Article

Financial South Asian Journal of

Macroeconomics
Sustainability and Public Finance
11(1) 116–142, 2022
of Microfinance © 2021 SAGE Publications India
Private Limited
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Macroeconomic DOI: 10.1177/22779787211007970
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Factors: A Case
of South Asia

Ainan Memon1 , Waqar Akram1 ,

Ghulam Abbas1 , Abbas Ali Chandio2,
Sultan Adeel1 and Iram Yasmin3

Abstract
This study explores the financial sustainability of microfinance insti-
tutions (MFIs) in the economic context to identify how macro-level
economic decisions affect the micro-level decisions in the microfinance
sector in South Asia. For that purpose, the data of 409 South Asian MFIs
combined with the macroeconomic variables of respective countries are
used over the period 1999–2017. The empirical analysis uses a fixed-
effect model (FEM) to analyse the unbalance panel data of microfinance
institutions and macroeconomic variables. We employ two-stage least
squares (2SLS) model for robustness and System Generalized Method
of Moment (GMM) to address the potential endogeneity and over-
identification bias. The results reveal that economic indicators such as
foreign investment, human development, inflation, interest rate, private

1
Sukkur IBA University, Sukkur, Sindh, Pakistan.
2
College of Economics, Sichuan Agricultural University,Ya’an, Sichuan, China.
3
Government College Women University Faisalabad, Faisalabad, Punjab, Pakistan.

Corresponding author:
Ainan Memon, Sukkur IBA University, Sukkur, Sindh 65200, Pakistan.
E-mail: [email protected]
Memon et al. 117

credit, and labour force participation have negatively influenced finan-

cial sustainability except for the GDP growth. The overall economic
results seem imperative from the good-governance perspective of MFIs.
Besides, the government and microfinance policymakers need to give
due consideration to the macro-level economic decisions to achieve the
financial sustainability of MFIs.

Keywords
Financial sustainability, microfinance institutions, macroeconomic
factors, South Asia
JEL Classification: A12, G21, G28, O1, Q01

Introduction
Microfinance institutions (MFIs hereafter) continue to play an ever-
increasing role in the socio-economic development of the world at large
and the less developed countries in particular. Since its inception, micro-
finance drew a great deal of attention from many economic theorists that
provide the foundation of this novel idea of lending to the poor people
who do not have sufficient collaterals against loans (Besley & Coate,
1995; Stiglitz, 1990; Varian, 1990). The MFIs are the microcosms that
provide loans to low-income people, including self-employed people
and small enterprises, who cannot access typical sources of finances like
commercial or investment banks. Unlike conventional banks, MFIs are
hybrid institutions that contain the salient features of banks (i.e., sustain-
able development, customer satisfaction) and social development (i.e.,
poverty alleviation and beneficiaries) (Battilana & Dorado, 2010; Kent
& Dacin, 2013). For such purposes, MFIs are an integral part of the
domestic financial system and play an active role in poverty alleviation,
economic development, women empowerment, microenterprise devel-
opment, small business initiatives and social benefits. Though the entry
of MFIs into the financial system increases the informal interest rates;
however, this entry is Pareto improving for the borrowers at large
(Mookherjee & Motta, 2014).
Over the past few decades, microfinance has emerged as one of the
effective sources of finance for socio-economic development in the
world and is recognized as an essential tool of financial inclusion
118 South Asian Journal of Macroeconomics and Public Finance 11(1)

(Soumaré et al., 2020).1 However, the magnitude and the real socio-
economic impact of MFIs are still debatable (Banerjee et al., 2015a,
2015b). A significant body of empirical research has questioned the abil-
ity of MFIs in the alleviation of poverty and reported their limited
impacts on the ownership of assets and consumption (Banerjee et al.,
2019; Desai et al., 2011; Karlan et al., 2010). The excessive profit-mak-
ing activities of some of the MFIs in India, Nigeria and Mexico have
provided a platform to the critics about the commercialization and the
original purpose of this financial system segment.2 Despite these critics,
the idea of microfinance has contributed significantly to poverty allevia-
tion at the macro level. The success of the idea of microfinance has been
culminated with the Nobel Peace Prize to Dr Muhammad Younus for
setting one of the progressive microfinance institutions in Bangladesh
(Grameen Bank). Since then, MFIs have grabbed the special attention of
researchers and policymakers to address socio-economic issues by
bridging the gap between low-income groups of people and formal
financial institutions (Xu et al., 2019). In the South Asian context, the
microfinance sector is serving the majority of the borrowers, nearly 60%
of the global outreach, in which India plays a leading role in the South
Asian microfinance sector by serving loans to approximately 51 million
people. Moreover, the South Asian MFIs are financially sustainable as
their operating self-sufficiency (OSS) ratio is 123% in 2018 (see Figures
A1 and A2).3
Despite the significant contribution of MFIs in addressing the South
Asian socio-economic issues, the region is still facing the persistent chal-
lenge of a high poverty ratio (UNESCAP, 2017). According to the world
development indicator (WDI) of 2018, the South Asian population

1
  The microfinance sector offered an estimated amount of $114 billion as microcredit to
139 million people globally, consisting of 80% female and only 20% male borrowers
(Microfinance Barometer, 2018).
2
  For example, SKS (India), LAPO (Nigeria) and Banco Compartamos (Mexico), see NY
Times, 13 April 2010.
3
  Figure 1 represents the OSS ratio of overall South Asian microfinance sector from 1999
to 2018 in which it shows that the OSS ratio is greater than 1 (100%). Therefore, it depicts
from Figure 1 that the overall South Asian microfinance sector is financially sustainable
since 1999. Figure 2 represents the OSS ratio of each South Asian country except Bhutan
and Maldives because data of these countries is unavailable in MIX market database. It
indicates that the microfinance sector of each South Asian country is sustainable in 2018,
in which Nepal is playing a leading role in achieving high sustainability ratio of
approximately 1.34 (134%).
Memon et al. 119

concentration is relatively high (1.814 billion); approximately 16.1%

live below the poverty line.4 The theory of socially determined aspira-
tions explains that poverty suppresses aspirations significantly that exac-
erbate the investment decisions of the people. Psychologically, they start
believing that it is impossible to come out of this poverty trap (Genicot
& Ray, 2017). Thus, it becomes inevitable to ascertain the sustainability
of MFIs because they directly discourse this issue of poverty alleviation
and economic development. Simultaneously, the rapid changes in the
complex business environment are also posing serious challenges to the
sustainability of MFIs. The sustainability of MFIs is categorized into
financial, social and environmental sustainability (Cull et al., 2018;
García-Pérez et al., 2017; Olawumi & Chan, 2018). Financial sustaina-
bility focuses on the narrative of self-sufficiency or self-reliance, while
social sustainability is based on social outreach. The environmental sus-
tainability of MFIs has grabbed the attention of many researchers in the
recent past and stresses the green environment performance of MFIs
(Mia et al., 2018; Tanin et al., 2019). However, this study focuses on the
financial sustainability of the MFIs, as only financially sustainable MFIs
can achieve social and environmental sustainability. Thus, specific gov-
ernance regulations of MFIs can effectively hedge the excessive amount
of risk coming from the macro-environment and ensure the stability of
the local financial system. Otherwise, it would further exacerbate the
social imbalance and economic downturn.
To analyse the financial sustainability of MFIs, this article uses both
social and economic factors, as the performance of MFIs is not only
influence by the internal factors but also by external factors that may
include economic, environmental and technological. Thus, it is quite
challenging to determine the financial sustainability of MFIs in the
increasingly complex macroeconomic environment. To the best of our
knowledge, the majority of the prior studies have evaluated the financial
sustainability of MFIs to institutional and governance factors (Gupta &
Mirchandani, 2019; Kauffman & Riggins, 2012; Sainz-Fernandez et al.,
2018; Schönerwald & Vernengo, 2016). There are quite a few studies
that have investigated the financial sustainability of MFIs in the macro-
economic context along with institutional and governance factors

4
  In 2013, last recorded in the WDI database, the poverty headcount ratio at $1.9 a day was
about 16.1% South Asian population live below the poverty line. More specifically, WDI
recorded the poverty headcount ratio, approximately 14.8 in Bangladesh, 1.5 in Bhutan,
21.2 in India, 7.3 in Maldives, 15 in Nepal, 4 in Pakistan and 0.7 in Sri Lanka in 2017.
120 South Asian Journal of Macroeconomics and Public Finance 11(1)

(Ahlin et al., 2011; Awaworyi, 2019; Imai et al., 2011; Vanroose, 2007;
Xu et al., 2016, 2019).
Given that, this research contributes to the microfinance literature by
establishing the empirical nexus between macroeconomic and firm-spe-
cific factors and financial sustainability of MFIs of South Asian coun-
tries, including Afghanistan, Bangladesh, India, Nepal, Pakistan and Sri
Lanka. For that purpose, we use unbalanced panel data of 406 MFIs with
2,229 firm-year observations ranging from 1999 to 2017. For the topic
under discussion, none of the previous researches has covered such a
broad sample in terms of MFIs and the number of countries in South
Asia. One of the key reasons for selecting the sample countries is based
on the vulnerability of the socio-economic dynamics of this region.
Although the governments are making serious efforts to uplift society’s
living standard, a significant fraction of the population in this region
lives below the poverty line. Therefore, this study would significantly
contribute to the existing literature on the financial sustainability of
MFIs in the macroeconomic context.
Further, the study also addresses the methodological issue of endoge-
neity in the model to avoid the lousy relationship between the explana-
tory and dependent variables. For that purpose, we use two different
robustness checks, two-stage least square (2SLS) regression and System
Generalized Method of Moments (GMM). The system GMM is a model-
ling approach with innate flexibility to fix the endogeneity problem in
the model.
The results of the GMM estimator show that private credit, labour
force participation and size of the firm negatively influence the financial
sustainability ratio, while the GDP growth at level, inflation, foreign
direct investment and human development influence the financial sus-
tainability of MFIs positively. In the case of profitability, the results are
relatively consistent in terms of the nature of the relationship except for
inflation that negatively influences the profitability of MFIs. Moreover,
this study also finds little variations in the South Asian perspective than
the global analysis previously conducted by Ahlin et al. (2011) and Imai
et al. (2011). The most likely reason could be the continuously changing
macro-environment and other social issues like low literacy rate, high
unemployment, gender inequality and high poverty ratio in this region.
This study further connects macro-level economic factors with micro-
finance sustainability for policymaking for both government and man-
agement of MFIs to reduce poverty, gender inequality, unemployment
and economic development. In this way, the results will help policy
departments of the South Asian Association of Regional Cooperation
Memon et al. 121

(SAARC) countries address these challenges. Further, this research helps

achieve Sustainable Development Goals (SDGs) and make purposeful
financial inclusion through the financial sustainability of MFIs.
The article as follows, the second section presents a detailed review
of prior studies. The third section describes the data, variables and esti-
mation techniques used to estimate the results. The findings are pre-
sented and discussed in the fourth section. Finally, the fifth section
presents the concluding remarks.

Literature Review
The microfinance sector is playing an integral role in the financial mar-
ket since the beginning. The concept of microfinance started in the 1970s
by Muhammad Yunus, the founder of Grameen Bank of Bangladesh, to
provide loans to poor people. The primary purpose of introducing a
microcredit facility is to offer under-served people financial services
who cannot repay a considerable amount of loans. Furthermore, research-
ers find various benefits of MFIs in economic and social development
(Xu et al., 2016, 2019). The benefits include poverty reduction, eco-
nomic development, women empowerment, microenterprise, small busi-
ness initiatives and social benefit, as their main target is to offer
microcredit to poor communities.

Financial Sustainability of MFIs and Its Measure

The success and growth of the microfinance sector are examined through
its financial ability to exist in the market, termed as financial sustainabil-
ity (Lensink et al., 2018). D’espallier et al. (2013) defined financial sus-
tainability as the firm’s ability to achieve financial objectives without
external support. It is measured through the OSS, financial self-suffi-
ciency (FSS), return on assets (ROA) and portfolio growth (Ahlin et al.,
2011). The OSS measures the ability of the firm to cover its operating
expenses from operating revenue without financing from an external
source (Meyer, 2002). The FSS is similar to the OSS, and it takes adjusted
values of revenue and expenses (Meyer, 2002). The above two measures
imply that any MFI that experience loss would not consider as finan-
cially sustainable even when they try to cover some of the cost by exter-
nal financing. The ROA measures the profitability of the firm, which is
the net income, divided by its total assets (Ross et al., 1995).
122 South Asian Journal of Macroeconomics and Public Finance 11(1)

In the literature of sustainability, most of the studies focus on estimat-

ing the determinants of MFIs’ sustainability (Tehulu, 2013). Nowadays,
lending to women (Kittilaksanawong & Zhao, 2018), microfinance plus
services (Lensink et al., 2018), governance (Bibi et al., 2017), capital
structure (Bayai & Ikhide, 2018) and others are emerging research stud-
ies conducted in the area of MFIs’ sustainability for alleviating poverty.
However, the economic impact in the literature of the financial sustain-
ability of MFIs is in question.

Economic Environment and Financial Sustainability of MFIs

In literature, macroeconomic stability and financial sector development
are the critical areas of research. The study found that economic deci-
sions and financial performance of any organization are interlinked
because the economic and monetary policies affect the financial devel-
opment (Fung, 2009). In particular, a few studies link the macro-level
indicators with microfinance performance to review economic decisions
and microfinance sustainability. Various economic factors can be
involved in contributing to the effect on the financial stability of the
microfinance sector that is discussed below.
First, the study conducted by Vanroose (2007) is based on literature
that is a driven study and gives a strong connection between economic
and microfinance performance. Moreover, Vanroose (2008) found that
gross national income and population density positively affect the per-
formance of MFIs. However, Honohan (2004) explains the lower varia-
tion between economic indicators and microfinance development.
Empirically, Ahlin et al. (2011) and Imai et al. (2011) critically reviewed
the macroeconomic indicators and institutional variables that influence
financial sustainability. Both studies found a positive impact of eco-
nomic growth on microfinance sustainability.
Moreover, the rate of interest and inflation are the two most direct
factors that can directly vary the revenue and cost of microfinance
schemes. Nwachukwu (2014) suggests the inflation and interest rate are
the key macroeconomic indicators, determining the stability of the econ-
omy and financial sector development. Country-related indicators are
external forces that affect the overall performance of all sectors, includ-
ing the microfinance sector. The economic policies of the country, like
interest rate, tax policy, inflation rate and unemployment, impact the per-
formance of the MFIs (Ahlin et al., 2011). To make MFIs sustainable, it
needs to understand the scope analysis of the country while making
microfinance strategy.
Memon et al. 123

In the literature of MFIs’ sustainability, only three studies link the

economic factors with microfinance sustainability conducted by Ahlin
et al. (2011), Imai et al. (2011) and Awaworyi (2019). Whereas other
studies just take economic factors as control variables to consider the
country level cross-sectional variance. Ahlin et al. (2011) examined the
four most important indicators: GDP growth, the share of the manufac-
turing sector, the rate of labour force participation and private credit that
significantly impact MFIs’ efficiency. In literature, a mixed relationship
is found between economic development and microfinance financial
sustainability. Previous studies found the insignificant impact of GDP on
MFIs’ sustainability when it takes as a country-specific control variable
in the model (Hartarska & Nadolnyak, 2007; Lensink et al., 2018).
Whereas, Ahlin et al. (2011) found that GDP growth positively impacts
MFIs’ performance because it increases the finances and investments in
the economy. Besides, it reduces the operating cost; thus, MFI performs
better. The results are different across the study due to the difference in
government policies and institutional standards of MFIs.
Vanroose (2008) suggests that MFIs are more effective in reducing
poverty, and it does not matter whether the economy is stable or not.
Conversely, Ahlin et al. (2011) argued that there is a strong causal asso-
ciation between GDP growth and the financial sustainability of MFIs.
The study found that inflation and income inequality also affect the
MFIs; the higher the inflation in the economy, the poor people need to
access credit for their basic needs like food, security, health and educa-
tion. Consequently, financial sustainability decreases due to low finan-
cial performance.
The above discussion raises the question that there is a relationship
between economic performance and MFIs’ performance. Therefore, this
study tries to identify whether and how macroeconomic level decisions
affect the financial sustainability of MFIs.

Research Methodology

Data and Variables

To evaluate the financial sustainability of MFIs of the South Asian region
in the macroeconomic context, this study uses a microfinance informa-
tion exchange (MIX) market database. The MIX is an online database
that provides a platform to exchange the financial and non-financial data
of MFIs worldwide to promote research and analytics in microfinance.
124 South Asian Journal of Macroeconomics and Public Finance 11(1)

The data of all macroeconomic indicators extracted from the world

development indicators (WDI, 2018) database except the human devel-
opment index (HDI) that is collected from the published reports of the
United Nations Development Programme (UNDP, 2018). The initial
sample consists of 411 MFIs operating in the South Asian region, with
2,242 yearly observations ranging from 1999 to 2018.5 To capture macro
variability at the firm level, we drop those firms with only three or less
than three annual observations over the sample period. Further, as we are
interested in studying the financially sustainable MFIs in the macro-
environment, we use operating self-sufficiency (OSS) as a data screen-
ing tool. Those MFI are considered as financially sustainable whose OSS
ratio is greater than 1 (100%) and vice versa. After that, the screened data
of the firm-specific variables of MFIs is merged with the macroeco-
nomic indicators of respective countries. As the panel is unbalanced with
respect to cross-sections of MFIs, the repeated macroeconomic observa-
tions are dropped in corresponds to the country and company-specific
values of MFIs. Imai et al. (2011) also use similar data management
practices. Our final data sample contains 406 MFIs with 2,229 firm-year
observations for the sample period ranging from 1999 to 2018. The sum-
mary of MFIs concerning age and type operating in the South Asian
countries is presented in Table 1. The majority of MFIs are mature and
belongs to non-bank financial institutions (NBFIs) and NGOs. For data
management and analysis, we use STATA-13 (licensed version).
Table 2 describes all variables consisted of dependent, explanatory
and control variables with its measurement. This study takes operating
self-sufficiency and returns of assets as the proxies of financial sustain-
ability (Ahlin et al., 2011; Lensink et al., 2018). In contrast, economic
indicators are taken as independent variables. With respect to firm-spe-
cific variables, we have added MFI size, taken as the natural log of total
assets in the model to control the firm difference. The difference in the
economy of South Asian countries, the MFIs are also differing in their
size. Therefore, the MFIs’ size selects as a firm-specific control variable.
Barry and Tacneng (2014) explained the positive effect of firm size on
MFIs’ performance; larger MFIs perform better because they have
enough resources to invest in the betterment of their clients. Moreover,
Table 3 presents the descriptive statistics of all the variables, consisting

5
  The sample of MFIs includes NGOs, rural and urban microfinance banks, non-bank
financial institutions (NBFIs), credit unions, cooperatives and others selected from
Afghanistan, Bangladesh, India, Nepal, Pakistan and Sri Lanka. The sample does not
include any of the MFI from Bhutan and Maldives because the data of these two countries
is not available in the MIX market database during the sample time period.
Table 1. Summary of MFIs in the South Asian Region

Age of MFIs Type of MFIs

Country Mature Young New Rural or Urban MFB CU/Coop. NBFI NGO Other Total
Afghanistan 4 0 4 1 1 3 1 2 8
Bangladesh 70 0 4 1 1 1 74 1 78
India 148 14 44 9 13 97 83 6 208
Nepal 41 2 1 14 14 1 14 1 44
Pakistan 32 2 4 9 0 6 28 0 43
Sri Lanka 18 2 4 1 1 14 8 1 25
Total 313 20 61 35 30 122 208 11 406
Source: Authors’ own calculations through STATA 13.
126 South Asian Journal of Macroeconomics and Public Finance 11(1)

Table 2. Description of Variables

Variables Symbol Description

Dependent variables
Financial sustainability
Operating self- OSS Operating revenue/(financial expense +
sufficiency loan loss provision expense + operating
expense)
Return of assets ROA Net operating income/total assets
Independent variables
Economic indicators
Economic growth GDP GDP growth (annual %)
Inflation INF Inflation, consumer prices (annual %)
Interest rate IR Real interest rate (%)
Human development HDI Human development index
index
Private credit PC Domestic credit to the private sector
(% GDP)
Foreign direct FDI Foreign direct investment, net inflows
investment (% GDP)
Labour force LFP Labour force participation rate, total (%
participation of total population ages 15+)
Firm-level control variable
MFI size lnSIZE Log of total assets
Source: Authors’ generated their own from data.

Table 3. Descriptive Statistics

Variables Obs. Mean Std Dev. Min. Max.

OSS 2,179 1.293 0.647 1.000 18.437
ROA 1,949 0.034 0.063 –1.083 2.089
GDP 2,179 6.358 2.084 0.120 21.021
INF 2,175 7.365 3.141 –8.283 30.555
IR 2,031 4.298 3.274 –10.246 14.319
PC 2,111 41.015 12.988 3.474 81.162
FDI 2,179 1.327 0.822 –0.098 4.319
LFP 2,179 59.404 9.627 50.622 86.033
HDI 2,179 0.568 0.062 0.408 0.770
lnSize 2,171 15.919 2.154 –0.693 22.635
Source: Authors’ calculation through STATA-13.

of six South Asian countries from 1999 to 2018, indicating that the South
Asian microfinance sector is sustainable enough to cover its total cost
because its mean value is greater than 1.
Memon et al. 127

Model Specification
A panel regression model is used to accomplish the objective of investi-
gating the economic impact on the financial sustainability of MFIs. The
general panel regression equation is expressed and given below:

Yit = b + | b ev EVit + cSIZE it + e it(1)

where Yit represents the proxies of financial sustainability of ith MFI

operating in South Asia at time t. EV indicates the vector of economic
variables like GDP growth, interest rate, inflation rate, human develop-
ment index, private credit, foreign direct investment and labour force
participation. Whereas the model contains MFIs’ size as a firm-specific
control variable to consider the cross-section variance because every
firm differs with respect to its size. While, β, bev and γ specify the coef-
ficients, and e is the error term.
Different researchers use different estimation techniques that best suit
their context of the study from the perspective of financial sustainability.
Previous studies used pooled ordinary least squares (OLS) with a ran-
dom effect model to identify the financial sustainability of MFIs (Ahlin
et al., 2011; Lensink et al., 2018). In contrast, Bibi et al. (2017) used the
Fixed Effects Vector Decomposition (FEVD) model to study the sustain-
ability of MFIs. Additionally, simple the OLS model (Quayes, 2012),
three-stage least squares (3SLS) (Imai et al., 2011), Logit model (Quayes,
2012), Probit model (Bayai & Ikhide, 2018) and the GMM model
(Mersland & Strom, 2010) have already employed to study the financial
sustainability. We consider fixed and random effect models and the
Hausman test to estimate the coefficients based on the literature.
Fixed and Random Effect Regression Model
The fixed and random effect models are panel regression models that
consist of both the cross-sectional and time-series data. Specifically, the
fixed-effect model permits the heterogeneity of the firm by permitting
each firm to have its intercept because every firm differs from each other.
Theoretically, the fixed-effect model is more suitable for estimating the
individual entity effect because every entity (firm or country) varies with
respect to its size, age, capital structure and policies (Gujarati & Porter,
2009). From Equation (1), the general form of the fixed-effect model
represents

Yit = b it + | b ev EVit + cSize it + e it(2)

128 South Asian Journal of Macroeconomics and Public Finance 11(1)

From Equation (2), the fixed-effect model for each proxy of financial
sustainability is given below:

OSS it = b 1i + b 2 GDPG it + b 3 INFit + b 4 IR it + b 5 PC it +

(3)
b 6 HDI it + b 7 FDI it + b 8 LFPit + c 1 Size it + e it

ROA it = b 1i + b 2 GDPG it + b 3 INFit + b 4 IR it + b 5 PC it +

(4)
b 6 HDI it + b 7 FDI it + b 8 LFPit + c 1 Size it + e it

In Equations (3) and (4) OSSit represents the operating self-sufficiency

and ROAit denotes the return on assets, used as a proxy of financial sus-
tainability of ith MFI operating in the South Asian region at time t. On
the right-side equation, b1i shows that each ith entity/firm has its inter-
cept and represents the vector of economic predictors and its coefficient.
Economic indicators include gross domestic product (GDP), interest rate
(IR), inflation rate (INF), human development index (HDI), private
credit (PC), foreign direct investment (FDI) and labour force participa-
tion (LFP), respectively. Firm size is included as a firm-specific control
variable in the model with c1 is the coefficient and eit is the error term.
Further, the description of all variables is reported in Table 2.
Despite the heterogeneity effect in the fixed-effect model, the inter-
cept is still time-invariant that does not change over time. In solution to
the time-invariant effect of each entity, the random effect model, also
known as the variance component model (VCM), considers the time
series variance of the model. Referring to the same fixed model, Equation
(2), the constant term b1i does not contain the ‘i’ subscript because it
treats as a random variable in the random effect model. Therefore, the
constant term for each firm expressed as

b 1i = b 1 + f i(5)

where εi is random error term with zero mean value and constant vari-
ance under normality assumption. The intercept b1 in the random model
shows that every firm has a common intercept, but now the individual
effect reflects in εi, instead of b1i in fixed effect model. The random
effect model specifies through substituting Equation (5) into Equation
(2), we obtain

Yit = b i + | b ev EVit + | cCVit + f i + e it(6)

Yit = b i + | b ev EVit + | cCVit + ~ it(7)

Memon et al. 129

where ~ it = f i + e it referred to as a composite error term, also known as

error component model (ECM) because it consists of both time-series
and cross-section error term in which it varies with the cross-section and
time. By following Equation (7), the random effect model for each proxy
of the dependent variable is given below:
OSS it = b 1 + b 2 GDPG it + b 3 INFit + b 4 IR it + b 5 PC it +
(8)
b 6 HDI it + b 7 FDI it + b 8 LFPit + c 1 Size it + ~ it

ROA it = b 1 + b 2 GDPG it + b 3 INFit + b 4 IR it + b 5 PC it +

(9)
b 6 HDI it + b 7 FDI it + b 8 LFPit + c 1 Size it + ~ it

Results and Discussions

The analysis begins with the correlation analysis to detect the multicol-
linearity between variables as there is always the danger of multicollin-
earity while dealing with a multivariate regression model. The
multicollinearity issue arises when there is a perfectly direct relationship
between explanatory variables. The problem of multicollinearity
increases the value of estimates when the variables are highly correlated
(Wooldridge, 2010). Moreover, this issue makes variables statistically
insignificant even when they are statistically significant in literature and
supported by theory (Wooldridge, 2010).
Table 4 presents the correlation matrix to identify the degree of cor-
relation between the variables. Kennedy (2003) suggested that the
threshold value of correlation analysis by which the value of correlation
coefficient equal to or greater than 0.8 is considered as the multicolline-
arity between two variables. Based on this rule of thumb, the degree of
correlation between any of the two variables in the correlation matrix is
below 0.8. So, there is no multicollinearity issue in each set of explana-
tory variables.
We then estimate the fixed and random effect model to analyse the
nexus between the financial sustainability of MFIs and economic varia-
bles. The Hausman test in the OSS and the ROA model is statistically
significant at 5% and 1%, respectively. Therefore, in both cases, we
reject the null hypothesis of random effect model is appropriate. It sig-
nals that the fixed effect model is the appropriate model to establish the
relationship between the financial sustainability of MFIs and economic
variables. Thus, the estimates of fixed-effect models for each proxy of
outcome variable along with the Hausman test are reported in Table 5.
Table 4. Correlation Summary

OSS ROA GDP INF IR PC FDI LFP HDI lnSize

OSS 1.000
ROA 0.645 1.000
GDP −0.030 −0.045 1.000
INF −0.071 −0.094 −0.003 1.000
IR 0.033 0.077 0.175 −0.401 1.000
PC −0.107 −0.138 0.468 0.221 −0.090 1.000
FDI −0.084 −0.072 0.370 0.233 0.171 0.518 1.000
LFP 0.041 −0.033 −0.259 −0.123 −0.385 0.027 −0.462 1.000
HDI −0.132 −0.140 0.332 0.139 −0.006 0.377 0.398 −0.462 1.000
lnSize −0.144 −0.081 0.032 0.090 0.082 0.075 0.145 −0.247 0.203 1.000
Source: Authors’ calculation through STATA-13.
Memon et al. 131

The fixed-effect model estimates in Table 5 indicate a positive and

significant impact of GDP growth on the OSS. In contrast, the coeffi-
cient of GDP growth is also positive in the ROA model, yet insignificant.
The results suggest that GDP growth increases the financial sustainabil-
ity of microfinance because it increases the financing and investment
activities in the economy and simultaneously reduces operating costs.
Thus, it increases the ability of MFIs to cover its cost. These results are
consistent with the previous studies (see Ahlin et al., 2011; Awaworyi,
2019; Hartarska & Nadolnyak, 2007).
Similarly, the ROA model results also exhibit a positive but insignifi-
cant effect of economic growth on the sustainability of MFIs. Whereas,
inflation has a significant negative impact on the OSS, which means that
the increase in inflation makes it difficult for MFIs to cover their finan-
cial and operating cost in an inflationary situation. We infer that high

Table 5. Fixed Effect Model Results

Dependent Variables: OSS and ROA

Variables OSS ROA
GDP 0.019c (0.0104) 0.001 (0.0010)
INF −0.014b (0.0166) 0.001 (0.0006)
IR 0.009 (0.0062) 0.003 (0.0006)
PC −0.001 (0.0047) −0.001b (0.0004)
FDI 0.024 (0.0298) −0.001 (0.0031)
LFP −0.044a (0.0171) 0.001 (0.0017)
HDI −0.103 (1.1475) 0.484a (0.1254)
lnSize −0.088a (0.0211) −0.008a (0.0027)
Constant 5.244a (1.3704) −0.165 (0.1403)
R-square Values
Within 0.023 0.018
Between 0.004 0.001
Overall 0.003 0.000
F-statistics 4.781a 3.260a
Hausman test
Chi-square 16.832b 30.341a
Source: Authors’ calculation through STATA-13.
Notes: The superscripts a, b and c denote the level of significance at 1%, 5% and 10%,
respectively.
The fixed and random effect coefficients and the Hausman test result are used to choose
the most appropriate model. Additionally, the table included R-squared within the cross-
section over time, between the cross-sections and overall panel. The f-statistics value
shows the overall model fit in the fixed-effect model, whereas the chi-square value is the
overall model fit in the random model.
Standard errors are recorded in parenthesis.
132 South Asian Journal of Macroeconomics and Public Finance 11(1)

inflation reduces the purchasing power of consumers indirectly and fur-

ther decelerates economic activities. As a result, it negatively affects the
financial sustainability of firms in general and MFIs in particular. Our
results are in line with the findings of Chernikova et al. (2018) and
D’Espallier (2013).
Concerning interest rate, it has an insignificant positive impact on the
OSS and the ROA, which shows that the interest rate is not a macroeco-
nomic driving factor for the financial sustainability of MFIs in the South
Asian perspective. The reason could be the intense poverty in the region;
borrowers must require a loan to meet their basic needs. The findings of
Nwachukwu (2014) are also consistent with these estimates. However,
private credit is negatively associated with profitability and sustainabil-
ity, yet it is insignificant for the OSS of MFIs. These results are in line
with the study of Imai et al. (2011), Ahlin et al. (2011) and Xu et al.
(2016). For the FDI, the results indicate a positive and negative impact
of FDI on OSS and ROA, respectively; however, it is insignificant in
both cases. Such a weak connection between FDI and the financial sus-
tainability of MFIs indicates that the South Asian microfinance sector is
an unattractive investment opportunity. Besides, foreign investors might
be reluctant to invest in this sector because the default risk in the micro-
finance sector is relatively high due to low collaterals. The overall results
are inconsistent with the previous studies conducted from a global per-
spective by Ahlin et al. (2011), Vanroose (2007), D’espallier (2013) and
Xu et al. (2016).
Finally, we find that both HDI and LFP have a positive (negative)
relationship with ROA (OSS). It implies that the increase in the labour
force participation makes the labour market more energetic, reducing the
growth opportunities for MFIs. These findings are consistent with Ahlin
et al. (2011) and Awaworyi (2019). Whereas, the positive and significant
connection of HDI with ROA indicates that human development in any
direction, that is, education, skill development, per capita income, life
expectancy, will positively impact the profitability of MFIs in South
Asia. These results are relatively consistent with the findings of Lensink
et al. (2018).

Robustness Checks
For robustness, we employed instruments based 2SLS model, proposed
by Lewbel (2012) to deal with endogeneity in the model. The main rea-
son behind using 2SLS is to confirm the overall endogeneity of the
Memon et al. 133

model and deal with endogeneity through instrument variables. Literature

argued that there are more chances of endogeneity when dealing with
economic data. This model also helps identify the quality of instruments
in the model; that is why we prefer 2SLS to estimate the coefficient. The
endogeneity issue ascends when the independent variable correlates with
the error term of the model (Lewbel, 2012). Mainly, the endogeneity
issue arises due to reverse causality, sample selection, measurement
error such as omitted variables and functional form misspecification
(Imai et al., 2011). To resolve the endogeneity, this study uses the instru-
ment variables based on the literature and correlation matrix (Imai et al.,
2011), taking the lagged value of endogenous variables (Mileva, 2007).
In addition, the Wu-Hausman and Durbin Watson score tests are con-
ducted to identify the endogeneity in the model after applying the 2SLS
model.
Imai et al. (2011) suggested that the GDP and the HDI can endoge-
nously impact the model of MFIs sustainability. The correlation between
the explanatory variables and model error term found that the GDP and
the HDI are highly correlated with the error term; hence, the model faces
an endogeneity problem. Therefore, we assumed that the GDP and the
HDI work as an endogenous variable in the model, and an instrumental
variable is required that must correlate with the endogenous variable and
not with the error term. Mileva (2007) suggested that we can use the lag
value of the endogenous variable as an instrument. Therefore, we have
taken lag of the GDP and the HDI as an instrument variable, also sup-
ported by Awaworyi (2019). After estimating the coefficients through
2SLS, we have tested the endogeneity in the overall model of instrument
variable and quality.
The estimated results of the 2SLS regression model, endogeneity test
and quality of instrument variables are given in Table 6. The Durbin
score and Wu-Hausman score were employed to test the endogeneity
problem. Both endogeneity tests suggested that variables are exogenous
in the OSS model that fails to reject the null hypothesis of exogenous
variables. However, the ROA model contains the endogeneity issue
because the Durbin score and Wu-Hausman scores are statistically sig-
nificant, and it does reject the null hypothesis that variables are exoge-
nous. It shows that the 2SLS estimates are true in the ROA model because
it contains endogeneity. Hence, we have discussed the ROA coefficients
only. Additionally, the test of the instrument variables predicts the qual-
ity of the instruments. The results suggested that variables are not weak,
rejecting the null hypothesis of variables as the minimum eigenvalue is
greater than the significant coefficient value.
134 South Asian Journal of Macroeconomics and Public Finance 11(1)

Table 6. Two-stage Least Squares (2SLS) Regression Summary

Variable OSS ROA

GDP −0.0002 (0.0305) −0.0045b (0.0020)
INF −0.0068 (0.2963) −0.0012a (0.0193)
IR 0.0019 (0.0059) 0.0002 (0.0003)
PC −0.0028 (0.0054) 0.0001 (0.0001)
FDI −0.0087 (0.0027) −0.0022 (0.0018)
LFP −0.0049c (0.0231) −0.0011a (0.0015)
HDI −1.0383a (0.0030) −0.0990a (0.0019)
lnSize −0.0297a (0.0068) −0.0009c (0.0004)
Constant 2.8236a (0.3466) 0.2044a (0.0226)
R-square 0.0443 0.0380
Chi-square 68.02a 122.14a
Observations 1454 1448
Durbin score 3.8029 7.76229b
Wu-Hausman score 1.8920 3.87242b
Eigen value 58.8153b 57.6609b
Source: Authors’ calculation through STATA-13.
Notes: The superscripts a, b and c denotes the level of significance at 1%, 5% and 10%,
respectively.
Standard errors are recorded in parenthesis.

The 2SLS regression model results for ROA report a significant nega-
tive association of GDP and INF with ROA. Such results for GDP imply
that economic growth negatively impacts the profitability of MFIs. Thus,
we need a further counter check on this empirical nexus between GDP
and ROA. However, the negative association of inflation with the profit-
ability of MFIs is consistent with the study of Chernikova et al. (2018).
The LFP and HDI also significantly and negatively impact ROA, and
these results also contradict the fixed-effect panel regression. However,
the negative impact of HDI on the profitability of MFIs is possible
because most MFIs are NBFIs and NGOs whose mission is not to earn
excessive profits; instead, they target socio-economic development.
In addition to that, we have also employed the dynamic panel model
System Generalized Method of Moments proposed by Arellano and
Bover (1995) and Blundell and Bond (1998) to deal with the unbalanced
panel bias and the potential endogeneity of explanatory variables. The
system GMM yields more consistent and efficient parameter estimates
as compared to panel OLS regression. This model is quite flexible con-
cerning the exogeneity of independent variables. The independent vari-
ables that are not necessary to be exogenous are correlated to the current
Memon et al. 135

and past errors. There is quite a fair chance of autocorrelation and hetero-
scedasticity within the individual groups (Roodman, 2009). This model
is relatively superior to the other dynamic panel mode in terms of flexi-
bility and reliability of results. Therefore, it is one of the frequently used
dynamic panel models to deal with the endogeneity and over-identifica-
tion of independent repressors.
The one-step system GMM of Blundell and Bond (1998) models the
unobserved cross-sectional effects correlated with the lagged dependent
variables. Although the two-step system GMM estimates are considered
more superior to the one-step system GMM, this marginal efficiency
gain is offset by the asymptotic standard errors in the two-step system
GMM, biased downward fine sample (Blundell and Bond, 1998;
Hoeffler, 2002). Thus, we have employed a one-step system GMM
model for both dependent variables (OSS and ROA), and results are pre-
sented in Table 7. For model (1), the lag value of OSS, economic growth,

Table 7. System GMM Model Summary

Dependent Variables: OSS and ROA

(1) (2)
Variables OSS ROA
OSS (−1) 0.411a (0.019) –
ROA (−1) – 0.165c (0.099)
GDP 0.014c (0.008) 0.001 (0.001)
GDP (−1) −0.006 (0.009) −0.001c (0.001)
INF 0.006 (0.008) −0.002a (0.001)
IR 0.008c (0.004) 0.001 (0.000)
PC −0.006 (0.005) −0.001 (0.000)
FDI 0.069c (0.041) 0.003 (0.003)
LFP −0.011 (0.014) −0.002 (0.002)
HDI 8.107 (6.394) 0.348 (0.364)
HDI (−1) −5.806 (5.941) −0.458 (0.323)
SIZE −0.058c (0.032) −0.002 (0.004)
Constant 0.972 (1.485) 0.292c (0.155)
No. of observations 1454 1277
Instruments 181 181
Groups 324 291
AR(2) 0.942 −0.91924
Source: Authors’ calculation through STATA-13.
Notes: (−1) represent the lag term of corresponding variables.
Heteroscedasticity consistent robust standard errors are in parentheses.
The superscripts a and c denotes the level of significance at 1% and 10%, respectively.
Standard errors are recorded in parenthesis.
136 South Asian Journal of Macroeconomics and Public Finance 11(1)

interest rate, and foreign direct investment has significant positive. In

contrast, the size of the MFI has a significant negative connection with
the financial sustainability of the MFIs. The rest of the macroeconomic
variables are not showing any significant relationship with the OSS. The
lag values of instrument variables (GDP and HDI) are also insignificant
in relation to OSS.
The system GMM model results for OSS are relatively consistent
with the fixed-effect model in terms of significance and direction except
for inflation and HDI. These discrepancies in the estimated coefficients
are quite likely to happen due to the differences in model specifications.
However, we would suggest considering the system GMM estimates
more reliable because it is superior to the former. Similarly, the system
GMM estimates of the model (2) also exhibit consistent results with the
fixed-effect model estimates. Only the HDI coefficient is inconsistent at
level, yet the directive connection of the lag value of HDI is in line with
the estimates of the fixed-effect model. The consistency of system GMM
estimation depends on one assumption that the error term does not have
a serial correlation. Thus, the insignificant values of AR (2) for both
models show no sign of serial correlation of the first-differenced error at
order 2.

Conclusion
This research tries to unearth the empirical connection between the
financial sustainability of MFIs and macroeconomic and firm-specific
indicators for South Asia by using unbalanced panel data of 406 MFIs
operating in South Asian countries. In terms of multidimensional pov-
erty, South Asia accounts for the highest share of poor people between
2010 and 2017 (Finnigan, 2019). Apart from that, there are many other
persistent socio-economic issues such as education, health, women
empowerment and human development that need to be addressed seri-
ously. Given that, the mission of MFIs is to be consistent in dealing with
these issues. Therefore, it is important to analyse the financial sustaina-
bility of MFIs in connection to macroeconomic indicators for South
Asian countries.
Based on the Hausman test statistic, we have employed a fixed effect
panel regression model in this study. For robustness, we have employed
a two-stage least square (2SLS) regression model and System Generalized
Methods of Moment (GMM) to deal with the endogeneity issue because
Memon et al. 137

the system GMM model is superior to the former, and the estimates of
this model got an efficiency advantage. The system GMM estimator pre-
dicts that economic growth, interest rate and foreign direct investment
has a significant and positive relationship with OSS. In contrast, the size
of the firm has a significant and negative relationship with the OSS. The
rest of the macroeconomic variables are not showing any significant
relationship with the OSS. The lag values of instrument variables (GDP
and HDI) are also insignificant in relation to OSS. With respect to ROA,
the results indicate that higher economic growth, inflation, labour force
participation and human development reduce the profitability of MFIs.
This study also found little variation in the South Asian perspective com-
pared to global analysis that was previously conducted in the literature
(Ahlin et al., 2011; Imai et al., 2011).
The results provide enough reasons for the policy department of
South Asian countries to ensure the financial sustainability of MFIs that
directly address poverty, women empowerment, financial inclusion and
other aspects of socio-economic development. South Asian countries can
quickly overcome these challenges by focusing on sustainable economic
growth powered by foreign direct investment and maintaining a moder-
ate inflation level. However, the results suggest that central banks of
respective South Asian countries need to increase the interest rate to
make small MFIs financially sustainable. Based on GMM estimates,
governments should focus heavily on human development to ultimately
achieve efficiency in complex business settings.

Acknowledgements
We are thankful to each and every researcher involved in the development and
writeup of this article and the research behind it; without their direct and indirect
support, it would not have been possible. We are genuinely thankful to our
reviewers who put their sincere efforts into increasing the quality of the research
paper through continuous reviews and feedback.

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research,
authorship and/or publication of this article.

Funding
The authors received no financial support for the research, authorship and/or
publication of this article.
138 South Asian Journal of Macroeconomics and Public Finance 11(1)

ORCID iDs
Ainan Memon https://orcid.org/0000-0003-4115-501X
Waqar Akram https://orcid.org/0000-0002-3003-0062
Ghulam Abbas https://orcid.org/0000-0002-6675-2454
Sultan Adeel https://orcid.org/0000-0002-1100-5857

Appendix A

Figure A1. The Trend of South Asian MFIs Sustainability (OSS)

Source: MIX market database.

Figure A2. Financial Sustainability of the Microfinance Sector in South Asian

Countries
Source: MIX market database.
Memon et al. 139

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