From Debt to Donations: Impact of Capital Structure on Risk and Return in Microfinance Institutions

This study investigates the impact of capital structure on the risk and return of microfinance institutions (MFIs) in Bangladesh by analyzing the yearly data of 61 MFIs from 2012 to 2023. Four capital structure components, i.e., the Grameen model, quasi-equity, debt, & philanthropic funds, are used in this study. Here, the portfolio yield and operating self-sufficiency are used as proxies of the return of MFIs, and the loan-to-deposit ratio is used as the proxy of the risk measure of MFIs. Moreover, the average loan size of MFIs is also used as the control variable, which measures the outreach of clients of MFIs. Panel data analysis is conducted utilizing the FGLS model, and the robustness of the results of the FGLS model is checked by performing the random effect model. The findings suggest that most capital structure elements adversely impact the returns of MFIs, except for the Grameen model, which has an insignificant correlation with returns. In contrast, the components of capital structure substantially raise the risk of MFIs, except Philanthropic funds, which exert an insignificant impact. The findings highlight the influence of capital structure on MFI performance, indicating that higher amounts of quasi-equity and debt diminish returns and amplify risk due to financial costs and adverse effects of leverage. The Grameen model's weak association with returns implies modest profitability effects, and the minimal impact of philanthropic funds on risk denotes that donations slightly influence financial stability. Microfinance institutions should strategically balance funding sources to improve financial sustainability while minimizing risk.