Financial Efficiency and Social Impact of Microfinance Institutions Using Self-Organizing Maps
Philippe Louis, Katholieke Universiteit Leuven
Alex Seret, Katholieke Universiteit Leuven
Prof Dr Bart Baesens, Katholieke Universiteit Leuven, University of Southampton, Vlerick Business School
I strongly believe that we can create a poverty-free world, if we want to.... In that kind of world, [the] only place you can see poverty is in the museum. When school children will be on a tour of the poverty museum, they will be horrified to see the misery and indignity of human beings. They will blame their forefathers for tolerating this inhuman condition to continue in a massive way.
Muhammad Yunus; Bangladeshi Nobel Peace Prize recipient
During the last decades, the microfinance industry changed dramatically as the original subsidized model is being replaced by a completely new microfinance paradigm. The idea is that financial services for the economically active poor should be provided on a large scale by competing, financially self-sufficient institutions. In contrast, funding was originally provided by donors or governments and institutional self-reliance and cost control were not considered crucial. A that time, the aim was to reach the ‘poorest-of-the-poor’ as microcredit programs have their roots in humanitarian and developmental plans. However, in the 1980s and 1990s, the continuing dependency on subsidies and evidence of unsatisfactory performance resulted in the aforementioned paradigm shift. Donors argued that subsidization resulted in a high degree of moral hazard, low operational efficiency, widespread corruption, high administrative costs, and a ‘grant mentality’ among clients.
Reasons for a new paradigm
A major argument is that self-sufficient MFIs set their interest rates high enough. This is essential for any business that intends to continue its operations beyond the short-term. Subsidized MFIs were often requested to enforce an interest rate ceiling, which was usually set at a level less than that required to cover its costs. This in turn required often re-capitalization by donors, reduced the MFIs willingness to expand operations, and discouraged private investors from supporting the industry. A second argument is that subsidies limit savings mobilization because the downward pressure on interest rates on loans kept the interest rates paid to depositors very low, thus giving savers little incentive to build up accounts. However, voluntary savings are believed to be important as they allow households to smooth consumption, to reduce the holding of cash assets, and to better prepare for emergencies. Savings mobilization programs have demonstrated that low income people will start depositing their funds if they have access to convenient and trustworthy saving facilities. Furthermore, these deposits can be used as an inexpensive source of funding for providing microcredit. Thirdly, self-sufficient MFIs are believed to produce more output (such as the number of loans) given the input (such as assets and staff) they have access to due to higher efficiency and stricter cost control.
Bringing the social benefits of microfinance to poor clients to often expressed through ‘outreach’. The most widely used dimensions are depth and breadth of outreach. Depth of outreach refers to serving the poorest people, whereas breadth refers to serving large numbers of people, even if they are relatively less poor. A commonly used indicator to measure the depth of outreach is the average loan size. It is argued that an increase in the average loan size indicates that the MFI has shifted to a more profitable customer segment. And although the majority of microfinance clients are women, outreach to women is also often considered.
Since self-sufficient MFIs can operate on a large scale because of more financial efficiency, they can service more poor clients and they are said to achieve higher social impact. Moreover, they claim that this is the only way to viably serve a large number of borrowers, resulting in a high breadth of outreach.
In recent years, it has been argued that microfinance institutions (MFIs) have abandoned their social mission due to an increased focus on financial performance. The prevailing theoretical belief is that focusing more on financial self-sufficiency and efficiency and relying less on donations would ultimately lead to fewer (depth of) outreach. The question is whether emphasizing self-sustainability results in mission drift. Answering whether this new approach has resulted in less social impact is not straightforward. This is mainly caused by the wide differences between microfinance institutions. After all, ‘microfinance institution’ is just an umbrella term that includes many different types. Firstly, MFIs operate in almost all parts of the world, making them exposed to different social and legal systems. Secondly, some MFIs operate as non-governmental organizations or cooperatives whereas others operate as banks. Thirdly, some MFIs are relatively young in contrast to others which have been in business for decades. Other MFIs focus their business on supplying loans only while others offer a wide range of financial products. In sum, the diversity among MFIs makes it harder to report conclusive findings.
Prior to 2007 most of the academic literature on this subject mainly consisted of theoretical discussions and sometimes anecdotal or limited empirical evidence. However, in a recent paper by Philippe Louis, Alex Seret, and Bart Baesens, we add to this debate by using an advanced statistical technique called self-organizing maps (SOM). We have used self-organizing maps (SOM) to graphically plot the heterogeneity among MFIs with regard to the different input variables. In a next step, the results from the SOM algorithm are used as input and grouped using the k-means algorithm into a predefined number of clusters obtained using the Davies-Bouldin index as a measure of cluster quality. Subsequently, the centroids of these clusters were analyzed with respect to their social and financial performance using an ordinal four-point scale ranging from ++: very good to - -: very bad. Several statistics that measure the degree of association between the social and the financial dimension were calculated using the differences between the observed and expected cell counts.
The analysis was performed on MIXMarket data of 2011 using a data sample of 650 MFIs that satisfy several data quality requirements. We find that the hypothesis of independence between financial performance and social outreach is rejected, pointing towards an association between the two dimensions. However, our results do not suggest a trade-off. On the contrary, we find evidence of a significant, positive relationship between social and financial efficiency. Consequently, the theory that financial performance comes at the prize of less social performance does not seem to be valid.
In recent years, some microfinance policymakers alleged that the increased focus on financial self-sustainability has pushed the quest for social impact into the background. A major difficulty in analyzing MFI data is the diversity between institutions. We have investigated whether the increased focus on financial self-sustainability of microfinance institutions has been disadvantageous to the target audience using a self-organizing map methodology to fully capture the existing heterogeneity among institutions. We find evidence of a significant and positive association between outreach and financial performance.
Reference of the study:
Louis, P., Seret, A., Baesens, B. (2013). Financial efficiency and social impact of microfinance institutions using self-organizing maps. World Development, accepted.