Rural Sector Profile And Rural Development

Published Date: 02 Nov 2017

CHAPTER 2

Literature Review

The focus of this chapter will be on international literature and reports related to the theme of this project. The construction of methodology and analysis which follow this chapter shall be built upon international findings observed in this literature. The background and evaluation of findings has been tried to be decomposed using a top-down approach. International rural sector profiles continuing to indicators of rural development and the importance of financial markets for rural development will be covered. This chapter then steers to the need for microfinance, the current state of this industry and finally the reforms and policies specific to this sector will be discussed.

2.1 Rural Sector Profile and Rural Development: A Cross Country Overview

Since Bangladesh’s independence in 1971, rural development has been of significance in terms of economic policies (Hossain et al., 2012). Policies, strategies and program were examined to understand the development of the rural sector. Hossein et al. (2012) in their paper used statistical tools to analyze secondary data. The results in the study show that the country has advanced from an agriculture-based to an export-oriented economy, since the share of agriculture in the GDP has decreased. There has been success of rural and agricultural programs in Bangladesh, since poverty has decreased in the country. Achieving growth with equity and decreasing poverty are the main aims of the development policies in Bangladesh. Somewhat the policies have been effective but poverty and inequality are significant in Bangladesh. Rural development is the basic agenda for the country’s development. The rural sector in Bangladesh was strategic in providing the agricultural labor and output to the country; however poverty was recognized as a threat. Past agricultural and rural development programs failed to raise the condition of the rural poor, despite of the fact that agricultural sector contributes a great deal to the country’s economic well-being. The reduction of agricultural sector pushed the economy towards industrialization. The contribution of agriculture is declining but its absolute value is expected to go up and its economic and socio-political significance will remain strong in terms of export earning, employment and food security.

Hossein et al. (2012) also mentioned that the reduction in poverty from 1983-84 of 54 % has decreased to 35% in 2009-10, which shows to the success of agricultural and rural programs to improve the life in the rural settings. Poverty and income inequality are serious concerns in the economy. Progress cannot be denied in terms of improvements in socio-economic indicators like population growth, life expectancy and literacy rate. However, rural development is very important for Bangladesh.

According to ASSOCHAM’s study "Rural Development in India: State Level Experiences" (Rao, 2012), the census conducted in India in 2011 estimated that 69% of the country’s population resides in rural areas. Rural development is a key challenge despite of the programs implementation in terms of employment opportunities and improving the quality of rural masses. Rural development increases the living standards by increasing the purchasing power of the people living in rural areas. The report studied how income/expenditure changes during the development process across the states by considering the real monthly consumption expenditure of the rural households. The author also mentions how the economic well-being of rural people has improved from 2004-05 to 2009-10. The methodology used, has taken average household monthly per capita consumption expenditure (MPCE) to indicate the development in rural areas. MPCE at current prices has been deflated by Consumer Price Index (CPI) to recognize the measure of change in real economic welfare across classes and regions with respect to price rise and population change. The results of the study established that at the All India level, growth rate of both average per capita expenditure and the subsequent demand increased through the study period. The average per capita consumption spending of the poorest 20% people remained unaffected, the average domestic income of the richest 20 % people increased by 7.7 % during the five year period, increasing inequality. A rural household in the richest 20 % category spent more than 258 % of what a household of similar size falling in the poorest 20 % group spent in 2004-05. This change has increased to 286 percent in 2009-10.

Winters et al. (2008) proposed a pattern of how rural development is associated with the decline in agricultural production and increase in non-agricultural sources of income, which leads to a rise in per capita income. Analysis of 15 developing countries is done, by using Engel’s law. The countries analyzed are Ghana, Madagascar, Malawi, Nigeria, Bangladesh, Indonesia, Nepal, Pakistan, Vietnam, Albania, Bulgaria, Ecuador, Guatemala, Nicaragua and Panama. The results show that per capita income has a positive relationship with share of income earned from rural non-agricultural activities and per capita income has a negative relationship with share of income earned from agricultural activities. Development is basically a change from labor-intensive, agriculturally-oriented enterprises to capital-intensive industries focused on production of manufactured goods (Lewis, 1954). As the GDP of a country increases, the share of agricultural production in GDP decreases and industries’ share in GDP increases. This pattern does not give a clear picture of the development in rural areas. (Winters et al., 2008) (Chenery & Syrquin, 1975)

According to Winters et al. (2008) economic development is seen in rural areas when non-agricultural activities increase. Higher income households are less involved in agricultural production. The study’s main aim is to understand whether there is a universal pattern for rural household development or not. The issues in this study were in terms of different behaviors of rural households in different countries due to geopolitical matters, type of government, resource allocation and investment choices. Income is divided into non-agricultural wage, agricultural production, agricultural wage, self- employment and all others (which includes all kinds of transfers) to understand which activities are important to rural households. When household income increases as there is a shift from agriculture to non- agriculture activities, Engel law is being followed which shows poorer households use higher percentage of their income on food than richer households. The agricultural production participation is more than 75 % for all countries except Pakistan and Indonesia. In Africa, average income from agricultural activities is greater than 50 % for all countries and in Asia it is between 19-56 %. In Latin America and Asia one third of the income is represented by 30 % of the households are participating in non-agricultural wage employment and more than 20 % in non-agricultural self-employment. This show how non- farm activities are important for economic growth. The study concludes that a shrinking agricultural sector and expanding non-agricultural sector increase economic growth. Rural development is seen when per capita income is increased, as households move from agricultural activities to non-agricultural wage and self-employment. Also, it is concluded that countries with a higher GDP per capita has more share of non-agricultural activities which shows how these countries have strengthened their development.

The structure of the rural economy is ever varying and the non-agricultural sector can become a pathway out of poverty for poor households, if policy makers look into it (Winters et al., 2008).

2.2 An Overview of Models of Rural Development

A lot of changes have taken place in the approaches towards rural development and the policies undertaken. Hodge and Midmore (2008) argue that economic and social change has been stable in rural areas over a long time period.

2.2.1 A Sectoral Approach

Hodge and Midmore (2008) stated that agricultural policy was prioritized after World War 2. The Committee on Land Utilization in Rural Areas 1942 concluded that the food security should be ensured and agricultural sector plays a vital role in rural areas. One agricultural policy covered objectives for food security, rural development, income from farms and protection of the environment. Agricultural sector was regarded the most important sector in the development of rural areas and the economy. If agricultural production decreases, rural people migrate to urban areas and the provision of services in the rural areas are affected. An agricultural policy supports the provision of food, creates more jobs, supports farm incomes, prevent rural to urban migration and promotes provision of services. (Hodge & Midmore, 2008)

Buckwell et al. (1982) stated that ever rising costs, environmental impacts of goods price supports and inefficiency in terms of agricultural products surpluses have challenged the approach towards agricultural policy. The mechanization and technology innovation in agriculture and the imported inputs has decreased the economic importance of agriculture locally. The decline in agricultural sector productivity and increased industrialization has proved that economic growth of rural areas depend less on agriculture and more on a shift away from agriculture to non- farm activities and businesses. (Buckwell, Harvey, Parton, & Thomson, 1982)

2.2.2 A Multisectoral Approach

Newby (1988) stated that in late 1980’s the policies were diversified, because there was a focus on supporting farm incomes. Farmers started to make use of land and buildings and got involved in non-agricultural economic activities. The reason for moving away from an agricultural policy were the high costs and surpluses associated with agriculture, which had very less economic impact in the rural areas. Industrialization became dominant along with other economic sectors in the rural economy. (Newby, 1988)

Shucksmith et al. (1989) emphasized on the diversified farm business and it helped to analyze the farm households, which helped to understand strategies for the long term household survival in rural areas. Small farms represented an impermanent phase in agriculture and agriculture being the support system of the rural economy was challenged. In addition to this, rural development can be achieved by creating more jobs in sectors other than agriculture (Gasson, 1988). (Shucksmith, Bryden, Rosenthall, Short, & Winters, 1989)

2.2.3 A Territorial Approach

Keeble and Tyler 1995 talked about the fact how new forms of economic activity can be created by employing modern ideas through the use of information technology in the rural areas and this has proved true in many rural settings which have led to an increase in employment. This shows how rural areas can be developed and costs of migrating to urban areas can be avoided as well. (Keeble & Tyler, 1995)

According to Lowe and Ward (2007), rural areas in the United Kingdom have performed well but some problems still remain such as those of low incomes and underemployment. If some economic stimulus is injected into the areas where there is little or no activity, it won’t affect the economic growth rate. Economic stimulus should be added to the areas where there are opportunities and the possibility of diversification. From farm activities, supporting farm activities can be created and hence create new jobs. Non-farm based activities can be undertaken and non-land based activities can be developed. This can be done through encouraging economic activity in such areas. (Lowe & Ward, 2007)

Hodge (1997) states that rural areas are very attractive in terms of living. The issue here is of underdeveloped infrastructure and low incomes. This show how economic change has different patterns of developed, calling this one as "contemporary" model of rural change. Generally less remote rural areas have become very accessible and new businesses have opened up, away from the urban congestion. Also there has been a development in roads and railway networks which make these areas more accessible. People have preferred to live in a comfortable area rather than the stressful urban areas. (Hodge I. , 1997)

Rural areas sometimes prosper and at times don’t prosper. They have different paths, even if the population does not decrease significantly, the incomes of people can go down and the low income receiving people might not be engaged in the agricultural activities. People with high incomes might face different problems in terms of access to services, high housing prices and provision of public transport. So people in rural areas can have different issues, according to the conditions. Some of the problems are lack of facilities and housing prices. So no one sector can be seen as a source of employment in rural areas, only specific opportunities depend on environment and topography, some might look for employment in nearby urban areas.

2.2.4 A Local Approach

Lee et al. (2005) talked about how the problems of agriculture have given importance to the role and need of social capital and networks in the development of rural areas. The development policy in the rural areas should be in terms of allocating resources equally and applying objectives at individual levels. A system needs to be established which can look into prioritizing individual households and businesses according to national policies at an individual level. This cannot happen in one step. Institutions should be developed at sub national level with an increase in the choice of applying the allocation of public resources.

Ward and McNicholas (1998) stated that initiatives have been taken to develop local institutions and social capital; however these initiatives are very small when compared to the total volume of support for rural areas. These local institutions can deal with complex policies by building social capital which can help in provision of information, coordination and networking amongst people. Also attention is required to form policies for rural development by allowing administration to intervene by conventional roles between public and private sector. This will introduce the idea of investment and maintenance of social capital. Implementation of such policies should be facilitated. (Lee , Árnason, Nightingale, & Shucksmith, 2005) (Ward & McNicholas, 1998)

2.3 A Review of Indicators of Rural Development

Sârb et al. examined some of the indicators of rural development in terms of demographic and labor situation, educational activity, equipping of territory, health, culture and arts, in order to understand how rural development can be practiced by using alternatives and also improving the economic conditions in the rural areas in the Bihor County. Rural development can be described has increasing social and economic benefits for the society by making the right use of resources by proper allocation. (Sarb, Mateoc Sirb, Camelia, & Diana, 2009)

2.3.1 Economic Parameters

Sarb et al. added that in the Bihor County of Romania, the quality of labor is not satisfactory because the labor force is not trained for specific jobs, which shows the low level of education. This has hindered the economic development because economic activity is not diversified due to the lack of skills in workers to meet up the job requirements. On concluding remarks, the authors state that the rural areas in the Tinca- Beius area has a lot of varied potentials and hence a high economic potential. There have been industrial activities in these areas which have raised the incomes of the population and also increased their standards of living. It is also stated that if the number of economic activities in these areas increased by the correct use of the economic resources, employment will increase and will add to the economic growth of these rural areas. The economic growth is further hindered by the lack of infrastructure, which needs to be improved as it affects the life quality and development of economic and social activities. (Sarb, Mateoc Sirb, Camelia, & Diana, 2009)

According to Arku et al. (2007) the majority of men and women in the rural areas earned their livelihood through farming. A very small portion of people said that their incomes depend on non-farm activities and these activities were not mentioned. The economic indicators identified were of trading and farming which are informal activities. The situation might be because of lack of education, which has hindered their participation in formal sector which requires skills and training for specific jobs. People in Ghana valued income generating activities more than wealth as their economic indicators of well-being. The reason is that the rural people are constrained by their cultural values and also they are not confident about rising above from their poverty levels.

2.3.2 Social Parameters

Difficulties in rural areas comprises of lack of medical and educational services. Due to the unavailability of transportation services, people cannot access schools and hospitals; this hinders the activity of doctors in rural areas in Bihor County as well (Sarb et al.). The authors further added that education plays a vital role in the prosperity of a country. Education is important to build up the brains of people and develop them intellectually, along with the training of the labor force. It is important to apply a certain level of education for professional training.

Arku et al. (2007) carried a research in Ghana to understand the well-being among rural men and women. Since rural men and women place their values on different indicators in terms of religion, economic, social and education, the differences has been analyzed as to what is more important for who. The research carried out applied the strategy that the respondents were asked to identify their own indicators of well-being. The rural people have lack of access to social amenities and the indicators are type of energy used, access to health facilities and income in order to understand the peoples’ well-being in countries. Respondents in this study said that income generating activities and religious factors are more important to them as compared to access to water, health and energy facilities. Despite the fact that they do not value these social indicators, they are useful to evaluate the performance of development and measure the well-being of people. Rural people do not understand the importance of such activities, because they consider income and religion as their responsibilities. However, people should be educated in terms of these facilities as increasing the standard of their lifestyles.

2.3.3 Infrastructure and Demographic Parameters

According to Sarb et al. the most important way of transportation in rural areas are roads and in Bihor County only half of the people have direct access to roads and more than 25 % people cannot access roads when the weather conditions are extreme, especially when it is raining. Land fund, capital and labor force are the main sources of sustainable rural development. Demographics of labor force perhaps play the most active role. Land management and technical equipment plays a major role. Development of infrastructure in terms of building up route networks, communication networks and buildings is an important consideration. The present state of infrastructure has hindered economic and social development in the rural areas. (Sarb, Mateoc Sirb, Camelia, & Diana, 2009)

Fan and Zhang (2004) explained how infrastructure is an important factor which affects the development of rural areas in terms of agricultural productivity, increased jobs in the non-farm activities and rural to urban migration. 45 % of the country has been covered in this paper because of limited access to data in the rural areas. The indicators used are agriculture productivity, employment in non-farm sector and rural urban migration. The results show that the rural infrastructure has played an important role in explaining the differences between productivity of farm activities and non-farm activities. If rural infrastructure is improved, non-farm activities will increase, people will have access to more markets and they will be able to expand their businesses and hence the income of people living in the rural areas will increase. The second conclusion is that the lower productivity in the western rural areas of China has been due to the lack of infrastructure, education, science and technology, so it is important to improve the level and efficiency of public capital to cater this difference. Lack of revenues to develop infrastructure has been a great challenge and due to this the non-farm activities have not been financed well. (Fan & Zhang, 2004)

2.4 Importance of Financial Markets for Rural Development

For a country’s economic development, capital and investment opportunities are important. In developing countries, an attempt is made to increase capital formation and financial means in the form of credit through financial markets. Yaron and Benjamin (1997) stated that many developing countries have tried to increase the income and reduce poverty by offering low interest loans, which has failed. Rural areas of many developing countries cannot operate resourcefully because of the every varying economic conditions, prejudiced policies, government intervention and lawful and supervisory barriers. Rural development has been neglected because of the biased policies which favor industry instead of agriculture and urban over rural areas. Macroeconomic conditions keep on changing due to real interest rates and exchange rates; also the unequal allocation of resources is destructive to the rural financial markets. Government intervention in terms of keeping huge bank reserve requirements, investments, fixed interest rates and laws hinder the allocation of resources. Legal barriers in terms of laws and regulations discourage the formal sector from offering credit to rural inhabitants. Also the usury laws avert small holders from using their land as collateral. However, there has been a considerable amount of progress in developing rural financial markets. The issue is to implement the policy, legal reforms to create a setting in which rural financial markets can be developed and flourished. (Yaron & Benjamin, 1997)

2.4.1 Informal and Formal Financial Markets

Rahman (1992) has discussed the informal financial markets in Bangladesh, to analyze the size of the market, to understand the link between the informal and formal financial sectors and how the development process is affected by this. His basic purposes are to prove that the informal financial markets in Bangladesh accounts for a significant part of the financial transactions in the economy, it’s difficult to remove informal transactions by strengthening the formal financial markets because informal and formal financial markets are related to each other and the Bangladesh informal financial sector has positive sides, which need to be developed through a policy for the informal markets. The informal financial markets are neglected because they are considered to be exploitative, unproductive and uneconomical and the formal financial markets are considered an effective replacement in terms of mediating and allocating the financial resources proficiently. Rahman (1992) concluded that the informal financial markets in Bangladesh are efficient and they endorse equity. They do have very high interest rates but it is possible to shove them down by suitable policies. If these markets are developed and controlled, they can remove negative impacts like high interest rates and proper collateral. (Rahman, 1992)

Chipeta and Mkhandawire (1992) in their article try to understand the characteristics of informal financial markets in terms of its origin and development to understand the savers, lenders, borrowers and terms and conditions of credit in Malawi. The informal sector in Malawi is larger than the formal and semi-formal sector. The employers of the informal sector are as large as the formal sector and the current economic conditions which have increased the growth of the informal sector will remain the same. The large size of the informal financial sector implies that the monetary data does not give the exact volume of financial savings and credit in the economy. The allocation of resources between formal and informal financial markets may lead to distortions in money-supply statistics, giving a false idea of the degree of monetary control. Also the informal financial sector in Malawi has played a vital role in relieving economic hardship among low-income groups. (Chipeta & Mkandawire, 1992)

Stanley and Bhattacharya (2008) examine the damage caused by the informal sector in terms of exploitation of the poor. The paper has focused on the low- to- moderate income Hispanic community in Orange County, California and examine why large number of people are unbanked. Although borrowing from an informal financial market is logical decision for the poor people, but it has increased poverty. The reasons include high interest rates charged by the informal sector, which drains the low incomes of the poor people, the poor cannot establish a financial history because transactions are not recorded and the growing informal sector has become a serious concern. Communities with well-functioning financial markets are stronger against economic downturns and can take better advantage of economic growth (Rhine et al., 2006). The results of this study showed that apart from the Hispanic community’s income, the two reasons of them being unbanked are the language status and education. The identification requirement for opening a bank account is a barrier and the apparently cheaper financial products from the informal sector are very attractive. The financial benefits of banking are not convincing because of high transaction costs, minimum opening balance requirement, and cost of account maintenance, time and location. If expansion of saving programs offered to the poor in the U.S. is done, it can change the dynamics of informal financial sector. (Stanley & Bhattacharya, 2008)

2.5 Review of policies for Rural Development

2.5.1 Financial Exclusion and Inclusion

Peachey and Roe (2004) emphasized on the importance of access to financial services and discussed the main obstacles to access of finance in different countries. Public and banking sector have been analyzed to understand how initiatives have been taken to provide finance and also how policies have been implemented so that the financial institutions can provide credit. Role of banks has been crucial in terms of providing credit to urban and more remote rural areas which have been located. Access to formal financial institutions is usually an issue in low income countries and these countries have been related to advanced industrial countries. They further specified that the proportion of rate of access in poorer developing economies is equal to the proportion rate of exclusion in richer industrial economies. In Kenya which has comparatively better financial systems in Africa 10 % of population have dealings with financial institutions or banks, in Mexico about 20 % of urban population have bank accounts, however in developed countries like Germany, access to credit is above 80 %. ( Peachey & Roe, 2004)

According to the World Bank (2000), poverty is an issue which can be addressed by solving the issue of financial access in low-income countries. It becomes linked to further issues such as basic necessities of education, clean water, improvement of labor and other incomes related to the production sector.

Now many low-income countries have economically progressed in terms of indulging into new banking facilities by electronic technologies. (Claessens, Glaessner, & Klingebiel, 2001)

Hicks (1969) suggested that a strong financial system is a powerful stimulus for economic growth, in terms of mobilizing capital for cosmic work.

Peachay and Roe (2004) further stated that financial systems provide three major contributions to spur economic growth. First one is the efficient allocation of resources, second is mobilization of savings and last is the risk of mitigation.

Pesaresi and Pilley (2003) talked about the fact that financial access in the developed countries is around 90%. Europe having the highest financial inclusion followed by Japan, then UK and US and then the EU states apart from Spain. All these countries have a well stable infrastructure for the provision of financial services. Access to financial services is related to the ability to save, and this ability rises as disposable incomes and employment rise.

Financial Services Authority (2003) in the UK used evidence from surveys to understand that people with low incomes and people who rely on income support have no bank accounts. About 6 – 9 % people fall in this category. Women are less likely to hold bank accounts in their own name, these women are usually poor. Owning a bank account is lowest amongst people under 20 years and people who are over 90 years. The reason for people with low incomes for not having bank accounts might be in terms of culture, language, religion and knowledge barriers. The reason for women not opening bank accounts can be because of their dependence on their husbands. Recently there has been a growth in range of consumer credit products and only 33 % of the UK households use no credit facilities.

Peachey and Roe (2004) also identified that the reason people don’t have access to credit is because they borrow from the informal sources. Also poor people do not get credit because they have poor credit histories. Some groups which are excluded from mainstream credit market choose to borrow from informal sector with transparent products, no hidden charges, defaults and penalties.

2.5.2 The Need for Microfinance

Mustafa et al. (2000) talk about how poor people in the developing countries take time to mobilize resources and start their businesses. If financial services are offered to these poor people, they can accelerate the process of building income and secure themselves economically. Conventional financial institutions rarely lend to these poor people, and hence their needs are not fulfilled. These people are often denied access to credit, and the problem fundamentally is the access to credit and not the unaffordable terms of loan.

Aziz (2000) talks about how microfinance is one of the most effective ways of reducing poverty. By providing credit to the poor, it was seen that they were able to repay their loans timely and use the proceeds to increase their income. Since the only alternative for them is to borrow from the informal sector at a much higher rate, it is more suitable for them to borrow from the microfinance providers at market interest rates. This showed how banks and savings and credits groups can make profit out of microcredit.

ADB (1999) and Yaron (1992) have advocated two approaches for the role of credit in reducing poverty. There is an income-generation approach which says that credit should only be given to poor entrepreneurs so that can establish their enterprises and generate income and there is a new minimalist approach which says that credit should be given to any poor person to fight poverty. Studies show that the minimalist approach can have a negative impact on future growth of microcredit, because these people usually consume and not invest their loans.

HDC (1999) and Narayan (2000) pronounce how several NGOs in countries like Bangladesh, India and Kenya have reduced poverty strategically. These strategies include provision of small loans to rural poor people at full interest rates, no collateral and they can repay the loan in installments. They borrowers are in groups which decreases the default risk. One of the main targets of the microcredit programs is women who have little or no assets. The provisions of loans to these women have increased their confidence, security and status.

Most organizations which offer intermediary services between government, and resource providers for development, authority tends to be tilted towards the minority that already holds more resources (usually land). This minority uses its power to use these resources for themselves. The poorest people who don’t own land drift away from these organizations because they don’t offer them anything. Since the power lies with minority, development hardly takes place. So the NGOs should involve poor people in governing and also provide services to these poor people (Uphoff, 1982).

According to Narayen et al. (1999), in order to provide resources to the poor and allocate the resources equally, the governments should collaborate with the NGOs. This can provide support of the majority and stimulate growth and development in a country. Government supported projects for development will become more sustainable and implementation will become easier. The poor people in majority will benefit from this.

2.6 Microfinance Industry: Operations, Efficiency and Outreach

2.6.1 Operations and Performance of the Microfinance Industry

Anduanbessa (2009) analyzed the performance and the determinants of performance in Ethiopia by using cross-sectional data from 26 MFIs. The outreach performance dimension of the MFIs is established by the number of active borrowers, deposit mobilized from clients and gross loan portfolio. The results concluded that the determinants of performance were identified by seemingly unrelated regression (SUR) model. The SUR model was fitted on the sustainability and outreach dimension y Factor analysis. The outreach performance of MFIs in Ethiopia was determined by the financial services rendered and the number of people working in a branch and their capital. The financial performance of the MFIs was formed by the profit margin, gross loan portfolio to total asset ratio, operational self-sufficiency and return on asset. The capital has an opposing effect on outreach of microfinance. The number of branches of a MFI has no effect on its performance. Financial viability of MFIs is in terms of average amount of loans given to people, cost per borrower ration and financial revenue ration. The author further suggested that the government and policy makers should make and implement policies to develop a mechanism to monitor and regulate the performance of MFIs. MFIs should be encouraged to increase the amount of loans they give out. According to the results there was no trade-off between outreach and sustainability, so the MFIs should reach to the marginalized people. The cost per borrower should be decreased to improve efficiency and a strategic mechanism needs to be designed to mobilize deposit from the public.

According to Mersland and Strom (2008) there is no difference between non-profit organizations and shareholder firms and banking regulations have no effect in terms of financial performance and outreach of MFIs. They observed the relationship between the performance of firm and corporate governance in MFIs. The results showed that financial performance progresses with local directors, a female CEO and an internal board auditor. The first aim of MFIs is to reach the marginalized people and the second aim is to ensure financial sustainability. Christen (2000) stated that financial performance is assessed in terms of overall profitability through return on assets, operational costs, revenues and operational self- sufficiency. Schreiner (2002) pinpointed the measures of outreach in terms of average outstanding loan and number of credit clients served.

Hartakska (2005) described the influence of governance on outreach and sustainability of MFIs in Central and Eastern Europe and the Newly Independent States. The microfinance institutions have to provide financial services to the poor and cover its costs as well. This shows the challenge these MFIs face in terms of outreach and sustainability. The paper has examined how the governance mechanisms affect the performance of MFIs using literature on corporate governance, nonprofit and bank governance, impact of management remuneration, diversity, board independence, external mechanisms of control by holding the macroeconomic and institutional factors for MFIs constant. The results showed that different factors have different effects on outreach and sustainability. The interests of managers and stakeholders have limited effect on microfinance. If an organization is carrying out multiple tasks, it leads to an expensive lack of focus and performance becomes less effective, however the board of directors is important in terms of governance. Independence of microfinance board needs to be promoted because large numbers of unaffiliated directors attain better outcomes. However, more data is required to learn about the governance of MFIs to understand the performance.

Godquin (2004) analyzed the performance of MFIs in terms of repayment according to group lending, nonfinancial services and dynamic incentives on the repayment performance. The endogeneity of the loan size is tested and instrumental variables are used to make corrections. Also the determinants of repayments performance are understood. Household level data was used to compute repayment performance variables. Results indicate that the provision of non-financial services have a direct relationship with loan repayment. As the age of borrowing group increases, more loans are given out to the borrowers and larger loans are given to homogenous groups in terms of age due to risk considerations.

2.6.2 Efficiency Analysis of Microfinance Institutions

Nieto et al. (2005) explained the efficiency of microfinance institutions by four principle components of efficiency. The efficiency was measured through a data envelopment analysis (DEA). The DEA scores helped to differentiate how effects are different in terms of country and NGO/non-NGO characteristics of microfinance institutions. DEA has been used to analyze the efficiency of MFIs in terms of their banking and social sides. It was seen the model specification is crucial in terms of efficiency assessment. 30 MFIs in Latin America were analyzed. A multivariate approach has led to understand how efficiency depends on overall efficiency, NGO status, input and output choices. There are specific features which differentiate NGOs from non-NGOs which help to understand why some MFIs as more efficient as compared to other. The efficiency also depends on country to country.

Hermes et al. (2011) used a stochastic frontier analysis (SFA) to understand whether a tradeoff exists between outreach and efficiency of microfinance institutions. The results indicated that outreach and efficiency of MFIs have a negative relationship and MFIs which have a larger proportion of women borrowers are less efficient. Rhyne and Otero (2006) stated that competition has increased between MFIs in several countries and Bolvian MFIs have increased their efficiency by providing a range of financial services to the people. In terms of Bolvia, competition has led to lower interest rates, fewer costs, more financial services and higher efficiency. Hermes et al. (2011) used a sample of more than 1300 observations using SFA. Results showed that MFIs which have a lower average loan balance are less efficient. Commercialization of microfinance industry has led to a decrease in efficiency of MFIs. This study indicated that efficiency can achieved if less focus is paid on the poor people, however it does not imply that a stronger focus on efficiency will be bad for poverty reduction. It is assumed that efficiency of MFIs lead to the improvement of economic conditions.

Khalily et al. (2000) evaluated the efficiency and sustainability of two microfinance programs; Grameen Bank being a formal program and ASA being a quasi-formal program. The analysis was carried out by the Efficiency and Subsidy Intensity Index (ESII), developed by the authors. The results showed that both these programs have high degree of cost and financial efficiency. ASA was found out to be more cost effective and sustainable than Grameen Bank. The difference is because of salaries and lending interest rates. ASA has a low salary base and high lending interest rates and opposite is the case in for Grameen Bank. At the given level of operations, ASA will be worse off if it operates on the average salary of Grameen Bank. However Grameen will be better off if it operates on the wage of ASA. If Grameen Bank is able to improve its cost efficiency by increasing the loan size and lending interest rate, it can lower down the social cost and improve sustainability after 15 years. However, ASA has reached a higher level of sustainability within 7 years of its microcredit provision. This shows how formal organizations like the Grameen Bank take more time to become sustainable and efficient.

2.6.3 Outreach of Microfinance

According to Peprah and Muruka (2010) the outreach of microfinance institutions (MFIs) in Ghana is uneven, because the poverty stricken areas that are in the north have few MFIs as compared to the southern areas where poverty is less. The result of the study shows that MFIs are established in areas where there are active clients, so the development and poverty are not the factors which contribute to the establishment of MFIs . The study also focuses on proposing on the fact that MFIs should be established in areas where there is high poverty. According to the Ghana Living Standard Survey (GLSS 4) report, approximately 60 % of the non-farm enterprises have no access to credit, which shows how access to credit hinders the development of these enterprises. There is a North-South divide in the population distribution in Ghana and the highest poverty stricken areas are Upper East, Upper West and Northern regions (Ghana Statistical Service, 2000). In the northern areas of Ghana, there are limited opportunities due to which people migrate to the southern areas to seek jobs which have further lead to the underdevelopment of the northern areas. The MFIs in southern areas of Ghana outnumber those in the northern areas. Using the outreach which is in terms of number of savers and borrowers as a measure of performance, northern areas lack the profitability and sustainability (Vanroose, 2008).

The approach used in this study is the usage of liner regression to understand which factors determine the distribution of MFIs in Ghana. Data used is secondary and includes data on microfinance institutions, the number of branches of MFIs in Ghana, poverty indices, economic activities and population figures. According to the results, MFIs are established in areas where the economic activity is high; there is high population density and a large population. Microfinance outreach is high in the northern areas where poverty is high but it is not because of the microfinance activities but because of the NGOs. Poverty and development does not affect the outreach of microfinance. Concluding remarks include that the microfinance institutions in Ghana are not making efforts to reduce poverty, they make profits through economically established entities. For sustainability, MFIs are concentrated in urban areas but they need to reach the poor communities in order to improve national development and outreach needs to be extended.

Vanroose (2008) applied a cross-country analysis covering 115 countries to identify the factors that describe why microfinance institutions are reaching more people in some countries as compared to others. The results show that rich countries have more MFIs and the countries which receive international assistance have more clients. Population density affects the outreach of microfinance; however industrialization and inflation do not. Microfinance institutions are not evenly spread across the world. Some countries have these institutions, while others do not (Hardy et al., 2002). For example Cameroon and Gabon, two Central African countries which are very similar but Cameroon has more outreach of microfinance. Also, in Latin America the development of the microfinance sector has been uneven. Vanroose (2007) has found several factors that play a part in the uneven development of microfinance institutions in Latin America. Results indicate that Gross National Income per capita plays a crucial role and shows how microfinance reaches more individuals in richer countries. Some MFIs are risk averse and avoid high-inflation countries, however in some regions inflation create a larger microfinance market. International organizations play a significant role in the development of microfinance markets; countries which receive aid from these organizations have higher microfinance outreach. It is fairly suggested that there is a need for minimum level of development, in order for microfinance to outreach to a substantial level.

2.7 Policies and Reforms in Microfinance Industry

Harutyunyan (2005) discussed how microfinance sector reforms have integrated into the financial sector of Armenia. The microfinance activities are carried out by Banks, NGOs and Non-depository organizations in Armenia. The regulations in microfinance banks are followed according to the banking laws and Central Bank regulations, the micro-lending foundations follow the Civil Code and the law on foundations and the Central Bank are taken initiatives in Armenia to ease the regulations for provision of credit by the organizations which do not attract clients. According to the regulatory reform the microfinance regulation issue was discussed by the Armenia Micro Enterprise Development Initiative (MEDI) and MEDI worked with the World Bank to insert a clause for the microfinance to be regulated by the central bank according to the legal framework for non-depository credit organizations and the central bank will ensure adequate regulation of the microfinance sector. The author proposed that if regulations are implemented the legal issues of MFIs would get solved, they will have a better structure and management and they will be able to penetrate into the financial system of the country by greater access to commercial sources of debt and equity.

According to the Operations Policies and Review Department African Development Bank (2006) microfinance is critical in order to achieve development efficiency in terms of poverty reduction, development of political, social and economic parameters, social empowerment, community participation and economic well-being of the society especially women. The microfinance policy and strategy rationale is to create a direct link of microfinance with development effectiveness, practice microfinance according to universal principles and standards and understand political consideration. Microfinance policy is based on the poor people’s need for financial services, build financial system which includes poor, remove interest rate ceilings which weaken the poor’s access to financial services and government should not be the direct microfinance providers but they should help these MFIs to establish and prosper. The goal of microfinance policy is to reduce poverty and increase prosperity in African countries to build inclusive financial systems.

Hardy et.al (2002) talked how many governments and non-governmental organizations have adopted policies for the promotion of MFIs. The extent and coverage of regulation of MFIs has been discussed. According to the authors, MFIs have been increasing in number and size since the last 25 years and have served a huge number of clients and achieved a good loan portfolio. This paper discusses some of the public policy issues related to the increase in MFIs. Concluding remarks include that MFIs are more efficient that other financial institutions in terms of benefiting the marginalized society. However, there are high costs and risk associated with MFIs and they do not receive the support they require. The paper suggests providing one time support to MFIs to cover up their startup costs. Regulation of MFIs should be in terms of establishing internal controls and record keeping, ensuring security and avoiding risk. Also policies should be implemented to convert the MFIs from small credit providers to full service providers of microfinance.