The effect of financial development and MFI's characteristics on the efficiency and sustainability of micro financial institutions

Ma a, Má io Nuno; Shah, Sadaqa Hussain; Sohail, Nida; Co ei a, Anabela Ba is a A icle The e ec o inancial de elopmen and MFI's cha ac e is ics on he e iciency and sus ainabili y o mic o inancial ins i u ions Economies P o ided in Coope a ion wi h: MDPI – Mul idisciplina y Digi al Publishing Ins i u e, Basel Sugges ed Ci a ion: Ma a, Má io Nuno; Shah, Sadaqa Hussain; Sohail, Nida; Co ei a, Anabela Ba is a (2023) : The e ec o inancial de elopmen and MFI's cha ac e is ics on he e iciency and sus ainabili y o mic o inancial ins i u ions, Economies, ISSN 2227-7099, MDPI, Basel, Vol. 11, Iss. 3, pp. 1-16, h ps://doi.o g/10.3390/economies11030078 This Ve sion is a ailable a : h ps://hdl.handle.ne /10419/328703 S anda d-Nu zungsbedingungen: Die Dokumen e au EconS o dü en zu eigenen wissenscha lichen Zwecken und zum P i a geb auch gespeiche und kopie we den. 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This a icle is an open access a icle dis ibu ed unde he e ms and condi ions o he C ea i e Commons A ibu ion (CC BY) license (h ps:// c ea i ecommons.o g/licenses/by/ 4.0/). economies A icle The E ec o Financial De elopmen and MFI’s Cha ac e is ics on he E iciency and Sus ainabili y o Mic o Financial Ins i u ions Má io Nuno Ma a 1, Sayyed Sadaqa Hussain Shah 2,* , Nida Sohail 2and Anabela Ba is a Co ei a 1,* 1ISCAL-Ins i u o Supe io de Con abilidade e Adminis ação de Lisboa, Ins i u o Poli écnico de Lisboa, A enida Miguel Bomba da 20, 1069-035 Lisbon, Po ugal 2Facul y o A s and Social Science, Depa men o Comme ce and Finance, Go e nmen College Uni e si y Laho e, Laho e 54000, Pakis an *Co espondence: [email p o ec ed] (S.S.H.S.); [email p o ec ed] (A.B.C.); Tel.: +92-333-445-3189 (S.S.H.S.) Abs ac : The Mic o Financial Ins i u ions (MFIs) ha e been ou ed as de elopmen s a egies o Eme ging Ma ke s and De eloping Economies (EMDEs) which me i s esea ch in o he e ec o inancial de elopmen on he e iciency and sus ainabili y o he MFIs. The E icien and sus ain- able MFIs signi ican ly pa ed he way o he economic de elopmen o a coun y pa icula ly in de eloping coun ies. Su p isingly he e a e e y a e s udies ha examine he nexus o inancial de elopmen , MFIs e iciency, and sus ainabili y. Also, hese s udies a e con ined o he impac o inancial de elopmen ei he on he e iciency o sus ainabili y o MFIs. Add essing his gap, he s udy a emp s o explo e he coun y-speci ic and MFIs-speci ic ac o s which signi ican ly a ec he e iciency and sus ainabili y o he MFIs. Fo his pu pose, he s udy i s de e mines whe he inancial de elopmen con ibu es o he e iciency and sus ainabili y o MFI. Secondly, he e ec o MFIs’ speci ic cha ac e is ics such as c edi isk, ma ke isk, liquidi y isk, lending s a egy, De elop- men Financial Ins i u ions (DFIs) unds managemen , inancial ou each, and po e y alle ia ion on he e iciency and sus ainabili y o MFIs. The s udy has been conduc ed o Bangladesh, India, and Pakis an consis ing o a panel da a se o 12 MFIs o e a pe iod spanning om 2008–2018 using S ochas ic F on ie Analysis and Cobb Douglas p oduc ion unc ion eg ession analysis. O e all empi ical analysis e eals ha inancial de elopmen has signi ican ly a ec ed he e iciency and sus ainabili y o he MFIs. While speci ic cha ac e is ics such as po e y alle ia ion and DFIs unds managemen ha e been shown o imp o e MFIs e iciency whe eas an inc ease in c edi isk, lending s a egy, and ma ke isk dec ease MFIs sus ainabili y and liquidi y isk along wi h an inc ease in inancial ou each leads o a dec ease in MFIs e iciency. The di ec ions and magni udes o he indings sugges he s akeholde s o all h ee coun ies o he signi ican di ec ion leads o he e iciency and sus ainabili y o MFIs. Mo eo e , u u e esea ch could s i e o unde s and he aspec s o inancial de elopmen which nega i ely co ela e wi h he MFIs’ e iciency and sus ainabili y such as s ingen ax policies, c edi o igh s p o ec ion, and implemen a ion o ules and egula ions. Keywo ds: Mic o Financial Ins i u ions; Eme ging Ma ke s and De eloping Economies; sus ain- abili y; De elopmen Financial Ins i u ions; S ochas ic F on ie Analysis; Cobb Douglas p oduc ion unc ion; ma ke isk 1. In oduc ion The Global Financial Sys em wi h i s as and in e connec ed inancial ins i u ions cons i u ing cen al banks, comme cial banks, insu ance co po a ions, in es men compa- nies, capi al ma ke s, money ma ke s, and inance minis ies holds immense impo ance in he inancial s abili y o he wo ld economy h ough managing public money being c ea ed Economies 2023,11, 78. h ps://doi.o g/10.3390/economies11030078 h ps://www.mdpi.com/jou nal/economies Economies 2023,11, 78 2 o 16 by economic sec o s ensu ing i s’ sui able use o bene icial objec i es p omo ing he ex- pansion o economic ac i i y (Khawja 2013). Howe e , inancial de elopmen de ined as ensu ing c edi o ’s igh s p o ec ion, educing agency- ela ed cos s, alle ia ing imbalance in in o ma ion, easing in o ma ion accessibili y, imp o ing inancial ins i u ion quali y, commi men o accoun ing policies, and inancial disclosu e anspa ency has p ima ily been concen a ed in de eloped economies (Lei e al. 2018). The non-p e alence o inancial de elopmen in he Eme ging Ma ke s and De el- oping Economies (EMDEs) has esul ed in he inancial exclusion o he 1.7 billion wo ld popula ion om he o mal inancial sec o de ined as he inabili y o ce ain popula ion segmen s om a ailing inances due o hei socioeconomic ci cums ances and he chal- lenges hey ha e in mee ing he equi emen s o con en ional inancial ins i u ions, hei in ol emen in he inancial sec o is es ic ed (Demi guc-Kun e al. 2017). De elopmen Financial Ins i u ions (DFIs) p ima ily unc ion o p o ide capi al o economic de elop- men p ojec s se ing as d i e s o indus ializa ion which necessi a es hei p esence o economic g ow h. Mic o Financial Ins i u ions (MFIs) se ices a e an ex ension o DFIs op- e a ing o he p o ision o inancial se ices o he Mic o, Small, and Medium En e p ises (MSMEs) which o m an in eg al pa o he de eloping economies (PIDE 2021). As a esul o he ini ia i e aken by Muhammad Yunus o Bangladesh in he 1970s in he o m o G ameen Bank o mains eam he ma ginalized sec o s o he economy by p o iding inancial se ices ailo ed o he c edi needs o he poo , he wo ld’s i s mic o- inance ins i u ion wi h he dual unc ionali y o social and inancial inclusion eme ged MSMEs (Mainsah e al. 2004). The only objec i e o es ablishing MFIs was o comba he in o mal in e media ion impeding he economic de elopmen o MSMEs, a signi ican economic sec o in he Eme ging Ma ke s and De eloping Economies (EMDEs) (IBRD IDA 2022). Lack o conside able colla e al, bo owe quali y e alua ion, and high expenses associa ed wi h p ocessing small loans ha e ende ed MFIs he only sou ce o g an ing mic oloans o bo owe s wi hou colla e al and c edi checks, making i di icul o emo e c edi es ic ions on low-income MSMEs (Wo ld Bank 2015). T adi ional inancial ins i u ions a e highly egula ed due o hei i al ole in he inancial s abili y o a na ion. The e o e, MFIs ha aim o inc ease inancial inclusion while con ibu ing o po e y alle ia ion mus demons a e inancial sus ainabili y and p o i abili y in hei po olio quali y (Basha a e al. 2014;Falcone 2018). The issue o shadow banking has led o he inancial exclusion o MSMEs in eme ging ma ke s and g owing coun ies such as India, Pakis an, and Bangladesh. Howe e , MSMEs ha ha e he po en ial o con ibu e o economic g ow h need inancial suppo , and MFIs se e he goal o in eg a ing impo e ished households and MSMEs in o he inancial sec o , con ibu ing o he de elopmen o he inancial sec o (Falcone 2020;Jassim and Khawa 2018;Wu 2022). To gene a e insigh s o he MFIs, i is necessa y o in es iga e he cause-and-e ec ela ionship be ween inancial de elopmen and he sus ainabili y and e icacy o he mi- c o inance sec o o he MFIs’ mission o b oadening inancial in eg a ion h ough po e y alle ia ion and expanding he each o an economy’s inancial sec o . The E icien and sus ainable MFIs signi ican ly pa ed he way o he economic de elopmen o a coun y pa icula ly in de eloping coun ies (Ba 2004). Bu mos o policymake s and schola s conduc sepa a e con e sa ions abou inancial de elopmen and mic o inance (Ba 2004). While inancial de elopmen and MFIs a e insepa able ha guide he s akeholde s o de ise he policyholde o subs an ial u u e inancial de elopmen goals. Fo b idging he gap o hese unno iced phenomena, he s udy a emp s o e alua e he e ec o inancial de el- opmen on he e iciency and sus ainabili y o mic o- inancial ins i u ions. Also, his s udy inco po a ed MFI-speci ic cha ac e is ics such as inancial ou each, po e y alle ia ion, lending s a egy, and DFIs’ unding managemen o o inancial isks such as ma ke isk, c edi isk, and liquidi y isk on he e iciency and sus ainabili y o MFIs o iden i y he signi ican g ass oo ac o s ha lead o economics p og ess. Economies 2023,11, 78 3 o 16 2. Li e a u e Re iew Financial sec o de elopmen assessed on ou key dimensions o size, access, e i- ciency, and sus ainabili y ocusing on inc easing inclusi eness in he inancial sys ems while imp o ing access o inancial se ices o he unde se ed alida es he ole o MFIs in elimina ing he cons ain s o g ow h o MSMEs (Wo ld Bank 2009). Financial in eg a ion o he shadow banking sec o can assis he inancial sec o in he managemen o liquidi y, ma u i y, and c edi isk he eby imp o ing he inancial sys em s abili y o Eme ging Ma ke s and De eloping Economies (EMDEs) (Ghosh e al. 2012). Financial de elopmen leads o a educ ion in liquidi y isk, p o ec ing c edi o igh s and acili a ing possession o colla e al in case o de aul allowing in angibles such as pa en s o be pledged as colla e al o secu ing inancial bo owing (Lei e al. 2018). The impo ance o mic o inance in eaping he bene i s o an inclusi e inancial sys em has been implemen ed in Islamic inance h ough he inno a ion o Islamic mic o inance cu ency encou aging inancial s abili y while c ea ing a communi y o Islamic mic o i- nance p o ide s, pa icipa ing me chan s, Zaka and Waq ins i u ions p o iding capi al assis ance o allow ecipien s in achie ing po e y educ ion and become Zaka paye in he u u e (Rozzani e al. 2015). The heo y o economic g ow h pos ula es he G ow h Model o analyze he e ec o changes in echnological p og ess modeled as p oduc ion unc ion augmen a ion on he le el o ou pu Y in a p oduc ion unc ion o e ime. Capi al augmen a ion includes e iciency pa ame e s in he p oduc ion unc ion h ough mul i- plica ion by Capi al K and can be used o assess he e ec o changes in echnological ac o s such as inancial de elopmen on he p oduc i i y o he inpu s in he p oduc ion o ou pu (Mankiw 2012). Taking his in o accoun , i seems possible o o mula e he ollowing hypo heses: Hypo heses 1 (H1). Financial de elopmen leads o a dec ease in he echnical e iciency o he MFIs. Hypo heses 2 (H2). Financial de elopmen esul s in he de e io a ion o he sus ainabili y o MFIs. The uniqueness o mic o inance in ul illing social objec i es as well as con ibu ing o inancial de elopmen h ough se ing p oduc i e sec o s o he economy domina ed by MSMEs in de eloping economies has shown o be a ec ed by he na ional income and de elopmen s age o he coun y (Maksudo a 2010). The impac o he inancial c isis o 2008 ac oss di e en owne ship ypes o MFIs showed ha mic o inance banks showed a p oduc i i y d op due o a decline in echnology, NBFIs showed dec eased p oduc i i y due decline in echnology and ine iciency, coope a i es showed dec eased p oduc i i y due o a educ ion in e iciency and inno a ion while among all he owne ship ypes, NGOs showed he lowes p oduc i i y decline (Wijesi i 2016). The e ec o inancial de elopmen in e ms o MFI owne ship ansi ion om s a e-owned o p i a ely owned banks on he p o i and cos e iciency o MFIs showed be e in e nal echnical e iciency as well as alloca i e e iciency o p i a ely owned MFIs along wi h e o ms such as lis ing on s ock exchanges and mac oeconomic condi ions such as g ow h a e and GDP pe capi a (Mu a indwa e al. 2021). Economic g ow h indica i e o he de eloped inancial sec o inc eases demand o c edi due o he expansion o p o i able oppo uni ies o mic oen e p ises allowing MFIs o cha ge highe in e es a es he eby lowe ing he cos o unds along wi h bols e ing inancial sus ainabili y h ough educing de aul as P i a e C edi o GDP is nega i ely associa ed wi h Po olio a Risk o mo e han 30 days (PAR-30) which is a majo indica o o MFIs’ sus ainabili y (Ahlin e al. 2011). Recen inancial de elopmen s in mic o inance such as inc easing compe i ion, comme cializa ion, echnological ad ancemen , inancial libe aliza ion, and egula ion policies o go e nmen ha e esul ed in inc easing ocus on he inancial sus ainabili y o he MFIs o educe he cos o lending money and co e Economies 2023,11, 78 4 o 16 i om he ou s anding loan po olio (He mes and Lensink 2011). Compliance wi h p uden ial egula ions and supe ision can be especially cos ly o MFIs equaling 12–13% o hei non-in e es paymen s as MFI supe ision has a causal e ec on he ade-o be ween p o i abili y and ou each wi h p o i -o ien ed MFIs acing p uden ial supe ision esponding h ough cu ailing hei ou each (Cull e al. 2011). The ollowing hypo hesis is as ollows: Hypo heses 3 (H3). MFIs’ sus ainabili y is a ec ed by he ma ke isk a ising om he ex en o inancial de elopmen in he economy. The in e sec ion o mic o inance a h ee poin s ende s MFIs iable as a de elopmen s a egy wi h i s ly he p ima y pu pose se ed by MFIs being po e y alle ia ion, sec- ondly p o iding in e media ion channels o inancial inclusion and hi dly egula ing MFIs ha ing access o capi al ma ke s and aking deposi s o ensu e an inc ease in he inancial ou each (O e o 1999). P o i -o ien ed MFIs ha e been shown o ope a e e icien ly se ing mo e app op ia e loan p ices due o being able o easily access in es men in o he sec o ega dless o ‘Mission D i ’ conce ns o ading-o social impac o inancial pe o mance while no - o -p o i o ganiza ions ha e been assumed o be insula ed om compe i i e p essu es and hence p one o ine iciencies (Robe s 2013). The success o MFIs in a coun y is de e mined by he incumben go e nmen ’s poli ical ideology as inancial inclusion o he poo ly ecei ed a en ion in he poli ical agendas o go e nmen s in de- eloping economies while MFIs unde igh -wing go e nmen s o cen is egimes ha e highe e iciency han MFIs ope a ing unde le -wing go e nmen s due o go e nmen in e en ion o cing cha ging o lowe in e es a es on loans (Gul e al. 2017). MFIs’ ou each is nega i ely co ela ed wi h hei e iciency, and MFIs wi h a lowe a e age loan balance, which is a measu e o he dep h o ou each, and mo e women bo owe s, which is a measu e o he b ead h o ou each, a e less e icien , indica ing ha MFIs s i ing o e iciency while egis e ing dec eased ou each o he poo led o g ea e po e y educ ion (He mes e al. 2011). One o he main unc ions o MFIs is he p o ision o inancial se ices o he excluded segmen s o he economy measu ed as inancial ou each and MFIs pu suing highe le els o ou each can be achie ed h ough an inc ease in o al asse s and he numbe o ac i e bo owe s (Liña es-Zega a and Wilson 2018). The s eng h o co po a e go e nance is conside ed a majo de e minan o MFI e iciency a e indeb edness as he e iciency o he Boa d o Di ec o s in i s moni o ing and ad ising oles is posi i ely associa ed wi h i s independence, boa d expe ise, audi commi ee, and sepa a ion o CEO and Chai man while i is nega i ely associa ed wi h he size o he boa d (Tchuigoua 2015). Taking his in o he accoun , i seems possible o o mula e he ollowing hypo hesis: Hypo heses 4 (H4). MFIs’ objec i es o po e y alle ia ion and imp o ing he ou each o he inancial sec o a ec MFIs’ e iciency. The analysis o he impac o mic o inance on he MSMEs as compa ed o o he sou ces o c edi such as bank loans and in o mal c edi showed ha mic o inance loans ha e he ad an age o mee ing he wo king capi al expendi u e o MSMEs which aises he issue o he ‘Financial sys ems’ app oach s essing MFIs o imp o e ope a ional sel -su iciency s. ‘Po e y lending’ app oach ocusing on po e y e adica ion h ough subsidized c edi on low-in e es a es (He mes and Lensink 2011). The impo ance o Comp ehensi e G oup T aining in mic o inance can be assessed h ough Mic o inance Clien Awa eness Index used o gauge he inancial li e acy o he cus ome s o MFIs which allows esponden s o sco e hei unde s anding o se ices being a ailed om he MFI. (Kal a e al. 2015). The di e si ica ion o MFIs’ e enue sou ces deals wi h high ope a ional cos s as- socia ed wi h smalle loans; howe e , di e si ied MFIs may ha e o deal wi h moni- o ing di icul ies and ope a ional ine iciencies while MFIs employing g oup lending s a egy show imp o ed ope a ional sus ainabili y al hough egula ion nega i ely a ec s Economies 2023,11, 78 5 o 16 sus ainabili y (Zamo e 2018). Social capi al is a o ably connec ed wi h Eu opean MFIs’ epaymen , p o i abili y, ou each, and e icacy. h ough lowe ing c edi isk while inc eas- ing inancial pe o mance and social ou each as he in ensi y o social capi al inc eases ( Chmelíko áe al. 2018 ). The adeo be ween he mic o inance ins i u ionalis app oach o sus ainabili y and wel a is app oach o ou each s esses app op ia e lending s a egy along wi h op imum loan amoun maximizing e iciency o he h ee loan echniques o indi idual lending, g oup lending, and illage banking, o a combina ion o he h ee loan me hods (Widia o e al. 2017). Taking his in o conside a ion, i seems possible o o mula e he ollowing hypo hesis: Hypo heses 5 (H5). C edi isk a ising om MFIs’ lending s a egy a ec s he sus ainabili y o MFIs. In e na ional ins i u ions’ unding Sou h Asian MFIs emphasize he social objec i e o high ope a ional cos s o loan gene a ion hu he b ead h and dep h o ou each, while he b ead h o ou each has a posi i e co ela ion wi h pe o mance de e minan s o MFIs and dep h o ou each has a nega i e associa ion wi h pe o mance de e minan s o MFIs ( Bibi e al. 2013 ). The p o ision o inancial se ices o he mic o-en e p ises equi es subsidies o inancial e iciency as e icien MFIs show be e pe o mance han comme cial banks in po olio quali y acili a ing he a e o loan eco e y by inc easing inancial li e acy and g oup moni o ing (Ko eos and Randhawa 2004). MFIs’ ans o ma ion om NGOs in o sha eholde -owned inancial ins i u ions o independence om dono s and gaining access o comme cial unding caused an a e age educ ion in ope a ional cos s and ola ili y in unding cos s while o e all p o i s dec eased due o en o cing compliance on egula ions imposing s ic e isk managemen (D’Espallie e al. 2017). The business model o MFIs is ca ego ized as p o i -o ien ed and sel -sus aining busi- nesses o subsidized and no - o -p o i o ganiza ions choosing be ween maximizing hei inancial e enue o yield which again can be seg ega ed in o ou pu ha maximizes a e - age loan size o ou pu ha maximizes he numbe o loans (Bos and Millone 2015). The social cos o subsidies g an ed o MFIs, as measu ed by he Subsidy Dependen Index, is an inpu o subsidized MFIs, whe eas ou each is he social ou pu , as measu ed by he Ou each Index. The inancial sus ainabili y o MFIs imp o es h ough lea ning by doing, which makes ma u e MFIs inancially e icien (Wijesi i e al. 2017). The ecen de- elopmen s in mic o inance such as inc easing comme cializa ion, he decline in subsidies, and he in ensi ica ion o global compe i ion ha e c ea ed an unce ain en i onmen in he mic o inance indus y wi h he MFI size a iable ha ing a nega i e and signi ican ela ionship wi h he social e iciency as compa ed o inancial e iciency (Fall e al. 2018). The mic o inance sec o o de eloping economies is exposed o h ee main ypes o inancial isk, namely liquidi y isk, in e es a e isk, and o eign exchange (FX) isk, necessi a ing inc eased inancial assis ance om in e na ional dono s and DFIs o isk mi iga ion, as banks o e ing mic oc edi acili ies ace g ea e liquidi y isk and lowe FX isk, whe eas MFIs ope a ing as NGOs, C edi Unions, and coope a i es ha e high-in e es a e isk and FX isk (Gie zen 2017). In line wi h he abo e-ci ed li e a u e, i seems possible o o mula e he ollowing hypo hesis: Hypo heses 6 (H6). MFIs’ exposu e o liquidi y isk due o he De elopmen o Financial Ins i u- ions’ unding managemen a ec s he e iciency o MFIs. 3. Me hodology The esea ch will de e mine he impac o inancial sec o de elopmen on he e i- ciency and sus ainabili y o Mic o Financial Ins i u ions, wi h MFIs’ e iciency and sus ain- abili y as he esponse o dependen a iables and inancial de elopmen as he p edic o o independen a iable, while assessing he impac o MFIs’ inancial isk managemen , inancial ou each, po e y alle ia ion, ad ancing me hodology, and DFIs’ unds. wi h Economies 2023,11, 78 6 o 16 MFIs’ e iciency and sus ainabili y as he dependen a iables and po e y alle ia ion, inancial ou each, ma ke isk, c edi isk, and liquidi y isk as he independen a iables while mode a ing a iables a e he MFIs’ ma ke isk × inancial de elopmen , c edi isk ×ad ancing me hodology and liquidi y isk × DFIs’ und’s managemen . A de ailed explana ion o he a iables and hei cons uc s is p o ided in Table 1below: Table 1. Explana ion o a iables and hei cons uc ions. Va iables Indica o s Financial Ra ios Financial De elopmen Bank Deposi s/GDP Bank Deposi s GDP MFI E iciency Re u n on Equi y P o i A e Tax To al Equi y MFI Sus ainabili y Ope a ional Sel Su iciency Ope a ing Re enue Loan loss p o ision+Financial Exp.+Ope a ing Exp. C edi Risk Loans W i en O Loans W i en O A g. Loans Ou s anding Ma ke Risk Deb o Equi y Ra io To al Liabili ies To al Equi y Liquidi y Risk Cash Posi ion Indica o Cash and Deposi s To al Asse s Lending s a egy Ope a ing Expense Ra io Ope a ing Expense A g. G oss Po olio DFIs’ Funds Managemen Funding Expense Ra io In e es Expense A g. G oss Po olio Financial Ou each Cos pe bo owe Ope a ing Expense No. o bo owe s Po e y Alle ia ion GNI pe capi a G oss Na ional Income Pe Capi a No e: See Appendix A—Cha ac e is ics o Va iables. 3.1. S ochas ic F on ie Analysis P e ious esea ch has p ima ily employed s ochas ic on ie analysis o es ima e he e iciency o p oduc ion unc ions. I is a pa ame ic on ie echnique based on he heo y ha no economic agen can exceed he ideal on ie , and i es ima es e iciency, which is de ined as he maximiza ion o ou pu wi h a gi en le el o inpu o p oduc ion echnology. S a is ically, on ie pa ame e s and ine iciency can be deduced by p o iding a p oduc ion, cos , o p o i unc ion and di e en ia ing be ween measu emen e o and esidual e m exp essing ine iciency. SFA p esupposes he quasi-conca i y o he p oduc ion unc ion and p edic s a declining ma ginal a e o echnical subs i u ion, as he en i y is conside ed echnically e icien when i is wo king a he bes p ac ice le el o p oducing maximum ou pu wi h esou ces equal o i s capaci y. The op imal p oduc ion unc ion o bank pe o mance has he ollowing unc ional o m and aking in o accoun he abo e, i is possible o cons uc he ollowing exp essions o es ing he ele an hypo heses: yi =βxi +εi (1) whe e εi = i + ui(2) The abo emen ioned equa ion indica es y i as he obse ed dependen a iable o MFIs’ e iciency which has been measu ed h ough ROE, β is he pa ame e ec o o inpu s, x i is ou independen a iables i.e., po e y alle ia ion, inancial ou each, ma ke isk, c edi isk, and liquidi y isk, εi is he e o e m, i is ime- a ian andom e o and u i is he ime-in a ian i m speci ic pa ame e (Mu a indwa e al. 2021). A s ochas ic p oduc ion unc ion wi h ou pu -o ien ed echnical ine iciency is speci ied as: lnyi= lnyi 0−ui(3) lnyi= xiβ+ i(4) The p esence o cons ain s will educe obse ed ROE om e icien ROE y i 0 o op imal ROE by non-nega i e e m u i and he pe cen age di e ence is a ibu ed o he p esence o echnical ine iciency. The in e p e a ion o u is u imes 100 measu es he pe cen age sho all o he desi ed on ie le el o ou pu due o echnical cons ain s. The alue o u is equal o ine iciency ha ing a dis ibu ion wi h mean µ and a iance σ2 exponen ially Economies 2023,11, 78 7 o 16 dis ibu ed ( µ = σ2 ) whe e modeling o ine iciency a iance is a unc ion o exogenous co a ia es (Kumbhaka e al. 2015). SFA will be applied o e alua e he i s and he second hypo hesis o assess he impac o inancial de elopmen on he e iciency and sus ainabili y o he Mic o Financial Ins i u ions. Hypo heses 1 (H1). Financial de elopmen leads o a dec ease in he echnical e iciency o he MFIs. lnPAT Equi yi =α1+β1lnBank Dep. GDP c + i +ui(5) In Equa ion (5), he PAT/Equi y is he a io be ween p o i a e ax and he o al equi y o mic o inance o ganiza ions as a p oxy o MFI E iciency, i.e., obse ed dependen a iable while Bank Deposi /GDP is he a io be ween o al bank deposi o mic o inance o ganiza ion o he g oss domes ic p oduc o he coun y as a p oxy o inancial de elop- men . α1 is a cons an , β1 is a co-e icien o inancial de elopmen , i is he ime- a ian e o e m, and uiis he ime-in a ian i m-speci ic e m. Hypo heses 2 (H2). Financial de elopmen esul s in he de e io a ion o he sus ainabili y o MFIs. ln(OSS)i =α2+β2lnBank Dep. GDP c + i +ui(6) In Equa ion (6), OSS is he Ope a ional Sel Su iciency as an indica o o MFI Sus ain- abili y while Bank Deposi /GDP is he a io be ween o al bank deposi s o mic o inance o ganiza ion o he g oss domes ic p oduc o he coun y as an indica o o inancial de elopmen o es H2 men ioned abo e. S ochas ic F on ie Analysis will be employed o examine he e ec o inancial de- elopmen on he sus ainabili y and e icacy o MFIs ope a ing in Pakis an, India, and Bangladesh. MFIs and o es he ele an hypo hesis we de eloped abo e. 3.2. Cobb Douglas P oduc ion Func ion The Cobb-Douglas p oduc ion unc ion in economics illus a es he echnological ela ionship be ween wo o mo e inpu s and he ou pu ha can be p oduced by hose inpu s. I is a me hod o calcula ing he e ec o changes in a p oduc ion unc ion’s inpu s, ele an e iciencies, and ou pu s. Conside ing he abo e, i is possible o cons uc he ollowing exp essions o es ing he ele an hypo heses: Y =α0×Lα1 ×Kα2 (7) Ln Y =α0+α1Ln L +α2Ln K + u (8) The abo e equa ion deno es Y as he ou pu , α0 as he cons an , L as he labo inpu , K as he capi al inpu , α1 and α2 a e he elas ici y pa ame e s and u as a andom dis u bance (Zellne e al. 1966). Cobb Douglas p oduc ion unc ion was used o de elop he ma hema ical guidelines o es ima ing he sus ainabili y o MFIs h ough he impac o inancial de elopmen on he ma ke isk hose MFIs ace and he impac o c edi isk depending on he lending s a egy while de e mining he e iciency o MFIs h ough he impac o po e y alle ia ion and inancial ou each as well as he impac o liquidi y isk b ough on by DFIs’ unding managemen using Gene alized Leas Squa es Hypo heses 3 (H3). The e ec o he ma ke isk a ising om he ex en o he inancial de elopmen o he economy on MFIs’ sus ainabili y. Economies 2023,11, 78 8 o 16 To es he ela ion in H3, he ollowing equa ion is cons uc ed; ln (OSS)i =β0+β1lnLiabs Equi.i +β2Bank Dep. G oss Domes ic P oduc ×Liabs Equi.c +εi (9) In Equa ion (9), OSS is he Ope a ional Sel Su iciency as an indica o o MFI Sus ain- abili y while Bank Deposi /GDP is he a io be ween he o al bank deposi o mic o inance o ganiza ion o he g oss domes ic p oduc o he coun y as an indica o o inancial de elopmen o he es H3 men ioned abo e. Hypo heses 4 (H4). The e ec o imp o ing he ou each o he inancial sec o and MFIs’ objec i e o po e y alle ia ion on MFIs’ e iciency. lnPAT Equi yi =β0+β3ln(GNI Pe Capi a)c +β4ln(Cos Pe Bo owe )i +εi (10) Abo e cons uc ed Equa ion (10) add esses he ela ion in H4 whe e PAT/Equi y is he a io be ween p o i a e ax and he o al equi y o mic o inance o ganiza ions as a poxy o MFI E iciency, i.e., obse ed dependen a iable while GNI Pe Capi a as a p oxy o po e y alle ia ion and Cos Pe Bo owe is an indica o o inancial ou each. Hypo heses 5 (H5). The e ec o he c edi isk a ising om MFIs’ lending s a egy on he MFIs’ sus ainabili y. ln (OSS)i =β0+β1lnLoans W i en O A g. Loans Ou s anding i +β2LiabsLoans W i en O A g. Loans Ou s anding ×Cash and Deposi s To al Asse s. c +εi (11) Equa ion (11) explains he associa ion o H5, whe e OSS is he Ope a ional Sel Su i- ciency as an indica o o MFI Sus ainabili y while Loans W i en O /A g. Loans Ou s and- ing is he a io be ween loans w i en by mic o inance o ganiza ions wi h hei ou s anding a e age loans o he poxy o c edi isk. Fu he , he Cash and Deposi s/To al Asse s a e used o assessing he liquidi y isk associa ed wi h he MFI. Hypo heses 6 (H6). The e ec o he MFIs’ exposu e o liquidi y isk due o he De elopmen o Financial Ins i u ions’ unding managemen on MFIs’ e iciency. lnPAT Equi. i =β0+β7lnCash and Deposi s To al Asse s i +β8In e es Expense A g G oss Po olio ×Cash and Deposi s To al Asse s i +εi (12) Equa ion (12) a emp s o explain he logical ela ion o H6, whe e PAT/Equi y is he a io be ween p o i a e ax and he o al equi y o mic o inance o ganiza ions as a poxy o MFI E iciency i.e., obse ed dependen a iable while Cash and Deposi s/To al Asse s a e used o assessing he liquidi y isk associa ed wi h he MFI and In e es Expense/A g G oss Po olio is used o DFIs’. 3.3. Da a Collec ion P ocedu e The esea ch da a consis s o panel da a om wel e MFIs chosen om Bangladesh, India, and Pakis an o e 10 yea s. The selec ed MFIs we e anked highes in each indi idual and inancial da a we e ob ained om he Wo ld Bank’s Mic o inance In o ma ion Exchange (MIX) 1 da a o he pe iod FY2008 o FY2018. 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