A Production Approach to Performance of Banks with Microfinance Operations

A Production Approach to Performance of Banks with Microfinance Operations

Emilyn Cabanda (Regent University, VA, USA) and Eleanor C. Domingo (Saint Mary's University, Philippines)
DOI: 10.4018/ijisss.2014040102

Abstract

Banking institutions, nowadays, serve as intermediaries of funds to a variety of clients, including the micro enterprisers. This study analyzes and measures the performance of rural and thrift banks with microfinance operations in the Philippines, using combined measures of data envelopment analysis and traditional financial performance indicators. Data envelopment analysis (DEA) method is employed to measure the productive efficiency of these banks under the production approach. The variable returns to scale is also used, with the assumption that not all banks are operating at optimal scale over the long-run period. DEA findings reveal that sample banks performed below the production frontier. The average technical efficiency score of these banks is 66.09% and additional 33.91% is needed to reach the production frontier. Overall, thrift banks are found to be more productively efficient than rural banks as depository banks. The authors have also found a strong relationship between financial performance measures and bank's productive efficiency. For thrift banks, sustainability, ROE and ROA measures showed a statistically significant positive correlation to the banks' productive efficiency while a negative relationship was observed in rural banks. Lastly, the authors can suggest that both DEA's productive efficiency and financial performance measures are consistently and strongly correlated when evaluating the overall performance of banks with microfinance operations.
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Introduction

Micro-financing is a significant element in the new developed form of globalization. This can help the world’s poorest people to discover their own power and potentials to achieve their goals. Venturing into this kind of activity is a high-risk undertaking. However, with a proper management strategy, microfinance industry has grown tremendously and made significant contributions to the poverty reduction. The performance of the rapidly growing microfinance sectors in and across Asia is still un-noticed and unrecognized by the world. Global audiences know little about the record of low transaction costs of microfinance in the Asian region (Llanto, 2000).

The financial performance of microfinance institutions has been largely highlighted by the international community (Christen, 2000; Woller, 2000; Tucker, 2001; Stephens, 2005). However, little research has focused on the implications of management policies (McGuire, 1999). The impact of some governance issues on development of performances has been assessed, but this has mostly been done at the macro-level (Campos and Nugent, 1999).

According to Schreiner (2002), microfinance is the supply of saving and loan services to the poor. Likewise, Zeller and Sharma (2000) argued that microfinance contributes towards the improvement of the well-being of the poor. Some scholars rather insisted on the importance of microfinance in the development of the population (Barboza and Bareto, 2006; Aniket, 2005; De Aghion and Morduch, 2005). They argued further that microfinance is essentially a means of providing low-income households with the possibility of benefiting from the same rights and services that all the others have. Microfinance, then, can complement the financial and banking environment.

Other scholars (such as Aniket, 2005) stressed that if appropriate procedures were followed, loans within the sector would not in fact, be as risky as some would like to have it believed. Aniket (2005) further stressed that the success of microfinance can be traced mainly to the constant improvement in its system of loans, wherein, the strategy was focused on reducing costs of un-guaranteed small loans by increasing their volume, and at the same time, ensuring high reimbursement rates.

The few academic publications available on management and governance issues in microfinance are mostly focused on corporate governance’s principle applications (Hartarska, 2005; Labie, 2001; Campion, 1998; Rock et al., 1998). Many studies have tried to assess the indicators that affect the financial performance of micro-finance institutions (MFIs) (Tucker, 2001; Stephens, 2005; Woller and Schreiner, 2006). Some main indicators used are the number of years of operations with some geographical differences, the number of borrowers, the ratio of financial operating expenses, and the number of years of operations (Stephens, 2005), staff productivity, and organizational structure of the MFI such as non-government organization (NGO), for-profit, or cooperative (Tucker, 2001). Woller (2003) found that depth of outreach, as proxied by the average loan to gross national product (GNP) per capita, is inversely associated with financial self-sufficiency. Deep outreach and financial self-sufficiency were then found to be complementary. Stephens (2005) found that there is a positive correlation between the size of the institution (proxied by the number of borrowers) and its sustainability. Shen (2005) conducted a study on the cost efficiency of bank in a partial universal banking system (PUBS), Taiwan, where his findings revealed that the estimated X-efficiency is found to relate more to the non-performing loans than to the return in equity.

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