The profitability of microfinance institutions and the connection to the yield on the gross portfolio: An empirical analysis

Anne Nørgaard Jørgensen

Student thesis: Master thesis

Abstract

Recent studies have shown that the microfinance industry is growing while undergoing a transformation from the donor-driven NGO framework towards a greater degree of capital market involvement. This change is due to many facts, e.g. that donations are getting harder to find, and businesses have started to see possibilities for profit in this industry. The main objectives of this paper is to find the factors that determine profitability, and to find out whether the high interest rates go hand in hand with high profits for the microfinance institutions as claimed by some critics. To attain the objectives, previous literature, studies and theory from the commercial banking industry have been formulated into a background study, identifying certain indicator groups with economical significance: outreach, financing structure, expenses, revenue, efficiency, quality of portfolio, and the peer group comparisons of deposit taking, age, legal status and profit status to be factors of profitability and thereby to be investigated further in an empirical analysis. The data used in the empirical analysis was found though MIX market, and a sample of 879 MFI‟s was processed and analyzed to test two profitability models with return on assets and profit margin as the dependable variables. I found that large variances in the microfinance industry became a problem when trying to estimate models to explain patterns, since the OLS regression is much influenced by outliers. Still, certain statistical trends were found which also aligns with theory or previous studies; Factors that statistically influenced profitability positively was the capital asset ratio, age (new) and the gross loan portfolio. Factors with a statistical negative influence were legal status (credit union) and cost per borrower. Two other variables also showed a statistical significance, but with the opposite influences than expected, and these were the operating expense over loan portfolio which had a positive influence, and number of active borrowers, with a negative influence. The unexpected signs of the variables could be explained by other influencing variables, time or other relationships than linear. The yield on gross portfolio did not show as a significant explanatory variable for profitability, and different correlations and robustness tests showed that there is no general trend that MFI‟s are charging a higher yield in order to get high profits, though it does occur. It is, therefore, clear that there is still much diversity in the industry, and no clear set of best practices for becoming profitable has been defined. However, as the industry is young and still changing, this is not a surprising result.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2011
Number of pages130