Determinants of profitability of microfinance institutions in Africa

Abstract

Microfinance institutions (MFIs) are one of the key ingredients in poverty reduction in Africa. Nevertheless, for the achievement of poverty reduction goal, profitability is crucial. Several factors such as outreach, institutional environment, age, size and type of MFI affect the profitability of MFIs, but labour efficiency role and credit risk effect on profitability of MFIs have seen little attention. This study therefore, sets out to investigate the potential determinants of MFIs profitability within African countries. The objectives of the study were to examine the trends in profitability of African MFIs and to estimate the determinants of profitability of MFIs in Africa. The study used a MIX Market data for the period 2007 to 2011 for 45 MFIs in nine African countries to obtain a balanced panel. The study estimated both fixed effect and random effect. However, based on the Hausman test, the fixed effect best suited the estimation. Profitability of MFIs was measured using Return on Asset (ROA) and Return on Equity (ROE). To ensure robustness of the model, other control variables were included in the model such as inflation, real gross domestic product, age, size and type of MFI. The study finds that labour inefficiency and credit risk relate to profitability of MFIs in African countries negatively. Other variables found to influence MFIs profitability include economic growth, inflation, size of MFIs and age of MFIs. Hence, it is recommended that governments may consider providing enabling environment that would foster GDP growth in order to increase funding from donors. Also, MFIs should ensure that they employ efficient labour to deliver their services and hence increase profitability.