Integrating Financial Services into the Poverty Reduction Strategy in the Case of Ethiopia By: Getachew Teka(Dr.) June 2006
Overview • Introduction • Socio economic trends in Ethiopia • The poverty profile in Ethiopia • The poverty Reduction strategy in Ethiopia • The state of the Financial sector in Ethiopia • Rural and small scale financial services • Linking the Commercial Banks with the MFIs-Policy • Conclusions and recommendations-options
Financial Services into the Poverty Reduction Strategy: The Case of Ethiopia • Introduction • Poverty is a persistent phenomenon in Ethiopia. • The factors of poverty are many. • Addressing the poverty issue requires Several strategies. • Creation of employment is at the center of addressing poverty. • Fostering self-employment requires access to finance. • The objective is to assess the efforts made to expand the financial services to the poor within the context of the overall poverty reduction strategy of the country.
2. Socio – Economic Trends in Ethiopia • Ethiopia is a landlocked country (1.14 million km2) with 45% of arable land. • Over 75 million population the 2nd populous country in SSA. • About 85% of the population is in the rural area, • With the growth rate of 2.75% Ethiopia’s population will be 100 million by 2018 • About 45% of the population is young, • Urban and rural unemployment is large and rising. • Increasing population has reduced the average land holdings from 0.5ha /person in the 1960’s to 0.11 ha in 1999
This increases the vulnerability of the rural population • Ethiopia is a federal state with nine regional national states and nearly 80 languages, • Ethiopia’s development challenges look rather formidable, heavy dependency on rain fed agriculture, low level of saving and investment, etc characterizes the economy. • Following the liberalization of the economy GDP grew on average by 4 to 5%. • Per capita income rose to 150 USD in 2005 from 100 USD in the early 1990s, • The agriculture accounts for about 45% of the GDP, for 90% of the export commodities, and employing for over 85% of the population. • Irrigated land hardly exceeds 3% of the potential. • The share of the industrial sector remained at about 13%.
3. The Poverty Profile in Ethiopia • Poverty is the fundamental problem in Ethiopia. • About 31 million people (44%) live below the poverty line, US45 cents or 3 Birr per day. • During drought years, the people below the poverty line tends to be higher. • Based on a dollar /person/ day, the people below the poverty line would be much higher • There is a wide urban- rural income gap. • Poverty incidence in the urban areas is 37%, and in the rural population is 45%,
4. The Poverty Reduction Strategy in Ethiopia 4.1 ALDI • Poverty reduction/ eradication has been the main policy objective of the government over the last 15 years. • The Government adopted an ALDI strategy in 1991/92 as a long-term vision and framework because: • Agriculture is the main stay of the economy. • Demand for industrial goods comes from the rural population, • Several efforts to raise yield and agricultural production have been made since 1991, (fertilizers and seeds, with credit services) • The agricultural Extension Program has embraced nearly four million farmers. • The inputs boosted production, but cereal prices dropped, creating new problems to the producers and the policy makers. • The need to link production with consumption centers, is the key to the development of the agricultural sector.
4.2 Sustainable Development and Poverty Reduction Program • To change the poverty landscape in the country, the Ethiopian government formulated a three years poverty reduction program in 2002: the Sustainable Development and Poverty Reduction Program (SDPRP). Major Thrust of the Strategy • The overriding objective of the SDPRP is to reduce poverty and maintaining macroeconomic stability. • The main thrusts of the strategy document are: • Agriculture would continue to be the main focus. • Agriculture is the potential source to generate surplus. • Unleashing the power and energy of the private sector in the drive to develop the industrial sector and promote off-farm employment opportunities.
Rapid export growth from agricultural and agro-industrial products. • Commit large investment on education and capacity building • Strengthen the decentralization process to effectively take the decision making process down to the grass root level, • Address governance issues and promote empowerment of the poor. • Promote effective use of agricultural research, water harvesting and small-scale irrigation for increased yield and production. • Increased water resource utilization to ensure food security. • Ensuring food security is the central theme of the SDPRP strategy. • Diversification of asset holdings of rural households and the income generating sources • Supplementary employment income schemes
Major Goals of the SDPRP • Reduce poverty by 10% pa from the level of 44% in 1999/00 . • The MDGs requires that halving the poverty level by 2015 a growth rate of at least 7% or above. • Reorient budgetary resource allocation toward poverty reducing sectors such as education, health, water supply, sanitation, etc. • Ensure equitable growth with greater social impacts in the economy. Major Achievements of the Program • The GDP growth rate was good. • Grew by over 12% in 2003/04 and by 8.9% in 2004/05, • The public expenditure towards poverty oriented sectors have increased from 12% of the GDP in the 2001/02 to about 14.5%, with a positive impact on the poor. • Large expansions in education at all levels, and other social facilities have been notable achievements in the last decade.
Major Challenges of the Economy • High rainfall dependence, • High population growth counteract against efforts to reduce poverty. • Rural and urban unemployment is high and rising. • Low level of human and institutional capacity. • Limited internal resources, dependence on foreign aid. 4.3. A Plan for Accelerated and Sustained Development to End Poverty (2005/06 - 2009/10) • Based on the achievements (SDPRP) and the challenges the economy is facing, the government has formulated a new Fiver Year Plan. • A Plan for Accelerated and Sustained Development to End Poverty up to 2010. • This Plan too takes agriculture as the key sector, • PASDEP has eight pillars around which the entire plan revolves. • A massive push to accelerate growth primarilythrough commercialization and intensification of agricultural production, and private sector’s investment.
Growth rate of 7% for the next five years to reduce poverty in the country. • A geographically differentiated strategy that aims at exploiting the potential resources. • Managing the Dynamics of Population • Unleash the potential of women • Expand infrastructure • Managing risks and volatility including through product diversification, irrigation expansion, etc. • Scaling up the efforts to reach the MDGs • Creating jobs through the expansion of labor-intensive productive activities.
5. The State of the financial Sector in Ethiopia 5.1 Background and Structure of the Financial Sector • Banking in Ethiopia started in 1905, but evolved starting from 1940s. • A number of banks were operating until they were nationalized/ merged into one government owned in 1976. • The competitive banking was replaced by the command system over the 1974-1991 period. • In 1991 the financial market was deregulated. • A proclamation no. 84/94 was issued to effect the deregulation and liberalization of the financial sector, • There are six private banks and three public banks. • Nine insurance companies, one pension fund. • 26 MFIs with a focus in the rural areas are operating.
There is one cooperative bank, recently established. • The DBE is a specialized bank in project financing. • Public banks dominate the financial industry. • The CBE accounts for nearly half of the branch networks, over 60% of the outstanding loans and about 70% of the deposits of the CBs. • The progress by the private banks in the last ten years appears commendable. 5.2. Financial Developments in Ethiopia • Financial development is low and the degree of monetization is very low. • There are only eight CBs for the 75 million population and the per capita CB is very low: about 9.4 million population per one CB. • Access of the population to financial services is limited. • The population to bank branch is 188,000 by 2005. • The private banks opened about 158 branches since 1995, • The number of Bank Branches in 1995 was 216 and the number has been increased to 388 in 2005. • The population to branch ratio in Ghana and Uganda is about 54,000 and 130,000, respectively, better than in Ethiopia.
The loans and deposit customers are unlikely to exceed 40,000 and 2,000,000 respectively. • Evidence from CBE show that its loans customers are 30,000 and deposit holders are less than 1,500,000. • Addis Ababa city alone claims for one-third of the total branches thus, access to formal banking services is limited. 5.3 Major Financial Product Services • The banking industry provides traditional commercial banking. • Credit is the key income generating activity for many of the banks. • Over 60% of the income of banks is derived from credit businesses, although fee based income are also growing. • Trade and WC finance dominates the CB businesses,
Many of the CBs focus on domestic and international trade. • The CBE has extended large amount of loans to farmers to finance fertilizer and improved seed purchase, on the basis of guarantees from regional governments. • However, extending loans to farmers with limited collateral has not been done on their own by any of the CBs and their business remained urban based. • On the deposit side, savings, fixed time deposit and checking accounts, regarded as interest bearing accounts. • Given average lending rates in the range of 8 to 10.5%, the average spread is in the range of 4.5% to 7%. • Technology based payment systems, have not yet been developed to a visible extent.
Many are yet to network their service channels. Some have introduced ATM in some sites in the city. • The Recent encouraging trends in the telecommunication sector, prospect for the introduction of electronic based banking products is promising. • 5.4 Supply-Demand Gaps in the Financial Sector • Ethiopia is one of the highly under-banked countries in the world. • Access to financial services to the wider public is limited. • The bank per capita is one of the lowest in Africa. • Supply of the banking services is growing from year to year. • But this has not led to an increased outreach of the banking system at large.
Private banks tend to be highly metropolitan oriented. There is large excess liquidity among the formal CBs. The excess liquid asset grew from 2.5billion Birr in 1993 to over 10 billion in 2005. The CBE has large idle fund with loan to deposit ratio below 40%. There is supply – demand imbalance in the market. The extent of demand for financial services is vast. The demand for banking services comes from population size and growth. The Ethiopian population is over 75 million. Ethiopia needs to double the existing CBs to reduce the population bank ratio from 9 million to 5 million.
It needs to have over 1,500 bank branches to reduce its population per bank branch to about 50,000 population, Better economic growth prospects could also be a source of demand for financial services. The GDP will grow by about 7% pa, the investment rate will increase to about 30% from about 23% in 2004/05. These trends would mean that demand for banking services would continue to expand. The rural households and small-scale urban-based operators are outside the radar of the formal banking system. The MFIs have succeeded to cover only 10% of the rural households. The few urban oriented MFIs have not yet been effective in accessing the small operators in the urban area.
Capital shortage and credit access are the top constraints for the expansion of MSE operators in the urban areas. IFAD (2001) indicates that the MFIs rural clients can be raised to 5.5 million, and the annual credit intake to 4.4 billion birr or USD 515 million Compared to the current level of 1.2 million households covered by the MFIs the unmet gap is wide. 5.5. The Legal and Policy Environment A sound legal and policy environment is a key prerequisite for the smooth operation and development of a banking system. The banking proclamation No.84/94 was issued in 1994. Proclamation No.84/94 stipulates, among others, that a company should be licensed to carry out banking activities, defines the conditions for bank licensing.
It defines that banks are established as share company, wholly owned by Ethiopian nationals, and the NBE should approve any share ownership transfers. Subsequently issued directives of the NBE defines the main functions and responsibilities of the CBs and other financial institutions. The proclamation No.97/1998 empowered the banks to foreclose collaterals The establishment and operation of MFIs has also been provided by proclamation No. 40/1996. MFIs are established as share companies wholly owned by Ethiopians and should be licensed by the NBE. 26 MFIs have been established and the micro credits have now been better streamlined.
5.6. The Role of the Government in the Financial Sector The government pursues a policy of maintaining a stable macroeconomic environment and a sound financial system Improving the operational quality and efficiency of the financial sector are its basic objectives. Three strategies have been reflected in the SDPRP: creating a favorable environment for the banking sector building internal dynamics of the banks promoting contestability of the market in the banking sector. The government has encouraged the development of micro financial services, largely to the rural people. The ALDI strategy takes rural finance as one of the key factors for enhancing agricultural production and ensuring food security.
An arrangement has also been made for the formal banks to provide input loans to the farmers to boost cereal production on the basis of interest spread sharing and guarantee from the regional governments. The collection and monitoring of the loans has been generally left to the regional governments. The SDPRP (2002) document clearly states the strategies for developing viable Rural Financial Institutions; Replace the large loans provided via the regional governments by a viable and reliable institutions. Strengthen the rural financial system by forging a strong working relationship between the CBs and the rural financial institutions. Promote group lending system. Strengthen rural banks and expand their operational scope. Directly extend credit to cooperatives with strong institutional and managerial capacity via forging a strong link between rural banks and cooperatives.
6.1 The Micro Finance Industry in Ethiopia 6. Rural and Small Scale Financial Services in Ethiopia Why Financial Services to the Poor? Finance is one of the robust determinants of economic growth. Finance can help in achieving the poverty reduction objective. Financial development reduces the poverty level of countries Finance broaden the investment opportunities of people and raise income of the poor. pro-poor growth that is would improve the condition of the poor and income distribution. Market failures in the credit market would continue to exclude the poor from accessing the financial services. This means that the specific needs of the poor cannot be met by the formal banking system.
The implication is that a new Financial Service Delivery mechanism proper to the poor should be devised. The MFIs are primarily to address the specific financial needs of the poor. MFIs are widely believed to constitute convenient, affordable and appropriate financial services to the rural and urban poor. The MFI industry is very young but it has made a significant advance in terms of the no. of clients. (>1.2 million) 6.2 Evolution of the MFIs Industry in Ethiopia Micro credit started as a government and NGOs motivated scheme. Following the 1984/85 sever drought and famine, many NGOs had started to provide micro credit along with their relief activities The Government also provided loans largely for the purchase of oxen through its Rural Finance Dep’t of the then MOA. But the loans were not based on proper needs assessment.
In many cases, the loans were not repaid and might have fostered a culture of not repaying loans. During 1974-91, the DBE and the CBE were extending loans to cooperatives largely in response to the government’s pressure. A massive default by the cooperatives had forced the CBE to withdraw from rural financing through the cooperatives. Since 1991 the CBE has continued to provide loans for the purchase of fertilizers and improved seeds on the basis of regional government guarantees. The DBE has also been providing loans to micro and small-scale operators in some selected towns. The scheme was based on donors fund in the form of revolving fund, and limited number of clients covered. Funds were simply given from the DBE to clients identified and screened by the Trade and Industry Bureaux of regional governments, and the Micro and Small Scale Agency,
Before the formalization of the MFIs, micro credit used to be provided in a fragmented and unplanned manner. The micro credit schemes were donor driven. Thus, their outreach and impact remained limited. The failure of the CBs to provide banking facilities, and the unsustainability of the NGO’s credit scheme led the government to issue a legal framework for the establishment and operation of MFIs. Success and growth of MFIs elsewhere also prompted the adoption of MFIs in Ethiopia. Proclamation No. 40/1996 allowed that micro credit should be provided by a licensed agent/institutions. Any institution desiring to engage in micro financing is required to:
Obtain license from the NBE Form a share company owned by Ethiopian national Deposit a minimum capital of 200,000 Birr The NBE has also set a loan ceiling of 5000 Birr now improved The MFIs loans durations was fixed to a maximum of two years with a possibility of rescheduling. MFIs are required to be registered when their deposit level reached one million birr and above. The regulatory framework has enabled to standardize the provision of micro credit services throughout the country. The institutionalization of micro finance has allowed the provision of deposit facilities to those wishing to earn interest The deposit facilities are: voluntary and involuntary saving deposits.
The emergence of the MFIs has helped to set out a clear vision, with regard to the provision of micro financing both on the part of the government and the individual microfinance institutions. The role MFIs can play are clearly stipulated in the government policies and strategies: the Rural and Agricultural Development Strategy (2001); the New Coalition for Food Security Program by the FDRE (2003) MFIs lending and deposit rate are deregulated with the exception of the floor deposit rates which is fixed at 3%. MFIs are free to open branches and sub-branches. The only requirement is to inform the NBE fifteen days after starting operation. Various institutional structures have been set up to enhance and monitor the sector. A new Department that supervises and regulates the MFIshas been established within the NBE.
A Rural Financial Intermediation Program Coordination Unit has been established within the DBE to coordinate donors’ intervention in the MFIs Industry. A Seven Year Program was prepared in 2002 with a total budget of 95 million USD, (IFAD, ADB and DBE). The Unit operates as an apex institution for the MFIs with regards to these funds. The key tasks of the program are capacity building and the provision of equity and credit funds to the MFIs. The Association of Ethiopia’s Micro finance institutions (AEMFI) is another wing involved in the capacity building of the MFIs, mainly through training, research and dissemination.
6.1. 3. Structure and performance of the MFIs Industry in Ethiopia About 26 licensed MFIs have now been established. The products provided by the MFIs are loans and savings deposits. At the end of 2005, the total outstanding loans and deposits of the MFIs were Birr 1,481.7 million and Birr 502.6 million, About one-third of the loans are financed from own deposit mobilization. The gap shows that MFIs are highly dependent on donors’ funds to meet the credit needs of their clients. Donors’ funds are relatively cheap, but the sustainability is a critical issue for the MFIs. Donors’ fund are relatively volatile and may not be available any time MFIs need them, Excess liquidity in the CBs coexists with deficits in the MFIs All the MFIs combined had about 1.2 million loan clients throughout the country.
The MFI industry is dominated by a few MFIs. The ACSI with 394,374 and the DECSI with 417,290 clients account for over two-third of the total clients of the entire MFIs. Three of the largest MFIs take over 80% of the market share, both in loans and number of borrowers. A couple of the MFIs are among the top MFIs in Africa. Regional governments, local NGOs, non-profit civic organizations, associations and private individuals representing foreign NGOs constitute the shareholders of the MFIs in Ethiopia. The source of equity funding for all the MFIs shows that about 75% is that of local NGOs and associations while 25% belongs to the regional governments. Even those MFIs whose 100% equity ownerships belong to private individuals used seed money from foreign NGOs
Foreigners are not allowed to participate in the financial sector, but can support the MFIs by providing fund as part of their objective of alleviatingpoverty and support development activities in the country. MFIs operate in a high-risk environment with the rural and urban poor, and cannot be attractive form of investments for private investors. Board of directors run the MFIs, but their attendance is reported to be low and lack experience and exposure with MFIs. Thus the governance issue is one of the key problems of the MFIs in Ethiopia. One of the impressive performances of the MFIS in Ethiopia is that Loan recovery rate is as high as 95%. Some of the MFIs, receive good support from the district level administration offices in the collection of loans from clients. The average number of active borrower per MFI is five times higher than any African counterpart MFI.
Average number of savers, deposit and loans balances per MFI are also significantly higher for Ethiopian MFIs than that of Africa. However, women constitute only 30% of the active loans clients against 65% of their African peers. Ethiopian MFIs are highly indebted compared to their African counterpart, as the average debt-equity ratio is 81% for Ethiopia compared with 1.5% for Africa. However, the ratio of commercial funding for the Ethiopian MFIs is only 7% against 46.4% for Africa. Average loan per borrower is also lower for Ethiopia than that of Africa. In terms of financial self-sufficiency, Ethiopian MFIs are also worse than their African counter part. Ethiopian MFIs, on average, tend to charge a lower lending rate compared with their African peers.
The MFIs in Ethiopia are heavily tilted towards rural financing, 80% of the MFIs clients are in rural. In 2003, five were urban based whose target groups is the micro enterprises and small scale operators. Another feature is that the operation of each of the MFI is confined to specific region. The MFIs in Ethiopia are rural focused, and have filled an important financial service gap in the rural areas. About 10% of the rural households have so far been covered by MFIs. MFIs are evaluated by the impact they have brought about in terms of reducing poverty and raising the income of the target group. The DECSI with over 400,000 clients operating in Tigray Regional State has managed to improve the living conditions of the clients.
According to the study: • Households have been able to diversity their assets towards cattle fattening, goat rearing, honey production, etc • Built a new house or expand their existing house • Able to send their children to school due to income increase • Managed to accumulate savings • Install water tap in their house • Establish shops, and small bars in the case of small rural towns • Rent in land from others to expand their cultivated land • Cultivate vegetables where there is enough water • In the urban areas many female-headed households have started establishing small business enterprises such as local brewery, food • preparation and selling. • The proportion of people whose condition have improved is 10% higher for clients than for non-clients
There are instances of indebtedness and defaulting owing to recurrent drought and poor agricultural production. Some times the youth, female-headed households, the landless and the extremely poor may be marginalized in accessing the financial service provided by the MFI. The youth, may be marginalized because they are treated as part of the parent households. Women may be marginalized because they do not have sufficient labor to till their land. The group formation is another factor for the marginalization of the youth, the landless, the women and the poorest of the poor.
6.1.4. Major Challenges of the MFIs Industry The MFIs industry is young and basically rural. Many of the large MFIs are region based. The client base of the MFIs are small scale operators located in a scattered manner. One challenge is the financial sustainability. The MFIs’ clients are low-income base thus the outreach objective could not be achieved at the desired speed without compromising self-sustainability. MFIs may desire to set a high lending rate, but as their clients are poor, the need to set a high lending rate would be diluted. The deposit mobilized from the MFIs target group is weak: only a 30% of the fund lent out by MFIs is covered from internally mobilized funds.
Cheaper donor funds rate are also challenges to rural finance as the incentive to mobilize deposits would be weaken. Loan repayment rate for all the MFIs is high, however, loans repayment and deposit mobilization of MFIs clients could be hampered by recurrent droughts. Clients engaged in non-agricultural activities are often affected by lack of market demand and competitions from foreign made goods, The quality of human resource is another challenge MFIs are facing as skilled personnel do not often tend to serve as staff of sub-branch offices in Rural areas. Governance is another challenge to the MFIs in Ethiopia. Group lending could turn against the MFIs objectives of expanding outreach as group members tend to exclude individuals with limited asset and perceived to be of high risk.
6.2. The Role of CBs in Providing Micro and Rural Financial Services in Ethiopia CBs are hesitant to involve in the provision of small and micro financial services for several reasons. Six obstacles as to why CBs fail to deliver small financial services are: lack of commitment and vision in this specific sector, lack of modality to deliver small financial services to small operators less cost-effectiveness in handling small loans, missing structure for micro financing in their organizational chart, the need to recruit and retain specialized staff trained in micro and small loans, and the nature of regulations and supervision that do not take the special nature of these loans.
These issues are also pertinent to the Ethiopian situation. The banks responded to the pressures of the government rather than being induced by the business opportunities. The CBE financed farmers’ cooperatives organized along socialist principles in the 1980s on clean basis. With the collapse of the socialist system, these cooperatives were disbanded, entailing large loan losses to the bank. The new government (1991) also took agriculture as the engine for growth and industrialization. A large-scale agricultural extension program with the support of NGOs has been implemented since 1994, largely driven by the supply of fertilizers and other input packages to the smallholder farmers.
6.2.1 The Experience of CBE The CBE was again called up on to finance the purchase of inputs, based on guarantees of the regional governments. An annual average loans of over Birr 860 million has been extended during the last five years for Agricultural input purchases To small farmers thru farmers’ cooperative. The annual budget of the regional governments is the collateral. The plan of the government is to gradually withdraw from this scheme as the MFIs and the cooperatives gain institutional and managerial strength. The CBE has recently opened an SME/MFIs Unit to entertain retail loans from small operators and wholesale loans to MFIs. The Unit handles the agricultural loans annually granted to the regional governments, and loans to agricultural cooperatives and unions. Agricultural produce marketing loans are provided to these cooperatives and unions during the harvest time. The average amount granted by CBE during the last two years has been over 191 million Birr and Farmer’s cooperatives purchase the produce of the their members to estabilize crop price.
This product will be replaced by a loan based on a warehouse receipt system as a collateral, as the Federal Government has recently established the legal framework to operationalize this system. The SME unit has managed to provide over Birr 30 million. Directly to two MFIs based on their managerial strength, and has over Birr 150 million in the pipeline. On the basis of 80% guarantees from an NGO - SAHEL ETHIOPIA, the Unit has set aside about 16 million birr to about 22 cooperatives operating in the NGO’s area of operation. The CBE also contributed about Birr 200,000 as equity contributions to MFI in Addis Ababa. CBE has the experience of administering the loanable fund from IFAD of about Birr 17.5 million to the poor.(Phased out)
6.2.2 Other Banks’ Experience This time there is a sign of growing interest among the private CBs to involve in micro financing. Awash International Bank, has been extending a credit line to one MFI over the last couple of years, partially based on the business plan of the MFI and partly on guarantee from a foreign business firm. Abyssinia Bank - also provided loans to an MFI based on partial guarantee provided from the USAID These trends are, however, individual banks’ initiatives not supported by the regulatory mechanism, and the sustainability of the program depends on the willingness of the banks involved. A sustained and scaled up involvement of the CBs in the MFIs business would require incentives such as less stringent regulatory roles for loans extended. It also requires strengthening the institutional, managerial and governance capacity of the MFIs, so that the CBs will have the confidence on the viability of these institutions.
7. Linking the CBs with the MFIs: Policy Options The establishment of the MFIs constitutes a step forward. The provision of micro credits by NGOs and Government have now been better streamlined. With the MFIs it is now possible to have a clear vision and mission with regard to rural finance developments. The key task is how to integrate the MFIs sector with the formal banking sector, because: Large excess liquid asset build up in the CBs Heavy dependence of the MFIs on donor funds Uncertainty with the duration and size of donors’ funds The question is what modality to devise that would work for the benefit of the CBs and the MFIs, The CBs are confined to the urban centers (15% of the population), while the MFIs are largely rural oriented,
The CBs serve the better–off and capable of absorbing large scale loans The MFIs operate with the poor who require small loans without collateral depositing smaller amount. The CBs are awash with excess liquidity while the MFIs are liquidity constrained. The products the MFIs provide are only credit and saving, and the rural population is excluded from the wide range of products provided by the CBs. Each of the MFI is operating in specific regions and can introduce local transfers and related services within their respective regions, and effectively evolve themselves into regional banks. All the CBs are headquartered in the city and the CBE has extended its branch network to medium sized towns. The issue is how this dualism be transformed into a unified system and ensure the sustainability of the operation of the MFIs.
Success in this would end the problems in the provision of financial services, and allow a free flow of funds between the rural financial systems and the urban CBs. The efforts of CBE to institute a SME financing unit that deals with the MFIs in the provision of wholesale credit lines is in the right direction. These efforts need to be a system encompassing all banks and products other than credit, and supported by regulatory system. There are important initiatives in many countries with regard CBs – MFI linkage mainly based on credit line. India’s self-help group CBs, and that of Nepal’s formal banks-MFIs linkage are notable. These linkage models shows that CBs contribute to the pool of fundable resources of the MFIs.
In Nepal in addition to wholesale lending to the MFIs, CBs are also involved in the capacity building of MFIs’ The provision of wholesale loans to the MFIs would partially obviate the risks and costs of CBs stemming from small loans. The MFIs are believed to be good at monitoring and administering small loans. The fact that their recovery rate is high indicates that the risk of lending to the MFIs is likely to be low. This business linkage benefits the MFIs and the CBs to operate on a wider area. CBs branches are located in towns and expanding their branch network to smaller towns entails a high cost. The most cost effective financial service delivery for the CBs would be through the MFIs vehicles. The question is would the CBs, be willing and able to scale up their loans to the MFIs.
Some CBs have started to extend loans to a limited number of MFIs, which can be as pilot, but scaling it up across the MFIs and sustaining it would, require an innovative approach that would encourage and motivate the CBs to involve in the MFIs sector. One option is the institutionalization of a guarantee fund from funds contributed by the NGOs, donors and government institutions a link between the banks and the MFIs. (The Nigerian Agricultural Credit guarantee scheme Fund is a case in point.) The banks would lend to the MFIs partly relying on the guaranteed portion and partly on their own assessment of the strength of the MFIs. This fund has to be managed by the central bank, In case of default, the guaranteed portion of the loan would be covered from the fund. The fund should be maintained until such time the CBs build up confidence with the MFIs and fully realize the business opportunities in the small business sector.
An alternative is to establish a Rural bank – that essentially mobilizes deposits from the urban areas and extend wholesale loans to the MFIs. Essentially, this is borrowing from the relatively rich segment of the population and lending it to the MFIs whose client base is the poor without viable collateral. Another related version is the institutionalization of an apex organ for the MFIs that coordinate the flow of resources to the MFIs, including from donors, CBs, government funds, etc. Another Option is the establishment of cooperativeBank(Cooperative Bank that belongs to the government to finance the rural poor or a cooperative Bank to be organized by the cooperatives themselves as an apex financial Institution for the cooperative sector).