The Ease of Starting a Business and MFI Performance

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The Ease of Starting a Business

and MFI Performance

Master Thesis

International Business and Management - International Financial Management Faculty of Economics and Business

University of Groningen

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Acknowledgement

This thesis is submitted in order to complete a Master of Science degree in International Business- International Financial Management at the University of Groningen. I am grateful to God, who has given me the strength to finish this thesis. It is always of great value to have people around that support you and contribute to the big achievements in life. Thereby, I want to extend my sincere gratitude to my supervisor Mr. Rients Galema. I attribute the level of my thesis to his patience, knowledge and effort throughout the process of my thesis. A word of appreciation goes to my family and friends, who supported and motivated me all the way.

It is my aspiration for this thesis to connect every reader with this topic which explores the influence of the ease of starting a business on financial performance and outreach of MFIs.

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Abstract

The macro-economic and macro-institutional environment has an influence on the performance of firms. When starting a business, every entrepreneur or firm has to take into consideration the regulation regarding entry. The degree of entry regulation in a country has an influence on the performance of firms. In this case we study how the ease of starting a business in a certain country affects the financial performance and outreach of Microfinance institutions (MFIs) in particular. This relationship is investigated by using panel data from the Microfinance Information Exchange (MIX) and the World Bank Doing Business database. Regression analysis is performed in order to analyze the data which comprises 4431 observations from 85 countries over a period from 1997 to 2008.

The findings suggest an insignificant relationship between the time and costs of starting a business and the outreach of MFIs. The number of procedures and cost to start a new business has a significant negative relationship with financial performance of MFIs. This is not the case for the time it takes to start a new business which does not show a significant result. The minimum required capital is positively related to financial performance of MFIs. The ease of starting a business is not significantly related to outreach of MFIs. Furthermore, the macro-economic environment and the size of the MFIs also influence the financial performance since the results illustrate that a larger MFI is able to serve more clients and receive higher return on their assets than a smaller MFI. The results indicate that the ease of starting a business affects the financial performance of NGOs and Credit Unions/Cooperatives more than the financial performance of NBFIs and Banks.

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1. Introduction

Nowadays, Microfinance is a popular strategy used to alleviate poverty in impoverished areas of the world. It has been recognized that microfinance offers multiple benefits. Posner (2006) described microfinance as the provision of small loans and other financial services to people not considered credit worthy by financial institutions. Another definition indicates that microfinance is the practice of offering small, collateral free loans to members of cooperatives who otherwise would not have access to the capital necessary to begin a small business or other income generating activities.

Although the effectiveness of microfinance as a poverty reduction strategy has been debated, it offers quite some benefits for the ones with fewer resources. It is argued that microfinance benefits the moderately poor more than the destitute. It is also stated that microfinance can cause people to enter a vicious circle of debt, increasing their dependency on the system and not creating stable jobs. On the other hand, microfinance is an effective way to provide low cost financial services to poor individuals and families. Furthermore, as the disposable income of individuals and families increases due to microfinance, it produces development and growth for the local economies. As could be seen, there are two sides of the coin and it is necessary for the program of microfinance to be provided in a careful and effective manner, in order to result in more benefits. This is the continuing job of the Microfinance Institutions (MFIs); offering financial services to their impoverished clients. Many eyes are turning to microfinance and there is a booming increase in the formation of MFIs.

Countless studies examined the performance and outreach of MFIs. There are several views on which factors affect the financial performance and outreach of MFIs. Vanroose et al. (2008) studied the effect of the host country’s banking system on the financial performance and outreach of MFIs. Ahlin et al. (2010) researched how the macro-economic and macro-institutional environments of MFIs serve as determinants of success for MFIs. These recent studies recognized the importance of macro-economy in the performance of MFIs. This study deals with the financial performance and outreach of MFIs focusing on the macro-institutional environment on a country level. Ahlin et al. (2010) concluded that even though macro-economic development is essential for the performance of MFIs, the role of the macro-institutional environment is even more of importance. This area of macro-institutional environment of MFIs has not been thoroughly studied regarding the financial performance and outreach of MFIs.

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business. The ease of starting a new business is related to MFIs performance. The aim is to find out how the process of starting a business in a country could affect the financial performance and outreach of MFIs. The above-mentioned researches examine the ease of doing business to new businesses in general. Ahlin et al (2010) brought this issue to the microfinance industry. This study is combining the literature on the ease of starting a business with the literature on MFIs and their performance. No previous study has specifically focus on how the ease of starting a business is related to financial performance and outreach of MFIs. MFIs are business so it is applicable to the creation and starting of new MFIs. MFIs supply loans to their clients, which are financially less fortunate people and they use the capital to start small businesses. A country’s institutional policies regarding starting a new business signify how easy it will be for these clients to start their own small businesses in order to generate income. To my knowledge, no study of this kind has already been done which uses an extensive panel dataset of MFIs in combination with the Doing Business database of the World Bank to illustrate the relation between ease of starting a business and MFI performance also accounting for the effect of the macro-economic situation on country level.

This study adds value to the existing literature by indicating how the ease of starting a business interacts with MFIs. After the MFIs provide loans to their less fortunate clients, these clients are supposed to start a small business to generate income. The institutional environment in a country determining entry regulation for new businesses is imperative for these clients of MFIs which are trying to succeed as entrepreneurs. The outcomes of this study are directed to MFIs in general since they could see if a country’s ease of starting a new business (referring to starting a new MFI and the clients of MFIs starting their own business) is likely to have an effect on the MFI performance and outreach. This study gives insight to the government to see whether stricter regulations of entry affect MFIs performance and which role the macroeconomic situation of the country plays herein.

The overall results suggest that generally there is a negative relation between the ease of starting a business and MFI performance. This entails that many procedures, time, costs and the minimum capital requirement are negatively related to MFI financial performance and outreach. The more procedures, time and costs to start a business does not always lead to better financial outcomes and MFIs reaching more clients and giving out a larger amount of loans. It could be noticed that the macro economy of a country is important when considering the performance and outreach of MFIs also in this case where the influence of the entry regulations is analyzed.

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Section 3 gives a description of the data used for this analysis. The research methodology applied to this study is explained in section 4 and section 5 presents the results and the corresponding analysis. A discussion about the results and a conclusion are given in section 6.

2. Literature Review

2.1 MFIs outreach and financial performance

As already mentioned above, the main focus of microfinance is to alleviate poverty by providing resources to the poor for them to start their own businesses and produce their own sources of income. This is referred to as outreach which Brown et al. (2005) describe as the attempts to expand microfinance services to the people who are undeserved by financial institutions. This mission of reducing poverty is costly to the MFIs since they have to provide capital to their poor clients. These poor clients are not always able to pay back their loans promptly to MFIs. Recent developments in the microfinance industry which is expanding and commercializing indicate the importance of MFIs to be profitable and sustainable. Rhyne and Christen (1999) state that commercialization is the phase of transition of the microfinance industry from its roots as a social movement to a competitive market place. Beside the goal of reaching many active borrowers, MFIs also aim to be competitive and financially sustainable. Microfinance has reached the era where their outreach and financial performance both are important for their existence.

Several studies have been conducted on outreach and financial performance of MFIs and what could possibly affect their outcomes. Cull et al. (2007) use a dataset of 124 institutions situated in 49 different countries to examine the patterns of profitability, loan repayment and cost reduction and the interaction between financial performance and the depth of outreach. Amongst other findings, they conclude that the lending method of MFIs determines their profitability. They imply that MFIs lending to individuals tend to be more profitable than group lenders since the individual lending approach is related to better-suited borrowers which are able to make larger loans and contribute more easily to profitability of a MFI. The average loan size is not significantly related to profitability. Moreover, Cull et al. (2007) suggest that the institutional design and orientation of MFIs are crucial in considering the interaction of MFIs financial performance and outreach.

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They also found that MFIs with more female borrowers are less efficient. In addition to the research of Cull et al. (2007) and Hermes et al. (2008) this study does not look at the interaction between financial performance and outreach but this interaction forms a base for the analysis of elements which can both influence the financial performance and outreach of MFIs. This study goes further than the interaction between outreach and efficiency in general. It focuses on how an additional element, the (macro-institutional) environment affects MFIs.

Vanroose et al. (2008) use an extensive panel data set derived from the MIX database and researched if the formal banking system of the host-country of a MFI significantly determines the MFI performance, specifically the profitability and outreach. They found that profitability and outreach of MFIs increases in countries where the access to the formal bank sector is low. Vanroose et al. (2008) emphasize in their findings that the macro-economic, macro-institutional environment and the formal financial system of the country do influence the performance of MFIs. Although this paper also uses the same source of extensive data of MFIs regarding financial performance and outreach from the MIX database as Vanroose et al (2008), it gives an indication of how the macro-institutional environment influences the financial performance and outreach. While Vanroose et al. (2008) studies the effect of the formal banking system, this study looks at how developments at the country level regarding starting a new business affect financial performance and outreach of MFIs an hereby also include the role of a country’s macro-economic situation.

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Ahlin & Lin (2006) study 112 MFIs with data of 5-9 years and conclude that the importance of the macro-economy for MFIs performance stems from the objective of MFIs which propose to bring development in the areas where macro-economy is unable to. This shows the impact that macro-economy of a country can have on MFIs. This study also emphasizes that although the macro-economy plays an important role in MFI performance, it does not surpass the role of institution-specific factors as a determinant of MFI performance. A study done by Ahlin et al. (2010) in which they examined determinants of success of 373 MFIs on a country level reinforced that overall economic performance of a country and MFI performance are complementary. They accounted for economic and macro-institutional aspects on country level. They concluded that MFI success is significantly affected by the macro-economic and macro-institutional environment of the MFI when regarding financial sustainability. Ahlin et al. (2010) include the difficulty of starting a business in a certain country as a macro-institutional determinant of MFI success. These were derived from the World Bank Doing Business Indicators which describe regulation of entry. These indicators have been widely used by many studies. Both studies use an extensive dataset to research the role of macro-economy on MFIs performance in general. Ahlin et al. (2006) focuses more on growth and the Ahlin et al. (2010) does a general review of indicators which have an influence on MFIs performance with emphasis on the macro-economic and macro-institutional environment. Ahlin et al. (2010) is one of the few comprehensive studies in this area. Their study also embraces the influence of macro-institutional variables on the financial performance and outreach of MFIs. This study is more specific since it focuses on the ease of starting a new business in a country and the developments around starting a business. Hereby macro-economy is considered since the economic situation of a country could influence how easy it is to start a new business.

2.2 Regulation of entry

Several studies examined entry regulation and its implications on firm performance. Ardagna & Lusardi (2008) study the effect of individual characteristics on entrepreneurship in different countries with different regulations. They denote that regulation reduces the effect of social networks on entrepreneurship and that regulation influences the decision of an individual whether to start a business. This entails that heavier regulated environments have an effect on the amount of the clients of MFIs that will engage in entrepreneurial activities. Softer regulation encourages entrepreneurship and enhances the effect of individual characteristics.

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government intervention have a much softer regulation of entry where it would be easier and faster to start new businesses. The research of Djankov et al. (2002) stems from de Soto (1989) which also elaborate on the role of the government in the economy. According to de Soto (1989), the intervention of the government in the economy by imposing regulation harms the functionality of the economy by forcing those who are not able to comply with the regulations to take another path. This refers to the existence of the informal economy. Moreover Klapper et al. (2006) suggest that entry regulation has a larger influence on the distribution of business activity between the formal and informal economy than on the total volume of business activity in a country. This involves that regulation of entry in a certain country could indicate whether more businesses are formed in the formal market or that more people will turn to the MFIs for support and not the amount of new businesses formed in total. This paper takes this idea of regulation of entry and relates it to performance of MFIs in particular.

Djankov et al. (2006) use the World Bank doing Business indicators for 135 countries to study whether regulation enhances the performance of businesses. They imply that the government’s regulation of business is a main indicator of business growth and present consistent evidence that business-friendly regulations are significantly related to higher growth rates. Regulations stimulating business formation have a positive influence on the business growth.

As could be noticed, previous literature covered the internal matters which influence the financial performance and outreach of MFIs. Recently, they investigated the effect of economic and macro-institutional indicators on MFI performance. Thereby Ahlin et al. (2009) included the difficulty of starting a business as a possible determinant of MFI performance. Djankov et al. (2002) did a thorough research on entry regulation depicting the difficulty of starting a business in general around the world. This study distinguishes itself from these previous studies since it focuses on the impact of the macro-institutional environment on the MFI financial performance and outreach. Specifically, the determinants of the ease of starting a business are addressed and how they influence the performance of MFIs. The main focus is on entry regulations on country level. This study differs from existing literature in that it combines entry regulations in a country with financial performance and outreach of MFIs and also accounting for the effect of macro-economic determinants. No existing study has specifically focused on regulation of entry with all emphasis on MFI performance.

2.3 Hypotheses

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interest theory of regulation which explains that the intervention of the government is needed when the market fails and is incapable of regulating itself. The market failure is existent where the price mechanism that regulates supply and demand breaks down and drives the government to take action. Djankov et al. (2002) relate this idea to the regulation of entry implying that the government introduces regulations of entry in order to screen the entrants to the market to ensure that new entrants meet the minimum standards in order to deliver quality products and service. In the case of MFIs one would expect that the entry regulations enable only MFIs that meet certain standards to enter the market and thus according to the above, these entrants will be able to qualitatively serve their targets and perform better. On the other hand, these entry regulations make it more difficult for the “poor” clients of MFIs to meet the entry standards and survive in the market. Therefore, rigorous entry regulations such as high number of procedures, more time and high costs could cause MFIs to reach fewer clients and thus have less outreach. This leads to the first hypothesis which is stated based on the above.

Hypothesis 1: The number of procedures, time and costs to start a business is negatively related to

outreach of MFIs.

Djankov et al. (2002) claim that this public interest theory expects that stronger regulation of entry measured by a higher number of procedures should be related to superior outcomes. The theory suggests an expectation that higher number of procedures to start a business should lead to better performance of MFIs and thus a positive relation between these two. The reason for this better performance is because the public interest theory predicts that those who are able to successfully undergo all the procedures necessary to start a new business and register themselves are also capable of a good performance in the market. On the other hand, the literature proposes that more regulation of entry leads to a weaker performance. Dawson (2007) examines the empirical relationship between federal regulation and macroeconomic performance in the US. The findings suggest a negative relation between regulation and aggregate economic performance. This implies that generally the existence of regulation is related to inferior economic performance. Klapper et al. (2006) investigate the relationship between regulation and entrepreneurship across 39 countries. Generally, they find out that time, the cost and number of procedures do not have a significant effect on the formation of young businesses.

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number of procedures, cost and time to start a business is related to self-sufficiency of MFIs in a negative but significant way. This means that when there are more procedures, cost and time involved starting a business; a MFI has fewer chances to become self-sufficient. It places a high barrier for starting MFIs but also for the clients who do not own many resources to successfully enter and perform in the marketplace. In order to be financially self-sufficient, MFIs have a good financial and social performance. Based on the above, stating that the number of procedures, cost and time to start a business has a negative relationship with financial performance, the second hypothesis is stated.

Hypothesis 2: The number of procedures, cost and time to start a business is negatively related to good

financial performance of MFIs.

The attempt of the government to set high standards for the minimum capital requirements stems from the idea of only permitting the desirable sellers of business to enter the market. Ahlin et al. (2009) stated that the minimum capital requirements have an insignificant positive relation with self-sufficiency of MFIs. An argument for a positive relation is that higher capital requirements could lead to higher chance of self-sufficiency. The expectation is that businesses which are financially able to meet high minimum capital requirements at their starting phase will also be able to perform well financially during their existence. Based hereon we state the third hypothesis.

Hypothesis 3: The minimum capital requirement to start a new business is positively related to financial

self-sufficiency (FSS) of MFIs.

The question arises whether these capital requirements are also positively related to the outreach of MFIs. If MFIs who manage to have enough capital to enter the MFI industry will also be capable to serve more clients. The research conducted by Stel et al. (2007) implies that the minimum capital requirement to start a new business is related to lower entrepreneurship rates. This entails that higher capital requirements to start a business diminishes the amount of entrepreneurs across countries. According to these results, clients of MFIs are less likely to succeed at becoming young entrepreneurs in countries where the minimum capital requirement is high. Thus more of the less fortunate clients will be available for the microfinance industry since they have fewer chances to start a business via normal banks and the formal market. This portrays a positive relationship between the minimum capital requirement and the outreach of MFIs. The fourth hypothesis is stated expecting a high minimum capital requirement to start a new business to be related to high outreach.

Hypothesis 4: The minimum capital requirement to start a new business is positively related to the

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The two last hypothesis deal with how the financial performance of the different types of MFIs is affected by the ease of starting a business. According to Hermes et al. (2008) the type of MFIs has an influence on the cost functions of the MFIs. This is because the different types of MFIs have different amount of subsidies they receive from donors. The question arises whether the type of MFIs also influence the ease of starting a business and the financial performance and outreach of MFIs.

Cull et al. (2009) makes a distinction between the type of MFI and their performance. They state that the microfinance banks are expected to be for-profit organizations, using the individual lending method. They serve the least poor clients which are more likely to borrow individually. They give larger loans and have less woman borrowers and earn more profit. At the other side, Nongovernmental organizations (NGOs) are characterized as non-profit organizations and the group lending method since they serve the poorest clients which are more likely to borrow in groups. They have smaller loan balances and more female borrowers. These institutions are mostly the less profitable institutions. Cull et al. (2007) confirmed that the lending method (individual or group) and the profitability of the MFIs have a positive relation for all types of MFIs. They find out that profitability is not linked to the loan balance MFIs lend to their clients. This involves that the type of MFIs (for profit or non-profit) does not significantly influence the profitability and thus financial performance of MFIs. The above denote a relation between the type of MFIs and its financial performance. The definition of NGOs1 explains NGOs as being less regulated than the microfinance banks. We could categorize the main types of MFIs, NGOs and the Credit Union/ Cooperatives as the less profitable and regulated institutions and Banks and the Non-Bank Financial Institutions (NBFI) as the more profitable and regulated institutions. One may expect that since the NGOs and Credit Union/ Cooperatives are less regulated their financial performance would be less influenced by entry regulation and thus the ease of starting a business than the Banks and NBFIs. The fifth hypothesis deals with the above relation.

Hypothesis 5: The ease of starting a business has no influence on the financial performance of NGOs and

Credit Union/Cooperatives while the ease of starting a business does influence the financial performance of NBFI and banks.

The question arises how the ease of starting a business will affect the outreach of the different types of MFIs since the different types of MFIs can be categorized as serving a certain type of clients. Cull et al. (2007) concluded that larger individual borrowers and the group-based borrowers are for a small

1

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percentage female and tend to receive larger loans. They are most likely to borrow from the NBFIs and Banks which tend to focus on financial performance and consequently less on outreach. Cull et al. (2009) confirms that the majority of the borrowers of NGOs are female. As it could be noticed, NGOs and Credit Union/ Cooperatives have lower loan balances and serve more woman. And the opposite applies for the NBFIs and Banks. Therefore, the analysis will see the outreach of which of these two categories are more affected by the ease of starting a business. Since NBFIs and Banks are the more regulated MFIs, the implication is that the outreach of NBFIs and Banks are more influenced by the ease of starting a business than NGOs and Credit Union/ Cooperatives.

Hypothesis 6: The ease of starting a business has no influence on the outreach of NGOs and Credit

Union/Cooperatives while the ease of starting a business does influence the outreach of NBFI and banks.

3. Data

In order to study the relation between the ease of starting a business and MFI performance, this research uses panel data of MFIs from 1997 to 2008, however some gaps exists in the availability of the yearly data for MFIs. The data is acquired from the Microfinance Information Exchange (MIX) website and the World Bank Doing Business database. The institutional variables used in order to measure the ease of starting a business are taken from the Doing Business database from the Worldbank and are also used by Djankov et al. (2002) and Ahlin et al. (2009). This database of regulation of entry by start-up business contains information from businesses in 85 countries. They acquired information about all the procedures and necessary permits that an entrepreneur needs to complete to start operating legally. The database is made based on two assumptions. That the information is readily available in the participating countries and that the governments of these countries perform efficiently and without corruption (Djankov et al., 2009).

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the variables will be tested by using the logarithm of the variable in order to reduce the effect of outliers on the outcome.

The data distinguishes 6 different legal statuses (type) of MFIs. It could be seen in table 1a that the most MFIs in this sample are NGO’s since 42% of the MFIs are Non- Governmental Organizations (NGO). This is different than expected since MFIs are currently commercializing and transforming into banks. However it may be due to the locations of the MFIs in this sample. But as Cull et al. (2007) conclude, NGOs still serve the highest number of borrower although the donors to MFIs have strongly reassured the commercialization of microfinance. The second largest type of MFIs in this sample is the Non-Bank Financial Institution (NBFI) which accounts for 35% of these MFIs. The Cooperatives/Credit Unions represent 13% of the sample and 8% of the MFIs are Banks. 3% of the MFIs in this sample are Rural Banks and 1% of the sample of MFIs has a legal status specified under the category Other. We categorize the type of MFIs in four categories which are NGOs, Credit Union/ Cooperatives, the NBFI and Banks. Banks comprise microfinance banks and rural banks.

[ Insert table 1a here ]

The region in which an MFI is located can have its influence on the performance of the MFI. For this sample it can be seen in table 1b that it is a quite diversified sample since the MFIs are well distributed and balanced around the world with exception of Latin America and the Caribbean (LAC) as the region with the most MFIs in this sample. LAC accounts for 35% of the MFIs in this sample and Africa comprises 20% of this sample. Eastern Europe and Central is the location for 19% of the institutions in this sample. Despite the magnitude of Asian countries, South Asia and East Asia & the Pacific comprise respectively 12% and 8% of the MFIs in this sample. The Middle East and North Africa has 6% of the MFIs.

[ Insert table 1b here ]

4. Methodology

The basic regression specification used is yit = α + β'Iit + β'Xit + β'Mit + uit.

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regarding the ease of starting a business. These are the number of procedures, time, costs and minimum capital required to start a business. The X stands for the set of macroeconomic control variables portraying a particular country. The set of macroeconomic variables consists of GDP per capita, private credit, the level of manufacturing, the unemployment, the FDI, remittances and inflation. And the M symbolizes the set of MFI specific control variables, in this case the size of the MFI. The type of MFI and region of MFI are accounted as dummy variables. The regression outcomes are evaluated based on the 99%, 95% and 90% confidence interval level in order to examine if the relationships are significant. Hereby the level of the p-value determines is the coefficient indicating the effect of a certain dependent variable on the independent variables.

This specification is used first to test the relationship between MFI performance and the institutional variables each separately and afterwards the specification is used as it is seen above by looking at all the institutional variables simultaneously.

Before performing these regression analyses, correlations are conducted of these variables in order to depict if there is any relationship between the variables and thereafter the regression analysis to illustrate the magnitude and relevancy of these relationships. Table 2a below presents the correlation analysis of the variables. Almost all the relationships presented in the table signify weak relationships. One could expect a negative relation between the number of procedures and the indicators of financial performance. The same is applicable for those indicators of outreach. The time is positively related to the number of active borrowers and woman borrowers. The costs of starting a new business are positively related to the ROE, the number of borrowers and the woman borrowers. It could be noticed that there is positive relation between the minimum capital requirement and all the financial performance and outreach indicators with exemption of the loan size.

[ Insert table 2a here ]

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Another technique is the between effects model which control for omitted variables that change over time but are constant between cases (Princeton University, 2007). This variation between cases makes it possible to estimate the effect of the omitted independent variables on the dependent variable.

In order to further explain the variables, table 2b presents summary statistics. [ Insert table 2b here ]

4.1 Dependent variables

The dependent variables are financial performance and outreach of MFIs. The indicators of MFIs financial performance are the FSS, ROA and the ROE. Outreach of MFI is indicated by the variables the number of active borrowers, the percentage of woman borrowers and the average loan size.

The FSS is used as a measure of Financial Performance of MFIs. The FSS gives an indication of how an MFI can sustain its lending costs. It measures whether the financial revenues are enough to cover the total costs. According to Djankov et al. (2002), more stringent entry regulations should be related to socially superior results which are in accordance with the public interest theory. Therefore, I test to see if strict entry regulations have significant influence on performance outcomes of MFIs, socially and financially. Hartarska (2005) stated that a MFI’s performance can be assessed based on the double objective of the microfinance industry which are reaching the most clients possible while being self-sustainable operationally.

In this set of independent variables we distinguish ROA which indicates the profitability of the MFIs in this case. The ROE measures the stake of shareholders in the MFIs profit. These three variables indicate both the profitability and the ability of MFIs to sustain them financially.

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In order to analyze the institutional environment of starting a business on country-level, some indicators of the Doing Business indicators of the World Bank are taken. The variable number of procedures gives the amount of procedures needed to start a business in a country. The set of institutional variables consists of firstly the number of procedures required to start a business which is mainly between 5 and 28 procedures for this sample. As stated by Vanroose & D’Espallier (2009), a higher number of procedures required to start a business should be related to better outcomes or performance. Thereby the variable number of procedures is included order to see if the number of procedures required significantly affects the state of performance of MFIs.

The time gives the time measures in days to start a business. Djankov (2009) concluded based on preceding studies that the time to register a new business stays a negative and significant determinant of entry. This involves that the more time is needed to start a MFI in a certain country, the less MFIs will be started in a certain country. Hereby, the analysis will show if there also is a negative and significant relation between time to start a MFI and performance of MFIs already existing.

The cost to start a business is indicated by the cost of income per capita. Alhin et al. (2009) affirmed that the number of procedures, cost, time plus cost and time to start a business is related to self-sufficiency of MFIs in a negative but significant way. So the more procedures cost and time involved to start a business gives a MFI less chances to become self-sufficient. Hereby the costs to start a business are also measured as the cost of income per capita.

The minimum capital requirement shows the minimum amount of money required by the country’s institutional environment to start a new business. Ahlin et al. (2009) stated that the minimum capital requirements have an insignificant positive relation with self-sufficiency of MFIs. This means that higher capital requirements could lead to higher chance of self-sufficiency. This variable seeks if the MFIs which manage to have enough capital to enter the MFI industry are also capable to serve more clients and better financial performance.

4.2 Macro-economic variables

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influence how easily MFIs can become profitable and thus their financial performance. They use the GDP per capita in order to measure richer and poorer countries. This is also sustained by Djankov et al. (2002), who stated that the per capita income was essential for their analysis in order to measure richer and poorer countries. They argued that a reason therefore is that richer countries (higher per capita income) can lead to softer regulations for starting a business, since they could deal better with market failures. One can control the influence of ease of starting a business on financial performance given that there could be a positive relation between GDP per capita and ease of starting a business. The real GDP per capita indicates the economic development in a country.

Ahlin et al. (2009) included remittances in their analysis and they concluded that remittances have a significant positive relation with self-sufficiency. Therefore, the more foreign wages earned lead to more self-sufficient MFIs. When analyzing the relationship between ease of starting a business and MFI performance, remittances are used as a control variable since they also have an influence on MFI self-sufficiency and thereby MFI performance.

Unemployment as a percentage of GDP gives the share of the population not participating in the workforce. This gives an indication of the need for microfinance in the economy. We look at unemployment because according to Ahlin et al. (2009), the workforce participation rate reflects the existence of labor opportunities in the economy which may be a substitute for microfinance institutions. This is because unemployment may stimulate the need for microfinance activities and low unemployment may decrease the use of microfinance instead of the conventional labor market.

Manufacturing measures the value added by the manufacturing industry to the GDP and illustrates an alternative for microfinance which people work in manufacturing industry for a wage.

The private credit is the measurement of the amount of the domestic credit to the private sector, divided by GDP which designates the development of the financial sector in a certain country. The foreign direct investment (FDI) is also used and is the net inflows from foreign direct investments. Lastly, inflation divided by the GDP indicates the change price level in a certain country.

4.3 MFI-specific variables

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when looking at the relationship between ease of starting a business and financial performance of an MFI, it is imperative to include the size of the MFI as a control variable.

The region of the MFI is functioning as a dummy variable and is labeled from region 1 to 6 with Africa as the omitted category. Djankov et al. (2002) confirmed that entry regulations vary across regions. This means that the region of a MFI could have a particular influence on the performance of a MFI.

The type of a MFI has different operations and the procedures to start a bank differ from those to start a NGO. Moreover, the focal objective of these types of institutions is not the same since some would be more directed towards outreach or financial performance. Therefore, when looking at the relation between ease of starting a business and performance of an MFI, the type of MFI plays a role in the outcome.

5. Results

This section deals with the results of the regression analysis conducted in order to examine the relationship between the ease of starting a business in a country and MFI performance. Since MFI performance is subdivided in financial performance and outreach, each will be presented separately.

5.1 Financial Performance

Table 3 indicates the relation between the financial performance of MFIs and the variables describing the ease of starting a business in a country.

[ Insert table 3 here ]

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start a business and the ROA. The minimum capital requirement is positively related to the ROA and is significant only at a 90% level of confidence. This result confirms the third hypothesis.

It is remarkable that control variables such as the real GDP per capita keeps showing a significant and negative relation with ROA. This may be due to the fact that MFIs have more success and better performance in less developed countries. This implies that in countries with higher GDP per capita (wealthier countries) it is harder for MFIs to have high ROAs. This is the same for countries with high unemployment. FDI has a positive and significant effect on the ROA. The effect of the ease of starting a business and the ROA is also somewhat explained by the result that the size of MFIs is positively related to the ROA of MFIs.

In the case of the ROE, it could be seen in table 3 that the number of procedures and cost denotes a significant and in this case negative relationship with the ROE. This is in line with the second hypothesis which depicts a negative relationship between number of procedures and costs and financial performance. However, in this case the second hypothesis cannot be completely confirmed since the time does not have negative relationship with the ROE. The time to start a business is positively related to the ROE. The more time it takes to start a new business results in a higher ROE of MFIs. It is a peculiar results since all the other institutional variables are negatively related to the ROE.

When it comes to the variables such as time and minimum capital requirement we could see that the private credit has a significant positive relationship with the ROE. The private credit has a more significant influence on the ROE than the time and minimum capital requirement to start a new business. It consistently shows that the real GDP per capita and thus the level of income has a negative relationship with the ROE. It is then harder to gain ROE in countries with higher income level. This is significant when controlling for the number of procedures and the costs of starting a business.

As table 3 depicts, the FSS of MFIs is significant and negatively related to the number of procedures and costs of starting a business. The second hypothesis is in accordance with these results with the exception of the time which is not significantly related to FSS.

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opportunities for the MFI industry resulting in better financial performance and financial sustainable MFIs. The results suggest a positive and significant relationship between the FSS of MFIs and FDI. This involves that higher FDI in a certain country results in financially self-sustainable MFIs.

5.1.1 Economic Impact on Financial Performance

The economic impact2 of the institutional variables on the ROA indicates how a standard deviation change of 1 will affect the ROA. It could be noticed in table 3 that costs of starting a business affects the ROA more than the other institutional variables since a standard deviation change of 1 of the number of procedures will result in a change of -0.0353of the ROA. The more costs involved in starting a business lead to a lower ROA. The costs have a substantial impact on the ROA since the -0.0353 is above the 0.01 mean of the ROA. The economic impact is also greater than the mean of the ROA for the number of procedures and time but not for the minimum capital requirement.

The cost to start a business has a larger impact on the ROE economically since a standard deviation change of 1 will result in a decrease of 0.2678 the ROE, as it is shown in table 3. This is a quite large influence compared with the 0.08 mean of the ROE. The number of procedures (-0.2022) and time (0.1825) also have an outstanding influence on the ROE.

Table 3 shows that the economic impact on the FSS is consistent with the ROA and the ROE. The cost to start a business has more influence on the change in the FSS of MFIs. The cost to start a business produces a 0.0878 decrease in the FSS for every standard deviation change in the costs. This is also the same for the number of procedures. More procedures and costs involved in starting a business results in a decrease of the FSS. However, these effects on the FSS are smaller than the mean FSS of 1.18.

5.1.2 Type of MFIs and Financial Performance

When looking at the type of MFIs, the results in table 4 imply that the ROA of NGOs is significantly related to the ease of starting a business. The number of procedures and costs to start a business is significant and negatively related to the ROA of NGOs. The time is significant and positively related to the ROA of NGOs. The costs of starting a business also have a significant positive relation with the ROA of banks. These results are not in accordance with the fifth hypothesis since it seems that the financial performance of the NGOs and Credit Unions/ Cooperatives are more significantly influenced by the ease of starting a business than the NBFIs and Banks. The average loan balances of NGOs are smaller. One possible explanation may be that NGOs account for a large percentage of the MFIs included in the data.

2

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The NGOs therefore have a significant result because they are a larger group in the sample so their influence on the ROA is bigger than the other types of MFIs.

Table 5 shows that as it is the case with the ROA, the ROE of NGO is mostly influenced by the ease of starting a business. The number of procedures and costs to start a business is significantly and negatively related to the ROE of NGOs while the time to start a business is significant and positively related to the ROE of NGOs. The table depicts a significant and positive relationship between the number of procedures and the ROE of Credit Unions/ Cooperatives. This is an unusual result since the number of procedures is mostly negatively related to the financial performance. The number of procedures has a significant and negative relationship with the ROE of NBFIs. These results are not completely in line with the fifth hypothesis since the Banks and NBFIs to be significantly influenced by the ease of starting the business.

Table 6 denotes a significant and negative relation between the number of procedures and costs of starting a business and the FSS of NGOs. The time is in this case also positively related to the FSS of NGOs. The FSS of NBFIs is significantly and negatively influenced by the number of procedures to start a business. The time to start a business is positively related to the FSS of NBFIs. In the case of the FSS of Banks it could be seen that the time to start a business is significantly and negatively related to the FSS of banks. The more time it takes the clients of microfinance banks to start a business lead to less financially sustainable banks. The costs to start a business are positively related to the FSS of banks. Thus, more costs to start a business lead to more financially sustainable microfinance banks. These results signify that the financial performance of all types of MFIs are somewhat influenced by the ease of starting a business.

5.2 Outreach

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The minimum capital requirement is positively linked to the number of active borrowers meaning that higher capital requirement can lead to the MFIs reaching more clients. Table 7 shows that none of the variables concerning ease of starting a business have a significant relationship with the number of active borrowers. The results do not confirm the fourth hypothesis. However it can be seen that the control variables which are country specific have strong significant relations with the number of active borrowers meaning that the economic situation of the country does have a strong effect on the ease of starting a business. The income level, unemployment, FDI, inflation rate and remittances of a certain country have an effect on how accessible the clients are for MFIs to reach out to. Further, it could be seen that the size of MFI has a substantial effect on the number of active borrowers which is logical since bigger MFIs have more capacity for clients than the smaller MFIs.

Table 7 demonstrates that the percentage of woman borrowers is not significantly affected by the ease of starting a business. It could be seen that the number of procedures and the capital requirements negatively affect the amount of woman borrowers although not significantly. The country-specific control variables show a significant effect on the percentage of woman borrowers. Most of the effect of the ease of starting a business on the percentage of woman borrowers is explained by the economic situation of the specific country. Inflation and remittances does not influence the percentage of woman borrowers substantially. It is noteworthy to state that the size of the MFIs has a significant negative effect on the percentage of woman borrowers. This involves that the percentage of woman borrowers diminishes as MFI size increases. The results do not significantly confirm the first and fourth hypothesis.

Table 7 also illustrates an aspect of the breadth of outreach which is the average size of the loans they offer, the average loan balance. The average loan balance of MFIs is not substantially influenced by the variables denoting the ease of starting a business. It does not sustain the first hypothesis which denotes a negative relation between the number of procedures, time and costs of starting a business and the outreach of MFIs. There is no statistical significant influence of the institutional variables on the average loan balance. However a change in the institutional variables representing the ease of starting a business will result in a substantial change in the average loan balance of MFIs.

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5.2.1 Economic impact on Outreach

As could be seen in table 7, the institutional variables have relatively small effect on the outreach compared to the mean number of active borrowers of 8.91. The number of procedures has the larger impact on the outreach since a standard deviation change of 1 in the number of procedures to start a new business will result in a decrease of 0.0475 active borrowers of MFIs. It could be the case that the prospective clients of MFIs wanting to start their own small businesses are discouraged by the required number of procedures to start a business. The more procedures required makes starting a business less accessible for the prospective clients leading to fewer clients for the MFIs. However one would expect that more procedures will make more people to turn to the microfinance industry. Table 7 also indicates that the minimum capital requirement has a larger impact (0.0342) on the number of active borrowers compared to his impact on financial performance. A higher minimum capital requirement leads to a lower number of active borrowers. This can be explained by the fact that the less fortunate people are not able to comply with high capital requirements and therefore turn to MFIs in order to start their own businesses. Table 7 illustrates that the real economic impact of the institutional variables on the percentage of woman borrowers is miniscule. The mean percentage of woman borrowers is 64%. The number of procedures has the largest impact (0.7%) on change in the percentage of woman borrowers. These results indicate that the ease of starting a new business does not significantly affect the amount of woman borrowers an MFI will reach out to.

Table 7 shows the economic impact of the institutional variables on the average loan balance is small compared with the mean average loan balance of 1026. It is the minimum capital required (62.96) that has the larger effect on the change in the average loan balance. This entails that a larger minimum capital requirement will lead to more positive change in the loan balance of MFIs since less people are able to comply with the minimum capital standards, MFIs will extend more and larger loans.

5.2.2 Type of MFIs and Outreach

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poorer clients, these poor clients cannot meet high capital requirement. Thus, when the minimum capital requirement to start a business is higher, the fewer people can reach and succeed to start a business. These results are not completely in line with hypothesis 6.

Table 9 shows that the number of procedures has a significant negative relationship with the percentage of woman borrowers of Banks. This result implies that when the number of procedures to start a new business increases, the banks will get fewer female clients. This supports the sixth hypothesis. The time to start a new business is significantly and negatively related to the percentage of woman borrowers of NGOs. The more time it takes to start a business, the less woman borrowers for NGOs. The cost to start a new business is negatively related to the percentage of woman borrowers. More time leads to less female borrowers. The percentage of woman borrowers of Banks is positively affected by the cost to start a new business. Higher costs lead to more female borrowers. The minimum capital requirement to start a business significantly related to the percentage of female borrowers of all the main types of MFIs. However, the results imply a negative effect of the minimum capital requirement on the percentage of female borrowers of NGOs and Banks. Contrary to that there is a positive relation between the minimum capital requirement to start a business and the percentage female borrowers of Credit Unions/Cooperatives and NBFIs. The findings do not support the sixth hypothesis which implies that the ease of starting a business does not influence the outreach of NGOs.

Table 10 shows that the number of procedures is significant and positive related to the average loan balance of Banks. The number of procedures has a negative effect on the average loan balance of NGOs. The cost to start a business has a positive effect on the average loan balance of NGOs and Credit Unions/ Cooperatives. Higher costs to start a business lead to higher average loan balances. This is logical since the borrowers will need higher loans to cover the higher costs. The minimum capital requirements to start a business are negatively related to the average loan balances of Credit Unions/ Cooperatives and NBFIs and a positive relation with the average loan balances of NGOs. This implies that for NGOs higher capital requirements will lead to higher loan balances for the clients of NGOs. The results imply that the ease of starting a business affect the outreach of all types of MFIs. This is not what the sixth hypothesis suggested which is no significant influence of the ease to start a business on NGOs and Credit Union/ Cooperatives.

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6. Discussion and Conclusion

6.1 Discussion

The literature is still evolving in the area of microfinance and the macro-economic and macro-institutional environment. This study relates the MFI performance with the macro-institutional environment, more specifically the ease of starting a business, across countries. This study contributes and adds value to the current literature in several ways. First, the number of procedures and costs to start a business is negatively related to financial performance of MFIs. The more procedures and costs involved in starting a new business in a certain country lead to poorer financial performance of MFIs. This is in accordance with Ahlin et al. (2009) which proposed a negative relationship between the number of procedure and costs to start a new business and self-sufficiency. Further on, the results suggest that the number of procedures required to start a business has a strong influence on the financial performance of MFIs. Economically, it is policies regarding the cost to start a new business that mostly impact the financial result of MFIs. It is remarkable that the time it takes to start a new business is not negatively related to the financial performance of MFIs. Although a negative relationship is suggested by Djankov et al. (2002) and Ahlin et al. (2009), the results indicate that the more days it takes to start a business are positively related to the financial performance of MFIs. This is an unusual result since the number of procedures is negatively related to financial performance and one would expect that the more procedures required to start a business will take more time to go through all those procedures. Thus the expectation was that both the time and the number of procedures would be negatively related to financial performance. The positive effect of time on the financial performance could be explained by the fact that the more time it take to start a business gives entrepreneurs more time to understand the procedures and prepare for business they are starting. Better understanding and performance could lead to better performance for the clients of MFIs which on their turn influence the financial performance of MFIs. For this reason the second hypothesis is not completely confirmed since the relationship between number of procedures, costs and time to start a new business is not in all cases negatively related to financial performance.

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businesses. Since the number of procedures, time and costs do not lead to more outreach, it does not result in MFIs reaching out to more clients and thus giving less people to receive a small loan in order to become small entrepreneurs. Therefore, the regulations regarding ease of starting a new business do not affect the amount of young business in a particular country. The results are not completely in accordance with the first hypothesis proposing a negative relationship between the number of procedures, time and costs to start a business and outreach of MFIs. The results signify a greater impact of the macro-economic environment of a country on the outreach of MFIs, not overlooking the effect of the size of a MFI on the outreach of that certain MFI.

Third, there is evidence for a positive relationship between the minimum capital required to start a business and the FSS of MFIs. Although Ahlin et al. (2009) suggest an insignificant positive relationship; the results indicate a significant and positive relation between the minimum capital required and the FSS of MFIs. This has two implications for MFIs. Higher minimum capital standards lead to higher FSS of MFIs indicating that the MFIs which succeed at complying with the minimum capital standards and are registered as new entrants are also able to perform well financially. Alternatively, the clients of MFIs which are able to fulfill the minimum capital standards in order to start their small business are also capable of paying back their loan to the MFIs leading to a better performance of MFIs since they will be able to receive return on their investments. In these cases the minimum capital required function as a filter to only accept those businesses which are financially qualified to enter the market expecting them to perform well financially. This sustains the third hypothesis.

The fourth hypothesis states a positive relationship between the minimum capital required and the outreach of MFIs is not completely supported by the results. The findings do not illustrate a significant relationship between these two variables, they signal a positive relationship. The minimum capital standards do not influence the outreach of MFIs.

Zeller and Meyer (2002) suggest a trade-off between financial performance, outreach and welfare impact of MFIs in the Critical Microfinance Triangle. The expectation would be that if the ease of starting a business negatively affects the financial performance of MFI, the ease of starting a business should affect the outreach of MFIs positively. However, these results do not indicate a trade-off between financial performance and outreach of MFIs when looking at the ease of starting a business. It could be seen that in cases when the ease of starting a business negatively affect the financial performance of MFIs, the ease of starting a business does not even have a significant effect on the outreach of MFIs.

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type of MFI and financial performance of MFIs. The fifth hypothesis which expected the financial performance of Banks and NBFIs to be significantly influenced by the ease of starting a business is not completely sustained. It could be seen that the NGOs and Credit Union/ Cooperatives which are less regulated and therefore supposed to be less influenced by entry regulations are significantly influenced by the ease of starting a business. In addition to the conclusion of Cull et al. (2009), the financial performance of MFIs does differ per type of MFI when we account for the ease of starting a business. The ease of starting a business does affect the outreach of the types of MFIs both for the less regulated MFIs as for the regulated MFIs. The outreach NGOs and Credit Unions/Cooperatives are affected by the ease of starting a business. Higher standards to start a new business affect both the regulated and less-regulated types of MFIs. As the sixth hypothesis suggests that the ease of starting a business does not significantly affect the outreach of NGOs and Credit Unions/ Cooperatives because these are the MFIs which are mostly non-regulated, not for profit and serving poorer clients. However, it could be seen that although their characteristics as institutions they are influenced by the variables denoting the ease of starting a business. These results are contrary than expected since the above results imply that the outreach is not significantly affected by the ease of starting a business. But however, when the results are separated by the different types of MFIs, it could be seen that the results are not similar for the different types of MFIs and significant relations are identified.

The question arises how the ease of starting a business will affect the outreach of the different types of MFIs since the different types of MFIs can be categorized as serving a certain type of clients. Cull et al. (2007) concluded that larger individual borrowers and the group-based borrowers are for a small percentage female and tend to receive larger loans. They are most likely to borrow from the NBFIs and Banks which tend to focus on financial performance and consequently less on outreach. Cull et al. (2009) confirms that the majority of the borrowers of NGOs are female. As it could be noticed, NGOs and Credit Union/ Cooperatives have lower loan balances and serve more woman. And the opposite applies for the NBFIs and Banks. Therefore, the analysis will see the outreach of which of these two categories are more affected by the ease of starting a business. Since NBFIs and Banks are the more regulated MFIs, the implication is that the outreach of NBFIs and Banks are more influenced by the ease of starting a business than NGOs and Credit Union/ Cooperatives.

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misrepresentation of the reality since the data collected is of the institution with the most available data and it is unknown how the results would have been if the data of the other MFIs were included. This research is also limited by the number of each type and region of MFI available. Furthermore, financial performance is a broad concept, in this study we considered the ROA, ROE and FSS to better define this concept.

Further research could involve the inclusion of corruption when analyzing the ease of starting a business and MFI performance. Studies such as Djankov et al (2002) and Ahlin et al. (2009) recognize corruption as a variable that could be of influence when analyzing the macro-institutional environment of a country since corruption gives an indication if the policies and regulations are followed as epected. Another implication for research would be to study how the microfinance industry influences the macro-institutional and macro-economic environment.

6.2 Conclusion

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Appendices

Table 1a: This table presents the type of MFIs recognized in the data of this research.

Type of MFIs Amount Percentage

Rural bank 144 3% Bank 355 8% Credit 497 11% NGO 1870 42% NBFI 1566 35% Other 20 0% 4452

Table 1b: This table depicts how the MFIs are divided in the different regions in the world.

Region Amount Percentage

Africa 909 20%

East Asia and the Pacific 369 8% Eastern Europe and Central Asia 843 19% Latin America and The Caribbean 1539 34% Middle East and North Africa 277 6%

South Asia 537 12%

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Table 2a: This table gives an indication of the correlation between the variables of financial performance,

outreach and the independent variables of the ease of starting a business.

ROA ROE FSS ActBor Womanbor Av.LoanBal NumProc Timedays Cost Mincapreq

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Table 2b: This table presents a summary statistics of all variables.

Variable Description Obs Mean Std. Dev. Min Max ROA (Net Operating Income, less Taxes)/ Assets 3802 0.01 0.14 -2.14 0.67 ROE (Net Operating Income, less Taxes)/ Equity 3804 0.08 2.00 -44.11 86.57 FSS

Adjusted financial revenue/ (Adjusted financial expenses + net loan loss provision

expenses + operating expenses) 3784 1.18 0.57 -0.10 19.39 ActBor Number of active borrowers 4474 8.91 1.83 1.39 15.67 Womanbor

Woman Borrowers/ Number of active

borrowers *100% 4474 0.64 0.27 0.00 1.00 Av.LoanBal

Average Gross Loan Portfolio/ average

number of active borrowers 4465 1026.01 3651.98 0.00 171473.00 NumProc Number of procedures to start a business 4004 11.30 3.27 5.00 28.00 Timedays Number of days to start a business 4004 61.53 34.43 6.00 202.00 Cost

Costs to start a business (% average of

income) 3986 83.30 9710605.00 6.70 910.00 Mincapreq

Mimimum capital required to start a business

(% average of income) 3842 86.56 163.71 0.00 744.70 domcredp

Domestic credit to private sector (% of

GDP) 4193 30.19 19.63 0.85 163.92

realgdpcap

GDP per capita, PPP (constant 2005

international $) 4348 4286.32 3358.38 252.23 22199.27 Manuf. Manufacturing, value added (% of GDP) 3916 1533225.00 5.60 2.58 46.25 Unempl. Unemployment, total (% of total labor force) 1667 9144001.00 5.50 0.68 37.26 FDI

Foreign direct investment, net inflows (% of

GDP) 3684 3.77 4.57 -14.37 46.48

InflGDP Inflation, consumer prices (annual %) 4179 8.60 20.31 -8.97 1058.37 remit

Workers' remittances and compensation of

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Table 3: This table presents the regression results with the variables denoting financial performance

The Ease of Starting a Business and MFI Performance