Microfinance: Is Outreach an Impediment to Financial Self-Sustainability Alex Leibowitz ‘06 (Sponsor: Professor Amy Ickowitz) Abstract Financial services are essential elements in any economy. Individuals who do not have access to these services are usually restricted in the way they smooth income and finance investments. This study examines the trade-offs between outreach and financial self-sustainability of microfinance institutions. Dependent variable •Financial self-sustainability • studied through operational self sustainability (OSS) • Indicates whether enough revenue has been generated to cover direct costs excluding adjusted cost of capital but including any financing costs incurred (has issues of subsidization) Implications 1) Size- increasing the number of borrowers of a microfinance institution increases its OSS up to a point 2) This study has found that providing savings accounts will increase OSS. 3) The higher the average loan balance the higher the OSS. 4) Microfinance Institutions that have a higher proportion of borrowers below the poverty line have a lower OSS than microfinance institution with a lower proportion of borrowers below the poverty line. What is Microfinance? Microfinance • A system that provides financial services to underserved groups • Not a new idea •1950s-1980s, government-run programs sought to target rural populations • Rural credit programs became a centerpiece in many countries’ development strategies throughout the world. • Unfortunately, many of these programs served to reinforce the idea that providing financial services to poor and rural population is unnecessary and costly. • Nearly all programs ended in disaster • Low loan recovery rates of 50% • Loans going to the politically connected. • New generation of microfinance institution avoids government intervention and concentrates on performance-based incentives. • The most noted of these institutions is the Grameen Bank Independent Variables Breadth-How a microfinance institutions reach an ever-wider audience. • Number of Borrowers • Number of Borrowers^2 • Dummy Savings Depth- How microfinance institutions reach an ever-poorer or previously excluded audience. • Average Loan Balance • Average Loan Balance^2 • Poverty Dummies Control variables- Account for legal status and geographical location Trade-Off Theoretically if a microfinance institution was to only have a finite amount of equity to loan then there would be a trade-off between the average loan balance and the number of borrowers. Using the coefficients of the continuous regression we developed a graphical model which analyzed the trade-offs between OSS, Number of Borrowers, and Average Loan Balance Per Borrower when the equity stock available to loan is held constant. Since the amount of funds to loan is held constant, as the number of borrowers increase the average loan balance decreases. In the figure below I present three cases where there is constant equity stock. The Study Examine how microfinance institutions outreach affects their financial selfsustainability. Determinants of OSS If a microfinance institution is endowed with $100 million of equity stock and begins to lend to 30,000 borrowers giving each borrower an average loan of $3333.33. The model shows an immediate drop off in OSS from the initial small number of borrowers with high loan balance. The model does not recover until the critical point of 99,000 borrowers with average loan balance of $1010.10 where it slowly begins to recover and then levels off. The model shows that having more borrowers is less important than average loan balance for small firms in terms of OSS but after the critical point for $100 million in constant equity stock, borrowers become more important than average loan balance. Data •Information from the mixmarket.org •Includes 362 Microfinance organizations •With data ranging from 1996-2005 •Areas: Africa, Eastern Europe, Central Asia, and East Asia •Issues about accounting standards (the information is not fully audited) Main Model OSS= F(controls, number, number2, loan-balance, loan-balance2, poverty_level_missing, poverty_level_medium + poverty_level_high,) Conclusion • This study has an increased ability to analyze policy suggestion over previous work. Former studies used indexes to account for outreach through my model both portfolio and poverty analysis can take place. • Shows the difficulty that microfinance institutions located in poor regions have with obtaining and maintaining OSS The second model replaces number, number2, loan balance and loan balance2 with categorical variables to confirm the results of the main model.