Determinants of profitability of microfinance Institutions in Africa

Abstract

Microfinance institutions (MFIs) are seen as one of key ingredients in poverty reduction in Africa. Nevertheless, for them to achieve their goal of poverty reduction, their 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). Labour efficiency was measured as the number of borrowers per staff of MFIs whereas credit risk was measured by loan default for thirty days. To ensure robustness of the model and that the estimated equation does not suffer from omitted variable bias, 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 relates to profitability of MFIs in African countries negatively. Also, credit risk exerts negative effect on profitability of MFIs in Africa. Other variables which were found to influence the profitability of MFIs include economic growth, inflation, size of MFIs and age of MFIs.