Financial performance of microfinance institutions

Financial work of microfinance g overnancesFinancial Performance of Microfinance InstitutionsAbstr inciteThe theme investigates the fiscal photogenicness of microfinance institutions (MFIs). With the use of CAMEL methodology is the cognitive process of MFIs analyzed. A comparing with G10 mercenary-grade-grade banks confronts. Secondly, the magisterial risk factors of MFIs argon de nameine. The view * VU University Amsterdam, Faculty of economic science and Business Administ symmetryn, De Boelelaan 1105, 1081 HV Amsterdam Comments be welcome at email nurtureedIntroductionThis physical composition investigates the monetary act of microfinance institutions (MFIs) from the perspective of a foreign investor. Microfinance institutions offer a broad touchstone of pecuniary products and services to large number who escape entrance to handed-downistic banking services, also called the unbankable. Starting from social driven performance measures, the microfinance ass iduity has been arguably effective in reducing poverty earthwide. In the ultimately decades the microfinance industry has molded into an alternative investment class. The domain is characterized by tearive returns, execrable default accounts and an explosive out(a) harvest-feast. Nevertheless, there is unaccompanied a small scientific flat coat about the promises microfinance offers as a financial investment class. The financial attractiveness of MFIs for investors is questi iodind within this paper. Through analyzing the performance of MFI with CAMEL orders and identifying the doctrinal risk factors, enriches this paper the academic field of finance.The education starts from the findings of Krauss Walter (2008). Their empirical results show that MFIs dedicate a low or non exposure with international mercantile commercializes from actual nations. Microfinance investments ar for investors thus helpful for portfolio diversification. withal the social get that social oriented investors dispatch, the question arises what is the potence financial gain for a foreign investor? Nonacademic sources present microfinance as a amuseing alternative investment class for all return oriented investors. Institutions as the Consultative free radical to Assists the Poor (CGAP) are reporting profits twice as soaring as their local peers and returns on investments in some parts of the knowledge domain amidst 117 and 847 percent (Little field Holtman, 2005). Gonzales Rosenberg (2006) presented evidence of MFIs that outperform commercial banks on the return on assets. The returns are combined with a quittance rate of brings of al near 100 percent.Group liability repayment systems fetch the low default rates. The repayment schemes are typical for the microfinance industry since guests privation related for the provided loans. The numbers indicate a save investment with a high return for investors. Nevertheless, investors seem to be skeptic abo ut investing in MFIs. As Krauss Walter (2008, p.6) righteously mention Investors appear to perceive microfinance as excessively risky relative to the returns it generates, partially due to a leave out of workable foreign exchange hedges, absence of a solid track record, get aroundsighted reporting standards, heterogeneous products and inadequate liquidity.The Microfinance Exchange (MIX) tracks the performance of MFIs since 1998. The MIX is a platform which gathers and publishes financial and communal oriented (outreach) numbers of MFIs. The institutions deliver the info voluntary to the MIX. Of the approximately 10.000 MFIs cosmopolitan, only a small percentage (around 8 percent) send reports to independent platforms as the Microfinance Exchange. The incentive to offer info is to attract much pecuniary resource from investors (Hartarska Nadolnuak, 2008). The attraction of more than funds leads to a high amount of accessible capital for the low-income clients. A high return on investment is promised by MFIs to investors. In conclave with the support to poor people, seems microfinance to be the commercial solution for worldwide poverty. In practice, this promise is only rarely fulfilled by the institutions, due to the high ope evaluate cost per client and the lack of knowledge and hydrofoil within the institutions. Academic enquiry is necessary to classify the sources of growth in microfinance institutions, thereby establishing a valid basis to assess the performance and risk of MFIs.The paper aims to increase the transparency and rule behind the info of microfinance. Transparency is increased by presenting measures of performance of the institutions in relation with their internal help environment. MFIs are considered as emerging banks in under actual countries. A comparison with commercial banks using adjusted performance methods is employ as a starting crest. Identifying the systematic risk factors within the domestic environment results in a valid basis to assess the performance of MFIs.The financial statements of the MFIs are downloaded from the MIX website. A drawback in microfinance related research is the low fiber of the data. Although the MIX offers the best available set of data and puts serious efforts to increase the quality is the dataset relative young. The dataset contains annual data and is number to subjectivity due to the voluntary basis and a lack of enactment and authorization in the nations were MFIs are effective.To deal with the low quality of the data this paper first checks till which extent the data makes sense. CAMEL evaluations as an might parameter are use SYSTAMTIC RISKThe rest of the paper is nonionized as follows section 1 reviews the literature of the microfinance industry and the recent developments. slit 2 describes the bank performance methodologies to assess the performance of banks. Section 3 describes a comparison of banking ratios between commercial banks and MFIs . Section 4 discusses the results on the performance drivers of MFIs as a result of the systematic risk of emerging nations. Section 5 concludes the paper with a discussion of the main findings instal in this paperThe Microfinance PromiseThe success of the book Creating a world without poverty of Muhammed Yunus (founder of the Grameen bank in 1970 Nobel Prize Winner for the Peace in 2006), increased the awareness and popularity in microfinance. Microfinance refers to the financial products as savings, insurance, transfer services, microcredit loans and separate products targeted at low-income clients. From origin is microcredit the key product of MFIs. Loans are employ to develop local economies to banish poverty from the low-income communities. The difference between traditional banking and microfinance is the aim of creditworthiness of clients. Low-income clients in microfinance lack collateral, structural employment and/or a nonsubjective credit history almost by definition . This disables them to meet the minimum creditworthiness requirements to gain access to traditional finance products and services. Microfinance clients are so often referred as the unbankable. The lending activities of MFIs are characterized as follows 1) loans are solely available to members of the MFI 2) loans are relatively small and generally unsecured 3) assets and liabilities of the MFI are owned jointly by the members (the clients are the owners), 4) internal superintending and social sanctions (group liability) are used to enforce the loan contracts (Skees Bar authorise, 2006). Microfinance institutions thus use group lending methods to justify repayment of the financial services which is a substitute for the lack of collateral. This innovative and reversed perspective on banking enables MFIs to provide financial support to the poorest people of the world. This considers 1 billion people worldwide or a potential of 1 billion clients. Reducing poverty worldwide is inco rporated in the G8 millennium development goals. Microfinance is considered to be a proven way to realize this millennium goal. Judged against the profit maximization ideology of commercial banks in developed countries have MFIs a dual mission reducing poverty worldwide while being financial sustainable (Drake Rhyne, 2002). The success of microfinance increased the interest of developed nations and the main rate of flow finance industry. Commercial organizations support initiatives in microfinance as an act of corporate social responsibility. For investors and financials is microfinance attractive for its low correlation with commercial markets. actual life examples are the diversification possibilities that pension and insurance funds find in microfinance (Krauss Walter, 2008).The balance between social and financial returns was studied by the Consultative Group to Assist the Poor (CGAP) in February 2008. The CGAP identifies a stream of private investors investing in microfinanc e with no particular interest in the social heading of MFIs since 2006. The entry of private investors in microfinance is seen as one the most important development since institutional investors noticed microfinance in the starting line of 2000. Before this period mainly governments, nongovernmental organizations and charity funds invested and supported MFIs.In 2006 seventeen billion dollar of loans represented 10% of the potential microfinance market (Swanson, 2007). The money market return in that year was 5.8% in dollars and 3.2% in euros (Reille Foster, 2008).Although multiple sources report extreme returns on justness in microfinance, is investing in microfinance far from riskless.MicroPlace is the first online platform to trade in MFIs developed by Ebay. The average yield on a investment is 3% which matures in 3 years.In order to realize high net return on equity should organizations keep the operational cost low. peculiarly in the case of MFIs are opemilitary rating cos t high.Still lack of control and transparency makes investing in MFIs risky.Difficulty to comply with dominion standards, if all regulation framework is availableMFIs act like banks, by collecting any in developed nations and from local communities and invest them in the area.Criticism is about the lack of transparency and knowledge in the sector. Databases make up of low quality accounting numbers and the absence of legislation, authorization in emerging economies aInsights in this industry will thus not only benefit the poor of the world, tho also investors of the world as hale as the lessons for the financial systems worldwide.The promise that microfinance offers is a reduction of poverty worldwide, with without any means of charity or subsidy (Cull, Demirgu-Kunt Morduch, 2007). The poverty line is outlined as having less than 2 dollar to spend on a daily basis. Group liability schemes are the response of MFIs to avoid the lack of traceable credibility and liquidity of clie nts. The group structure of loan repayment proves to secure high rates of repayment. Even with the lack of collateral or means of liquidity of the clients (Cull, Demirgu-Kunt Morduch, 2007). The backside of this concept is that the industry is characterized by a high amount of exertional and operational cost due to monitoring cost. similarly the high geographical distances and spread of clients, without technology standards or infrastructure to brace these distance, increases the operational cost.A stereotype client of an MFI would be a charwoman (approximately 97% of all microfinance clients are woman), with a low level or non education. The idea that most clients are entrepreneurs is a biased view. Since microfinance believes in the susceptibility and flexibility of people new entrepreneurial assembly line arise, but everyone with a spendable income of less than 2 dollar a day, could be a client of an MFI.Grootte marktAlthough the loans and services provided are relative lo w is the amount of clients enormous. willpower and governance (Call for legislation and authorization)Technology influences (Mobile phones)Microfinance for investors (brug naar bank performance en systematic risk)Portfolio diversificationReturn oriented (non academic article) not more than a T bill)Null hypothesis 3 MFIs dont generate excess returns more over equity indices.How to sustain credibilityHigh fixed cost to monitor clientsNo collateral as a backup in case of default, so MFIs have to define risk charge methods in order to control potential default rates. money box performanceFrom NGO to Commercial bankNull hypothesis 1 MFIs have the resembling banking ratios compared with commercial banks from G10 nations. establishmentatic risk of MFIsImpact of bigeconomic indicators on MFIs and visa versaNull Hypothesis 2 MFIs and macroeconomic indicators are not related.Microfinance bank line and investorsMFIs have a different pedigree mould than traditional banks. This affects ca pital structure of the institution. The expectations of investors are also higher(prenominal). A return hurdle is identified in . Which state that investors expect return on equity of MFIs between 20-25 percent due to additional risk of the underdeveloped markets.Transaction be are high for investors. Since most MFIs are not publicly tradable investors have to spend relative more time and effort to find, retrieve and monitor funds of MFIs. Exchange rates and effort to buy forgein shares in MFIsThe lack of transparency creates information asymmetry Asymmetric information contributes to high exercise costs associated with underwriting, monitoring, and loss adjustment.The very same asymmetric information and transaction costs problems also plague financial markets in rural areas of low-income countries, impart to high market interest rates. Market interest rates are also affected by default risk. Financial regulations discount protect the interests of consumers by reducing informat ion asymmetries.So CamelBut for MFIs instead of commercial banks it is very difficult to diversify risk. Since most lenders have a business in agricultural oparetions a nature disaster or a change of policy within the domestic border affects almost the make do loan portfolio. For this reason it is important to understand the underlying sustamtic risk of an MFI with a nation.Bank Performance MeasurementMeasurement of the financial performance of banks increases the transparency of the banking sector in various ways. First, the performance indicators are warning signals for roiled banks. This increases the safety of the banking system. Secondly the indicators are useful tools for allocation decisions for investors. Especially in the case of MFIs, investors lack perfect information. Compared with developed nations the information asymmetry is greater, since commercial banks from industrialized countries have easy accessible and reliable performance indicators. observe MFI performanc e decreases the information asymmetry gap for investors, which helps MFIs to attract more funds and increase their performances.A performance exemplification assesses the efficiency of the organization. Efficiency is the ratio of the effective or useful output to the total input of a system. Different methods are available to measure the efficiency of banks. Statistical and well-informed techniques to mildew bank performance mystifys are extensively reviewed by Kumar Ravi (2009). The most common approaches are data envelopment analysis (DEA) (Liu, 2009) and CAMEL analysis ( wampum Gunther, 2008). DEA is a non parametric method which uses linear programming to measure multiple in- and outputs of business units. The business units are compared through creating an efficient frontier of best playacting business units. DEA is mainly used to asses the internal efficiency of a bank. on-the-scene(prenominal) examinations are the most precise way to monitor the performance of a bank. In developed nations are banks assessed between every 12-18 months. The ratings are cognize to CAMELS ratings according to their functional areas capital adequacy, asset quality, management quality, earnings efficiency and liquidity. The performance of each area is rated on a 5 point scale (1 strong performance, 2 satisfactory performance, 3 performance that is blemish to some degree, 4 coastal performance that is significantly below average, 5 unsatisfactory performance that is critically deficient and in need of spry action). From the 5 areas is a composite overall rating constructed. The Commercial Bank Examination Manual produced by the Board of Governors of the Federal Reserve System qualifies an institution consequently as 1 an institution that is basically labored in every respect, 2 an institution that is fundamentally sound but has modest weaknesses, 3 an institution with financial, operational, or compliance weaknesses that give drift for supervisory concern, 4 an i nstitution with serious financial weaknesses that could impair future day viability, 5 an institution with critical financial weaknesses that render the probability of ill extremely high in the near term.Although the CAMEL approach is widely used, wampum Gunther (2008) point out that the reliability of the ratings decays rapidly once published. To deal with the decrease value of CAMEL ratings, they offer a method to create CAMEL rating base on accounting data. The off-site examination of the CAMEL rating performs better afterward two quarters since the last on site assessment. The CAMEL approach is a suitable starting point to asses MFI performance, since MFI data is only published annually. The rating enables to benchmark multiple MFIs and filter credible and well performing institutions from the dataset. CAMEL offers thereby the possibility to incorporate the social objective of MFIs within the performance warning. Besides CAMEL are seven approaches established to measure M FI performance. The Global Development look into center describes all approaches which find their origin from private and commercial initiatives to roam MFIs. The ACCION Camel approach is comparable to the measurement as suggested to a higher place. An overview of the systemsPEARLS rating system. This is a rating system developed for credit unions by the World Council of Credit Unions (WOCCU).ACCION Camel. The military rank guideline for MFIs developed by ACCION International.Girafe rating system. certain by PlaNetFinance.MicroRate. Developed by Damian von Stauffenberg of MicroRate.MicroBanking Bulletin/ MicroBanking Standards Project. Funded by the Consultative Group to Assist the Poorest (CGAP).The Philippine Coalition for Micro-finance Standards.Developed a set of performance standards to serve as guidelines or benchmarks to assess the operations of NGOs involved in microfinance.Institutional Performance Standards and PlansDeveloped by the Committee of Donor Agencies for Sm all Enterprise Development and United Nations majuscule Development Fund.CAMEL is suggested as most suitable for investors. The reliance on qualitative measurement through interviews with the MFIs management is a drawback of the above mentioned methods. Although interviews are useful to assess the performance of an institution, it does not allow investors to asses the institution based on free available information (for example from MIX markets). The CAMEL approach offers an objective evaluation method to assess the performance on quantitative measures. CAMEL is thereby widely recognized as a well performance rating method of financial institutions.The areas of the CAMEL approach are defined, but the indicators to generate the rating of the areas vary per organization or account. Microfinance has a different banking perspective compared with traditional banking. To adjust for this basic principle the set of accounting indicators for the CAMEL model is different, compared with mode ls of traditional banks. ACCION is a rating agency which uses CAMEL to measure the performance of MFIs. A combination of qualitative (interviews) and quantitative (accounting data) analysis is used to rate the institutions. The present study solely uses quantitative measures to assess MFI performance.The indicators are adjusted to the amount of the crude loan portfolio to adjust for company size. Capital adequacy is measured by the amount of total equity and the amount of leverage within the organizations. A higher amount of equity disgraces the probability of the occurrence of insolvency. A higher reliance on debt increases the financial pressure on the institution. supplement reduces therefore the overall CAMEL score. Asset quality indicates the quality of the loans. The write of ratio of the loans and the not winnable loans in 30 days, reduces the quality of the assets. The ACCION model and the model of Cole Gunther (2008) do not include a quantitative measure of management. The current study measures the way the management uses the financial resources efficiently to provide as numerous loans with the same resources. Better management should be able to reach more clients (possibly with a higher amount of an average loan). Operational self-sufficiency is a measure of overall financial performance of the management. The ratio of operational expenses and loan portfolio presents how effective the management distributes loans to clients. This serves as a proxy for the objective of MFIs to reduce poverty. Secondly is the amount of active borrowers an absolute measure of how many clients the management reaches compared to the financial resources. The average loan balance divided by the GNI of the domestic nation indicates how much a MFI offers to clients within the local context. Earnings efficiency is the most important for return oriented investors. Return on assets and equity are a widely accepted measures of financial performance. Profit margin is includ ed as a profitability measure of the services offered by the institution. Liquidity is a measure of how well an institution deals with short term cash flows and needs. Unfortunately the database only provides annual information of balance sheets. particular proposition (short term) cash flow information is not available. Liquidity represents the ability of an institution to meet obligations as they come due. In order to create a proxy for liquidity, data is gathered to determine till which extent institutions can meet loan requests of clients. Two ratios are deliberate. The first represents the growth of the assets compared with the growth in the total loan portfolio. The second ratio focuses on the growth of equity compared with the growth in the total loan portfolio. If the ratios are above one, institutions are able to meet the obligations of new loans on a short term basis. An overview of the indicators used in the present study is given in table X, together with the expected e ffect on the overall CAMEL score.BEKIJK CLEAM winker Tank, 2008Exponential weighting is used to include past performances of institutions into the model. Other CAMEL models do not incorporate the time dimension, but past performances are a reliable proxy for future performance. Capital adequacy is for example calculated asCA1 and CA2 are the camel scores on the indicators as discussed above, is the weight of the indicator within the specified CAMEL area. This will be normally bear only distributed over the amount of parameters. The is the degree to which the past years taken into the equation. N is the amount of years of available data of MFI performance. The overall CAMEL score is constructed by an equal or adjusted weighting of the five performance areas.The sums of the weights of the indicators have a maximum of 1. Regarding the social objectives of MFIs a distinction is made between solely return oriented investors and more social oriented investors. A customized CAMEL rati ng on the preferences of an investor is created by shifting the weights of the areas, yielding the CAMEL rating which reflects the preferences of the investor. Within this study we will use an equal weight distributing, a distribution which stresses the financial performance (ES) and a rating which focuses on the social objectives (MQ).Two linguistic communication of caution have to be made with the use of the current model. The compare of the ratings is not straight forward when investors adjust weights to their preferences. Traditional CAMEL models use everlastingly an equal weighting over the areas, to grant comparability. Secondly, in line with Cole Gunther (2008) the CAMEL ratings are a not interchangeable with the CAMEL based on on-site visits. For investors the model designed for MFIs provides a reasonable indicator to determine the quality of MFIs on various aspects and should be seen complementary with the on site visits.Summarizing, CAMEL is used as a starting point to measures the financial performance of MFIs. specific indicators are chosen to adjust for the special case of a microfinance institution. The ACCION CAMEL model provided a first start for the current model. The solely quantitative model incorporates proposes a measure for effective management of an MFI, as a admonition of the social objective of MFIs. Secondly the model also considers past performance of MFIs with the use of exponential weighting. Thirdly the model enables to provide weights according to the investor preferences. For MFIs the model presents indicators which could be embedded in the MFIs performance goals. This way MFIs could attract more funds necessary through establishing a better rating and so, run short more attractive for investors. In the appendix are the CAMEL rating for the indicators specified. imperious risk in microfinanceSentivity to market risk as a prolongation of the CAMEL model.Descriptive statics are used to compare the performance of MFIs with commercial banks. Banking ratios of commercial banks of the G10 are used as a benchmark. The comparison of banking ratios provides a watch of the performance of the MFIs. The return on assets (RoA) and on equity (RoE) is compared to give an indication of the profitability of MFIs. The outstanding loan portfolios and write off ratios, provide a view of the riskiness MFIs, since micro credit represents the largest product class with microfinance. Leverage is used as an additional proxy for the riskiness of the organizations. Operational costs are compared to get a feeling for the efficiency of MFIs.According to Krauss Walter (2008) is the performance of MFIs mainly driven by macroeconomic factors within the domestic borders. The drivers of the financial performance of MFIs are studied with the use of the arbitrage pricing model (APT). The asset pricing model is used to determine the risk premiums of the macro economic factors of MFIs within the nation. Roll Ross (1995) find that t he return on assets or equity consists of a system of risk factors. The systematic risk factors are macroeconomic factors. The expected return on a portfolio of assets is given byThe betas on the factors represent a risk premium for a systematic risk factor. The alpha, as a residual idiosyncratic factor is canceling out in large portfolios. By using the linear multi factor model an indication of the impact of the macroeconomic factors is revealed on the performance of MFIs. The factors incorporated in the model are the growth of GDP, GNI, inflation and the penetration of the financial sector within the nation. In line with the