4.3 Measures of Outreach and Sustainability
4.3.1 Outreach Dimensions
4.3.1.6 Scope of Outreach
4.3.2 Financial Sustainability Measures
As outlined in Chapter 2, MFOs were often not designed to function as true financial intermediaries, but were vehicles that channeled government funds to the poor. These organisations mostly did not function under financial viability constraints that led to inefficient operations, injudicious credit granting decisions and limited accountability. Poor financial reporting often resulted in optimistic pictures of financial performance being presented to donors, governments and other stake holders (Yaron, 1997). However, the important issue is to assess whether public and donor funds used to finance MFOs have been put to their best alternative use. Cost-benefit analyses are often expensive to conduct, while simple measures of cost efficiencies, collection rates, and interest rates charged by MFOs do not provide an in-depth view of the cost to society of MFOs (Yaron, 1994; Schreiner and Yaron, 1999).
The subsidy dependence index (SDI) is a less expensive and relatively easy to calculate measure of social cost, where social cost is the opportunity cost of the public funds used by the MFO less what the MFO could pay back and still break-even in a given time frame. An MFO with no social cost is subsidy-independent (Schreiner and Yaron, 1999). Where possible the SDI will be computed for the KZN study MFOs. In addition, information on interest charged, costs and loan collections will be reviewed as these all contribute to the overall financial well-being of an MFO (Yaron, 1994; Christenet al., 1994; Riley, 1996).
4.3.2.1 The Subsidy Dependence Index (SDI)
Standard accounting measures such as profit, rate of return on equity and rate of return on assets are of limited use as an indicator of self-sustainability as MFOs may have benefited
from some form of subsidy not captured in the income statement. The standard SDI as developed by Yaron (1992) measures the percentage increase in the average on-lending interest rate that is required to compensate the MFO for eliminating all subsidies in a given year. The important underpinning of the SDI is that an opportunity cost is attached to the equity in the MFO's balance sheet (Yaron, 1994). Such a measure is useful and enhances the fmancial analysis of a MFO in three ways: fIrstly, subsidies received by the MFO are quantifIed. Secondly, it computes a measure that relates the subsidy received to an MFO's main income - interest, and thirdly, it resolves the problem of costless equity. Knowledge of this cost is important to all stakeholders in the continued evaluation of whether development funds have been put to their best alternative use (Yaron, 1997; Schreiner and Yaron, 1999).
Following Yaron (1992), Schreiner (1997) and Schreiner and Yaron (1999), the SDI is computed in the form of a ratio where the numerator is the subsidy in a given year and denominator is the revenue from lending (see equation (4.1».
SDI=-S-
LP*i (4.1)
Ct1!£
where S = subsidy and LP = average outstanding loan portfolio and i is the average interest rate. The subsidy (S) consists of six components, three of which are equity grants that affect the balance sheet, but not the profIts; and three are profIt grants that are reflected in the income statement. ProfIt grants do ultimately affect equity in the balance sheet (Schreiner, 1997; Schreiner and Yaron, 1999).
Equity grants form the fIrst two components of the subsidy and consist of direct grants and paid-in capital. Direct grants are cash gifts and gifts in-kind such as equipment. Paid-in capital is obtained by selling shares to governments and donors. ProfIt grants make up the
next three forms of subsidy and are the sum of revenue grants, discounts on debt and discounts on expenses (see equation (4.2)).
where PG RG A m c DX
PG = RG+A(m - c)+DX Profit grant
Revenue grant Average public debt
Opportunity cost of public debt to society Price that MFO paid for debt, and
Discount on expenses.;
(4.2)
Revenue grants are cash gifts similar to equity grants except for recording them in the income statement. Revenue grants can influence profitability, albeit in a misleading way since the revenue is not generated from normal operations. The discount in public debt A(m - c) is the opportunity cost of public debt which can again inflate profits. Discounts on expenses are costs absorbed by third parties such as donors. These do not necessarily need to be recorded as expenses in the income statement of the MFO. True profit is the last form of subsidy that reflects the change in retained earnings in the absence of profit grants (Schreiner and Yaron, 1999). Finally, S can be summed as follows:
where S m E A c K P
S=(m. E) + A(m-c) + K-P Subsidy
Opportunity cost of equity Average equity
Average subsidized debt borrowed from governments and donors Interest paid on subsidized debt
Revenue grants and discounts on expenses, and Accounting profit.
(4.3)
Equation (4.3) shows that the SDI accounts for implicit cost of equity capital and provides a measure of the true cost of a donor or government funded MFO. The underlying assumption of the SDI is that an increase in interest rate is the only change that is required for an MFO to become self-sustainable (Yaron, 1992). This may not necessarily be so, since improved cost
efficiencies and fmancial technologies may also contribute to this process. The increase in interest rates required may also not be accepted by clients in the market.
Schreiner (1997) shows that subsidies would not be entirely eliminated even if the on-lending interest rate was increased by the requirement of the subsidy. This is because increased revenue from higher interest rates increases profits. This increases equity and thus increases the opportunity cost of the equity in the SDI calculation. The SDI also does not account for income tax since the formulation by Yaron (1992) uses before-tax profits. However, a profit maximizing institution will pay tax. Schreiner (1997) argues that taxes are important, particularly for private investors since in their assessment of returns they are likely to account for taxes - he thus adjusts the SDI to account for tax.
The SDI was designed as a tool to measure social costs, yet the assumption made by Yaron (1992) is that self-sustainability implies profit maximization. Schreiner (1997) argues that investors want to maximize profit, whereas society would want improved welfare. The opportunity cost of equity is based on that of investors and not for society. Another shortcoming of the SDI is that it equates subsidy-independence, which equates to self- sustainability. However, there may be more to self-sustainability than just generating profits.
Self-sustainability requires strong organisations with good structures in place that can adapt to changing environments while not losing their core mission and objective (Gonzalez-Vega et al." 1997). A profitable organisation may change markets, develop worse rather than better products, or charge interest rates that reduce the overall welfare of those that it serves.
Finally, the SDI is not a flow concept and cannot be computed over long time frames (Schreiner , 1997).
For all its short-cornings, the SDI has provided analysts and rnicrofinance practitioners with a tool to evaluate the true cost of rnicrofmance programmes without incurring huge expenses in doing so (Schreiner and Yaron, 1999). A subsidy dependent organisation may still be sustainable - this is not necessarily a poor allocation of resources, as long as the funds could not have been applied in a better alternative development use. Subsidy independent organisations may not necessarily improve welfare if they impart huge costs to users of the financial services. Data permitting, the SDI will be computed in this KZN study for the MFOs that are subsidized. The simplest form of the SDI calculation will be used since data collected from the financial organisations are very much at an aggregated level.