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The sustainability of microfinance institutions in Pakistan: empirical issues

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Article in International Journal of Trade and Global Markets · December 2022

DOI: 10.1504/IJTGM.2022.128130

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144 Int. J. Trade and Global Markets, Vol. 16, Nos. 1/2/3, 2022

The sustainability of microfinance institutions in

Pakistan: empirical issues and challenges

Muhammad Saad*
Fast School of Management,
National University of Computer and Emerging Sciences,
Karachi, 75120, Pakistan
Email: saad.siddiquie@nu.edu.pk
*Corresponding author

Hasniza Mohd Taib

School of Economics, Finance and Banking,
Universiti Utara Malaysia,
Sintok, Bukit Kayu Hitam 06010, Malaysia
Email: hasniza@uum.edu.my

Abul Bashar Bhuiyan

Faculty of Business and Accountancy,
Universiti of Selangor,
Selangor 45600, Malaysia
Email: bashariuk@gmail.com

Rashid Bhutta
School of Economics, Finance and Banking,
Universiti Utara Malaysia,
Sintok, Bukit Kayu Hitam 06010, Malaysia
Email: rashidbhutta@msn.com

Abstract: The sustainability of microfinance institutions (MFIs) is important

not only for the institution itself but also for the overall economy because of its
contribution to poverty reduction. The purpose of this paper is to identify the
factors that influence the sustainability of MFIs in Pakistan. Using unbalanced
panel data of MFIs from Pakistan for the year 2006-2015. Fixed effect
regression is used to identify factors that influence sustainability. Additionally,
the Granger causality test is applied to check for the possible reverse causation
effect of each and all variables. Results suggest that return on assets and
borrower per staff member are the key determinants of sustainability. The
findings of this study will help practitioners and regulators to enhance the
effectiveness of MFIs. This study is an initial attempt to study the influence of
factors identified by the Consultative Group to Assist Poor (CGAP) and Micro
Rate on the sustainability of MFIs.

Keywords: sustainability; MFIs; microfinance institutions; Pakistan; poverty;

causality; random effect; operational self-sufficiency; robustness.

Copyright © 2022 Inderscience Enterprises Ltd.

 The sustainability of microfinance institutions in Pakistan 145

Reference to this paper should be made as follows: Saad, M., Taib, H.M.,
Bhuiyan, A.B. and Bhutta, R. (2022) ‘The sustainability of microfinance
institutions in Pakistan: empirical issues and challenges’, Int. J. Trade and
Global Markets, Vol. 16, Nos. 1/2/3, pp.144–162.

Biographical notes: Muhammad Saad is currently working as an Assistant

Professor in Fast School of Management at National University of Computer
and Emerging Sciences, Karachi Pakistan. He has completed his PhD in
Microfinance in 2019 from Universiti Utara Malaysia. Until 2014, he has
served in banking sector as Operation Manager. He is Editorial Board member
of South Asian Journal of Social Sciences and Humanities and reviewer for
Kybernetes, Journal of Review on Global Economics and Pakistan Journal of
Social Sciences. His research interest focuses on microfinance, development
and corporate finance and banking industry and has published several papers on
research interest above.

Hasniza Mohd Taib is a Senior Lecturer at School of Economics, Finance and

Banking of Universiti Utara Malaysia (UUM). Her areas of specialisation are
capital market, microfinance and Islamic finance. She has been appointed as
principal researcher at Institute for Business and Management Research
(IMBRe). She is Fellow at Asian Research Institute of Banking and Finance
(ARIFB) and internal auditor at UUM. Currently, she is appointed as a
Manager of AACSB unit in her university, responsible to maintain the
accreditation of business undergraduate and postgraduate programs.
She is a reviewer in Institutions and Economics, Jurnal Pengurusan, Jurnal
Pengurusan and Muamalat, and Malaysia University Journals.

Abul Bashar Bhuiyan is an Associate Professor at Faculty of Business and

Accountancy (FBA), University of Selangor (UNISEL), Selangor, Malaysia.
He has graduated with PhD degree in the area of Microfinance in 2012 from the
National University of Malaysia (UKM), Malaysia. He has served as a Senior
Lecturer in the last 10 years at the University Malaysia Perlis (UniMAP) and
University Utara Malaysia (UUM). His research interests are on governance,
performance, efficiency, and management related issues in the area of
accounting, microfinance, Islamic finance, and banking green economy,
finance, accounting, sustainable livelihood and poverty alleviation,
development economics, and environment.

Rashid Bhutta is a PhD scholar at Universiti Utara Malaysia. He has served for
several years in banking industry of Pakistan. His area of interest is corporate
finance, corporate risk, corporate bankruptcies and sustainable finance.

1 Introduction

Microfinance institutions (MFIs) are the key financial service providers for the poor
people of the society. MFIs provide collateral-free loans through different approaches,
including progressive lending, group lending and regular payment schedules.
Nevertheless, providing microfinance is a costly business due to high transaction and
information costs. Therefore, sustainable MFIs are important for serving the maximum
number of poor people (Naz et al., 2019). Sustainability of MFIs is also important for
cost management, controlling the impact of formal lenders, institution and management
146 M. Saad et al.

development (Naz et al., 2019), experimentation, innovations and to achieve poverty

reduction goals (Tehulu, 2013; Vinelli, 2002).
In developing countries, microfinance is considered as a tool to fight against
poverty. Due to the positive impact of microfinance in poverty alleviation; developed
countries, non-government organisations, bilateral donor agencies and multilateral donor
agencies support MFIs operating in developing countries. These agencies inject millions
of dollars to support the microfinance sector. For instance, World Bank has granted
USD 378 million to support MFIs in 2009. Over the years, the total sum of grants
exceeds USD 1.29 billion (Nanayakkara, 2017; Nanayakkara and Mia, 2012). The
effective utilisation of these funds offered by donor agencies that originate from
taxpayers of wealthy countries depends on the ‘sustainability’ of MFIs. Given
the responsibility of properly utilising such large sums of donor funds and for the
significant positive role played by the MFIs, identifying factors that influence MFIs’
sustainability is a critical issue (Ahmed et al., 2016; Khan et al., 2017).
The literature on microfinance also highlighted that MFIs in developing countries are
facing the sustainability issue. The contribution of MFIs in reducing poverty and support
in the economy of the country has drawn attention of scholars to better understand MFIs
sustainability. Existing literature provide several evidences of the attempts to ascertain
the determinants of sustainability but the determinants identified and their level of impact
vary (Quayes, 2012; Bhanot et al., 2015). According to Consultative Group to Assist
Poor (CGAP), efficiency, portfolio quality, liability management and profitability
are critical factors in determining MFIs performance (CGAP, 2003). Besides, Micro Rate
identified that productivity assessment and subsidies significantly influence
sustainability. However, these determinants are not certain, as no such comprehensive
study is found to analyse the influence of all these factors on MFIs sustainability.
This study is an initial attempt to empirically investigates the influence of profitability,
portfolio quality, productivity assessment, efficiency, liability management and subsidies
on the sustainability of MFIs. Moreover, this study includes the most recent years’ data
for analysis by examining the period 2006–2015.
This remaining research includes review of existing literature, selection of variable,
methodology and data sample, results, and conclusion.

2 Literature review

Pakistan has a large population of almost 200 million, with 44% of people below poverty
line having an income of less than $2 per day (Global Monitoring Report, 2015).
In Pakistan, “Poverty is increasing due to low GDP and inequality. It is the responsibility
of the state to eradicate poverty. As long as the country will not be free of poverty, it
cannot be fully functioned on the way to progress” (PMN, 2017).
The government of Pakistan took several initiatives to eradicate poverty including
establishment of MFIs (Burki et al., 2018). The first microfinance program initiated by
the government of Pakistan in 1953 was through village AID package, in the form of
five-year plan that was later abandoned in 1962 after the establishment of Agriculture
Development Bank. Agriculture Development Bank (now known as ZaraiTaraqiati Bank)
was established in 1961 to overcome poverty by giving subsidised funds and small loans
to the farmers (Rauf and Mahmood, 2009; Farooq and Khan, 2014). Later, during the
decades of 1980s and 1990s, several rural support programs were also started by the
 The sustainability of microfinance institutions in Pakistan 147

government to overcome poverty level through subsidised funds. These include Orangi
Pilot Project (1987), Agha Khan Rural Support Program (RSP) (currently, known as First
Microfinance Bank), National RSP (1991) and Sarhad RSP (1989) (Ahmad, 2011). Under
development program for microfinance sector, Khushali Bank in the year 2000 was the
pioneer MFI in Pakistan to provide subsidised loans and credits to the poor (Rauf and
Mahmood, 2009; Burki et al., 2018).
According to Rauf and Mahmood (2009) Pakistan Microfinance Network (PMN),
a representation of developing MFIs was established in 1998. After two years, the
Pakistan Poverty Alleviation Fund was initiated in 2000 to promote the MFIs wholesale
refinancing. Currently, it refinances microloans to almost 56% of PMN members with a
loan amount of USD 175.2 million (PKR 10,513 million) and an outstanding
loan portfolio of USD 66.9 million (PKR 4013 million) (Shirazi and Khan, 2009).
Moreover, Agriculture Development Bank has established a new loan fund of
USD 15 million to assist newly licensed Pakistani MFIs at district and provincial
levels. State Bank of Pakistan has set up a guarantee facility of 10 million pounds,
with UK Department of International Development, to assist development financial
institutions and banks in facilitating MFIs to avail credits for an increase in outreach
(State, 2008).
As evident above, development institutions have made significant efforts to reduce
poverty through microfinance, still, the performance and sustainability of MFIs has not
produced the required output (Abdulai and Tewari, 2017; Cull and Morduch, 2007;
Saad et al., 2019). The fundamental question is whether MFIs could maintain its
sustainability to overcome poverty (Rahman et al., 2015).
Chaves and Gonzalez-Vega (1996) view sustainability as the organisation’s ability
to use its financial resources or borrowings on market rates for providing financial
services on regular basis. Okumu (2007) cited the definition of sustainability as the
institution’s ability to generate enough reserves for capitalisation by covering its
operational cost. MFIs sustainability is determined by its ability to generate revenues
that cover its operational cost and provide continued services to poor people which were
denied services from commercial institutions (Rao, 2014).
It refers to MFIs ability to generate revenue that can cover cost of operations and
other related costs, generate profit and continue their operations without support from
donors, governments and other subsidy providers. Traditionally, MFIs sustainability is
their ability to be financially independent in meeting their operational needs after a
certain period. According to Mahapatra and Dutta (2016), MFIs can achieve financial
sustainability when they generate sufficient capacity to cover their funding cost, default
cost and administration cost. Majority of MFIs does not adopt cost-based pricing strategy
due to which they are unable to generate revenues (Pollinger et al., 2007).
In Microfinance, sustainability is considered at different levels: financial, managerial,
individual, group and institutional level (Mahapatra and Dutta, 2016). According to
“Microcredit summit campaign”, financially sustainable MFIs have the capacity to cover
their operating expenses, financial expenses, inflation adjustments and subsidy
adjustments. This is termed as becoming financially self-sufficient. In literature,
financial sustainability is measured using financial self-sufficiency (Haider et al., 2018;
Khan et al., 2017) and operational self-sufficiency (Mahapatra and Dutta, 2016;
Naz et al., 2019; Burki et al., 2018). However, this study considers operational self-
sufficiency as proxy for MFIs sustainability. MFIs sustainability attracts the attention of
researchers after it was proven worthwhile for sustainable development of the poor
148 M. Saad et al.

population (Iezza, 2010). Limited studies found in the literature on determinants of

sustainability are discussed below.
Bhanot et al. (2015) investigated the factors which contributed to MFIs sustainability.
Cross-sectional data was obtained from the Mix market for 81 MFIs for the year 2010.
A study found that number of active borrowers (NAB), gross loan portfolio (GLP),
portfolio at risk greater than 30 days (PAR), and number of borrowers per staff
member (BPSM) contributes significantly for MFIs sustainability. Daher and Le Saout
(2015) found that ratio of GLP to the asset, capital to the asset, portfolio quality, MFIs
size, cost per dollar lent and average loan balance per borrower (ALPB) has a correlation
with MFIs sustainability. They also concluded that PAR and cost on each dollar lent have
a significant negative correlation with MFIs sustainability. Mia et al. (2015) studied the
relationship between MFIs resources and financial sustainability and concluded that
sustainability could be achieved by enhancing the ability of MFIs in generating higher
revenues. Basharat et al. (2015) suggested that interest rates affect the relationship of
financial sustainability and MFIs outreach.
Five MFIs from Bangladesh were selected by Rahman and Mazlan (2014) to study
their determinants of sustainability. Data was obtained from the Mix market for the year
2005–2011. Results of multiple regression suggested that size, cost per borrower,
personal productivity ratio, have a significant correlation with sustainability. Age, debt to
equity ratio (DER), ALPB, and operating expense ratio (OER) have negative correlation
with sustainability. Moreover, the yield on GLP of MFIs has no significant relationship
with sustainability.
Tehulu (2013) found that the GLP to asset and MFI size has a positive correlation
with its financial sustainability. The study also found that management inefficiency,
credit risk, PAR and OER are inversely related to MFI’s financial sustainability. The
determinants of financial sustainability were investigated in his study using unbalanced
panel data of 23 MFIs in East Africa from year 2004–2009. Sekabira (2013) studied
impact of capital structure on MFI performance in 14 MFIs from Uganda. Results
suggested that grants and debt have negative correlation with MFIs performance.
Additionally, the study concluded that dependence of MFIs on grants has a damaging
impact. Moreover, Sekabira (2013) also suggested that MFIs should emphasise on share
capital to achieve long-term sustainability.
Quayes (2012) investigated the impact of outreach on MFI sustainability by using
data from the Mix market of 702 MFIs across 83 countries. Empirical results found
that outreach depth and MFI sustainability positively complement each other. Rai and Rai
(2012) studied the factors influencing the sustainability of MFIs from India and
Bangladesh. Data of 26 MFIs from each country during the year 2005–2010 was tested
using multiple regression and the result showed that PAR, OER and capital to asset ratio
were significant contributors to achieve sustainability.
In Ethiopia, a sample of 14 MFIs for the year 2002–2010 was taken to identify factors
that affect sustainability (Kinde, 2012). Results of quantitative study found that outreach
depth and breadth, per borrower cost, and dependency ratio are significant contributors to
sustainability. However, staff productivity and capital structure are insignificant for MFI
sustainability. Moreover, Haq et al. (2010) found that increase in the non-performing loan
due to cost efficiency negatively affects MFIs sustainability.
According to Ayayi and Sene (2010), instruments of MFIs financial sustainability
include interest rate, credit portfolio, profitability and efficient management. Age of MFI
and outreach have a lesser but positive impact, whereas the percentage of women
 The sustainability of microfinance institutions in Pakistan 149

borrowers have an insignificant effect on the financial sustainability of MFIs. Results

from Gutierrez-Nieto et al. (2007) study depicted that increase in the rate of interest and a
reduction in a number of loans outstanding increase the financial sustainability of MFIs.
In summary, previous studies reveal several factors that influence the sustainability of
MFIs and the findings of these studies are mixed. The current study contributes to the
existing literature by identifying the impact of profitability, portfolio quality, productivity
assessment, efficiency, liability management and subsidies on the sustainability of MFIs.
Furthermore, this study also contributes by examining the reverse causation effect of each
of the variables used in this study.

3 Methodology and data

To empirically identify the factors that influence MFIs sustainability, this study yielded
an unbalanced panel data sample of 37 MFIs operating in Pakistan from the year
2006–2015. These MFIs include nine banks, four rural support programs, and 24 MFIs.
Data for all MFIs are collected from audited annual reports, Pakistan Microfinance
network, and Mix market database.

3.1 Variables selection and hypothesis development

In this section, the variables used in this study are identified and the measurements
used for these variables are discussed. The dependent variable used in this study is
sustainability of MFIs. Moreover, independent variables used in this study are those
suggested by CGAP and Micro Rate. An operational definition of all these variables is
discussed below and their measurement is presented in Table 1.
Dependent variables
Operational self-sufficiency (OSS), is used as dependent variable for MFIs sustainability.
OSS measures MFIs capacity of generating profits by covering its cost of operations
(Saad et al., 2018). This cost includes financial, operational and provision for loan losses.
OSS has been used by existing researchers to measure MFIs sustainability (Rai and Rai,
2012; Annim, 2012; Zerai and Rani, 2012).
Independent variables
The independent variables used in this study are profitability, portfolio quality,
productivity assessment, efficiency, liability management, and subsidies.
The ratios of the return on asset (ROA) is used as a measure of profitability. In
general, MFIs having positive ROA are relatively safer. Therefore, conventional
profitability to sustainability hypothesis would imply a positive influence of ROA on
sustainability of MFIs. Positive values of profitability attract commercial investors, which
lead MFIs towards regulated commercial institutions. MFIs which focus on profitability
usually target to make bigger loans for clients better-off resulting in increased loan
repayment and minimum cost per loan (Tucker and Miles, 2004). These results
were achieved by reducing excess to women borrowers who are costly to reach
(Cull, 2011). According to Von Stauffenberg et al. (2003), profitability reflects the
overall performance including efficiency and portfolio quality of MFIs. However
150 M. Saad et al.

increased focus on profitability results in the deviation from the social mission of
reaching the poor.
H1: ROA significantly impact MFIs sustainability.
A portfolio at risk greater than 30 days is used to measure the quality of loan portfolio.
If the institutions are unable to recover the amount of loan within due date, then the loan
portfolio is at risk. There is a possibility that loan could not assist the poor in overcoming
poverty and may result in loan default. When loan default gets older, recovery for the
loan becomes difficult. Furthermore, if 10% or more of the loan overdue exceeds
30 days, MFIs would suffer problems as they have no collateral against them (see, for
example, Rosenberg, 1999). Therefore, increase in loan portfolio may indicate a decrease
in sustainability of MFIs.
H2: Portfolio quality has a significant association with MFIs sustainability.
Productivity assessment determines the ability of the firm to execute its operations
smoothly. The most widely used indicator of productivity is borrower per staff member.
Since the management decisions do not easily manipulate productivity indicators, they
are easily measured as compared to profitability across the institutions. Sustainability can
be achieved with increased focus on employee development which will uplift overall staff
productivity (Ayayi and Sene, 2010). Staff productivity and MFIs financial sustainability
have a positive correlation (Nwachukwu, 2014; Nyamsogoro, 2010). Furthermore,
MFIs which operate in countries with high income per capita usually have less productive
staff due to lower outreach (Nawaz, 2010). Very few studies have focused on staff
productivity while approximating MFIs sustainability (Twaha and Rashid, 2012).
H3: Productivity assessment significantly influence MFIs sustainability.
The OER is used to measure the impact of efficiency in expenses management on MFI
sustainability. This ratio includes managerial and operating cost but exclude provision for
loan losses and financial expenses. Institutions which manage their expenses better tends
to be more profitable (Bourke, 1989). Pasiouras and Kosmidou (2007), and Zopounidis
and Kosmidou (2008) have a negative correlation between OER and profitability of
institution. On the contrary, Molyneux and Thornton (1992) approximated that increased
expense on productive staff leads to a profitable institution. Furthermore, Hudon and
Traca (2011) found that efficiency and MFI sustainability have a negative relationship.
They emphasised on the use of subsidies to become operationally efficient. Thus,
inconsistent results were found for the influence of efficiency on MFIs sustainability.
H4: Efficiency has a significant relationship with MFIs sustainability.
Liability management measures firms’ ability to repay loans by utilising their equity.
If MFIs fail to manage their liquidity position and GLP, they would not be able to
efficiently manage their credit operations. Moreover, it becomes more critical for MFIs
that are utilising their depositor savings. Furthermore, irregular use of equity may result
in financial risk for MFIs. Since the risk associated with management of liabilities is
high, it may significantly impact the sustainability of MFIs. In this study, GLP and DER
are used as a measure of liability management. Several studies have found empirical
evidence of positive relationship while approximating firm’s leverage and performance
(Roden and Lewellen, 1995; Berger and Di Patti, 2006). Other studies found that
 The sustainability of microfinance institutions in Pakistan 151

businesses debt level has a negative relationship and sustainability (Rajan and Zingales,
1995; Wald, 1999; Booth et al., 2001).
H5: Liability management and MFIs sustainability are related significantly.
The final independent variable, which is subsidy can be defined as the financial support
provided by the donors at less than market rate. Schreiner (2000) and Rhyne (1998)
emphasised that new MFIs should use subsidies for their survival. They further argued
that MFIs need 5–10 years to achieve stability. However, excessive use of subsidies and
grants has resulted in non-sustainable MFIs (see for example, Bogan, 2012; Morduch,
2000). Therefore, it is expected that there is a negative relationship between subsidies
(SUB) and MFIs sustainability.
H6: Subsidies is expected to have a significant impact of MFIs sustainability.

Table 1 Variables measurement

Variables Proxies Measurement Sources

Dependent variable
Sustainability Operational self- “Operating revenue/(financial expense Quayes (2015) and
sufficiency + net loan loss provision + operating Naz et al. (2019)
expense)”
Independent variables
Profitability Return on assets “(Net operating income – taxes)/average Daher and Le Saout
assets” (2015) and Bhanot
et al. (2015)
Portfolio quality Portfolio at risk (Unpaid principal balance of past-due Janda and Zetek
greater than 30 loans with overdue>30 days)/gross (2014) and Tehulu
days outstanding loan portfolio” (2013)
Productivity Borrower per staff (Total number of active Quayes (2015) and
assessment member borrowers)/number of loan officers” Naz et al. (2019)
Efficiency Operating expense (Total operating expense)/average Cull (2011) and Khan
ratio outstanding portfolio” et al. (2017)
Liability Debt to equity Total liabilities/total equity” Ngo et al. (2014) and
management ratio Abate et al. (2014)
Gross loan Amount of principal loan outstanding Bogan (2012) and
portfolio excluding loan write-off” Ngo et al. (2014)
Subsidies Subsidies Annual subsidy received by MFIs at less Bogan (2012)
than the market rate

3.2 Model specification

In order to assess the influence of the independent variables (profitability, portfolio
quality, productivity assessment, efficiency, liability management and subsidies) on the
sustainability of MFIs, the following model has been developed.
OSSit = α 0 + β1 ROAit + β 3 PARit + β 4 BPSM it + β 5OERit
+ β 6 DERit + β 7 GLPit + β8 SUBit + ε it
152 M. Saad et al.

Where i refers to microfinance institutions; t refers to year, OSS refers to operational

self-sufficiency, ROA refers to return on assets, PAR refers to portfolio at risk > 30 days,
BPSM represents borrowers per staff member, OER refers to operating expense ratio,
DER represents debt to equity ratio, GLP refers natural logarithm of gross loan portfolio,
SUB represents natural logarithm of subsidies and is the error term.

4 Empirical results

Several diagnostics are performed to check the data before using regression
analysis. These tests include descriptive test, autocorrelation, multicollinearity, and
homoscedasticity. According to Gujarati (2003), diagnostic tests are conducted to ensure
that expected value is genuine and has a minimum value for a variance. After the
approximation for diagnostic tests, appropriate panel data was used to run the regression
analysis.

4.1 Descriptive statistics

Table 2 shows the descriptive statistics of the variables used in this study. The dependent
variable OSS has a high score of 2.787 or 278.7% and the mean value of 1.06 or 106%.
MFIs having OSSratio of 100% or more are considered sustainable (Bhanot et al., 2015).
This implies that MFIs in Pakistan are achieving higher financial sustainability level. The
mean value of ROA shows a negative score of 0.0039, indicating that MFIs are not able
to generate profit while using their assets. The mean and maximum value of ROE is 0.19
and 8.33 indicating that some MFIs are efficient in generating positive returns on their
equity. Whereas, the minimum value for ROE has negative score of 2.29. Moreover,
PAR, BPSM, and OER have mean value of 0.04, 138.39, and 0.17, respectively. DER has
a mean score of 2.61 and has a maximum score of 60.8. The maximum value for DER
indicates that some MFIs have a high debt proportion as compared to equity, which is
very risky.
The standard deviation for GLP and subsidies reported in Table 2 are relatively high.
The higher values indicate the possibility of outliers in the data. Data is checked for the
possible outliers using Residual and Cook distance test. Results suggest that there are no
possible outliers in the data.

Table 2 Statistical description of variables

Variable Obs. Mean Std. Dev. Min Max

OSS 268 1.074 0.388 0.031 2.787
ROA 268 –0.003 0.094 –0.585 0.244
PAR 268 0.049 0.113 0 0.834
BPSM 268 139.70 92.75 0.223 586.04
OER 268 0.171 0.158 0.015 1.282
DER 268 2.664 9.718 –51.09 60.80
GLP 268 1,436,011 2,877,728 763 24,612,129
SUB 267 424,627 959,688 0 5,620,845
 The sustainability of microfinance institutions in Pakistan 153

To identify the existence of multicollinearity problem, variance inflation factors of all the
variables under study are presented in Table 3. The value for Variance inflation factors of
all the variables is below 10, which supports non-existence of multicollinearity (Gujarati,
2003). Additionally, we check for the heteroskedasticity problem since the study uses a
data sample of 38 MFIs with 273 observations. Results of the Breusch–Pagan testfor
heteroscedasticity does not shows the existence of heteroskedasticity in the data.
However, Breusch-Godfrey serial correlation LM test identified that the problem of
autocorrelation exists in the data as the probable Chi-square value shown is less than
0.05. The same has been removed in regression by using White-cross section as shown in
Table 5.

Table 3 Variance inflation factors

Variable Centred VIF

ROA 1.214
PAR 1.082
BPSM 1.092
OER 1.183
DER 1.085
GLP 1.205
SUB 1.143

4.2 Regression estimation

Fixed and random effect techniques are mostly used for the panel data analysis. Hausman
test is used to identify the appropriate technique for regression analysis. Results presented
in Table 4 suggest that at a 0.05 significance level, we reject the alternative hypothesis
that the preferred model is fixed effect in favour of the null hypothesis that the random
effect model is preferred for the current study. Therefore, we choose the random effect
model for our panel regression.

Table 4 Correlated random effects test-Hausman test

Test summary Chi-Sq. statistic Chi-Sq. d.f. Prob.

Crosse-section 8.649 7 0.278

Table 5 shows the result of the regression approximated using random effect. The aim of
current study is to identify the potential factors that may influence the sustainability of
MFIs. The goodness of fit for the model is presented by R-Squared (R2) value of 0.6634,
which indicates that 66.34% of the variance in sustainability is significantly explained
by all independent variables, which are profitability, portfolio quality, productivity
assessment, efficiency, liability management and subsidy. The remaining 18.83% is
comprised of some other factors that are not part of this study.
The regression estimates show that ROA and BPSM influence MFIs sustainability.
ROA has positive coefficient and significant at 1%. This entails that the increase in ROA
results in improved MFI sustainability. Berger and Di Patti (2006) suggested that MFIs
that are efficient and maintain their portfolio quality usually achieve positive ROA and it
154 M. Saad et al.

indirectly helps MFIs to achieve sustainability. Several other studies support the result of
our study that ROA has a positive correlation with the sustainability of MFIs (see for
example, Tucker and Miles, 2004; Louis et al., 2013, Daher and Le Saout, 2015).
Results in Table 5 present that BPSM significantly influences the sustainability of
MFI at 5%. These findings are consistent with the argument that MFIs achieve
higher sustainability levels when they have more productive staff members. Ayayi and
Sene (2010) supported the results of this study and found that BPSM is significant across
all the regions except Sub-Saharan Africa. The results of this study are also supported by
Bhanot et al. (2015) and Twaha and Rashid (2012) for MFIs in India. Note that empirical
results of this study also show that variables including PAR, OER, DER, GLP and SUB
have insignificant relation with sustainability.

Table 5 Random effect model

Variable Coefficient Prob.

C 0.982 0
ROA 3.184*** 0
PAR –0.177 0.297
BPSM 0.0006** 0.012
OER 0.088 0.666
DER –0.0001 0.908
GLP 0 0.662
SUB 0 0.622
Dependent variable Operational self-sufficiency
Total panel (unbalanced observations) 267
R-squared 69%
F value 82.37***
**, ***, represents significance at 5% and 1%, respectively.

4.3 Robustness check

Additionally, several tests are performed to check the robustness of results. The use of
control variables for robustness of the results is supported by Vanroose and D’Espallier
(2013), Cull (2011) and Bogan et al. (2007). Specifically, the dummy variables
for all three categories of MFIs, bank and RSPs are used in this model to control for
the effect of legal status. MFIs with different legal status are monitored under different
regulations and have different operational structures which may affect their sustainability
performance. Results in Table 6 are consistent with our previous result and shows that
profitability is still significantly associated with sustainability of MFIs. The coefficient
for the profitability is very high indicating the strong impact of profitability among all the
other explanatory variables. This implies that irrespective of the legal status, MFIs need
to focus on achieving higher profits to attain a higher sustainability level. Additionally,
staff productivity has a positive significant relationship with sustainability. This implies
that MFIs with different legal status and operational structures need to focus on employee
productivity.
 The sustainability of microfinance institutions in Pakistan 155

Table 6 Robustness check for legal status

Variable Coefficient Prob.

C 1.094 0
ROA 3.178*** 0
PAR –0.117 0.471
BPSM 0.0005** 0.045
OER 0.093 0.652
DER –0.0001 0.909
GLP 0 0.290
SUB 0 0.399
DMFI –0.092*** 0.008
DMFB –0.170*** 0
Dependent variable Operational self-sufficiency
Total panel (unbalanced observations) 267
R-squared 70.64%
F value 68.73***
**, *** represents significance at 5% and 1%, respectively.

As another robustness check, the sensitivity of the results is reaffirmed by considering

age in the regression model. Ayayi and Sene (2010) highlight that mature MFIs have
better experience in dealing with operations that improve their likelihood of being
sustainable. MFIs are inefficient in the beginning, but they learn from their mistakes
and improve their control gradually. Mature MFIs use their expertise to reduce the risk
associated with credit management and manage their operations efficiently to achieve
higher sustainability. To address this concern, age of MFI is used as a control variable to
check for the robustness of the results. Results for model 1 in Table 7 provides regression
results with age as control variable. Results of model 1 endorse the previous findings and
conclude that irrespective of maturity of MFIs, profitability and staff productivity are the
key factors that influence the financial sustainability of MFIs.
Additionally, size measured by total assets is a significant base for MFIs
performance. Size reflects MFI’s awareness of the market (Nhung and Okuda, 2015) and
their ability to compete in the market (Gonzalez, 2007). The size also indicates the
growth of MFIs regarding client base; the working area covered as well as assets owned.
As in other business firms, the size of MFIs is essential for acquiring commercial
financing, use of modern technology and innovations. The size also influences managers
of MFIs in implementing different operations and growth strategies such as internal
control, revenue enhancement, geographical coverage as well as an internal decision
regarding the use of resources. The sensitivity of the results is reaffirmed by considering
size in the regression model. Model 2 in Table 7 further endorse the findings for the
regression model and highlights that similar signs and magnitude are found for
profitability and staff productivity.
156 M. Saad et al.

Table 7 Robustness check for age and size

Variable Model 1 Model 2

C 0.923 0.974
(0.000)*** (0.000)***
ROA 3.099 3.170
(0.000)*** (0.000)***
PAR –0.183 –0.174
(0.273) (0.308)
BPSM 0.0005 0.0007
(0.024)** (0.011)**
OER 0.094 0.093
(0.637) (0.649)
DER –0.0005 –0.0004
(0.681) (0.774)
GLP 0 0
(0.494) (0.262)
SUB 0 0
(0.599) (0.335)
AGE 0.006
(0.000)***
TA 0
(0.021)**
Dependent variable Operational self-sufficiency
Unbalanced panel observations 267
R-squared 70.02% 69.15%
F value 75.34*** 72.31***
**, *** represents significance at 5% and 1%, respectively.

5 Granger causality test

The Granger causality test is applied to understand better the causal relationship between
each, and all the dependent and independent variables used in this study. According to
Cheng and Lai (1997), the first variable m is said to Granger cause the second variable n,
if the currently predicted value of n is improved by using past value of m.
To estimate the granger causality, the lag length criteria are estimated by using the
Variance autoregression model. The lag order for the current data is selected using
Schwarz criteria, which is presented in Table 8. The Schwarz criteria have the minimum
value for the first lag order. Therefore, granger causality of the variable is tested at first
order.
Pairwise Granger causality test is done with the first lag order to obtain the causality
effects between each and all the variables used in this study. Table 9 provides the results
for null hypothesis that are rejected, thus accepting the alternate hypothesis in Granger
causality test. Results suggest that OSS Granger causes ROA at significance level of 1%,
thus rejecting the null hypothesis that OSS does not Granger cause ROA. The hypothesis
OER does not Granger cause ROA is rejected. This indicates that OER Granger causes
 The sustainability of microfinance institutions in Pakistan 157

ROA at significance level of 5%. This implies that MFIs in Pakistan tend to be profitable
in the long-run if they reduce their operational costs. Descriptive statistics in Table 2
shows that MFIs in Pakistan have negative mean value for profitability. The possible
reason may be that banks in Pakistan hold the major share of the market and are more
profit oriented. On average, MFIs are not efficient in reducing their cost of operations and
industry mean has a negative value. Reducing operating costs may help MFIs to increase
their efficiency and profitability.
Additionally, it is also evident from the results that OSS and SUB also Granger cause
BPSM at a significance level of 1%, indicating that increase in value of BPSM is
influenced by the change in value of OSS and subsidies. Moreover, the change in value
of BPSM is influenced by the change in value of ROA as the alternate hypothesis ROA
does not Granger cause BPSM is accepted at 1% significance level. This implies that in
the long-run, staff productivity is affected by profitability level, dependence on subsidies
and operational self-sufficiency.

Table 8 Variance auto regression lag order selection criteria

Lag Schwarz criteria

0 24.30744
1 21.55969
2 23.63912
3 23.4809
4 24.62463
5 25.11911
6 26.04013
0 24.30744

Table 9 Summary of significant causation effect

F-statistics F-statistics
Null hypothesis (Prob.) Null hypothesis (Prob.)
OSS does not Granger cause ROA 16.455*** SUB does not Granger cause BPSM 13.2649***
(0.00007) (0.0003)
OSS does not Granger cause BPSM 17.7494*** ROA does not Granger cause BPSM 10.4079***
(0.00004) (0.0014)
PAR does not Granger cause OSS 5.69687** OER does not Granger cause ROA 3.98261**
(0.0178) (0.0471)
OSS does not Granger cause OER 6.57028** GLP does not Granger cause OER 5.261**
(0.011) (0.0227)
OSS does not Granger cause SUB 3.03798* GLP does not Granger cause PAR 3.26384*
(0.0827) (0.0721)
ROE does not Granger cause DER 3.34722* BPSM does not Granger cause SUB 3.42235*
(0.0686) (0.0656)
PAR does not Granger cause BPSM 3.07357*
(0.0809)
*, **, *** represents significance level at 10, 5, and 1%, respectively.
158 M. Saad et al.

Result also suggests that a change in value of OSS may be due to change in value of
PAR, where null hypothesis PAR does not Granger cause OSS is rejected. Table 9 further
presents the results for the causality effect of several other variables. These results further
show that PAR Granger causes BPSM at significance level of 10% indicating a
unidirectional causality. This may further be seen as the hypothesis BPSM does not
Granger cause PAR is accepted. It is also evident from the result that GLP Granger
causes PAR at significance level of 10%, showing a unidirectional causality.
The results presented in Table 9 show that majority of the alternate hypothesis
accepted shows unidirectional causality. However, only the causality effect between SUB
and BPSM has a reverse effect. This can be explained as the hypothesis SUB does not
Granger cause BPSM and BPSM does not Granger cause SUB are rejected. Thus, null
hypothesis is accepted, showing that SUB Granger causes BPSM and BPSM Granger
causes SUB at significance level of 1% and 10%, respectively.

6 Conclusion

Empirical results in this study suggest that ROA has a significant impact on the
sustainability of MFIs. ROA is the most significant indicator, with the highest coefficient
value of 2.853. This indicates that increasing the size of operations only does not increase
sustainability. Instead, MFIs should generate positive returns by efficiently utilising
its assets. When MFIs have high returns, their ability to give more loans increases,
which decreases their dependency on external borrowings. Moreover, MFIs that have
more productive staff achieve higher sustainability levels. The study recommends that
managers of MFIs and decision-makers in the region should focus more on improving
productivity and adopting cost-effective and efficient strategies. This can be achieved by
strengthening staff appraisal systems, incentivising hard-working staff, stepping up
monitoring to improve on loan collections, and adopting appropriate information
communication technologies to help increase outreach and reduce the cost of operations.
Moreover, empirical results suggest that PAR (proxy for portfolio quality), OER
(Productivity assessment), DER, GLP and subsidies has no significant impact on
sustainability of MFIs in Pakistan.
Granger causality test is also performed in this study to study the causality effect of
each or all of the variables used in this study. Several null hypotheses are accepted and
few of them were rejected, indicating a unidirectional causality effect. However, SUB
and BPSM have a reverse causality effect indicating that both the variables Granger
cause each other.
This study has certain limitations as the data for the study was obtained for MFIs
in Pakistan. A comprehensive study with cross country analysis may be done to further
generalise the results. Additionally, several studies have argued that as MFIs grow in
their size, their sustainability increases. This needs to be empirically investigated to
further identify the impact of age and size on sustainability of MFIs. Moreover, future
research may also identify the interaction effect of age and size while studying the impact
of profitability, portfolio quality, productivity, efficiency, liability management and
subsidies on the sustainability of MFIs.
 The sustainability of microfinance institutions in Pakistan 159

Acknowledgement

The study was funded by FRGS Research Project entitled “Formulation of Microfinance
Institutions Sustainability Index (MISI) in Malaysia” (Ref No. FRGS/1/2018/
SS01/UNISEL/02/2).

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