A return to self-sufficiency in microfinance

Microfinance institutions, and indeed, other enterprises in the social enterprise space, need to be clear about the significance of depending on income from core operation and not windfalls. Indeed, they should more than anything else, understand the risk they take not to cover their costs from earned revenue. In order to have any modicum of hope of continued existence, they must ensure that income from core operation, which we shall explain presently, exceeds expenditure at each point in time. Technically, that is what specialists in the field call financial viability.

Most of these socially inclined institutions are funded by donors and many entities that support charitable causes. However, reliance on donor funding is not only outmoded but also unsustainable. Relying on donors is now like living on borrowed time. Donor funds have not only dried up, for many obvious reasons, donors are even tired (the so-called donor fatigue). They have been fatigued long since before the current widespread economic crises among countries. The arrival of the pandemic merely exacerbated what was already a pretty bad situation. Financial viability has therefore assumed a more important position, under the combined weight of poor global economic conditions and the distorting influence of the pandemic.

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Subsidies are made to operators to help them reduce the pressure of costs that often reduce their ability to deliver services to their clients. Even then, most governments are facing critical decision challenges regarding their fiscal operations, and are no longer readily persuaded to subsidize certain important but not critical activities. It has now become very important to manage resources to ensure that cost of operation does not consume the operator. Subsidy dependence ratio measures the rate at which an operator depends on subsidy. It is computed for information so as to find ways of reducing such dependency.

When organizations want to determine the likelihood of their operations continuing into the future, they compute certain indicators known as Financial Self-sufficiency Indices. There are two ways to look at this concept. One way is to look at Operational self-sufficiency and the other is Financial Self-sufficiency. It is important for operators to know the factors that drive both operational and financial self-sufficiency. When we say that an institution is viable, that is what we mean. It says that the firm is both operationally and financially sustainable. So we cannot discuss sustainability without ensuring that those ingredients that bring it about are all in the kitty.

Revenue, Return on Assets and Outreach, by which we mean the number of clients the operator reached, are key elements of sustainability. Dependency Index tells us how much an entity depends on subsidies, windfalls or other non-core income. Once we are able to determine this index, we can go ahead and work out the level to which interest rate could be raised to cover the dependency gap. Revenue that comes from the loan portfolio must take care of costs and both should be watched together to ensure that the latter does not run away. This is why cost containment should be like a religion in the effective management of a successful lending institution. There must therefore be a culture of constantly comparing the yield (Revenue from assets) to the expenditure that brought it about. When revenue exceeds expenses, the entity is said to be self-sufficient.

In considering revenue for purposes of financial viability, only revenue from operations is taken into account. By operating revenue, therefore, we refer to the income that comes from saving and loans, and investment. Microfinance and some other social enterprises make loans and undertake other activities that also bring in revenue. Income from such other activities, and this includes donations from charity, do not form part of operating income, for the purpose of financial viability determination. In particular, donations are gifts the frequency or occurrence of which cannot be predicted. Therefore, since financial viability is concerned with the ability of an enterprise to cover its costs from earned income and not gifts, donations and windfalls do not count.

The Central Bank has been involved in the funding of MSMEs through soft loans made available through microfinance institutions. Revenues from the on-lending activity relating to such funds form part of the operators’ revenue, so long as they are earned from lending operations.