Analysis of microfinance performance and development of informal institutions in Cameroon

II.2- The Self-Sufficiency and Sustainability of MFIs

Unlike formal sector financial institutions, the large majority of MFIs are not "sustainable," where sustainability is equated in microfinance literature and parlance with financial self-sufficiency¹. Instead, most MFIs are able to operate without covering their costs due to subsidies and gifts from governments and other donors. Notwithstanding, the microfinance industry is dominated by an institutionist paradigm (Morduch (2000), Woller et al. (1999a)) asserting that an MFI should be able to cover its operating and financing costs with program revenues. The conceptual foundations of the institutionist paradigm stem to a large degree from the work of researchers at the Ohio State University?s Rural Finance Program. Their analysis of the failed rural credit agencies established by several LDC governments during the 1960s and 1970s diagnosed the primary cause of failure to be the «lack of institutional viability» (Gonzalez-Vega (1994)). This diagnoses led logically to two principal conclusions: (1) institutional sustainability was key to successful provision of financial services to the poor and

¹ Morduch (2000) reports a rough estimate that only 1 percent of MFIs are currently financially self-sustainable and that no more than 5 percent ever would be.

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Analysis of microfinances' performance and development of informal institutions in Cameroon

By Djamaman Brice Gaétan

(2) financial self-sufficiency was a necessary condition for institutional sustainability². The institutionist argument is consistent with Hollis and Sweetman (1998a) who discuss six historical cases in an attempt to identify the institutional designs that facilitated success and sustainability for 19th century loan funds in the UK, Germany, and Italy. The authors conclude that subsidized loan funds were more fragile and lost focus more quickly than those that obtained funds from depositors.

In contrast, Welfarists take odds with institutionists over the issue of sustainability. Welfarists argue that MFIs can achieve sustainability without achieving financial self-sufficiency (Morduch (2000), Woller et al. (1999a)). They argue that donations serve as a form of equity and as such, the donors can be viewed as social investors. Unlike private investors who purchase equity in a publicly traded firm, social investors do not expect to earn monetary returns. Instead, these donor-investors realize a social, or intrinsic, return. Social investors can be compared to equity investors who invest in socially responsible funds, even if the expected risk-adjusted return of the socially responsible fund is below that of an index fund. These socially responsible fund investors are willing to accept a lower expected financial return because they also receive the intrinsic return of not investing in firms that they find offensive. Microfinance social investors take this notion to the limit, generally earning zero financial returns and relying totally upon intrinsic returns.

Welfarists tend to emphasize poverty alleviation, place relatively greater weight on depth of outreach relative to breath of outreach, and gauge institutional success more so according to social metrics³. This is not to say that neither breadth of outreach nor financial metrics matter. Welfarists feel these issues are important, but they are less willing than institutionists to sacrifice depth of outreach to achieve them. Welfarists envision an industry characterized by a plurality of institutional types (including both profit-seeking and social-mission entities) targeting different markets, with different combinations of market and non-market funding, and with different levels of commitment to social versus financial return.

Morduch (2000) refers to the debate between institutionists and Welfarists as the «microfinance schism.» Driving the schism are competing perceptions of the implications for financial self-sufficiency on depth of outreach. General consensus holds that there exists a tradeoff between

² Additionally, Bennett and Cuevas (1996) argue for the need of building sustainable financial systems for the poor from three perspectives: a) financial sector development, b) enterprise formation and growth, and c) poverty reduction.

³ Depth of outreach here refers to servicing the very poorest of clients, whereas breadth refers to servicing large numbers of clients, even if they are only marginally poor or non-poor.

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Analysis of microfinances' performance and development of informal institutions in Cameroon

By Djamaman Brice Gaétan

financial self-sufficiency and depth of outreach (e.g., von Pischke (1996)). But masked by this consensus is much disagreement about the nature, extent, and implications of this tradeoff. Nonetheless, what little evidence exists suggests that those MFIs that have achieved true financial self-sufficiency have also tended to loan to borrowers who were either slightly above or slightly below the poverty line in their respective countries (Navajas et al., (2000)).

These MFIs are able to capture economies of scale by extending larger loans to the marginally poor or non-poor. Although still an open question, this limited evidence leads many to conclude that if financial self-sufficiency is desired, then the very poor will not be reached by MFI services. That is, the MFI will not be able to achieve enough depth to reach those who need credit the most desperately.

An important area of financial research that has yet to be rigorously explored but which has significant potential to inform the debate mentioned above is the feasibility of introducing microfinance into the world capital markets. With the high repayment rates of many MFIs (e.g., upper 90% in many cases), there exists the potential to tap MFIs into world capital markets through instruments such as commercial banks loans, commercial paper, bond financing, equity financing, or through the bundling and securitization of MFI loans. Determining avenues to permit investment in MFIs via capital markets is an area of research that seems tailored to the tools and theory of finance academics.

In practice, there are currently several ongoing attempts to tap capital market investors for MFI funding. The ACCION Gateway Fund makes equity, quasi-equity, and debt investments in MFIs with a proven track record of financial sustainability. The AfriCap Microfinance Fund makes equity investments in African-based MFIs, as well as financing technical assistance for said MFIs. Blue Orchard Finance promotes private investments in microfinance by identification and analysis of MFIs and investment monitoring and reporting of its funds. Using a venture capital approach, ProFund International is an investment fund that attempts to earn a competitive return for its shareholders while facilitating MFI growth. Finally, the Community Reinvestment Fund provides a secondary market for microfinance loans by securitizing the microloans and collateralizing bonds that are sold to private investors⁴. If capital markets can be tapped to give MFIs the needed funds to be self-sufficient, and if investors can earn returns commensurate with the risk borne, the vision of a poverty-alleviation mechanism that pays for itself (both implicit and explicit costs) may be realized in greater proportions. Issues surrounding MFI sustainability

⁴ The bulk of the information in this paragraph is drawn from an ACCION website at URL: http://www.accion.org/technical_assistance/micro_links2.asp Q_K_E_2.

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Analysis of microfinances' performance and development of informal institutions in Cameroon

By Djamaman Brice Gaétan

+and self-sufficiency, and the implications/tradeoffs implied therein seem well-suited for finance researchers. Few rigorous studies have been conducted in a financial institutions framework to develop and test theory pertaining to MFI self-sufficiency.

Some evidence does exist however, that MFIs have historically been very resilient and sustainable. Hollis and Sweetman (2001) discuss the microloan funds in 18th and 19^th century Ireland. They report that Irish loan funds thrived for over 100 years due to their ability to change rapidly to external conditions, at one point providing financial services for 20% of Ireland's population. It took a combination of formal bank lobbying that resulted in anti-MFI legislation and the Irish potato famine to cause the demise of these early loan funds. Patten et al. (2001) provide a more recent historical example of the resilience of MFIs and their clientele.

They compare the performance of the Indonesian MFI Bank Rakyat Indonesia (BRI) to formal Indonesian banks during the East Asian financial crisis. They find that BRI performed superior to the formal banking sector when comparing both loan repayment rates and savings rates of members. Having discussed MFI self-sufficiency and sustainability, we now turn our attention to the products and services offered within the current microfinance framework.