Sa-Dhan Newsletter Volume 5 Issue 1

Operational Costs of Delivering MicroFinance

Operating Expenses in MicroFinance

Using illustrations from M-CRIL's database, N. Pathak elaborates

on the crucial role that an organisation's operating expenses play in its sustainability

W

It is only the best performing institutions (M-CRIL's Top10),

hat constitutes operating expense?

Grameen model MFIs and individual model MFIs that typically

charge adequate interest rates and recover loans efficiently

Operating expenses in any business refer to the expenses that

enough to cover (or nearly cover) expenses. A high enough

are essential to run the operations of the business. In a

yield from the portfolio is necessary to meet the operating

typical microfinance institution (MFI), 'operating expenses'

expenses of the organisation. The objective of delivering MF

refer to all types of non-financial costs, essential to run its

services at low cost to the client is threatened if the OER of

operations. It, thus, includes all types of cash expenses on

the MFI is not kept within reasonable limits; specifically less

salaries and wages of staff, commissions not classified under

than the yield from portfolio. On the other hand, a low OER

financial costs, administrative expenses, expenses for the

enables the MFI to hold down its interest rate thereby making

promotion of groups and non-cash expenses like amortisation

the service more affordable to low-income clients. By the

and depreciation of assets. By their nature, the components

same measure, a decline in the operating expense ratio can

of operating expenses are critical to the operations of an MFI.

enhance the profitability and sustainability of an MFI.

Later in this paper we will show how operating expenses have

a very strong correlation with staff productivity, profitability

Factors affecting the operating expenses

and sustainab7ility of an MFI.

An examination of the distribution of operating expenses over

Why are operating expenses important?

broad expense categories (Figure 1) enables a greater

understanding of the means to ensure sustainable and low

One of the primary objectives of MFIs is to provide sustainable

cost delivery of MF services.

microfinance (MF) services to low-income clients at reasonable

cost. The sustainable delivery of MF services at reasonable

Figure 1

cost calls for efficient operations. The M-CRIL database1 of

Distribution of expense categories for different models of

rated MFIs shows an interesting correlation between yield2 on

MFI

portfolio and the Operating Expense Ratio3  of MFIs in the

Asian region. Since yield consists of earnings on portfolio,

100%

it is naturally determined by the interest charged by the MFI,

35%

the quality of its portfolio and the efficiency with which

39%

39%

44%

75%

collection of loan instalments takes place.

5%

5%

5%

17%

50%

Table 1: Comparison of OER and Yield for different models

of MFIs

60%

57%

51%

25%

44%

Comparison by model

0%

Model

OER (%)

Yield (%)

4

G

IB

M

SHG

G

32.1

29.2

Salaries

Depreciation

Other admin

IB

12.8

20.4

M

37.7

23.1

The graph clearly shows that the cost of human resources

- salary of staff - accounts for the major proportion of

SHG5

63.8

13.8

expenses in MFI operations. Grameen and SHG model MFIs

M-CRIL:

are more highly staff cost-intensive than the others.  By

the same measure individual banking MFIs are more fixed

Sample

48.3

18.5

asset intensive with a higher depreciation cost. Such MFIs

Top10

23.8

29.9

usually have more branches and automation and, therefore,

India

52.9

16.3

greater fixed assets.

1

M-CRIL (Micro-Credit Ratings International Limited) is a credit rating agency specialising in the risk assessment of microfinance

institutions. Established in the year 1998, it has rated close to 200 MFIs in different parts of Asia till December 2003. Its database

consists of information from all the rated MFIs and provides a benchmark for setting industry standards.

2

Yield on portfolio is the proportionate recovery from average portfolio of an MFI over a certain period of time - usually one year.

It is the income of the MFI from its lending business.

3

Operating Expense Ratio (OER) of an MFI is the ratio of its operating expenses and its average portfolio over a (usually) one

year.

4

Here G refers to the MFIs using the Grameen Bank model for practicing microfinance. Similarly SHG, IB and M refer to MFIs

using self- help group, individual banking and mixed models of microfinance respectively.

5

Higher OER in the case of  SHG and mixed model MFIs should be seen as aberration as the majority of MFIs of database are

inefficient and incidentally they use SHG or mixed model for microfinance delivery.

4