be helpful in helping new organizations start-up and covering expenses in regions with high operating costs, over-subsidization is a threat for the industry and subsidization takes away from the financial sustainability of MFIs.

1.1.3 In Terms of Trade-Offs

In terms of trade-offs, financial sustainability is relevant in that it is one side of the paradox. By definition, an MFI has a dual objective: to cover its costs (self-sufficiency) and to reach many poor borrowers (outreach) (Hartarska & Nadolnyak, 2007). The trade-off states that financial inclusion (outreach) keeps the interest rates of MFIs low, but financial sustainability supports operational self-sufficiency. Most literature is in agreement that there are two extremes: the poverty/outreach approach and the self sustainability approach (Schreiner, 2002). According to Hermes and Lensink (2007), “although this issue is the subject of a heated debate, there is a lack of systematic empirical analyses on the nature and determinants of the trade-off.”

As previously discussed, the poverty and outreach approaches are directed more on improving the standard of living for poor individuals. This approach focuses on the impact of the MFI on the individuals within a community. The success of an MFI with the poverty approach is measured based on how well it fulfills the needs of the poorest individuals in the short term. Mostly, donations fund these MFIs and there is a significant dependence on financial help from third parties. The main justification for subsidizing the MFIs with donations is because of the poverty alleviation efforts MFIs provide (Quayes, 2012).

The self-sustainability approach focuses more on a formal financial system where success is measured through profitability. In the self-sustainability approach, donations cover start-up costs and fund experiments meant to find innovations (Schreiner, 2002). Because of these innovations, in the long term, revenue from clients will be able to cover the costs. There is apprehension about financial self-sufficiency, in that it may adversely affect the mission of social outreach of providing credit access to the poor (Quayes, 2012).

A financially sustainable organization should ideally be able to maintain self-sufficiency while keeping interest rates and operating costs low. According to the concept of social entrepreneurship, a business should be able to be profitable and serve a social need (Martin & Osberg, 2007). While most research agrees that there is a tradeoff, in theory, an MFI can be financially sustainable without compromising on providing help for impoverished communities. While there might still be a tradeoff, financial sustainability is a key aspect in the functioning of an MFI to meet their overall goal of providing loans to a population with an unmet need.

1.2 Region of Focus: Sub-Saharan Africa

The scope of this paper is Sub-Saharan Africa (SSA). The sub-Saharan African region is defined as the following countries: Angola, Benin, Botswana, Burkina Faso, Burundi, Cabo Verde, Cameroon, Central African Republic, Chad, Comoros, Democratic Republic of the Congo, Republic of the Congo, Cote d'Ivoire (Ivory Coast), Equatorial Guinea, Eritrea, Ethiopia, Gabon, Gambia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mali, Mauritania, Mauritius, Mozambique, Namibia, Niger, Nigeria, Rwanda, Sao Tome, Senegal, Seychelles, Sierra Leone, Somalia, South Africa, South Sudan, Sudan, Swaziland, Tanzania, Togo, Uganda, Zambia and Zimbabwe, or a total of 48 nations. Some countries within Sub-Saharan Africa did not report data to the Microfinance Information Exchange, and therefore are not included within this study. Those countries are indicated in red in Figure 1. Figure 1 contains a visual representation for the geographic scope of this research.

Figure 1: Region of Focus: Sub-Saharan Africa

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Source: The World Bank, 2018

This region was chosen because it is an especially poverty ridden area and the MFIs within the region face more challenges than in other regions of the world. More information on the situation in Sub-Saharan Africa as well as microfinance in the region will be discussed.

1.2.1 The Situation in Sub-Saharan Africa

The need for microfinance as a means for poverty alleviation is evident within the region. Although the percentage of Africans who are poor has fallen from 56% in 1990 to 43% in 2012, due to the growing population, the number of poor has increased from 280 million to 330 million respectively (The World Bank, 2016). Extreme poverty remains a challenge especially within the SSA region. Figure 2 depicts the population in poverty as a percentage of total population for each of the countries in this study.

Figure 2: Population in Poverty (as % of total population) in Sub-Saharan Africa

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Source: The World Bank, 2018

Appendix 10.2 shows the complete overview of results of the countries of study, including GDP growth, total population, percent of population in poverty, total population in poverty and percent of population with an account at a financial institution. The values are from the most recent year reported by The World Bank. As an overview, the world average for the population in poverty is 10.7%. In Sub-Saharan Africa, the average is 43%. Additionally, the total population in the countries of focus is about 1 billion. The world population is about 7.4 billion, so the Sub-Saharan region makes up about 13.5% of the world’s population. Additionally, it is estimated that 446 million people in the region live in poverty (at $1.90/day). An estimation of the world’s population in poverty is at 796 million, which means that 56% of the people in the world that are living in poverty live within the Sub-Saharan African region. With such a highly concentrated number of impoverished people, this indicates just how important microfinance is for the African region.

The economic situation in Africa is promising. Again, results from each country can be seen in Appendix 10.2. The world GDP growth rate (in annual %) is 2.50% while the average for the Sub-Saharan African region is 3.02%. It is unclear whether microfinance is affecting the GDP growth, but either way, the region is developing quickly.

1.2.2 Financial Inclusion in Sub-Saharan Africa

In Sub-Saharan Africa, three quarters of the adult population lack access to formal banking services (World Bank, 2014). As of 2014, 29% of adults (aged 15+) in Sub-Saharan Africa held an account at a financial institution, which is an increase from 24% in 2011. Also, in 2014, only 16% of adults had any type of formal savings and 6% participated in formal borrowing (The World Bank, 2014). For comparison, in high income economies, almost 89% of adults have an account at a formal financial institution, and 41% have an account in developing countries (Bayar, 2013). Africa is behind, and this indicates that financial institutions are not prominently used within Africa. Figure 3 further demonstrates the lack of financial inclusion in SSA.

Figure 3: Population with an Account at a Financial Institution in Sub-Saharan Africa

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Source: The World Bank, 2018

As can be seen in Appendix 10.2, the world average for population with an account at a financial institution is 60.7%. Sub-Saharan Africa has a percentage in the 20’s, indicating that most people are not using financial institutions, so there is a low level of financial inclusion. Again, this result further emphasizes how important microfinance institutions are to this region.

1.2.3 Microfinance in Sub-Saharan Africa

Overall, MFIs in Sub-Saharan Africa are struggling. In a study covering Africa, East Asia, Eastern Europe, Latin America, the Middle East and South Asia for the years 2003 and 2006, Africa had the highest percentage of unsustainable MFIs (38.02%), the highest percentage of portfolio at risk (7.03%), and the lowest average return on assets (0.38%) (Bogan, 2012). As the worst performing region, this makes Africa an interesting region of study. Many MFIs in Sub-Saharan Africa are underperforming and struggling to remain in the business (Chikalipah, 2017). In a region where poverty is prominent, financially sustainable MFIs are especially important for them to continue to help the poor.

2. Literature Review

As a relatively new industry, the availability of literature on the topic, specifically regarding Sub-Saharan Africa, is limited (Chikalipah, 2017). Most of the research has been conducted within the last 20 years, making most research on the industry fairly recent. Thus, it is an ongoing topic of discussion, and further research is constantly being done. This literature review aims to provide a comprehensive look at the microfinance industry. During the analysis, aspects of this literature review will be used in the evaluation of business models for sustainable institutions.

The structure for the literature review is as follows. First, microfinance will be defined and the history and current developments will be discussed. Then, an overview on previous research will be conducted, followed by challenges the industry is facing. Theories on the MFI funding processes will be addressed, as well as case studies regarding sustainable and successful MFIs. The previous findings section of this literature review has been separated into three topics: financial sustainability, outreach and business models. The aim of these sections is to discover what previous research has been conducted and which financial indicators have been used. However, not all research will be relevant to the Sub-Saharan Africa region. While financial sustainability is the key topic for answering the defined research question, outreach has a direct impact because of the tradeoffs, so this must be investigated as well. The business models section aims to look at what kinds of structures MFIs maintain. Additionally, challenges will be discussed, and brief case studies will examine how certain MFIs are operating.

2.1 Microfinance Industry Overview

Worldwide, there are an estimated 10,000 microfinance institutions (Platteau & Siewertsen, 2009). However, since this information is from 2009 it is likely outdated, and the number of MFIs has significantly increased since then. The compound annual growth rate is estimated to be more than 15% by 2020 (Technavio, 2016). According to BNP Paribas (2017), there were 123 million customers at microfinance institutions worldwide in 2016, for a loan portfolio of $102 billion indicating just how large the market for small-scale loans is. The potential for growth within microfinance is huge. Additionally, there are over 3,000 MFIs in 110 countries, which represents over 92 million borrowers and 66 million depositors (Bayar, 2013). Growth in the microfinance industry is not new, even from 2004 to 2008, microfinance “enjoyed unprecedented growth in emerging markets” with an average annual asset growth of 43% (Chen, Rasmussen, & Reille, 2010).

Microfinance has a proven history of success in poverty alleviation. In a survey done comparing individuals in microfinance programs and those without access, 57.5% of borrower households from Grameen Bank were no longer poor as compared to 18% of nonborrower households, measured over eight years (Marar, Iyer, & Brahme, 2009). In Indonesia, the average income of Bank Rakyat Indonesia borrowers increased by 112% and 90% of households graduated out of poverty. The article from HSBC puts it best: “although the amounts involved may be small, the services that microfinance offers have been proven to be a powerful instrument for reducing poverty” (Marar et al., 2009).

This section of the literature review will not be specific to Africa, but rather to give an overview of what microfinance is and how it has developed. Microfinance, other types of lending, it’s history, current developments and greenfield microfinance will be further discussed to provide a comprehensive overview of microfinance.

2.1.1 Defining Microfinance

To establish the groundwork for the basis of this thesis, it is important to define the scope of what microfinance is. Microfinance is a type of banking, where small scale loans are offered to those who would otherwise not have access to financial resources. It is an instrument aimed at providing financial services (such as microloans/microcredit, micro-savings, micro-insurance) to low income populations which traditional financial institutions have neglected, thus helping to reduce poverty (Bayar, 2013). Microfinance is different than typical financial services in that it targets clients whom typical banks would not be interested in (Schäfer & Fukasawa, 2011). Microfinance has emerged as a feasible financial alternative for poor people with no access to credit from formal financial institutions. Its objectives include poverty alleviation by fostering small scale entrepreneurship through simple access to credit. It distinguishes itself from formal credit by disbursing small loans to the poor, using various innovative nontraditional loan configurations such as loans without collateral, group lending, progressive loan structure, immediate repayment arrangements, regular repayment schedules and collateral substitutes (Quayes, 2012).

A microfinance institution then, is an institution that offers financial services to these target clients. The target clients are generally impoverished people within a poor community. The goal of microfinance is to provide these individuals with small scale loans that would then give these poor people an opportunity to become self-sufficient (Investopedia, 2018). Microfinance loans are small in scale. According to Investopedia, microloans can be anywhere from $100 to $25,000, but other sources suggest that loans are even smaller, often $100 or less (Schäfer & Fukasawa, 2011; Investopedia, 2018). The idea is that by giving a poor individual a loan, they would be able to invest that money into their own business ventures in order to generate an income. In poor regions of the world, jobs with normal paying salaries are not common. A poor person living in these conditions would also likely not have any collateral tied to their name, making a loan impossible to receive from a typical financial institution (Schäfer & Fukasawa, 2011).

Microfinance institutions have a range of different legal standings. There is a variety in the types of formal and semiformal institutions within the market including cooperatives, credit unions, non-governmental organizations, non-banking financial institutions, rural banks, postal banks, and commercial banks (Daher & Le Saout, 2013). The legal status’ identified by the MIX Market, the data source for this paper, include NGO, NBFI, Banks, Rural Banks and Credit Unions/Cooperatives as well as “other.” Research has shown that NGOs account for less than a quarter of total borrowers; most microfinance is provided by governments, such as state-owned institutions or self-help groups that are financed by state banks. About a sixth of borrowers are served by private banks and finance companies (Gonzalez & Rosenberg, 2006).

To define terms, an NGO is a non-governmental organization. NGOs are organizations registered as a non-profit for tax purposes or some other legal charter. Their financial services are usually more restricted and do normally include deposit taking. NGOs are also typically not regulated by a banking supervisory agency (MIX Market, 2018). An NBFI is a non-bank financial institution, which provides similar services to a bank, but is licensed in a different category. This could be because of lower capital requirements, limitations on financial service offerings, or due to supervision under a different state agency. In some countries this corresponds to a special category created especially for microfinance institutions (MIX Market, 2018). A bank is simply a licensed financial intermediary regulated by a state banking supervisory agency. It provides financial services including deposit taking, lending, payment services, and money transfers (MIX Market, 2018). A rural bank is a banking institution that targets clients who live and work in non-urban areas and who are generally involved in agricultural-related activities (MIX Market, 2018). Lastly, cooperatives and credit unions are non-profit, member-based financial intermediaries. They offer a range of financial services, including lending and deposit taking for the benefit of its members. They are not regulated by a state banking supervisory agency, but they might be under the supervision of a regional or national cooperative council (MIX Market, 2018). These can also be either for-profit or non-profit organizations. Unlike financial institutions, which are subject to many regulations, MFIs can be either regulated or non-regulated (Hartarska & Nadolnyak, 2007).

The different forms of institutions operate in diverse ways. For example, NGOs tend to make smaller loans, which are substantially costlier per dollar lent, and thus require higher interest rates, than microfinance providers chartered as banks or NBFIs. Not only do they make smaller loans, NGO microfinance institutions also lend substantially higher shares of their portfolios to women (Cull, Demirguc-Kunt, & Morduch, 2016).

Many MFIs are not only involved in lending, but they offer additional services such as bank accounts and insurance products, and they also provide financial and business education (Investopedia, 2018). Some might offer additional sources such as savings accounts, insurance, health care and personal development, making the scope of MFI’s work go beyond only financial matters (Jha, 2016). In fact, MFIs are trying to build a unique atmosphere of financial inclusion intertwined with a sustainable livelihood aimed at empowering poor communities. This is in line with the MFI goal of reducing poverty by giving poor the resources needed for them to become self-sufficient. Many MFIs are also involved in several social development initiatives such as capacity-building, education, financial literacy, water and sanitation, livelihood promotion, preventative healthcare and training (Jha, 2016).

2.1.2 Informal Lending as a Type of Microfinance

The concept of small-scale lending extends beyond just typical institutions, and it includes several types of lending, many that are mostly through informal organizations. While the majority of the research throughout this paper focuses on institutions, ideas and practices from these other lending types can be used in considering effective business models that MFIs could implement or consider. Additionally, informal groups create a more competitive landscape for microfinance institutions. Other types of microfinance lending are essentially centered around group lending and group saving.

Group lending is a common type of microfinance loan where the group represents a borrower (Zuru, Hashim, & Arshad, n.d.). The loan is disbursed to a group and members of the group, usually four to ten individuals, are responsible for the repayment of the loan (Chetty, 2017) Mostly, members include farmers, tenants and other rural workers. For a loan provider, this often minimizes risk of lending, as the basic idea is that individual risks are overcome by the collective responsibility and security granted by a group (Grameen Bank, 2018). Group lending focuses on social capital, which promotes social interaction, information sharing and trust. These factors are all foundations of group lending methodology (Kamukama & Natamba, 2013). Mostly, these formation types do not require financial administration. A challenge faced by group lending is personal preferences in lending credit. Group lending can also be referred to as joint liability groups.

Savings groups are similar to group lending and the two often work together. Savings groups provide members a secure place to save, the opportunity to borrow in small amounts and on flexible terms, and can even provide affordable basic insurance services (Ledgerwood & Rasmussen, 2011). Usually groups have between 15 to 25 individuals who meet regularly and save a pre-determined amount. Groups then pool this money and it can be used to provide a loan for an individual within the group and invested. Worldwide, it is estimated that about 5 million poor people are members of savings groups, implying that these savings groups also play a significant role in poverty alleviation within rural communities (Ledgerwood & Rasmussen, 2011). Many lending groups also promote group savings and encourage members to save small amounts of money on a scheduled basis. Often, saving money can be a pre-requisite for being allowed membership. These groups can be very successful, as the average return on assets in 2011 was 37.5%, with most groups charging 5 to 10% interest per month for loans (Ledgerwood & Rasmussen, 2011).

A Village and Savings Loan Association (VSLA) is basically a group of people that participate both in group lending and group savings, which account for about 8 million members in Africa alone (Svarer, 2014). Again, these types of groups are very similar to both saving and lending groups. However, VSLAs are “a more transparent, structured and democratic version of the informal savings groups found in villages and slums in many parts of the developing world” (VSL Associates, n.d.). VSLAs operate with groups of 15 to 25 self-selected individuals that purchase “shares” at each of their weekly meetings. The share-prices have been set by the group at the beginning of a savings cycle, which usually lasts for about a year.

Self-help groups are mostly non-profit organizations that assume the responsibility of debt recovery through a common fund to meet emergency needs of businesses (Chetty, 2017). Most of the members within these groups come from similar socio-economic backgrounds. These groups are popular in Africa, and group members participate in informal banking, social welfare, sharing knowledge, news, ideas and tradition, and income generating projects (Masita-Mwangi, Ronoh-Boreh, & Aruwa, 2011). Basically, self-help groups just allow communities to pool their resources together. There are two types of self-help groups: Rotating Savings and Credit Associations (ROSCAs) and Accumulating Savings and Credit Assocations (ASCAs). In ROSCAs, members save and borrow in a rotational manner while in ASCAs members accumulate a fund from which they can borrow from at an agreed interest rate (Masita-Mwangi et al., 2011). Again, self-help groups have many similarities with both group lending and group savings as well.

The Grameen model works more as an institution than an informal lending service. With this type of microfinance, a bank is set up with a manager, employees and an assigned geographic area. The manager and employees familiarize themselves with the community and provide training and information about the bank. They then select groups of prospective borrowers (five individuals) and two of them receive a loan. The group is observed for a month to see if members follow the bank’s rules, and only if the two borrowers repay their loans, the other members of the group become eligible for loans. The Grameen model focuses on collective responsibility of the group as collateral for loans (Grameen Bank, 2018).

Many of the informal groups discussed are extremely similar in their practices. However, the interesting feature in all of them is that they focus heavily on groups. Additionally, most groups have self-selected members, which means that members are admitted into the groups based on their relationships with peers. Individuals are unlikely to recommend someone for a group if they know that the individual is unlikely to pay back their loans or if they know the individual is dishonest or immoral. Thus, these groups utilize their knowledge of a person’s character to make decisions on admittance into a group as a form of risk management.

2.1.3 History of Microfinance

The beginnings of microfinance start in the early 1970s with the creation of Grameen Bank in Bangladesh by Muhammad Yunus (Daher & Le Saout, 2013). Grameen bank began as an experiment for a credit system catering towards the rural poor with the intensions to extend banking facilities to the poor, eliminate exploitation of the poor by money lenders, create opportunities for self-employment and reverse the circle of “low income, low saving & low investment,” into a virtuous circle of “low income, injection of credit, investment, more income, more savings, more investment, more income” (Grameen Research, 2016). Grameen Bank is probably the most successful example of an MFI, and the Nobel Peace Prize in 2006 was awarded jointly to Muhammad Yunus and Grameen Bank “for their efforts to create economic and social development from below” (, 2006).

Due to the financial crises in the 1980s alongside the mismanagement of banks and financial institutions, many development banks dedicated to reducing poverty were forced to be liquidated (Ayayi & Sene, 2010). Because of this, many small operators moved away from classic financing structures. Microfinance emerged as a solution to providing financial services in the countryside and towns excluded from typical banking. The microfinance industry itself only recently began to make significant progress in the early 2000s (Chikalipah, 2017). For example, between 1997 and 2005 the number of microfinance institutions increased from 618 to 3,133 and the number of people who received credit from these institutions rose from 13.5 million to 113.3 million, with 84% of them being women (Daley-Harris et al., n.d.; Hermes & Lensink, 2007). Also, between 1998 and 2004, the number of microcredit clients at year end grew by an average 12 percent per year (Gonzalez & Rosenberg, 2006).

Microfinance has undergone the most change within the last 30 years. Back then, it was represented by only a handful of NGOs; however, with the development the industry has gone through, there is a large number of stakeholders (Daher & Le Saout, 2013). The banking sector has aimed to become more sustainable in two ways. First, they have pursued environmental and social responsibility through the banks operations, such as recycling programs, donations or cultural events. Second is where microfinance falls in, with the integration of sustainability into the bank’s core business, including in its products, services, mission, policies and strategies (Ingham, Grafé-Buckens, & Tihon, 2013). Commercial banks have spread their operations into microfinance, but also specifically microfinance institutions have emerged as well.

2.1.4 Current Developments in Microfinance

Microfinance was founded on the idea that it would be used for poverty alleviation. However, more recently, MFIs have adapted to have a for-profit business model instead of a non-profit (Chikalipah, 2017). As an example of this transition, Grameen Bank was established as a non-profit in 1980 but converted in 2002 into a profit-oriented business (New Internationalist, 2012). What was once a non-profit organization funded mostly through subsidies, is now a corporate bank. Interestingly enough, the commercialization within the microfinance industry has not translated into increased financial sustainability (Chikalipah, 2017). An increasing amount of commercial banks are more eager to enter the microfinance sector (Daher & Le Saout, 2013). The entrance of commercial banks is significant since it indicates the potential for success within the industry and opportunities for profits, and the growing concern for running socially responsible businesses.

The topic of financial sustainability became more important after the collapse of Pride Zambia in 2009 combined with the failures of over 30 MFIs in 2013 in Ghana (Chikalipah, 2017). Many MFIs in Sub-Saharan Africa remain dependent on significant donor funding to survive, which means they are not financially sustainable (Hermes & Lensink, 2011). Failing MFIs are seen as harmful to the industry as a whole, and unsustainable MFIs work in the present to help the poor, but become redundant in the future when they fail to survive (Schreiner, 2000; Chikalipah, 2017). With a newfound interest in financial self-sufficiency, some researchers also suggest that this has come at the cost of cutting other programs that could significantly improve borrowers lives, specifically with the empowerment of women (Haase, 2010). Non-financial services have a significant role within microfinance, since it gives borrowers the tools and education necessary for becoming better entrepreneurs.

Lately, financial performance has developed into one of the essential goals for both non­profit and for-profit MFIs. The entire industry is focusing on reducing their reliance on subsidies (Quayes, 2012). When a commercial bank enters microfinance, they essentially have two methods for becoming involved. The first strategy is to lend directly to the poor by providing similar services as MFIs provide, increasing competition in the sector. The second strategy is through financing, by creating a separate entity which supports microfinance activities. In turn, the bank can exhibit corporate social responsibility and it creates an attractive risk-return profile (Dieckmann, 2007).

2.1.5 Greenfield Microfinance

Greenfield microfinance is designed to expand access to financial services for the low-income market in underdeveloped economies (Cull, 2015). The greenfield business model is focused on expanding financial services through two main elements: the creation of a group of “greenfield MFIs” and the central organizing bodies that create these MFIs (Earne, Jansson, Koning, & Flaming, 2014). The greenfield MFIs are simply institutions that are newly created, without preexisting infrastructure, staff, clients or portfolios. Typically, the organizing bodies are holding companies that manage the MFIs through common ownership. Much like regular microfinance, greenfield microfinance targets small scale entrepreneurs. The greenfield business model is usually backed by foreign-owned holding companies or networks that provide initial capital, expertise, common branding, and standard policies and operating procedures (Cull, 2015).

Greenfield microfinance first entered the African market in the early 2000s, when the microfinance industry was still young. The presence of greenfield microfinance has experienced rapid growth in recent years, and today there are more than 30 greenfield MFIs in Africa (Cull, 2015). At the end of 2012, the 31 greenfield MFIs in SSA had more than 700,000 loan accounts, an aggregate loan portfolio of $527 million, and close to 2 million deposit accounts with an aggregate balance of $445 million (Earne et al., 2014). When compared to regular MFIs, greenfield MFIs have on average achieved “considerably larger size, greater reach, higher loan quality, and better profitability than MFIs with no strong holding/network affiliation” (Earne et al., 2014).

Greenfield MFIs have an advantage because through their network structures they are able to transfer knowledge and practices from one greenfield MFI to another. Some of the factors that have led to their success have been their focus on human resources development, in terms of training their staff. Especially in less developed financial markets, greenfield MFIs have had a huge role in expanding “the financial access of microenterprises, small businesses, and low-income households” (Earne et al., 2014).

Overall, the success of greenfield MFIs is an indicator to the traditional banking sector that targeting underserved markets can be a profitable business segment. Studies have shown that the greenfield model, and particularly the formal greenfield model (which is backed by mostly consulting firms), has been an effective and profitable means of broadening financial inclusion in Sub-Saharan Africa within a short time period (Cull, 2015).

2.2 Financial Sustainability

As the importance of financial sustainability in MFIs has grown, two theories have emerged: the financial systems approach and the poverty lending approach (Hermes & Lensink, 2007; Robinson, 2001). The financial systems approach will be discussed within this section, but the poverty lending approach will be addressed later in section 2.3. In general, both approaches agree that the ultimate goal is to serve as many poor people as possible, but the method to achieve this is what differs. The question really comes down to whether or not subsidization of interest rates is justified (Hermes & Lensink, 2007).

To begin this section, the quote “financial sustainability is the prerequisite of institutional sustainability” seems appropriate (Hollis & Sweetman, 1998). Financial sustainability is the ability for a microfinance institution to cover its expenses with the revenues received, and as the quote indicates, it is the prerequisite for institutional sustainability as well. It is a simple concept: without money, a business cannot continue operations. Institutional sustainability is the ability of the organization to survive.

2.2.1 Financial Systems Approach

The financial systems approach focuses on operational self-sufficiency, because given the scale of the demand for microfinance worldwide, it is the only way to be able to meet that client demand (Robinson, 2001). The financial systems approach focuses mostly on lending to the creditworthy among the poor and on voluntary savings mobilization. MFIs that are truly financial sustainable tend to target clients that are either slightly above and slightly below the poverty line, because they can benefit from economies of scale by extending their loans to marginally poor and non-poor clients (Ayayi & Sene, 2010). Therefore, this approach receives criticism in that it is not actually reaching the poor, or at least that it is making a half-hearted effort at it. Supporters of this theory believe that empirical evidence neither shows that the poor cannot afford higher interest rates nor that there is a negative correlation between the financial sustainability of the institution and the poverty level of the customers (Hermes & Lensink, 2007).

Essentially there are two types of MFIs: those that are operating as nonprofit organizations with a purely social motive, and for-profit organizations seeking to also make a profit while serving the poor. However, there has been a collective drive by funding agencies for MFIs to attain financial sustainability (Quayes, 2012). The emphasis on financial performance is because donor agencies have a vested interest in the efficient utilization of funds allocated, and financial efficiency is an essential part of the future self-sufficiency of MFIs. There is an indication that a trend towards improving financial sustainability is present: data from 2001 and 2004 shows that based on the borrowers served, the profitability has increased from 53 percent to 64 percent respectively (Gonzalez & Rosenberg, 2006). According to Quayes, initially it was expected that MFIs would be able to wean themselves off donor subsidies and achieve self-sufficiency as their rate of recovery of loans increased, but other research contends that the high rate of recovery in the microcredit industry has failed to transform the donor-dependent MFIs into independent self-sustaining organizations (Quayes, 2012).

2.2.2 Indicators for Financial Sustainability

To measure financial sustainability, researchers use several different indicators, which will be further investigated in this section. One of the key indicators for financial sustainability is operational self-sufficiency, which is frequently used in literature. It is defined as the MFIs ability to cover its costs through operating incomes, including financial expenses, impairment losses on loans and operating expenses since they are a normal and significant cost for an MFI (MIX Market, 2018). Operational self-sufficiency (OSS) is a key indicator used for this analysis, as it adjusts for subsidies.

Indicators used in different studies include the following. In a study called “Factors Determining the Operational Self-Sufficiency Among Microfinance Institutions,” OSS, number of borrowers, write off ratio, depositors/borrowers ratio, cost per borrower/GNI per capita ratio, gross loan portfolio at risk > 30 days, deposits/gross loan portfolio ratio, market penetration and growth in borrowers are used (Schäfer & Fukasawa, 2011). A study called “Financial sustainability of microfinance institutions in sub-Saharan Africa: evidence from GMM estimates” found that return on assets is the major determinant of financial sustainability in Sub-Saharan Africa (Chikalipah, 2017). It suggests that MFIs’ ability to generate higher net income from their credit portfolio is the critical factor for achieving financial sustainability.

2.2.3 Results from Previous Studies

In a study conducted in 2014, an in-depth analysis revealed that only 60% of MFIs were financially sustainable (Chikalipah, 2017). This data also revealed that most of these MFIs were both mature and regulated. Chikalipah found that reducing the costs per borrower is paramount to achieving or improving financial sustainability. Other factors that improve financial sustainability include increases in the number of borrowers, higher interest rates, and higher return on assets. Also, “the results provide strong evidence which supports the notion that portfolio quality captured by Portfolio at Risk (PAR) improves financial sustainability” (Chikalipah, 2017). It was also found that GDP growth improves financial sustainability, specifically in the Sub Saharan African region, while increases in deposits decrease financial sustainability.

In a study called “Depth of outreach and financial sustainability of microfinance institutions,” the results showed that financial performance has a positive impact on the depth of outreach and depth of outreach increases the probability of attaining financial sustainability (Quayes, 2012). Additionally, “the depth of outreach is positively affected by financial sustainability, and firms which are operationally self-sufficient have a smaller average loan size than firms which are not” (Quayes, 2012).

A study by Bogan (2012) indicates that the size of an MFI’s assets and an MFI’s capital structure are associated with performance, in terms of both sustainability and outreach. Grants as a percentage of assets is significant and negatively related to sustainability, but they are positively related to MFI cost per borrower. However, there is evidence to support the assertion that the use of grants drives down operational self-sufficiency (Bogan, 2012). Additionally, a study by Hartarska and Nadolnyak (2007) showed that financial performance is affected by the capital ratio: less leveraged MFIs have better operational self-sufficiency which a link between donors’ willingness to provide equity to MFIs that do well and prefer to extend loans to those MFIs that slack off.

Research by Schäfer and Fukasawa (2011) suggests that an MFI can expand its outreach and serve more customers with microfinance intermediation, which results in higher financial stability and operational self-sufficiency. The more borrowers an MFI has, the more they can leverage economies of scale and economies of scope, therefore reducing costs per borrower. They also found that as the write off ratio reduces the gross loan portfolio, it also reduces the ability to earn interest on the loan and reduces an MFI’s revenue. With less revenue, the operational self-sufficiency is reduced (Schäfer & Fukasawa, 2011).

2.2.4 Financial Sustainability and Interest Rates

In order for an MFI to have a great depth of outreach and to maintain financial sustainability, they must charge a higher interest and incur a greater cost of disbursing loans (Quayes, 2012). There are three main approaches to considering interest rates in microfinance. The first is that the poor cannot pay interest rates at market prices and thus, loans must be made with interest rates between 1 to 3 percent regardless of inflation. This kind of model is said to only be possible with subsidies. The second method is to have interest rates slightly below those of commercial banks, which is more feasible because the institutions benefit from subsidized credit and/or international aid. The third method is most attributed to financially self-sufficient organizations as it has the highest interest rates of the three options (Ayayi & Sene, 2010). For the last option, interest rates can be extremely high. It was reported that in West Africa, financially sustainable MFIs had interest rates up to 84%. Similarly, in Indonesia interest rates can be between 35% and 60% (Ayayi & Sene, 2010). According to Bogan (2012), as protection from default, MFIs have charged nominal interest rates of 30 to 60%. While these interest rates may cover operating expenses, they are not ideal for expanding outreach in poor communities. However, empirical research has proven that MFIs with the highest interest rates are the best performers, the most efficient and the most financially sustainable organizations (Ayayi & Sene, 2010).

Literature emphasizes the trade-off between outreach and sustainability that argues that MFIs wanting a greater depth of outreach must charge higher interest rates in order to cover the cost of administering loans to maintain financial sustainability. However, evidence demonstrates that there is only marginal variability in interest rates across MFIs within the same country for the same loan product (Quayes, 2012). In fact, some say that there is a higher rate of recovery from poor borrowers, which challenges the principles of the trade­off.

Unlike traditional development banks, MFIs use many innovative lending methods and charge market-based interest rates to compensate for the higher costs associated with conducting this type of business (Hartarska & Nadolnyak, 2007). The interest rates cover the cost of screening, monitoring and enforcing loans. The implication of these findings is that MFIs should implement thorough pre-loan screening systems, which can assess the creditworthiness of borrowers and reduce the loan default rates among MFIs (Chikalipah, 2017).


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The Financial Sustainability of Micro-Finance Institutions in Sub-Saharan Africa
Cologne Business School Köln
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microfinance, micro-finance, finance, financial sustainability, micro loans, micro lending, poverty alleviation
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Hanna Kattilakoski (Author), 2018, The Financial Sustainability of Micro-Finance Institutions in Sub-Saharan Africa, Munich, GRIN Verlag,


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