Pursuing Efficiency While Maintaining Outreach: Microfinance in India

Posted: 19 Mar 2010

See all articles by Abhijeet Chandra

Abhijeet Chandra

Vinod Gupta School of Management, IIT Kharagpur

Date Written: February 14, 2010

Abstract

Poverty reduction is held as the ultimate objective of microfinance. Microfinance addresses the small financial needs of the unbanked. The demand of basic financial services by the poor is evident. Estimation from the World Bank target over 2 billion people, of which a quarter of the Asian population. These individuals lack access to adequate forms of financing, many of whom are already borrowers of microloans. Overall the market size for the poor is estimated at $ 300 billion, of which only about 4% is met. The market for microfinance is expanding. There were 2.8 billion people worldwide living on less than 2 dollars a day, 10,000 microfinance institutions and 93 million of microfinance beneficiaries (Attali, 2006). The potential market is huge, with an upside of $100 billion and a sector growth of 20% per annum (Monfort, 2007). Financial sustainability and efficiency of microfinance institutions is very important for a well functioning financial system in developing countries. Financial sustainability is equally important for any microfinance institutions as is wide outreach. Relationship between outreach and efficiency is one of the most important topics in recent discussion on microfinance across the geographies.

Using a sample of more than 70 microfinance institutions in India, our study attempts to examine the dynamic relationship between outreach to the poor and financial efficiency of microfinance institutions. We explore the patterns of profitability, loan repayment, and cost reduction. This paper also examines the empirical relationship between financial sustainability and wide outreach and its accompanying effect, the effect of outreach on financial self-sufficiency using abundant financial data for MFIs across India between 2003 and 2008. We provide detailed econometric and statistical analysis in this regard. Univariate and multivariate statistical methods have been applied in order to describe the correlates of profitability, focusing particularly on the roles of cost and interest charged on loans, and its relationship on outreach of MFIs.

The results of the study addresses the following issues: Does raising interest rates exacerbate agency problems as detected by lower repayment rates and less profitability? Is there evidence of a trade-off between the depth of outreach to the poor and the financial pursuit of sustainability? What is the possibility of occurrence of mission drift? Based on the survey and analysis of high quality financial data of more than 70 microfinance institutions from across India reveals that financial sustainability largely depends on an institution’s lending method. As far as trade-off between outreach to the poor and financial sufficiency is concerned, we find that larger loan sizes are associated with lower average costs for both individual-based lenders and solidarity group lenders. On the whole, our results suggest that institutional design and orientation matters importantly in considering trade-offs in microfinance. The results underscore the need to better understand how contracts function using high-quality financial data. The results of this study have high policy implications for socially-oriented microfinance institutions who strive for a wide outreach to the poor while maintaining financial efficiency for sustainability.

Keywords: Micro finance, Outreach, Financial efficiency, Mission drift, Sustainability

JEL Classification: A11, B23, G21

Suggested Citation

Chandra, Abhijeet, Pursuing Efficiency While Maintaining Outreach: Microfinance in India (February 14, 2010). Available at SSRN: https://ssrn.com/abstract=1570443

Abhijeet Chandra (Contact Author)

Vinod Gupta School of Management, IIT Kharagpur ( email )

Kharagpur, 721302
India

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