Sa-Dhan Newsletter Volume 5 Issue 1

Operational Costs of Delivering MicroFinance

Taking Interests At Large

Are we inefficient, asks V. Prasad,

wondering why MFIs charge high interest rates to serve the poor?

Loan processing fees are another source of income ­

`Sustainability' ­ a term that has become increasingly

again, an aspect that is not uniform across all MFIs. SHGs

significant for the microfinance (MF) sector and understand-

generally do not charge a loan-processing fee while

ably so, since this has to be one of the primary goals for

Grameen MFIs usually charge a certain percentage of the

any Micro Finance Institution (MFI) that wishes to expand

loan as group tax.

its services and outreach and attract external funds, be it

equity or debt. Exactly how does one define `sustainability'?

One way of explaining it is that it is the ability of the MFI

Yield on Portfolio (Real)1

to continue serving its clients long after donor support in

(by Methodology) MBB # 9, July 2003

the form of grants and subsidies have ended. For an MFI

Individual

30.2

to tap into private investment and to access debt from

mainstream financial institutions, the latter has to regard

Solidarity Groups

35.6

it as a professional, profitable and competitive institution.

Village Banking

57.1

Key elements would therefore be operational and financial

(All figures for financially self sufficient MFIs)

self-sufficiency. Achieving them would ensure continued

service to clients using only the MFI's income from financial

An MFI also earns revenue in the form of interest on

operations.

investments. Keeping in mind the MFI's cash flows and

with a view to ensuring proper liquidity management, MFIs

MFIs attain self-sufficiency through cost and income

normally make both short-term and long-term investments

structures that vary across regions. The Micro Banking

as a means to earning income. The extent of this income

Bulletin's (MBB) analysis of this indicates that while Asian

will obviously depend on efficient management by the MFI

MFIs that are financially self-sufficient achieve profitability

as well as prevalent interest rates.

due to the low costs in the region, MFIs in other regions

(Latin America, Africa, Eastern Europe) face higher costs

Elements of Expenditure

and thus attain self-sufficiency through a combination of

higher income and productivity.

Interest Expenditure: As MFIs gradually move away from

a subsidised environment and reduce their dependence on

A host of performance indicators and ratios are commonly

grants, they start to access debt from mainstream financial

used to evaluate an MFI on parameters such as portfolio

institutions. This debt has a cost ­ one that is for most

quality, profitability, outreach and efficiency.

part driven by macro-economic forces and over which the

MFI has little control. This is not to say the MFI has no

Efficiency indicators measure how well an MFI is using

bargaining power ­ it does, and this depends on the credit

its resources, particularly its assets and its personnel. These

rating of the MFI, its financial performance and its overall

indicators take into account the cost of inputs (operating

reputation in the sector. Some MFIs access soft loans from

expenses) relative to outputs (loan portfolio). Efficiency

development financial institutions, thus attempting to reduce

indicators are influenced by credit methodology, loan size

their interest costs but as far as loans from commercial

(target clients) and growth strategy. These indicators

institutions are concerned, there is a limit to the amount

however tend to be more comparable across MFIs because

of control that can be exercised by the MFI.

they are not affected by sources of funding or loan loss

reserve policies of MFIs. The most commonly used measures

Loan Losses: The loan portfolio of an MFI is considered

are the operating cost ratio, which measures operating

to be its most important asset as well as its largest source

costs as a percentage of average gross portfolio in a year,

of potential risk. The loan loss of an institution and the

and borrowers per Staff member.

resultant provisioning that it would need to make in this

regard are dictated by law as well as by the MFI's own

Elements of Revenue

internal policy on this matter and would thus constitute

another prominent element of expenditure for the MFI. The

The elements of revenue for an MFI generally include

Provisioning Ratio is normally calculated as follows:

interest income, which is the income earned by the MFI

on its loans to clients. The pricing of loans by MFIs has

Loan Loss Provisioning Expense for the period / Average

of course been the subject of a long-standing debate but,

Gross Portfolio

in the end, the decision has to be linked to the cost

structure of the MFI. There cannot be uniform pricing

What this measure indicates is the expense incurred by the

among MFIs given the diversity in methodologies and the

institution in anticipation of future loan losses. For regulated

variations in the cost structure of different models, not to

MFIs the minimum rate of provisioning is prescribed by

mention geographical and social constraints.

the regulatory body in question. NGO-MFIs however, are

1 Financial Revenue from Loan Portfolio/Average Gross Loan Portfolio (adjusted for inflation)

9