Do transaction costs affect technical efficiency? Case of Indian microfinance institutions

Abstract

The present paper measured and analyzed the technical efficiency for a sample of 74 MFIs of India using the stochastic production frontier approach, which incorporates a model for technical inefficiency effects including administrative expenses, personnel expenses and fixed cost. The study revealed that the mean technical efficiency of MFIs turned out to be 68 per cent and also reported wide variations in technical efficiency across sampled firms ranging from 39 per cent to 97 per cent. The presence of substantial amount of technical inefficiency suggests that microfinance institutions can increase their output level by 32 per cent without increasing the quantum of inputs. The study, further, highlighted that reduction in administrative costs and fixed costs on the one hand, and enhancing the personnel expenses on the other, would be cumulatively handy in enhancing the efficiency of MFIs operating in India. The variations in transaction costs owing to age, location and level of maturity may be the significant factors for enhancing the efficiency and performance of MFIs. The study recommends that transaction costs especially administrative and fixed needs to be taken into account while examining the interest rates charged by microfinance institutions.