Peer review

This article investigates the efficiency of microfinance institutions (MFIs) in extending financial services to the poor by comparing their cost efficiency with that of commercial banks (CBs). Using an unbalanced panel data of fourteen MFIs and seven CBs for 2001–08 in Ethiopia, a stochastic frontier model is estimated in which heterogeneities (in the working environments and nature of businesses) between MFIs and CBs are controlled for in the cost function. The result indicates that the MFIs are, on average, 33.5% less efficient compared with the CBs mainly due to their smaller size, focus on outreach and reliance on non-commercial sources of funds such as donations. In fact, the largest MFIs are found to have cost efficiency scores that are comparable with that of the most efficient banks. Despite the wide efficiency gap, there is a strong evidence of convergence.

Text in English