THE RELATIONSHIP BETWEEN FINANCIAL SUSTAINABILITY AND OUTREACH OF MICROFINANCE INSTITUTIONS IN KENYA MUTHOMI ERIC

Transcription

1 THE RELATIONSHIP BETWEEN FINANCIAL SUSTAINABILITY AND OUTREACH OF MICROFINANCE INSTITUTIONS IN KENYA MUTHOMI ERIC A research Project submitted in partial fulfillment for the award of Master of Arts in Economic policy Management at The University of Nairobi 2015

2 DECLARATION This research Project is my original work and has not been presented for a degree award in this or any other university Signature Date Eric Muthomi X51/76407/2012 APPROVAL This research project has been submitted for examination with my approval as university supervisor Signature Date Dr. Joy Kiiru School of Economics University of Nairobi ii

3 ACKNOWLEDGEMENT I would like to sincerely thank my supervisor Dr. Joy Kiiru for patience and able guidance throughout the research process. I acknowledge and thank the Association of microfinance institutions of Kenya (AMFI-K) for giving me access to their database that was key in this research. Whereas all the data sources have been duly acknowledged, I solely take responsibility for any mistakes or misrepresentations that may arise from the research. iii

4 TABLE OF CONTENTS DECLARATION... ii ACKNOWLEDGEMENT... iii TABLE OF CONTENTS... iv LIST OF TABLES... vi LIST OF FIGURES... vii ACRONYMS AND ABBREVIATIONS... viii ABSTRACT... ix CHAPTER ONE: INTRODUCTION Background Research problem Objective of the Study The research questions of the study Significance of the Study Research Scope... 8 CHAPTER TWO: LITERATURE REVIEW Introduction Theoretical Review Concept of Financial Sustainability Concept of Outreach Theoretical Review of Microfinance as Poverty Alleviation Tool The Institutionists Theory The Welfarists Theory Empirical Literature Review Overview of the literature CHAPTER THREE: METHODOLOGY Introduction The Conceptual Framework The Estimated Model Definition of variables Classical Linear regression assumptions in this study include the following; Diagnostic Tests Data type, source, and analysis iv

5 CHAPTER FOUR: DATA FINDINGS AND ANALYSIS Introduction : Charter Type : Gender Branch network : Active Clients : Financial Sustainability (OSS) : Years of operation Inferential Statistics Correlations Analysis Regression Analysis CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS Introduction Research Conclusions Recommendations Further Research suggestion BIBLIOGRAPHY Appendix I: Data Used in the Study v

6 LIST OF TABLES Table 3.1: Definition of variables Table 4.1: Charter Type Table 4.2: Gender Table 4.3: Branch network Table 4.4: Active Clients Table 4.5: Financial Sustainability (OSS) Table 4.6: Years of operation Table 4.7: Correlations Table 4.8: Model's Goodness of Fit Statistics Table 4.9: Analysis of Variance (ANOVA) Table 4.10: Regression Coefficients Table; 4.11: T test of Credit only and DTMs Table 4.12: T Test analysis for outreach based on the gender of the CEO vi

7 LIST OF FIGURES Figure 3.1 Conceptual framework...18 vii

8 AMFI-K: ACRONYMS AND ABBREVIATIONS Association of Microfinance institutions of Kenya CEO: Chief executive officer DTM: Deposit taking microfinance institution K-REP: Kenya rural enterprise program KWFT: Kenya women finance trust MB-MFIs: Member based microfinance institutions MFIs: Microfinance institutions NGO: Non-Governmental organization PRSP: Poverty reduction strategy paper SMEs: Small and microenterprises OSS: Operational self sufficiency OLS: Ordinary least squares viii

9 ABSTRACT There are divergent views among scholars in regard to outreach and financial sustainability of microfinance institutions (MFIs). Two main schools of thought have gained prominence on the subject. The Institutionists school of thought lays more emphasis on the institutional framework of the MFIs aimed at strengthening the financial muscle of the institutions from internally generated resources without depending on external sources such as donations. The proponents of this school of thought argue that for the poverty alleviation goal of microfinance to be achieved, strong financially stable MFIs need to be created first. The Welfarists school of thought on the other side argue that, the source of funds notwithstanding, MFI s should reach the poorest cadre of society and that the main objective of MFIs should be poverty alleviation and not necessarily creation of strong internal balance sheets. It is against this conflicting background that this research was necessitated to empirically study the relationship between financial sustainability and outreach of MFIs in Kenya. The study utilized cross-sectional data for the year 2013 used in the Association of Microfinance institutions of Kenya in their 2014 microfinance sector report. The data was derived from the individual institutions audited financial statements as at December 2013.The findings of this study indicate that there is a strong positive relationship between financial sustainability and outreach of MFIs in Kenya, this implies that MFIs that have strong financial muscle have the ability to reach more clients and consequently contribute to poverty alleviation. The study also found out that there is a strong positive relationship between outreach of MFIs and the number of branches meaning that the more branches an MFI has, the more clients it is able to serve. The study also revealed that MFIs headed by male CEOs have greater average outreach in terms of active clients (499,912) served compared to the MFIs whose head is female whose average clients was found to be 243,979. Deposit taking MFIs were also found out to have a larger outreach at an average of 1,027,890 active clients compared to credit only MFIs hose average active clients was found to be 17,433. These findings augment the theoretical arguments that DTMs have a higher capacity to serve more clients because of their huge financial muscle resulting from deposits mobilized. Recommendations drawn from the results include the need to encourage formation of more DTMs, create conducive environment for MFIs expansion to more areas with an aim of increasing outreach for poverty eradication. Stakeholders are also encouraged to put up measures aimed to improve OSS since it is seen to have a positive impact on outreach and ultimately to poverty alleviation. In view of these findings, this study is more inclined to the Institutionists school of thought, however more research is necessary especially with regard to the depth of outreach that would shed more light on the effect of pursuit of financial sustainability on the poorest of the poor in society. ix

10 CHAPTER ONE INTRODUCTION 1.1 Background Micro finance aims at poverty alleviation by providing support to the economic activities of the low income earners and Small and Micro enterprises. This support is in the form of financial services to this economic segment that is excluded from the formal financial services sector (Morduch, 2000; Lingerwod, 2001). Microfinance can be generally referred to as the advancement of Micro financial services to low income aimed at overcoming access barriers to the poor (Karling & Goldberg, 2007).Examples of small scale financial services provided by microfinance include the following: Micro insurance, Savings, money transfers and the most common one being micro credit. Microfinance services thus can be referred to as the advancement of relatively low credit, micro insurance, savings money transfers and other financial services to the low income households and their micro enterprises (Mwenda & Muuka, 2004). Microfinance can thus be referred to as the provision of financial services to the segment of the economy not served by the formal financial system. Some of the factors that lead to this exclusion include social, cultural and economic factors. These factors perpetuate the exclusion of some economic segments and especially the rural poor from formal financial participation, Microfinance seeks to bridge the gap through easing access to micro financial services to these segments. Microfinance concept gained prominence in the 1970s in Bangladesh and it is mostly attributed to Mohammad Yunus an economics professor at Chittagong University. 1

11 Mohammad Yunus started lending micro credits to the basket weavers in the village and motivated by the positive impact these advances were making to the poor villagers coupled with their reliability to repay, he founded the Grameen bank which was based on the principals of trust and solidarity. Grameen bank was a success and by the year 2002 it had over 2.4 million members, its success and especially the group lending model has inspired the formation of similar entities around the world (Armandariz & Morduch, 2005). Mohammad Yunus extensive contribution to the microfinance movement and poverty eradication contributed to his Nobel Peace Prize in 2006, evidence of his great contribution to poverty eradication through microfinance. Microfinance is mainly provided through microfinance institutions (MFIs) that act as the formal channels/tools or agents of microfinance towards elevation of the poor through financial empowerment. The Microfinance institutions are in the form of registered and unregistered Microfinance Institutions or Non-Governmental organizations (Omino, 2005). Current debate in the stakeholders circles argue that for the MFIs to make a substantial impact though large scale and sustainable outreach, then they (MFIs) need to have a long-term agenda aimed at sustained microfinance provision especially to the vast poor and those excluded from the formal banking system. Non-Governmental Organization Microfinance Institutions (NGO-MFIs) in most cases lend collectively and the group bears a collective responsibility for repaying the loan advanced. Most NGO-MFIs employ graduation schemes whereby clients are allowed incremental borrowing depending on their repayment record. Registration is a 2

12 primary legal requirement for NGOs to carry on microfinance activities, The NGO- MFIs allowed to mobilize deposits (Savings) from members of the public because they have no external regulatory framework. There are also member based Microfinance institutions (MB-MFIs) which are mainly saving association and credit Co-operative societies (SACCOS). Here loans are advanced to members only through the individual lending model. The members are mostly required to have some minimum saving as a prequalification for loan advancement. The MB-MFIs are licensed and regulated by The Kenya Co-operative Societies Act. The Act deals with all types of Co-operatives and supervised by the Ministry responsible for Co-operatives. Some Formal financial institutions including commercial banks also offer microfinance services and their clientele target are individual micro savers and SMEs. In Kenya Chase bank is a good example of a bank offering Microfinance services through its micro wing RAFIKI microfinance bank. K-REP bank, Jamii Bora bank, Equity bank, and Post bank are other main examples of commercial banks offering microfinance services. In Kenya and indeed other developing countries most low income earners reside in rural localities or informal settlements, these areas and populations are not adequately covered by the commercial banks that are profit driven and as such do not view the Poor as worthy clients. Microfinance Institutions effectively compliment the commercial banks in advancing financial services to the unbanked poor. 3

13 Recent debate on Micro finance has been to a large extent hinged towards the financial sustainability of microfinance institutions. Sustainability can be simply referred to as the going concern, i.e. the ability of the microfinance institutions (MFIs) to continue with their operations without the intention of significantly curtailing their activities in the short run. It can thus be viewed as the MFI s capacity to cover its operation and financing costs without depending on external support. Immense evolution of sector in Kenya has seen some major microfinance institutions transform into commercial banks, they include KREP, Equity bank, KWFT and Faulu bank. Some analysts and scholars have argued that transformation is informed mainly by the pursuit of Profitability and sustainability. Outreach in regard to Microfinance institutions (MFI S) can be defined as, the ability to reach as many clients as possible including a large number of poor clients as well, this is the Welfarists approach. Reaching as many clients as possible is the breadth aspect of outreach whereas reaching a large number of poor clients is the depth. The primary objective of microfinance thus is the outreach to the poor through provision of financial services in a sustainable way via Microfinance Institutions. The Microfinance sector especially in Kenya has witnessed vibrant growth in the recent times; this can be attributed mainly to their flexibility and pro-poor lending terms. The PRSP of 1999 indicates that vast number of Kenyans depend on MSEs as their main source of income a phenomenon that makes the advancement and growth of the Microfinance in the country a key concern for the drivers of development. 4

14 Recent debate has ignited the need to look at the corporate governance perspective of MFI s which has brought interest on the gender aspect of leadership. It has been argued that MFI s steered by women are more sustainable in terms of outreach and financial sustainability. Some of the arguments brought forward by this assertion include the ability of women leaders to source for alternative financing channels and their frugal use of the available finances. MFIs chartered as NGOs or SACCS have been pivotal sources of loans to a lot of households and SMEs in the informal and rural areas of the country. Providing credit to the poor and helping them start their own income generating ventures however, has proved to be a very costly affair. Outreach thus may appear to conflict with the sustainability especially financial sustainability of the MFI s. Donors have in some instances stepped in to help the MFI s reduce their lending cost mostly by advancing cheaper than market rate loans. 1.2 Research problem Financial sustainability entails employing the most efficient means of operation aimed at cost minimization. In order for a MFI to be financially stable, it may have to revise some of its ways of doing business especially the manner in which lending activities are carried out, for instance vetting of potential clients with an intention of determining their credit worthiness and the cost of lending to particular clients. In recent times more MFIs in Kenya have embraced the developments in the financial sector such as information sharing through credit reference bureaus thereby helping MFIs weed out potential clients who are deemed high risk based on the information available on their credit history. 5

15 Most poor people lack of adequate collateral to guarantee the loans advanced to them coupled with their desire for smaller credit quantities borrowed frequently make it administratively expensive and as a result some MFIs tend to shy away from advancing credit to the poor due to the MFIs profit motive which is a key factor to their financial sustainability mission. Many MFIs are now appreciating the need for financial sustainability through increased operational earnings a move that appears to affect the outreach objective of Microfinance either by offering limited range of services to the poor or diverting their services to the wealthier clients (Von Pischke, 2007). Stake holders and scholars in the Microfinance sector have argued that MFIs ought to be sustainably stable to be able to offer meaningful contribution to the fight against poverty (Adam et al, 1984; Schreiner, 2000). MFIs that have attained financial sustainability have higher chances of improving millions of the poor due to the fact that they are able to continue offering their services with less administration constraints or interruptions as a result of the internally generated funds at their disposal (Thapa et al, 1992).We have two main approaches to Microfinance as a poverty alleviation tool. The Welfarists school of thought lay emphasis on the poverty levels of clients reached by the MFIs argument being that funds source should not be a major concern for the institutions, The Institutionists on the other hand argue that MFIs should concentrate on ensuring that they generate enough internal funds without depending on donor funds or subsidies in order to tackle poverty alleviation menace in a sustainable manner. There being no consensus among the various scholars on whether the pursuit of financial sustainability has a negative or positive relationship with the outreach mission of the said MFIs, this study seeks to contribute towards narrowing this 6

16 consensus gap by conducting an empirical study on the microfinance institutions in Kenya by utilizing the data from the association of microfinance institutions in Kenya (AMFI) sectoral report Objective of the Study The central objective of this study is to empirically analyze the relationship between financial sustainability and the outreach of Microfinance institutions in Kenya. The specific research objectives 1) To establish the correlation between charter type of MFIs in Kenya and their outreach. 2) To establish the effect on the number of branches on outreach. 3) To draw policy recommendations from the findings of the study. 1.4 The research questions of the study The study seeks to answer the following questions. 1) Is there as significant relationship between outreach and financial sustainability of MFIs in Kenya? 2) Is there a significant correlation between the number of branches and MFIs outreach? 3) How does the gender of the CEO of the MFIs affect the outreach of MFIs? 1.5 Significance of the Study Policy makers and other relevant stakeholders concerned with alleviation of poverty through microfinance need to think about policy measures that will ensure that 7

17 microfinance through a market based solution provides a promising means to the excluded poor. To this end therefore, this study will be relevant to various parties as highlighted in this section. The policy makers in the field of microfinance and those charged with poverty alleviation for instance the National and county Government officials will find the findings of this study useful in policy formulation as it will shed some insight in regards financial measures towards sustainability on their impact on the society in its quest for poverty alleviation through microfinance. The Future researchers and scholars in the field of Microfinance will also find this study a relevant point of reference in their research endeavors. Those involved with regular operation of Microfinance institutions, shareholders as well will find the findings and recommendations of this study very useful in informing organizational strategy formulation and implementation. 1.6 Research Scope This research utilized data for the year 2013 derived from the audited financial reports of all the member participants in the 2014 AMFI sectoral report on microfinance in Kenya. The period of study in this research thus is

18 CHAPTER TWO LITERATURE REVIEW 2.1 Introduction Theoretical and empirical literature on microfinance institutions MFIs is reviewed on this chapter, their sustainability and outreach is presented. The theoretical review is based on the approach to microfinance as a poverty reduction/alleviation means. This chapter starts by defining key concepts used to explain how pursuit of financial sustainability impact on outreach objective of Microfinance institutions in Kenya. 2.2 Theoretical Review Concept of Financial Sustainability When the microfinance concept begun exhibiting significant growth trends policy makers and other interested parties including donors started advocating for profitability from these institutions. Financial Sustainability is a key and arguably the most significant dimension of microfinance sustainability. Financial sustainability is the ability to continue with the microfinance objectives without sustained donor aid (Dunford 2003). Financial sustainability can also be explained by the ability of a Microfinance Institution in covering operational as well growth expenses from income derived from its own activities (Thapa et al (1992). An MFI is said to be operationally sustainable if it can absorb its operation expenses from its own operations even if it is not subsidized (Meyer, 2002). Financial Selfsufficiency on the other hand is when an MFI is able to its operational and financing costs at market prices. MFI self-sufficiency can be equated to nonprofit equivalent of profitability (Woller and Schreiner, 2002).A MFI that is able to cover the cost on non- 9

19 cash expenses including the cost of inflation and at the same time has the ability to continue its operations without grants or subsidized inputs is said to have attained self-sufficiency (Christen 1997). In this study, the researcher uses OSS ratio to measure Microfinance financial sustainability. The OSS ratio is calculated by the formula, Revenue /Expenses (AMFI, 2014). Pursuit of financial sustainability has necessitated some MFIs to adopt approaches such as the gathering of Market intelligent and introduction of cost cutting measures aimed to checking the market forces and increasing efficiency which eventually leads to sustainability (Christen & Drake, 2002).The adoption of these market based approaches such as the use of gathered market intelligence to guide the provision of Microfinance services has been critiqued in some quarters as a threat to the poverty reduction objective of the said MFIs since they are seen to shun poor clients for wealthier ones who have a relatively higher chance of repaying the loans and also a lower cost of administration due to the larger quantities advanced to them at any particular point (Woller,2002) Concept of Outreach Microfinance outreach is viewed in two major aspects, number of poor people microfinance can reach (Depth) and number of people served by MFI without necessarily considering their poverty levels (Breadth). In other words the depth of microfinance can be viewed in light of poverty levels of the people reached. This aspect can also be referred to as the social impact objective of Microfinance since it 10

20 views Microfinance as a poverty alleviation tool (Bauman, 2001). Proponents of this definition argue that a financial institutions that disregard the economic status of the clients or does not consider the poor in their lending or financial services provision is no longer a microfinance but rather a bank (Hulme & Mosley, 1996).This arguments cements the position of the poor in Microfinance. In Kenya some MFIs such as K- REP and FAULU have converted into commercial banks and this has led to a lot of debate on their commitment to the microfinance movement. Advancing loans to small borrowers who are in most cases are very poor is more often expensive especially due the administrative expenses (Conning, 1999). Recent studies have on the contrary indicated that advancing micro loans does not necessarily lead to losses or less profitability (Cull et al, 2007). Scholars have also indicated that indeed an MFI can reach more poor people while at the same time reducing their dependence on donor and other external funding (Fruman and Paxton, 1998). On the other hand, outreach in terms of breadth can be defined as the scale of the microfinance institution in question without necessarily putting into consideration the economic status of the person. MFIs breadth can be defined as the ability of a MFI to reach a wide range of clients (Conning, 1999). Scholars in the microfinance field argue that large number of clients in good standing enhance financial sustainability (Logotri, 2006).The cost of lending per borrower is however a key factor in determining the impact of large volume of borrowers to microfinance sustainability. More emphasis has been laid on the breadth rather than the depth of microfinance premised on the argument that the poor are many but the funds for poverty alleviation through microfinance are limited (Navajas et al, 2000).The Institutionists are 11

21 concerned about advancing access to a wider net clients not adequately served, further arguments suggest that sustainability is a means to attain outreach (Rhyne, 1998). Bearing in mind the possibility of MFIs services not reaching the majority of the poor populations, research and scholars have demonstrated that they are likely to benefit from the spillover effects (Zeller and Johannsson, 2006), Some of such spillovers are manifested through employment opportunities, higher standards of living by family members and associates accruing to those establish enterprises and other income generating activities from micro credits advanced. For the purposes of this study, outreach will be taken as the number of active clients due to the inadequacy of available data of the poverty levels on the clients served by the microfinance institutions in Kenya Theoretical Review of Microfinance as Poverty Alleviation Tool Microfinance is considered as a poverty alleviation tool/mechanism through increase to credit and financial services especially to the poor. There are various theoretical schools of thought as to the most effective approach regarding alleviation of poverty. In this study, Institutionists and the Welfarists Approaches are reviewed The Institutionists Theory This approach emphasize mainly on the system and institutional enhancement of MFIs aimed at enhancing profitability through efficient running and administration of the microfinance institutions. The proponents of the institutional argue that institutional strength ought to be the key concern (Brau & Woller, 2004), this is due to the fact that more often than not, donor dependence is not certain and as such the 12

22 going concern of the microfinance institutions may not be attained. The Institutionists also view the establishment of economic bridge to help the economically challenged citizens as the main objective of microfinance institutions (Woller et al, 1999).This school of thought is hinged on the premise that ensuring the financial sustainability of Microfinance institutions through proper corporate governance stands a better chance of helping the poor due to the availability of a stable source of Microfinance services since the donor funds are not stable and guaranteed, To this end therefore, only Microfinance institutions that are able to sustain themselves from internally generated funds stand a chance of meeting their long term objectives. Critics of the Institutionists school of thought argue that too much emphasis on profitability could catalyze a MFIs drift away from the poverty alleviation goal otherwise known as mission drift (Copestake, 2007).Mission drift in this regard refers to cases whereby MFIs, in their quest for Financial sustainability move away from activities that s appear to compromise their profitability and in most cases these unprofitable ventures are pro-poor. Recent developments in Kenya s Microfinance industry has seen key MFIs such as Fualu and Kenya Rural Enterprise Program (K-REP) transform into fully fledged commercial banks arguably in pursuit of profitability and sustainability. This has seen them get out of the reach of many rural poor people while at the same time improving their institutional appeal and sustainability prospects The Welfarists Theory The Proponents of this school of thought do not lay much emphasis on the source of funds for the microfinance institutions but rather on the fact that the institutions 13

23 continue with their operations hence meet their social objectives. This approach is concerned with poverty alleviation by the Institutions not just by the number of clients reached (Brau & Woller, 2004). This therefore implies that this school of thought regards poverty reduction and economic empowerment of the poorest of the poor as the purpose of microfinance. The Welfarists assert that a microfinance institution should be in as far as possible be in a position to serve the poor even when the profitability appears to be at stake, they continue to argue that the operations deficit should be filled through Government and donor support (Woller et al,1999). It has been argued that there is a tradeoff between sustainability as measured by profitability and focusing on lending to the poorest segment due to the inefficiency and higher administration costs involved in lending to the lowest economic cadre of the citizenry and as such donor support is essential on sustaining this venture (Paxton, 2002). To reach the poorest segment groups, exclusive focused programs for example programs targeting poor women, youth, and slum dwellers among other vulnerable groups are essential and this needs constant donor funding (Rhyne, 1998, Murdoch, 1999). 2.3 Empirical Literature Review Various researchers have delved into related aspects of financial sustainability and its relationship with outreach of MFIs.Some of the empirical studies on the topic include the following. Tuuli (2010),examined the Mission drift Theory of MFIs, a case of Uganda and found out that drive for commercialization of microfinance has significantly affected the outreach objective of the MFIs in Uganda and as such he recommends a careful 14

24 and in-depth study on the compatibility or tradeoff between outreach and pursuit of financial sustainability. Tuuli (2010) in his analysis of outreach of individual lenders, established the existence of a tradeoff between financial sustainability and outreach. Ganka (2010) sought to find out the impact of determinants of financial sustainability on sustainability of MFIs at their startup and take off stage. This study also found out that outreach related factors such as cost per borrower and number of borrowers affect financial sustainability. The findings of the study revealed a positive relationship between profitability and number of clients served by MFIs. Cull et al (2007) used a dataset of one hundred and twenty four (124) leading micro banks in forty nine (49) countries to examine financial stability and outreach, the findings established that there was conflict between outreach and financial sustainability of MFIs. Makame and Murinde (2006) in their study of commercialization of microfinance, used a data set of thirty three MFIs in Five East African countries. The findings of the study indicated a negative relationship between profit pursuit by MFIs and the poverty eradication strife. 2.4 Overview of the literature Literature on the significance of the relationship between outreach and financial sustainability of MFIs has presented varied evidences. Most of them though have indicated existence of negative relation between pursuit profitability and poverty eradication, they include; (Ngheim & Laurenuson, 2004), (Adongo & Stork, 2005), 15

25 (Annim, 2009), (Crawford, 2011), (Kablan, 2012), These studies have indicated that the MFIs that perform well in financial sustainability have done so at the expense of poverty alleviation. The studies whose conclusions indicate complementarity between outreach and financial sustainability include: (Paxton & Fruman, 1998), (Kabeer, 2001) and (Brau & Woller, 2004). This study sought to bridge the gap between the divergent views in this area of study by carrying out a comprehensive study on the microfinance institutions in Kenya with an intention of finding out how outreach is related to the financial sustainability of MFIs in Kenya. 16

26 CHAPTER THREE METHODOLOGY 3.1 Introduction Here the model specification including conceptual and functional model is highlighted. The ordinary least squares method (OLS) including its diagnostic tests to ascertain its suitability in this study was examined. The Variables used are also defined and discussed. Data type, source and sampling is highlighted as well. The estimation technique is also given in this section. 3.2 The Conceptual Framework The conceptual framework is premised on the accounting profit theory which unlike the economic profit theory, ignores the unrealized losses or gains. The accounting Profit theory ignores the market values and concentrates only on the book values when determining income. For purposes of this study financial sustainability is measured as income realized by a Microfinance institution as a ratio of its expenses. The operational self-sufficiency (OSS) ratio is used to compare the profitability of the MFIs in question. The literature reviewed in chapter two suggests the possibility of a two way relationship between outreach (measured by the number of active clients served by the institution) and financial sustainability. Theory suggests that the more the clientele base of a microfinance institution the more profitable the institution is likely to be and consequently the MFI gains even more financial muscle to reach more and more clients including the poor who may either benefit directly or from the spillover effects of the services offered by the sustainable microfinance institutions. 17

27 Theory as reviewed in chapter two also indicates that Microfinance institutions that have a large network of active clients (Wide outreach) are likely to earn more interests from loans disbursed, deposits mobilized and other financial services offered consequently increasing their financial sustainability. Figure 3.1 Conceptual framework Outreach of MFIs (Number of clients) Increase in clientele leads to increased earnings Financial Sustainability of MFIs (Profit Levels) Increase in Profits increases the ability to serve more clients Source: Author s Theoretical review 3.3 The Estimated Model Cross-sectional data model is utilized to analyze the relationship between outreach of MFIs in Kenya and their financial sustainability, Branch network, type of the institution and the gender of the head of the organization as well. The Cross-section data is collected from the MFIs used for the 2014 Sector report of Microfinance institutions by the AMFI-K. Here Profitability figures is taken as the operational selfsufficiency (OSS) ratio for the year Number of active clients for the same period was the measure of outreach. The gender information on the top leadership of the Microfinance institutions is also utilized. 18

28 The fact that cross sectional data gives more representative data and less chance of collinearity makes it ideal for this particular study. The General regression model will take the following form...equation 1. Where; Y represents outreach which is the dependent variable (Number of active clients), is a constant, b,b1,b2,b3 measures the partial effect of the respective independent variables (x,x1,x2,x3) on the dependent variable (Y); X, X1, X2,X3 represents the explanatory/independent variables which in this study include: Financial Sustainability, Number of branches, type of the organization and the gender of the head of the firm, i.e. the CEO or the general manager as the case may apply, e on the other hand represents the error term. In the study, outreach objective of microfinance institutions is taken as a dependent variable of financial sustainability and other factors such as the branch network, the type of the said microfinance institution and the gender of the head officer as well. Outreach will be regressed against Financial Sustainability (Measured by the operational self-sufficiency ratio), Number of branches, type of the MFI (credit only, Microfinance banks, banks) and the gender of the CEO. This can be functionally represented as below. Outreach=F (Financial Sustainability, Number of branches, Type of the MFI, Gender of the MFI s CEO) equation 2. 19

29 The ordinary Least Squares (OLS) method of estimation is preferred because it gives the Best Linear, Unbiased estimates, it is also straight forward and relatively simpler. 3.4 Definition of variables Table 3.1: Definition of variables VARIABLE DEFINITION EXPECTED SIGN Outreach This is the number of clients served by the MFIs in question (Active clients). Dependent/explained variable Financial Sustainability MFI s capacity to absorb Positive (+), A profitable or its operation and growth financially sustainable expenses from its operational income. In this study It is taken organization is theoretically assumed to have the financial muscle to reach more clients as profitability and also offer a large range of represented by the OSS services. ratio. Number of branches This refers to the number of branches the organization operates. Positive (+). It is expected that the more the number of branches the organization operates, the more the number of clients it is likely to attract. 20

30 Type of the MFI/Charter type This refers to the registration status or the type of an MFI, for instance is the MFI deposit taking, Nondeposit taking, or A deposit taking MFI is expected to have a positive(+) relationship with outreach whereas a Non deposit taking MFI is expected to have a Negative commercial offering services. bank microfinance (-) relationship with outreach, A DTM may have a positive(+) sign as it is expected to attract a larger number of clients due to its profitability and deposits mobilized. A commercial bank may have a positive (+) sign due to economies of scale arising from their relatively large operations and clientele base. Gender of the CEO Male or Female Positive (+) for female and negative for male (-). Recent debate indicates that female CEOs tend to have more positive results in terms of outreach and sustainability. 21

31 3.5 Classical Linear regression assumptions in this study include the following; The error term is normally distributed, E (U) =0, Normality assumption indicates that the model is unbiased and as such it can be relied upon to give unbiased estimates to the population. The error term has a zero mean; E (U) =0. The population of all possible values of the error term for each period is assumed to contain negative, positive or zero values whose total sum is zero, i.e. the negative and positive values cancel out. There is no Multicollinearity; E (Xi, X1j) =0, i.e. the relationship between explanatory variables is not linearly perfect. If multicollinearity exist, the function cannot be relied upon to obtain unbiased numerical values for each parameter separately and this consequently breaks down the least squares. This assumption is easily met in practice because it is very rare for any two values to be exactly correlated in a linear form. There is no correlation between the error term and any explanatory Variable;(E(X,U)=0 3.6 Diagnostic Tests The researcher carried out the following diagnostic tests to establish whether the Ordinary least squares estimates are unbiased estimators of the population parameters. Autocorrelation test done using the Durbin Watson test, the Durbin Watson value of (table 4.7) implied that there was no serious case of autocorrelation since it is close to 2. Thus the model can be relied upon to give unbiased estimates. 22

32 The test for detecting multicollinearity was carried out. The person s correlation coefficients in table 4.7 indicated that there was no perfect linear correlation among the variables and as such all the variables were deemed reliable for use in the model. 3.7 Data type, source, and analysis The study utilized secondary cross sectional data. In this study an analytical survey was used where the researcher took into account data on all the microfinance institutions used by AMFI-K in their 2014 sectoral report. The survey included nineteen (19) credit only MFIs, Nine (9) Microfinance banks, four (4) commercial banks offering microfinance services. These participants are representative of the microfinance population since they include various aspects of microfinance including NGOs, trusts, microfinance banks, commercial banks and credit only MFIs. They also have a wide branch network across Kenya thus their representability is enhanced. Data was analyzed with the aid of statistical package for social scientists (SPSS) version 20, SPSS is preferred because of its wide range of analytical tools including regression, and it is also user friendly and has a rich variety of tutorials and learning resources that will come in handy for the researcher. The software is also readily available and accessible to the researcher. 23

33 CHAPTER FOUR DATA FINDINGS AND ANALYSIS 4.1 Introduction This chapter presents the descriptive and analytical findings of the relationship between financial sustainability and the outreach of Microfinance institutions in Kenya : Charter Type The charter type of the MFIs in the study include Credit Only MFIs, DTMs, and Commercial Banks. Majority of the firms in the study are Credit only MFIs constituting 59.4%, DTMs had 28.1% and Commercial Banks 12.5%. Table 4.1: Charter Type Charter type Frequency Percent Valid Percent Cumulative Percent Credit Only Valid DTMs Commercial Banks Total Source; Author s calculations 24

34 4.2.2: Gender The table below indicates that 72% of the MFIs studied have men as the CEOs Table 4.2: Gender Gender of CEO Frequency Percent Valid Percent Cumulative (MFIs) (%) (%) Percent (%) M Valid F Total Source; Author s calculations Branch network The branch network is distributed as per the table below. Majority of the MFIs had between 1 to 10 branches representing 46.9% of the sample, 25% of the firms had between 11 to 20 branches, firms with and 51% and above constitute 9.4% while 6.3% have between branches and 3.1% have between branches. Table 4.3: Branch network Number of branches Frequency (MFIs) Percent (%) Valid Percent (%) Cumulative Percent (%) Valid Above Total Source; Author s calculations. 25

35 4.2.4: Active Clients The number of active clients in this study represents the outreach of MFIs. Majority of the MFIs have 10,000 and below active clients constituting 31.3%. Table 4.4: Active Clients Number of Active clients Frequency Percent Valid Percent Cumulative (MFIs) (%) Percent below , ,001-30, Valid 30, , , ,001-Above Total Source; Author s calculations 4.2.5: Financial Sustainability (OSS) The table below illustrates financial sustainability as measured by the operational selfsufficiency ratio. Majority of MFIs have OSS of constituting 50% of the firms considered for the study. This is an implication that most of the firms have reasonable stable income. 26

36 Table 4.5: Financial Sustainability (OSS) OSS ratio Frequency Percent Valid Percent Cumulative (MFIs) (%) (%) Percent (%) 50-Below Valid Above Total Source; Author s calculations 4.2.6: Years of operation The years of operation of the MFIs were also considered and from the table below, a majority of the MFIs considered have been in operation for 15 to 20 years. Table 4.6: Years of operation No of years of Frequency Percent Valid Percent Cumulative operation (MFIs) (%) (%) Percent 6 to to Valid 15 to Above Total Source; Author s calculations 27

37 4.3 Inferential Statistics Correlations Analysis The Pearson s coefficient was used to test for linear correlation between and among the independent variables. There is no significant evidence of multicollinearity among the variables since none was found to have a perfect linear correlation with another as illustrated by the table below. This is an implication that all the variable could be relied on to be used in the model. Active Clients Table 4.7: Correlations Pearson Correlation Active clients (Outreach) Operational Self- Sufficiency ratio Number of branches Type of the MFI/Charter type Gender Sig. (2-tailed) N Pearson Operational Self- Correlation Sufficiency ratio Sig. (2-tailed) N Pearson Correlation Number of Branches Sig. (2-tailed) N Pearson Type of the Correlation.528 ** ** MFI/Charter type Sig. (2-tailed) N Pearson Correlation Gender Sig. (2-tailed) N Correlation is significant at the 0.01 level (2-tailed). Source; Author s calculations derived from SPSS output 28

38 4.3.2 Regression Analysis Table 4.8: Model's Goodness of Fit Statistics Adjusted R Std. Error of R R Square Square the Estimate Durbin-Watson.734 a a. Predictors: (Constant), (Financial Sustainability, Number of branches, Type of the MFI, Gender of the MFI s CEO). This is evidence that the relationship between the explained and explanatory variables studied is linear, the correlation coefficient (R) of indicates this strong positive linear relationship. The coefficient of determination, adjusted R-square of implies that 50.3% of the total observations can be explained in the model. Durbin Watson test was used to test for autocorrelation within the model s residuals. Given that the Durbin Watson value was close to 2 (1.421) thus there was no autocorrelation in the model s residuals. Table 4.9: Analysis of Variance (ANOVA) Model Sum of Squares df Mean Square F Sig. 1 Regression a Residual Total a. Predictors: (Constant), (Financial Sustainability, Number of branches, Type of the MFI, Gender of the MFI s CEO) b. Dependent Variable: Outreach The ANOVA statistics presented in the table above was used to present the regression model significance. An F-significance value of p = was established showing 29

39 that there is a probability of 3.9% of the regression model presenting a false information. Thus, the model is significant. Table 4.10: Regression Coefficients Unstandardized Coefficients Standardized Coefficients Model B Std. Error Beta T Sig. (Constant) Financial Sustainability Number of branches Dependent Variable: Outreach Source; Author s calculations. The above results indicate that there is a strong positive relationship between outreach and financial sustainability. The regression coefficient of implies that a unit increase in the OSS ratio would lead to 54.1% increase in outreach of MFIs in Kenya. This finding thus implies that financial sustainability is a very important factor of consideration if MFIs in Kenya have to achieve increased levels of outreach. There is also a very strong positive relationship between the number of branches and the outreach of MFIs in Kenya. The regression coefficient of implies that a unit increase in the number of branches by MFIs leads to 64.4% increase in the number of active clients (Outreach) of MFIs in Kenya. This finding implies that MFIs may consider increasing their branch network in order to achieve more outreach in terms of the number of clients served. 30

40 The study results indicates that deposit taking MFIs have a higher average outreach as measured by average active clients compared to credit only MFIs. This was established by T test analysis illustrated below. Table; 4.11 T test of Credit only and DTMs. Group Statistics Credit Only N Mean Std. Deviation Std. Error Mean ACTIVE CLIENTS Non- Credit Credit Only Source; Author s calculations Deposit taking MFIs have a higher average outreach of 1,027,890 active clients while Credit only MFIs have an average of 17,433 active clients (outreach). This outcome is backed by theory that suggests DTMs have a potential for a higher outreach due to their relatively higher financial muscle arising from deposits mobilized However, it is important to note that the commercial banks which operated microfinance sections were categorized as DTMs for this particular test. The T test results also indicated that MFIs headed by a male CEO had a higher average outreach compared to MFIs whose CEO is female, however this may not be quite representative since the majority of MFIs studied in this research are headed by male CEOs and only 28% of MFIs studied are headed by female CEOs. Table 4.12: T Test analysis for outreach based on the gender of the CEO Group Statistics Run by Male N Mean Std. Deviation Std. Error Mean ACTIVE 0(Female) 9 243, CLIENTS 1(Male) , Source; Author s calculations 31

41 CHAPTER FIVE SUMMARY, CONCLUSION AND RECOMMENDATIONS 5.1 Introduction Here a summary of findings of the research findings is presented upon which conclusions and recommendations derived. 5.2 Research Conclusions This research was conducted to investigate the relationship between financial sustainability and outreach of MFIs in Kenya. The research findings conclude that there is a positive relationship between outreach (active clients) and financial sustainability of MFIs.This is illustrated by the regression coefficient that implies that a unit increase in financial sustainability by one unit, Outreach (active clients) increases by 54.1% A significant positive relationship was also established between outreach and the number of branches a MFI operates. This is indicated by a regression coefficient between outreach of MFIs and the branch network. The charter type was also found to have a relationship with the outreach of MFIs in Kenya. For instance Deposit taking MFIs were found to have a positive relationship with outreach. 5.3 Recommendations The study recommends that stakeholders in microfinance pay more attention to the financial sustainability of MFIs due to its positive impact on the outreach objective that would contribute significantly in building strong MFIs and contribute a great deal 32