The efficiency and effectiveness of microfinance: evidence from programs of non-governmental organisations in Vietnam

Financial services have long been recognised as having an important role in economic development. However, more than one billion poor people in the world are still excluded from the formal financial systems because they are considered to have a high default rate and because the transaction costs associated with servicing them are high relative to the expected return. Economic theories that relate to this outcome include the information asymmetry between borrowers and lenders and the diseconomies of scale in providing small loans. Microfinance services mainly address this issue by using jointliability lending and peer monitoring to replace physical collateral and to reduce the delivery and monitoring costs. Since the mid 1970s, microfinance has emerged from a grassroots movement to become a global industry, serving about 70 million clients in 40 countries in the world (Harris, 2005). The industry has attracted attention and support from major development agencies such as the United Nations and even private investors such as the Citibank Group. Despite the rapid development of the microfinance industry, many poor people still lack reliable access to financial services. One way to increase the outreach of microfinance on a sustainable basis is to improve both effectiveness and efficiency of financial service delivery. However, in the context of microfinance, there is an absence of comprehensive research on these two issues - a gap which this study aims to address. This thesis contributes to the literature by introducing a conceptual framework of efficiency and effectiveness analysis that describes the relationship between components of microfinance programs and the operating environment. Regarding the efficiency aspect, this study suggests using the production frontier approach to efficiency measurement in preference to the traditional accounting ratio approach, which is unable to properly accommodate the complex nature of microfinance services. In addition, the former approach represents a total factor productivity measure whilst the latter provides only a partial measurement of productivity. The concept of effectiveness analysis in this study is based on an assessment of direct and intended effects of microfinance, rather than measuring the more distant changes that are often included in microfinance impact studies. In addition, it is practical for effectiveness assessment to focus on examining effects at household and individual levels because it may take some time for effects at wider levels to occur. It is emphasised that rural households play both roles of consumers and producers, therefore one should examine microfinance effects under various aspects (e.g., income, consumption and poverty reduction), given the fungibility of money. An institutional survey of microfinance programs and a household survey of client and non-client households were conducted to shed light on those issues. Also, semi-structured interviews and other participatory rural appraisal techniques such as group discussions were also conducted with key stakeholders. Empirical results regarding efficiency show that there remains some potential for microfinance programs to improve, as their average technical efficiency score is 75 per cent. That is, they can reduce the input quantity by 25 per cent while maintaining the current level of outputs. The second stage regressions suggest that the efficiency of microfinance programs decreases as they become more mature, which is in contrast to the conceptual expectation. It is hypothesised that the departure of clients to other financial institutions as they escaped poverty and the difficulties associated with serving extremely poor clients may contribute to this outcome. In terms of effectiveness, the econometric analysis of household welfare revealed that access to microfinance provides insignificant contribution to the income and consumption of member households. However, microfinance programs contributed positively to poverty reduction using the both national and international poverty lines. In addition, participating in microfinance programs is likely to improve the skills and confidence of members in using financial services with an increase in both frequency and volumes of transactions. In addition, the contribution of microfinance to household welfare is modest when compared to the contribution of other important factors such as productive land, physical capital and education. This study proposes three main policy recommendations. Firstly, given the insigmfkant contribution of microfinance in comparison with other factors, better coordination between microfinance schemes and other development programs is needed. This also suggests that extremely poor people should be covered by a social safety net while microfinance programs continue to be required to operate on a sustainable basis. Secondly, there is a need for the Vietnamese government to define clearly the role they see microfinance playing in the future. At present, policies appear as an awkward mix of objectives, some of which are mutually exclusive. Thirdly, the promotion of experience sharing among NMPs is beneficial for the improvement of their operational efficiency