IJERD – International Journal of Environmental and Rural Development (2017) 8-1

Research article
erd

Evaluation of Microfinance Institutions in Ethiopia from the
Perspective of Sustainability and Outreach
FRAOL LEMMA BALCHA*Tokyo University of Agriculture, Tokyo, Japan
Email: fraolgel@gmail.com

SALEHU ANTENEH TAMARE
Addis Ababa University, Addis Ababa, Ethiopia
Received 11 December 2016

Accepted 28 2017(*Corresponding Author)

Abstract Ethiopia is a developing country, the second most populous in Africa with anestimated population of more than 94 million. The Ethiopian economy is based on agriculture,and poverty reduction has been the overriding development agenda. The coverage of formal
financial services estimated to be less than 10 percent, nevertheless banks consider the poor
“un-bankable”. It has been assumed that Microfinance Institutions (MFIs) have reached thepoor on a sustainable basis. Considering the situation, this study aims at evaluating the outreachlevel of Ethiopian MFIs and its sustainability. In order to achieve the planned research
objectives, quantitative as well as qualitative research methods are used. The target of thisresearch is MFIs currently operating in the country. The 14 samples of the study were selectedfrom operating 34 MFIs by using purposive sampling technique to include all categories. Data
were collected through questionnaires, whereas, secondary data from annual reports and otherdocuments. The analysis indicated that the breadth and the depth of outreach of Ethiopian MFIs
are in an increasing trend. The increase in the amount of voluntary savings was remarkable, andits ratio to the compulsory savings was 482.51 percent from 2005 to 2014. With regards todepth of outreach, 54.73 percent of women and relatively insignificant number of crop
producing farmers have been covered by microfinance services. The Operational Selfsufficiency Ratio and Financial Self-sufficiency Ratio of Ethiopian Microfinance Institutions’are in increasing trends because of the enhancements in generating more revenue. Outreachtrend is promising, though they have challenges to address the disadvantaged group of thesociety. The sustainability indicators suggested that the increase of operational sustainability
and financial sustainability ratios are due to the increase in revenue and the contribution ofdonors and/subsidization. It is also advisable to improve its sustainability by increasing theefficiency.
Keywords outreach, sustainability, microfinance, savings, subsidization

INTRODUCTION
The emergence of Microfinance institutions (MFIs) is a late phenomenon in Ethiopia compared toother developing countries. It only counts back to the second half of the 1990s as a pilot in one region,
and as a result of its success, the microfinance service was gradually replicated in other regions. The
MFIs in Ethiopia focus on group-based lending and promote compulsory and voluntary savings. Theyuse joint liability, social pressure, and compulsory savings as alternatives to conventional forms ofcollateral (SIDA, 2003). These institutions provide financial services, mainly credit and saving and, insome cases, loan insurance. The objectives of MFIs are quite similar across organizations. Almost all
MFIs in the country have poverty alleviation as an objective. They focus on reducing poverty andvulnerability of poor households by increasing agricultural productivity and incomes, diversifying offⒸ ISERD

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farm sources of income, and building household assets. They seek to achieve these objectives by
expanding access to financial services through sustainable microfinance institutions.
There is a big challenge in accessing financial resources from formal financial institutions/ banksby the poor in Ethiopia due to various reasons, and particularly, collateral. The experiences of some
Asian countries like, Bangladesh, were considered as a success stories in tackling the problem ofaccess to finance, and the Ethiopian government issued proclamation no. 40/1996 in 1996 that allowed
the establishment of MFIs. The government takes financial inclusion as a policy objective and assumed
MFIs can fill this gap. A number of studies indicated that sustainability is the basic question andchallenges of MFIs in developing countries, which hinders their ability to outreach the poor. This
problem has attracted the attention of many researchers and as a result many strategies have been put toensure that MFIs are sustainable (Yaron, 1992). Therefore, one of the objectives of this study is toclearly understand the factors affecting the outreach and sustainability.
The main objective of this study is to evaluate the current performance of Ethiopian MFIs to pointout the influencing factors of the sustainability and level of outreach for the better progress inperformance and as well to contribute to policy formulation.
METHODOLOGY
Outreach and sustainability: Meyer (2002) noted that the poor needed to have access to financial
service on long-term basis (sustainability) rather than just a onetime financial support. This indicates
that, outreach and sustainability are inseparable although there is a tradeoff between them (Izumida,
2003). Due to this fact, this study employed both outreach and sustainability to evaluate the position of
Ethiopian MFIs. This study used both primary and secondary data. Primary data were taken fromquestionnaire followed by interviews. On the other hand, secondary data were taken from time series
data (2005-2014) collected from reports, journals, and other financial statement sources. The study
employs both quantitative and qualitative methods of analysis. Thus, multiple regression models havebeen used with IBM SPSS statistical software. The sampling was done on the basis of purposive
sampling technique to incorporate from all categories (large, medium to small). Accordingly, 14 MFIs
were selected as a study sample from the targeted population of about 34 MFIs operating in the country.
RESULTS AND DISCUSSIONA) Outreach level of Ethiopian MFIs: Various studies have used the number of borrowers as ameasure of microfinance breadth of outreach (Nyamsogoro, 2010; Mersland and Strom, 2009; Harmes
et al., 2008). It is generally assumed that the increasing trend/ the larger the number of borrowers thebetter the outreach. The number of borrowers of Ethiopian MFIs were about 68, 000 in 2005 while thisnumber increased to about 2 million in 2014. In this case we are able to say that, the Ethiopian MFIs
have been expanding its outreach to the poor. The average balances of outstanding loans are proxy
indicators used to indicate a client’s socioeconomic level or depth of outreach. The lower the loan sizeis the indication of the quality of depth of outreach in which the industry average low end depth ofoutreach is loan size less than USD 150. The Ethiopian MFIs average loan size was about USD 121,
which qualifies good quality of depth of outreach. But there was also some MFIs tending to exceed thethreshold of the industry, which needs further investigation whether they are lean towards mission drift
or not. Provision of different kind of product by MFIs is also noted as performance indicators.
As depicted on Table 1, the types of financial services were concentrated on saving and credit
services, it has limitations on addressing the various scopes of needs of the poor. The loan programmes
actually performing better thought the geographically remote area, where poor farmers have very small
access to the financial services of the MFIs. Crop producing farmers have limited access to thesefinancial services. The other indicator of outreach is the percentage of women. With regards to thisⒸ ISERD198

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indicator the Ethiopian MFIs covered only about 55%, compared to the average coverage of South
Asia 86% and Africa 61%. With respect to saving characteristics, the ratio of voluntary savings tocompulsory savings stretched to 482.51 percent in ten years’ period of time from 2005 to 2014 which
is a well-off progress.
Table 1 Types of services, loan programmes, and clients of Ethiopian MFIs
Type of financial services by MFIs

Percentage

Pension
Saving and Credit
Insurance
Money Transfer
Type of loan programme

28.6%
100%
21.4%
21.4%

Loan for Geographically Remote Area
Loan for SME
Loan for Women
Loan for Farmer

28.6%
100%
54.4%
85.%

Percentage of MFIs who
have rural farmer clients
14.3%
21.4%
64.3%
MFIs serving
10%
40%
50%
Average

Percentage

< 10%
< 50%
> 50%
Crop producer
farmers
7.1%
22.9%
40%
35%

B) Sustainability: The definition of sustainability pointedly varies due to the big divides of thought(Institutionalist Vs Welfarist) in the industry. The institutionalist basically assumes MFIs as a purely
business entity. They argued that, the Dollar invested as a loan in microcredit should have to work in
the free market and poverty can be reduced by commercialization, democratization of capital andfinancializing of development (Roy, 2010). But the Walfarist argued, MFIs can achieve sustainability
without achieving financial sustainability. Sustainability basically appraised by two levels ofsustainability. These are Operational Self Sufficiency (OSS) and Financial Self Sufficiency (FSS). OSS
requires MFIs to meet all administrative costs and loan losses from operating income of any kind;
while FSS measures the extent to which an MFI’s business revenue; mainly interest received covers
the MFIs adjusted costs. Both OSS and FSS ratios are expected to be equal and/or more than 100% toprove sustainability of a particular MFI. Based on this assumption the analysis of the trends of OSS
and FSS ratios are indicated in Figure 1 below. Ethiopian MFIs were in increasing trend both in OSS
and FSS during the study period of time, except it tends to decrease of FSS ratio from 2013. The basic
question here is, what are the influencing factors behind this trend.

Fig. 1 Trends of OSS and FSS ratios of Ethiopian MFIs

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Multiple regression models have been used to assess the significant determinants of sustainability.
OSS and FSS are the dependent variables, where about eight independent variables have been
identified based on the Microfinance Information Exchange platform (MIX market), and from thedetailed reviews of the related literatures. These variables are YIELD, Cost Per Borrower (CPB),
Operating Expense Ratio (OER), Active Loan Balance Per Borrower (ALBPB), SIZE, Debt to Equity
Ratio (DER), Number of Active Borrowers (NAB) and Age of MFIs. The IBM SPSS statisticalsoftware have been used for empirical analysis. To apply this model most of the assumption of theregression model has been implemented; and the validation of the data used have been done.
Accordingly, the regression diagnostic test of the null hypothesis “normally distributed errors” hasbeen done and the Shapiro-Wilk’s tests for normality showed, there is insufficient evidence to suggestthat the data set is not normally distributed. Test of skewness and kurtosis also indicated the value of‘zero’ is within the 95% confidence interval. So in both tests we fail to reject the null hypothesis. An
admittedly arbitrary rule of thumb is established to constrain simple correlations between explanatory
variables to be smaller than 0.8 to 0.9. The null hypothesis to check for “No Multicollinearity” hasbeen tested using person correlation and reject the null hypothesis. To solve this problem, number ofactive borrower is removed according to its relative importance to size and the second test proves nomulticollinearity problem. The Durbin-Watson (DW) test for autocorrelation has been done and failed
to reject the null hypothesis, “no autocorrelation”. The disturbance of the error was also checked byscatterplot and proves no autocorrelation. After the consecutive test of validity and reliability of thedataset, the OSS and FSS determinants are identified along their significance level.
Determinants of Operating Self Sufficiency
Table 2 Econometric Results of OSS’s Determinants

Variables(Constant)
SIZE
YIELD
CPB
OER
ALBPB
DER
Age

Std. error
1.099
0.046
0.022
0.003
0.129
0.127
0.101
0.114

Standardized
coefficients
Beta
0.249
0.738
-0.951-0.698
0.052
0.775
0.221

t

Sig.

0.170
0.768
0.636
-4.129-0.456
3.486
0.786
0.184

0.245
0.228
0.267
0.000***
0.327
0.002**
0.222
0.428

Dependent Variable: OSS, *** Significant at 1%; ** Significant at 5%; * Significant at 10%
Source: Author’s Computation using IBM SPSS (2016)

As it can be seen from Table 2 above, from the estimated seven variables only about two variables
have a significant impact on OSS. The null hypothesis for these factors were as follows.
Ho: There is a negative significant relationship between cost per borrower ofmicrofinance institutions and operational self-sustainability.
H0: There is no significant positive relationship between average loan balance
per borrower and operational self-sustainability.
The result revealed that CPB have a negative significant impact on OSS at 1% significant level.
Therefore, we failed to reject the null hypothesis. The findings by (Woller and Schreiner, 2002;
Christen et al, 1995) also indicated the CPB negatively and significantly affect operationalsustainability. With regards to ALBPB, the statistics result indicated that it has positive impact on OSS
at a significance level of 5%. The ALBPB for Ethiopian MFIs is about USD 121. Thus, the EthiopianⒸ ISERD

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MFIs average loan size evidences high cost from this analysis. The smaller the loan size, the better inoutreach, but the higher the cost; here is where the tradeoff between the two triggered. The averageloan size for African countries was 307 USD during the study period of time. Other studies, forinstance (Adongo and Stork, 2006) similarly found that profitability is related to selling bigger loans.
Determinants of Financial Self Sufficiency (FSS)
The result of the econometric analysis indicated that, about three factors, namely, CPB, YIEDER, andDER have significant effect on financial sustainability. The proposed hypothesis for the above
mentioned influencing factors were as follows.
Ho: There is negative significant relationship between cost per borrowerof microfinance institutions and financial self-sustainability
H0: There is a significant positive relationship on the yield on gross loan
portfolio of microfinance institutions with financial self- sustainability.
H0: There is no positive significant relationship between debt to equity ratioof microfinance institutions and financial self-sustainability.
Table 3 Econometric Results of FSS’s Determinants

Variables(Constant)
SIZE
YIELD
CPB
OER
ALBPB
DER
Age

Std. error
0.706
0.030
0.144
0.085
0.083
0.082
0.065
0.073

Standardized
coefficients
Beta
0.371
0.879
-0.951-0.048
0.118
0.792
0.235

t

Sig.

0.652
0.163
3.532
-3.976-0.376
0.320
3.141
0.780

0.262
0.436
0.001**
0.000***
0.356
0.104
0.003*
0.224

Dependent Variable: FSS, *** Significant at 1%; ** Significant at 5%; * Significant at 10%
Source: Author’s Computation using IBM SPSS (2016)

As one can depict from Table 3 above, CPB have a negative significant effect on FSS at 99%
confidence interval, we failed to reject the null hypothesis. To the contrary, the study made by(Nyamsogoro, 2010), indicates that CPB has no significant impact on FSS of Tanzanian MFIs. The
YIELD from gross loan portfolio influenced FSS positively at 95% confidence interval, fail to reject
the null hypothesis. Correspondingly, the research finding by (Cull and Morduch, 2007) indicates thatthe coefficient for gross portfolio yield is positive and significant on financial self-sufficiency. The
result also exhibited DER have positive effect on FSS, rejects the null hypothesis. In the same way,
(Coleman, 2007) for example, found that highly leveraged microfinance institutions have higher ability
to deal with moral hazards and adverse selection than their counterparts with lower leveraged ratio.
This states that high leverage and profitability are positively correlated
CONCLUSIONS AND RECOMMENDATIONS
Access to financial resources in Ethiopia, particularly by poor is very limited, and the poor are
regarded as unbearable by formal banks. MFIs are playing vital roles to fill these gaps. In this study the
MFIs are evaluated on two main indicators, outreach and sustainability. Concerning the outreach, it isfound that the outreach level of Ethiopian MFIs has been improving in width and depth, although thereⒸ ISERD

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is still a need to diversify the services and programs to address the uncovered need of the disadvantagegroups of the society, such as people in the geographically remote location, gender, crop farmers. We
recommend the MFIs have to work against achieving this goal to fight poverty as per their major goals.
The government is also expected to set appropriate regulations, and policy framework which motivateand enable the MFIs to address these unmet needs, for instance supporting the MFIs to access cheaploans. The intervention of the government in the operations of MFIs, particularly in a loan recruitment
is vital because the MFIs cannot fully operate in self-sustainable manner.
Sustainability was measured on two levels, operationally, and financially. The study revealed that
Ethiopian MFIs are operationally self-sufficient while financially subsidy dependent. The increasing
trend of both financial and operational self-sufficiency is mainly due to the increase in revenue, and theexistence of subsidy; we recommend to keep the trend. The determinant factors on operationalsustainability were the cost per borrower, and loan size. Therefore, the MFIs are expected to reduce
cost per borrower by innovation, for instance, by introducing village banking systems, and mobile
phone in microfinance services. In case of loan size, the current loan size of the MFIs is desirable,
qualifying depth of outreach but risks sustainability. Hence, we recommend the donors andgovernment should give priorities for those MFIs addressing the need of the very poor providing smallloans. The influencing factors for financial sustainability were the cost per borrower, and yield fromgross loan portfolio and debt equity ratio. The MFIs have to work against these negative factors byincreasing their yield innovatively, increasing the volume of revenue, and/or the profit margin and by
reducing the cost to the optimal level. The debt equity ratio basically refers to cheap fund. It may bedesirable to increase this ratio by attracting the interest of donors/lenders using inclusive plan toaddress the need of the poor, particularly to reach the female beneficiaries. The study also recommendthat the government of Ethiopia should encourage involvement of private sector and donors in building
capacity of MFIs.
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