title: Empirical essays on sustainability, portfolio risk, and outreach of Islamic microfinance institutions
Creators: name: Tamanni, Luqyan
Publisher: name: University of Glasgow
Year: 2017
Subjects: subject: Microfinance, Islamic microfinance, sustainability, outreach, mission drift.

description: Islamic microfinance is a growing sector that is expected to provide a long-term solution to poverty in the Muslim world, home to more than 600 million poor people. The role of microfinance institutions in poverty alleviation is still debatable, however established literature provides assurance that microfinance does contribute to the development of financial sector and reduction of poverty in developing countries. Nonetheless, the rise of competition in the microfinance sector has forced many microfinance institutions to resort to commercial funding and lending activities, which according to some studies has led microfinance institutions to trade off poverty alleviation objective with commercial goals of profitability and sustainability. 

This thesis examines the impact of commercialisation push and its subsequent impacts on Islamic microfinance institutions in three empirical chapters. They are a) comparison of financial performance i.e. profitability and sustainability, between Islamic microfinance institutions with conventional microfinance institutions, b) examination of portfolio risk and vulnerability of Islamic microfinance institutions (IMFIs), and finally c) survey of the presence or absence of ‘mission drift’ at IMFIs. The thesis benefits from the latest panel data provided by MIX Market database, which is obtained from the publicly accessible websites at www.mixmarket.org. MIX Market provides reliable dataset for many microfinance institutions from all regions in the world. However, the dataset used for this research covers 1,320 microfinance institutions during the period of 1998 to 2014, from four regions where IMFIs exist, namely East Asia and Pacific, South Asia, Middle East and North Africa and Eastern Europe and Central Asia. IMFIs represent about 2.88 per cent, or only 38 IMFIs, in the dataset from the overall sample.

Using Ordinary Least Squares regression to analyse financial performance, portfolio risk, and poverty outreach, the research finds mixed results. Overall, although IMFIs are worse off than their conventional counterparts in terms of financial performance, i.e. lower profitability and high cost, they are relatively better off with outreach to the poor, indicated by lower average loan balance per borrower to income per capita (depth of outreach) and positive number of active borrowers (breadth of outreach). 

In addition to lower or negative profitability, the first empirical chapter also indicates that IMFIs are operating at higher cost per borrower than conventional MFIs. However, interestingly IMFIs manage to record positive operational self-sufficiency (being a ratio of financial revenue over expenses, or OSS), which is an important indicator of sustainability, in addition to return on assets (ROA). Lower ROA is attributed to higher operational cost, e.g. cost per borrower, while OSS is higher mainly due to irregular funding mechanism of IMFIs. Many of the IMFIs rely on donations or charitable funds and also to a certain extend grants from government and donors. 

The second empirical chapter explores portfolio and default risk of IMFIs and find that they are facing relatively lower risks than conventional MFIs. The result defies expectation, as IMFIs are face challenging working environment and operate in some of the poorest countries in the world with frequent natural disasters or armed conflicts. They are also less vulnerable despite their clients are from the poorest segment in the society, often with lower educational level, and the nature of Islamic financial products are relatively unknown to most clients. Many of the IMFIs and their clients live in countries considered to be high risk or have histories of instability, either politically or economically. 

Finally, the third paper examines poverty outreach performance of MFIs to find any evidence of mission drift in Islamic microfinance institutions. Using similar method with the first empirical chapter, the paper finds that there is no clear evidence of mission drift at Islamic microfinance institutions, as indicated by lower Average loan balance per borrower to income/capita and at the same time significantly lower percentage of women borrowers. However, this claim requires more explanations to qualify as convincing evidence. The findings contradict the argument for mission drift, i.e. the presence of higher Average loan balance and lower Percentage of women borrowers. The results do not confirm nor reject the hypothesis that there will be no mission drift at Islamic microfinance institutions. Nonetheless, the results are consistent with literature i.e. there is no clear evidence of mission drift in existing and mostly conventional microfinance institutions. 

Overall, the regression results of all three empirical chapters of the thesis indicate that IMFIs are still loyal to their primary mission of poverty alleviation, despite operating at a loss and high operational cost. Their relatively positive outreach, in both scale and depth, is complementary to consistently high operational self-sufficiency. Although sustainability is important in microfinance, IMFIs are not currently concerned with sustainability objectives as their funding mechanism can still support their pursuit of poverty alleviation. However, as the drive of commercialisation and intensifying competition continue, especially with many international donors becoming more selective, IMFIs must abandon over-reliance on subsidy or grants. Should their current financial performance persists, i.e. lower return and higher cost, IMFIs may soon discover poverty alleviation mission as liability, not an achievable goal.