Does The Micro Financing Term Dictate The Performance of Micro Enterprises?

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Procedia Economics and Finance 35 ( 2016 ) 281 – 286

Available online at www.sciencedirect.com

Peer-reviewed under responsibility of Universiti Tenaga Nasional doi: 10.1016/S2212-5671(16)00035-6

ScienceDirect

7th International Economics & Business Management Conference, 5th & 6th October 2015

Does The Micro Financing Term Dictate The Performance Of

Micro Enterprises?

Othman Chin

a,*

and Maisyarah Mohd Nor

a

a,_{College of Business Management, Unversity Tenaga Nasional, Bandar Muadzam Shah, 26700, Pahang, Malaysia}

Abstract

This paper studies the impact of micro financing or micro credit services towards micro enterprise performance in Malaysia. A conceptual framework has been developed to reveal the essential financial elements involved in this study. The elements include financing or loan tenure, collateral, margin of financing and repayment method. Quantitative data have been analysed using the statistical method of correlation and regression analysis. The purpose of this study is to examine the financial services in micro financing that dictate the performance of micro enterprises in Malaysia. It was a lack of studies towards the performance of micro enterprise when it involve in micro financing or micro credit of financial services. The development of micro enterprise scheme in Malaysia needs strong support from all agencies involved especially the government and MFIs to ensure micro enterprise performance.

Peer-reviewed under responsibility of Universiti Tenaga Nasional. Keywords: Financial terms; Micro enterprise; Performance

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1. Introduction

The Malaysian government is strongly committed and is actively promoting micro financing as one of the strategies in developing the young entrepreneurs, especially those among the Malay community (Hanif and Iqbal,

*

Corresponding author. Tel.: +60-9-455-2025; Fax: +60-9-455-2006 E-mail address: [email protected]

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2010). Most micro-entrepreneurs will initially not be able to finance the start-up costs of their micro-enterprises out of their own pockets. Thus, the most obvious option is to partner up with a micro-credit company to give these entrepreneurs access to micro-credits with a fixed amount on predefined terms for starting the new small business.

Microcredit, in its simplest form, involves granting individuals who have lack of money access to capital in the form of uncollateralized small (micro) loans designed to be repaid with interest. Microcredit and micro franchise

share the prefix “micro,” which for both constructs, is synonymous with a focus on select services for very low income clients (Fairbourne, 2007b). At least since Muhammad Yunus and his Grameen Bank won the Nobel Peace Prize in 2006, micro-credit has become well-known in the Western world. But what are the differences between the different concepts and where does micro-franchising fit in? This paper will investigate how far the micro credit or micro financing helps the infant entrepreneur in micro franchising scheme. This paper speaks of the issue of how far the micro credit scheme provided by Financial Institutions helps the infant micro franchisee in Malaysia by looking into the financial elements offered by financial institutions in Malaysia. Micro franchise is the one of the methods to create the employment opportunities in a particular country especially in developing countries.

The tenure of the given loan is an important determinant to the micro enterprise performance and their growth performance. For example, increasing the size of a given loan is important for extending the market and the size of business. The flexibility of appropriate amount given to micro enterprise helps them to start the business properly, time responsiveness and provides adequate information about the terms of service. This is an important determinant in order to ensure micro enterprise meet the goals.

Even though the economic theory suggests that a more flexible repayment schedule would benefit clients and potentially increase their repayment capacity, microfinance experts believe that the discipline imposed by regular repayment maintains high repayment rates in the absence of collateral. Although this feature is less usual than the previous mechanisms, it helps MFI to maintain high repayment rates (Armendariz & Morduch, 2000; Morduch, 1999). In the MFI, the repayment starts almost immediately after disbursement and then occurs on a weekly or monthly basis.

The government encourages more financial institutions to offer micro financing or micro credit scheme to aid businesses at every level, including entrepreneurs from lower income groups (Bernama, 2015).

2. Problem Statement

With regard to the above issues, no study has been conducted to develop a framework regarding the financing terms and micro enterprise performance. Therefore, this paper targets to explore the effect of financial terms towards the micro enterprise performance and to identify whether those financial terms have a significant impact to the return on Investment of micro enterprise.

3. Research Questions

a) Does tenure positively relate to the return on investment in micro enterprise? b) Does collateral negatively relate to the return on investment in micro enterprise?

c) Does the interest rate of financing positively relate to the return on investment in micro enterprise? d) Does mode of payment positively relate to the return on investment in micro enterprise?

4. Research Objectives

This paper is focusing on the main elements that will be looked into both internally and externally. Specifically, this research has the following objectives:

a) To identify the relationship between tenure of financing and return on Investment for micro enterprise performance

b) To examine the relationship between collateral of financing and return on Investment for micro enterprise performance

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c) To explore the relationship between interest rate of financing and return on Investment for micro enterprise performance

d) To discover the relationship between repayment method of financing and return on Investment for micro enterprise performance

5. Literature Review

Micro-financing had been famous for over three centuries when Friedrich Willelem Raiffeisen established the first cooperative lending banks to support farmers in rural Germany. However, this concept was modernized in 1970s when Muhammad Yunus established Grameen bank in Bangladesh. In particular, Grameen Bank was successful in fighting poverty and prospered the economic wellbeing of micro entrepreneurs. This has attracted many government and nongovernment organizations attention to the possibility of replicating this experience especially in developing countries. Indeed, a surge growth of microfinance institutions has been noticed in the developing countries especially in Asian countries since the birth of the Grameen Bank in 1975. Microcredit Summit Campaign (2012) reports that the number of the poorest clients with microcredit has grown from 7.6 million in 1997 to 137.5 million in 2010. It was also found that at among those poorest clients, over 113 million were women. This number was collected from 31,652 microfinance institutions around the world.

5.1 Financing or lending terms

There are a lot of studies that investigate the relationship between lending or financing terms and access to credit (Mann, 1997; Yehuala, 2008) but the study about business performance after loan approval is still in a critical part. The lack of study regarding this issue creates something new to discover. The findings, reasoning and arguments made by other studies/writers that indicate that stringent lending terms significantly affect enterprise performance.

5.2 Tenure

Tenure has also been found to be critical for access to enterprise performance. Yehuala (2008) found that loan repayment period negatively influences access to credit as it has a major bearing on the total amount to be repaid. Specifically, making a long-term financing or loan will increase the rate of interest to be paid in the long run. When enterprisees perceive repayment period as inflexible, they will have no chance to apply for another financing and this will affect the performance of enterprise to obtain back their investment. Mutesasira et al. (2001) also found that the short term repayment period does not meet the enterprise’s long term financing and as a result, they will take any amount of loan that the financial institutions are willing to offer them. From the discussion above, it can be concluded that tenure has an insignificant effect towards the performance of micro enterprise in terms of return on Asset. This conclusion is drawn from the fact that tenure has its own antecedents such as individual’s capacity and

financial institution’s ability to collect and ensure repayments. Therefore, the following proposition is formed:

Tenure of the loan is negatively affected to the micro enterprises business performance. 5.3 Collateral

Giving the example of pledging business collateral limits the firm’s ability to acquire future loan or financing from other financial institutions and this creates a position of power for the lenders which are financial institutions and commercial banks (Alon, 2004). Collateral value requirement discourages enterprise borrower from seeking credit (Zeller, 1994). Commercial banks or financial institutions usually provide larger loans with longer period and offer lower interest rates when borrower has a collateral to pledge the financing (Safavian et al, 2006). This means that collateral would bring better rating to borrower (Lehmann, 2001). Therefore, the following proposition is formed:

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5.4 Interest Rate

According to the Maes & Reed, 2012, only 200 million poor people were served by MFIs compared to the 900 million poor people in the Asia-Pacific Region alone. Therefore the interest rate charged by MFIs is not subjected to market forces as in commercial banks. Due to the small size of the loans and the information asymmetry problem, the interest rates charged by MFIs are much higher than commercial rates(Calabrese, R., Zenga, M., 2008) in most situations. Support for MFIs to charge higher interest rates was found by Chaudhary and Ishfaq (2003) who report that subsidised interest rates have no significant impact on business performance. Therefore, the following hypothesis is formed:

The interest rate charged by financial institution to micro enterprise is positively affected to the micro enterprises business performance.

5.5 Repayment Method

Even though the economic theory suggests that a more flexible repayment schedule would benefit clients and potentially increase their performance in business, microfinance experts believe that the discipline imposed by regular repayment maintains high repayment rates in the absence of collateral. Although this feature is less usual than the previous mechanisms, it helps MFI to maintain high repayment rates (Armendariz & Morduch, 2000; Morduch, 1999). In the MFI, the repayment starts almost immediately after disbursement and then occurs on a weekly or monthly basis. Therefore, the following proposition is formed:

The repayment method by micro enterprise business enterprise is positively affected to the micro enterprises business performance.

6. Hypotheses

According to the above proposition, the hypotheses drawn as follows:-

H1: Tenure of the loan is negatively affected to the micro enterprises Return on Investment.

H2: The collateral that pledged by the enterprise is negatively affected to the micro enterprises Return on Investment.

H3: The interest rate charged by financial institution to micro enterprise is positively affected to the micro enterprises Return on Investment.

H4: The repayment method by micro enterprise business enterprise is positively affected to the micro enterprises Return on Investment.

7. Framework

Taking into consideration of the important the following terms of financing in micro financing, the following framework was adapted from Al Shahmi S.S.A et al.(2013). The previous study as follows:-

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Micro financing terms’ framework for micro enterprise performance.

8. Methodology

8.1 Sample data collection

The analysis conducted in this paper is based on data and statistics provided mainly by financial provider for example Perbadanan Nasional Berhad (PNB), SME Bank and other related banks which provide micro financing schemes to their clients. They play a major role in financing system which contribute more than sixty percent in Malaysia.

8.2 Validity and reliability

According to Cole 1998, validityis the extent to which an instrument measures what it is supposed to measure and performs as it is designed to perform. Reliability estimates are used to evaluate the stability of measures administered at different times to the same individuals or using the same standard (test–retest reliability) (Crocke, 1994), the equivalence of sets of items from the same test (internal consistency) or of different observers scoring a behavior or event using the same instrument (interrater reliability). Reliability coefficients ranging from 0.00 to 1.00 with higher coefficients indicate higher levels of reliability. Prior to the field survey, the issues of validity and reliability were given strong effective consideration. To ensure reliability, the study has used the data base from MFIs while the validity was tested through the comparison of prior research views contained in literature reviews with the responses from the research participants.

8.3 Data analysis

The study will use correlation and regression to analyze the data. Model

ROIൌ ߚ݋ ൅ ߚͳܶܧܷܴܰܧ ൅ ߚʹܥܱܮܮܣܶܧܴܣܮ ൅ ߚ͵ܫܴ ൅ ߚͶܴܯǡ ൅ߝ݅

Keys:

ߚ = coefficient

ROI = Return on Investment COLLATERAL = Collateral

IR = Interest Rate

RM = Mode of Payment

9. Expected Outcomes

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micro enterprise. Furthermore, the can be used by financial institutions and related agencies to restructure their micro credit products in order to help the micro enterprises sustain in their business. Lastly, results from this study will assist the government to enhance the entrepreneurship financing programme, particularly in financing scheme.

10. Conclusion

The study’s objective can be reached through the existence of micro financing offered by several authority bodies in Malaysia like Permodalan Nasional Berhad (PNB), SME bank or commercial banks in various sectors. By looking at the four important elements that have been discussed earlier, this service was able to show the impact on micro franchising schemes in terms of financial services offered by financial institution. Micro financing is the one solution for micro franchisees; it provides access to capital while micro franchisees provide turnkey opportunity to business. Through the findings, these four elements have their own significance in the performance of micro enterprise, of which, tenure and collateral have a negative relationship with Return on Investment.

This study should be repeated by future researchers by looking at the relationship between micro financing and micro enterprise as a partnership in the financial services concept. The continuous study about this issue can improve the performance of micro enterprises especially in return on investment. Lastly, this study uncovers the impact of micro financing or micro credit towards the micro enterprise systems in the context of financial services. The development of micro enterprise scheme in Malaysia needs strong support from all agencies involved especially the government and other related institutions to ensure the micro enterprise performance.

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