Efficiency & Productivity Indicators
Efficiency and productivity indicators give an indication of how well an institution performs operationally. Productivity indicators reflect the amount of output per unit of input, while efficiency indicators also take into account the cost of the inputs and/or the price of outputs. Since these indicators are not easily manipulated, they are more readily comparable across institutions than profitability indicators such as Return on Equity and Return on Assets, for example. On the other hand, productivity and efficiency measures are less comprehensive indicators of performance than those of profitability.
Microfinance institutions have much lower rates of efficiency than commercial banks because on a dollar per dollar basis, microcredit is highly labor intensive: a hundred-dollar loan in a microfinance institution requires about as much administrative effort as a loan that is a thousand times larger in a commercial bank.
In this blog we will look at Operating Expense Ratio and how it can contribute towards defining the overall quality of the portfolio.
Operating Expense Ratio
This ratio provides the best indicator of the overall efficiency of a lending institution. For this reason, the ratio is also referred to as the Efficiency Ratio, measuring the institutional cost of delivering loan services compared to the average loan size of its portfolio. Therefore, a general rule is the lower the Operating Expense Ratio, the higher the efficiency.
This is an important ratio because it can be internally managed and is critical for the banks survival in competitive markets. If the MFI has high operating costs, margins will be affected making it increasingly difficult to compete on price.
Portfolio size, loan size, credit methodology and market prices can help put efficiency levels into context. Portfolio size matters, but the benefit of economies of scale from portfolio size rapidly diminishes in importance once the portfolio size of an institution exceeds US$ 5 million. Small MFIs can therefore become more efficient simply by growing, while larger institutions must resort to other measures.
Another factor to consider is the difference between largely rural operations and urban microcredit programs. The operating expenses of rural microlenders tend to be much higher since their clientele is more widely dispersed and therefore more expensive to reach. Operating costs are also strongly correlated to salary levels, as is to be expected in a highly labor-intensive industry. It is important to distinguish between cases where an MFI underpays its staff and where it simply operates in a low-cost environment.
The Operating Expense Ratio for MFIs is similar to the Efficiency Ratio or Cost/Income ratio used by the traditional banking sector to determine how efficiently the bank uses its assets and liabilities within internal operations related to the loan portfolio.
In the next blog we will look at Cost per Borrower Ratio and how it impacts the overall efficiency and productivity of a MFI.