Fast Forwarding Evolution

Fast Forwarding Evolution: the Case of Micro Finance Institutions

The transformation of humanitarian organizations into financial institutions in 1997 was the beginning of operation of Micro Finance Institutions (MFIs) in Ethiopia. From then on, MFIs have showed remarkable progress in number, outreach, coverage and performance. Currently, 40 MFIs operating in the country serve close to 10 million clients nationwide while 15 more are in the making. Breaking the trend in the rest of the world, Ethiopia’s microfinance industry is born and raised in rural parts of the country. However, MFIs are currently conquering urban Ethiopia and providing credit especially for business establishments. Urbanites now make up close to 10Pct of the clientele of MFIs. The four pioneer MFIs, whose capital is way larger than most small and mid sized banks, are planning to mold themselves into conventional banks. On the other hand, the rest are pushing up their credit limits in order to capture the attention of the large segment of the unbanked population. Although most MFIs in Ethiopia have reached maturity and success, they are not immune from problems. EBR’s Ashenafi Endale reports.

Micro Finance Institutions (MFIs) are a relatively recent phenomenon in Ethiopia. Over the last decade, however, their operations have reached urban areas going beyond their traditional rural vicinities. Although the rural part of the country still remains the stronghold of MFIs, the mushrooming urban based micro and small businesses that generally have difficulty accessing startup as well as working capital from the conventional banking industry, have increasingly made up their urban clientele.

In fact, the operation of MFIs is currently firmly situated in urban areas marking a notable drift from earlier confinements in rural areas. Nowadays, 10Pct of the clients of MFIs are urbanites engaged in cottage industries, animal rearing and fattening as well as other micro and small business establishments.

Specialized Commercial Microfinance is one of the MFIs operating in the capital. One of its branches located on a nearly completed building at Shola Gebeya, in Yeka District, serves at least five new individual credit seekers and up to 10 group collateral requests per day, according to Wosene Girafie, branch manager. The institution, which started operation two years ago, provides credit only for businesses that have been in operation for at least six months and are in need of working capital. “The total credit disbursed by the institution has doubled to ETB10 million in 2018/19 from the previous year,” explains Wosene. “Most of our clients are traders in active business and groups.”

Currently, close to one million businesses operating in urban areas are clients of MFIs. Considering micro financing emerged in Ethiopia in the late 1990s, over a couple of decades after Muhammad Yunus first institutionalized it in Bangladesh in the 1970s, and the absence of MFIs in urban Ethiopia until 2010, the pro-poor business and development strategy of micro-banking is growing throughout Ethiopia.

It was as a result of the economic liberalisation introduced in 1994 that the Ethiopian government adopted micro finance as the main component of the economic growth policy. So, the government introduced a legal framework in 1996 that governs the activities of MFIs and helps them supply financial services to the poor in a sustainable manner.

Besides transforming from humanitarian-oriented organisations to financial institutions, MFIs showed remarkable progress in number, outreach, coverage and performance in the last two decades. Currently, some of the MFIs operating in Ethiopia are considered to be among the strongest self-sufficient MFIs in Africa with significant outreach in rural areas.

MFIs status
In September 2019, the number of MFIs operating in Ethiopia reached 40 while 15 more are in the pipeline. With 500 branches and 1,500 satellite offices, these MFIs serve close to 10 million people. Overall, the performance of MFIs operating in the country is encouraging as their total capital and total asset reached ETB16.6 billion and ETB83.5 billion respectively by the end 2018/19. Compared with the previous year, both total capital and assets of MFIs showed a staggering 20Pct increment.

In the same manner, the deposit mobilization and credit provision of MFIs is expanding remarkably. Compared to 2017/18, the deposit of MFIs surged by 26.1Pct and reached ETB41.9 billion while outstanding credit climbed by 30.5Pct to ETB58.7 billion, according to the National Bank of Ethiopia (NBE).

Amhara Credit and Saving Association (ACSI), one of the first five MFIs established in 1997, currently has capital and assets of ETB8 billion and ETB24 billion, respectively. Its deposits also stood at ETB19 billion while its has 1.4 million clients.

The biggest five micro finance institutions, namely: ACSI, Dedebit, Oromia, Omo and Addis micro finance institutions, dominate the sector by accounting 83.4Pct of the total capital and 88.1Pct of the total assets held by all MFIs as well as 87.7Pct of the credit disbursed by MFIs operating in Ethiopia until the end of the 2018/19 fiscal year.
“Our deposits and loan amount is increasing annually,” says Mekonen Yelewwosen, general manager of ACSI and board chairperson of Association of the Ethiopian Micro Finance Institutions (AEMFIs).

The success of ACSI and other big MFIs is attributed partially to considerable government support. In addition to direct government subsidies, public owned MFIs do not pay dividend. So, their profit is added up to capital. As a result, the big MFIs managed to provide demand-driven financial services and become sustainable institutions that can cater to the huge unmet demand of small farmers and poor households as well as micro and small entrepreneurs. However, the proactive role of the government has its own disadvantage by severely distorting the market and crowding out small, young and privately owned MFIs.

Yemisrach Microfinance Institution is one of the private MFIs operating mainly in urban areas like Addis Ababa. It was established last year. “The business is not attractive nowadays,” Teshome Yiheyes, general manager of Yemisrach told EBR. , “Credit repayment rate is slower due to economic slowdown and political unrest. But the demand for credit is very high especially in urban areas, where there is acute shortage of working capital.”

Mekonen of ACSI also observed that there is liquidity problem and signs of stagnation in the industry. “This is mainly due to the absence of peace and stability, which deterred the flow of money and people in the country as well as economic slowdown, and absence of loanable cash in banks.”

The disproportionate deposits and credit ratio is one of the major factors challenging especially young and small MFIs in Ethiopia. The source of two thirds of the credit disbursed by MFIs is mobilized from clients mostly micro, small and medium enterprises who deposit 20Pct of the loan they request. The rest of the credit is financed by concessional loans from commercial banks, program loans from NGOs and through government subsidies.

“Although the credit demand is high, we cannot provide more than ETB700, 000 per person, due to shortage of loanable money,” says Wosene. Due to the scarcity of loanable fund, MFIs are forced to charge high interest rates. Currently, loan interest rates charged by the big MFIs, including ACSI, is between 10Pct and 15Pct while that of new, small and medium MFIs ranges between 24Pct and 36Pct.

“The interest rate at Specialized Microfinance Institution is between 20Pct and 30Pct,” says Wosene. “This is because of shortage of loanable money.”

The high interest rate is also pushing entrepreneurs from accessing finance from MFIs. After completing his engineering studies five years ago, the 26 year old Birhanu Neway had been unemployed until four months ago when he established a small business comprising of five youngsters. The business is engaged in finishing buildings, undertaking maintenance works and executing small constructions. After completing all the necessary paper work at his kebele in Sebeta town and depositing 20Pct of the total investment, he went to Oromia Credit and Saving Institution for a loan of ETB300, 000. However, he backed out of the deal after the money was approved.

“It is difficult to pay the credit with 15Pct interest starting from the first month. The interest is way higher than that of the 8Pct charged by the Youth Revolving Fund I approached primarily,” said Birhanu.

The lending interest rate of MFIs is calculated using two methods. In flat rates, the interest is calculated on the principal amount of the loan. MFIs also calculate interest using reducing balance rate method on the outstanding loan amount on monthly basis. Since flat rate method can be complex especially during early and late payments, the NBE is currently finalizing a new directive that puts an end to calculating interest using the flat rate method.

On top of high transaction costs for clients, micro finance services for the low-income population are characterised by deposits mobilization strategy mainly based on compulsory savings. However, the range of products offered by MFIs has expanded slowly over time. For many years, group lending was the only financial product provided by MFIs. However, individual lending has been introduced recently. Some MFIs also started to engage in microinsurance and pension fund administration.

Teshome says raising deposits is critical to sustain lending. “Especially the small and medium institutions have been hit hard because they had nowhere to access finance.”

Mekonen agrees.“Saving is highly critical. We are going into an economic slowdown. If the poor saving culture continues, there will be no investment,” argues Mekonen.

Until four months ago, MFIs accessed loan fund from private banks due to the requirement that forces private banks buy 27Pct of bonds for every loan DBE disburses. This is no more the case since the government put an end to this practice. Director of Association of Ethiopian Micro Finance Institutions (AEMFI), Teshome Kebede, contends that the government needs to devise another policy tool to fill the gap. “The government could make it mandatory for banks to allocate 20Pct to 30Pct of their loan portfolio for micro and small enterprises (SMEs) as it is done in some countries. Then the banks can channel the amount through MFIs to borrowers.”

Unless enough loanable fund is available for MFIs, industry players warn their profitability and sustainability will be compromised. In terms of profit, Ethiopia’s MFIs are categorized into three. The first group is made up of small MFIs that have been operational for a few years with profits of only less than 5Pct of thier total asset, mainly due to narrow base and higher operating cost. The second group comprises of medium MFIs with profits of between 10Pct to 20Pct. The last group consists of old MFIs, which were established 20 years ago, whose profit stands between 20Pct and 40Pct. The five big MFIs, for instance, made profits of over half a billion birr each, last year.

Teshome argues profitability is determined by minimizing overhead cost. “When an MFI grows, its overhead cost automatically minimizes, due to the economics of scale. When the client base widens, the cost per branch or client gets smaller.”

Tekei Alemu (PhD), AEMFI advisor and economics lecturer at Addis Ababa University who specialized in micro-insurance, says MFIs still need policy instruments to access more loanable fund for them to stay profitable and address the chronic finance shortage. “Until MFIs came into being, small scale farmers and entrepreneurs in urban areas, mostly the youth, could not access loan from banks. This should not be the case again.”

The big leap
Despite the major problems facing MFIs, some of them are preparing to transform themselves into a bank by the end of the current fiscal year. ACSI is one of such MFIs. “When ACSI becomes a bank, it will have a mandatory MFI wing that serves its existing clients. Currently, ACSI’s equity level is comparable only with big commercial banks,” explains Mekonen.

Tekei, on the other hand, is against the transformation of MFIs into banks. “I am not sure if the rural modality can be widely successful in an urban setting. Urban clients need huge financing than farmers. Urban people are mobile, unlike the rural. So, MFIs will have to finance enterprises than people, if they choose to upgrade to banks.”

Tekei also thinks that the recent rush to transform MFIs to banks will affect the industry. “I believe the idea behind this move is to eradicate MFIs and leave the financial sector only for banks. MFIs are doing good in their current shape. The only difference with banks is that they cannot be involved in international trade. If MFIs were to be allowed to get involved in global trade, it would boost their performance and coverage without the need to transform them into banks.

The big MFIs are also currently investing in buildings and tangible properties, in addition to their efforts to transform to banks. “We are also finalizing a 34-storey building near the National Theatre to house our future bank,” said Mekonen.

Letenah Ejigu (PhD), finance lecturer at Bahir Dar University, does not agree with this ongoing trend. He thinks MFIs have to allocate more of their assets to productive uses such as disbursing loans rather than current assets or fixed assets. In his research entitled ‘Performance analysis of MFIs in Ethiopia’, Letenah argues that MFIs still have to work on outreach, particularly women. “Failure in outreach and shifting client base is a mistake and abandoning thier original mission. The midsized and small MFIs shall go for massive scaling up strategies as size has a clear impact on profitability and sustainability,” he noted.

To ensure the sustainability of their operation, MFIs are establishing a research and training center through AEMFI. The center conducts studies on challenges they are facing and modern financing as well as technology and digitalization. Core banking, which currently links 12 MFIs and can accommodate 25 when fully finalized, has already been kicked off. In addition, MFIs are expected to start agent and mobile banking in the near future. EBR


9th Year • Apr.16 – May.15 2020 • No. 85

Ashenafi Endale


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