From NGOs to Banks: Does Institutional Transformation Alter the Business Model of Microfinance Institutions?

Abstract

Microfinance, which pledges to provide financial services to people without access to banking, is chiefly run by non-governmental organizations (NGOs). Little is known about the extent to which the transformation of these NGOs into shareholder-owned and, most often, regulated firms affects the way microfinance institutions (MFIs) conduct their business. By applying the event study methodology to 66 MFIs that have transformed, we quantify the effect that transformation has on the MFIs' business models. Our results suggest that portfolio yield is driven down by 3.9 percentage points due to transformation, indicating that clients get more favorable interest rates. At the same time, MFIs are able to significantly cut down their operational expenses, of which 1.1 percentage points can be attributed to transformation. Other findings include a steep increase in commercial debt leverage and deposits, a significant decrease in the fluctuation of funding costs and a sharp rise in average loan size. Profitability goes down in the short and medium term, while return on equity is driven up in the medium to long run. By exploiting within-MFI data, our approach goes beyond previous studies that mainly relied on between-MFI data. Overall, the results suggest that transformed MFIs become an attractive environment for investors, potentially encouraging a more profit-seeking behavior among transformed MFIs. Acknowledgements.We thank Victoria van Lennep and Li Yang for research assistance in data gathering data. We also AbstractMicrofinance, which pledges to provide financial services to people without access to banking, is chiefly run by non-governmental organizations (NGOs). Little is known about the extent to which the transformation of these NGOs into shareholder-owned and, most often, regulated firms affects the way microfinance institutions (MFIs) conduct their business. By applying the event study methodology to 66 MFIs that have transformed, we quantify the effect that transformation has on the MFIs' business models. Our results suggest that portfolio yield is driven down by 3.9 percentage points due to transformation, indicating that clients get more favorable interest rates. At the same time, MFIs are able to significantly cut down their operational expenses, of which 1.1 percentage points can be attributed to transformation. Other findings include a steep increase in commercial debt leverage and deposits, a significant decrease in the fluctuation of funding costs and a sharp rise in average loan size.Profitability goes down in the short and medium term, while return on equity is driven up in the medium to long run. By exploiting within-MFI data, our approach goes beyond previous studies that mainly relied on between-MFI data. Overall, the results suggest that transformed MFIs become an attractive environment for investors, potentially encouraging a more profit-seeking behavior among transformed MFIs.Word count: 210

Board Governance: Does Ownership Matter?

“…This contradicts typical recommendations in the industry that NPO‐MFIs should transform into shareholder‐owned banks (for an overview of the MFI transformation literature, see D'Espallier et al. ), although it is in line with earlier findings reported in the microfinance literature (Mersland and Strøm ). Another finding worth reporting is the positive effect of an international initiator on client outreach.…”

Determinants of the Performance of Microfinance Institutions: A Systematic Review

“…Results are also mixed regarding the influence of age on social performance (D'Espallier et al ., ) and more specifically environmental performance (frequently considered as a sub‐category of social performance). The evidence on environmental performance depends on the geographical context.…”

“…In most cases, these are larger, mature, regulated and relatively well‐known MFIs (Deutsche Bank, ). The non‐profit NGOs are still the main type of MFIs, representing almost half of the total number of MFIs (D'Espallier et al ., ). The median level of financial sustainability does not differ much between non‐profit and/or NGOs on the one hand and for‐profit or microfinance banks on the other hand (Cull et al ., ).…”

Does Religious Affiliation Influence the Design of Corporate Governance? Evidence from the Global Microfinance Industry

“…In the microfinance industry, there is increasing debate over whether MFIs should be regulated by local banking authorities. Several unregulated MFIs have recently opted to transform into banks and thereby come under regulatory scrutiny (D’Espallier et al ., ). Because regulators normally demand that regulated institutions have identifiable owners, they normally only allow shareholder‐owned institutions to be regulated (D’Espallier et al ., ).…”

“…Several unregulated MFIs have recently opted to transform into banks and thereby come under regulatory scrutiny (D’Espallier et al ., ). Because regulators normally demand that regulated institutions have identifiable owners, they normally only allow shareholder‐owned institutions to be regulated (D’Espallier et al ., ). As a result, if Christian MFIs tend to be NGOs, they will have a lower probability of being regulated.…”