Matthew Conner

English

Research Papers in Economics

Fall 2008 • Region Focus 7
T
he goal of “microbanks” is to reduce poverty by pro-
viding short-term, low-principal loans that serve to
increase access to credit which might otherwise be
closed to those in the developing world. The literature con-
cerning microlending ranges from unabashed praise to
harsh criticism. 
Some see the trend as one of the greatest forms of
humanitarianism in recent years — Muhammad Yunus,
founder of the Grameen Bank of Bangladesh, one of the 
pioneer microbanking programs, recently received the
Nobel Peace Prize. Others see microlending as little more
than a glorified welfare program.  
Subsidies appear to play a very
large role in the sustainability of
nearly all microbanks. This is due
to the fact that microbanks face
two large problems. One, they
lend primarily to people who can
offer no collateral. Two, they
attempt to generate profit while
granting relatively small loans. 
Even the Grameen Bank of
Bangladesh, which has reported profits nearly since its
inception, may not be as self-sufficient as once thought.
According to economist Jonathan Morduch of New York
University, when Grameen's accounts are followed over
time, he finds that “categories and expenses are moved
around to ensure that Grameen posts a modest profit.” 
In addition, he also notes the fact that the subsidy rate (as
a percentage of total loan portfolio), while falling over recent
years, still rests at approximately 9 percent. In a comprehen-
sive survey of microfinance firms targeting the poorest
borrowers, research showed that these banks were generat-
ing only enough revenue to cover 70 percent of their 
full costs. 
However, microbanking is a very complex industry with
many variations in how each institution lends money and the
mechanisms used to encourage repayment. In a recent 
article, Morduch and economists Robert Cull and Asli
Demirgüç-Kunt of the World Bank performed a global
analysis of leading microbanks. They split microbanks into
three categories depending on lending type: 1) village lend-
ing in which there is large-scale joint liability for repayment
2) group lending where the focus is on self-formed groups of
borrowers (solidarity groups) that assume joint liability for
repayment and 3) individual lending that centers around a
more traditional bilateral relationship between bank and
customer. 
To assess the profitability of these microbanks, the
researchers used a financial self-sufficiency ratio, a measure
of a bank’s ability to generate enough revenue to cover its
costs. The ratio is derived from revenue divided by the sum
of adjusted financial expenses, adjusted net losses from
loans, and adjusted operating expenses. 
Village banking serves the poorest customers, with an
average loan size of approximately $149, but it also reaches a
large number of borrowers. The troubled financial positions
of the clientele causes the average interest rate of village-
based loans to be the highest of the three types studied. 
These banking operations also face the highest average
costs, since the small loan amounts
generate small incremental pay-
ments compared to the operating
costs associated with managing
such a vast number of outstanding
loans. According to the survey, the
average return on assets for vil-
lage-based lending was negative.
The banks that employ the
group lending technique follow
the same guidelines as the village
banks but on a smaller scale. Group banks have an average
loan amount of $430.98 and also charge slightly lower inter-
est rates, given that their clients are financially better off and
are more likely to fully repay loans. Operating costs are also
lower than village-based lending because of the larger loan
amounts and smaller outreach, but these banks also show a
negative return on assets.  
Individual-based lenders are the only group that reported
profit not enhanced by subsidies and grants, but they also
exhibited the lowest amount of outreach. The average loan
amount for these banking operations is approximately
$1,220, which reduces average costs and allows for a slightly
positive return on assets.  
Working with customers who can handle such large loans
and are obviously not the “poorest of the poor” seems to
veer from the primary targets of microbanking. There
appears to be a viable trade-off between profits and out-
reach, with the more profitable banks possibly experiencing
what the authors refer to as “mission drift,” or a shift toward
prioritizing revenue over the reduction of poverty.
This situation presents a conundrum. It seems that the
surest way to be a successful microbank is to act more like a
traditional bank. The authors note that there are “examples
of institutions that have managed to achieve profitability
together with notable outreach to the poor — achieving 
the ultimate promise of microfinance. But they are, so far,
the exceptions.” RF
Microbanks: Subsidy Dependent or Self-Sufficient?
BY MATTHEW CONNER
RESEARCHSPOTLIGHT 
“Financial Performance and Outreach: 
AGlobal Analysis of Leading
Microbanks” by  Robert Cull, Asli
Demirgüç-Kunt, and Jonathan Morduch. 
Economic Journal, February 2007, 
vol. 117, pp. 107-133.

Research spotlight : Microbanks : subsidy dependent or self-sufficient?

http://www.richmondfed.org/publications/research/region_focus/2008/fall/pdf/research_spotlight.pdf

Research spotlight : Microbanks : subsidy dependent or self-sufficient?

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