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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
Integrating Financial Services into the Poverty Reduction Strategy in the Case of Ethiopia
By: Getachew Teka(Dr.)
Financial Services into the Poverty Reduction Strategy: The Case of Ethiopia
Major Thrust of the Strategy
Major Achievements of the Program
4.3. A Plan for Accelerated and Sustained Development to End Poverty (2005/06 - 2009/10)
5.1 Background and Structure of the Financial Sector
5.2. Financial Developments in Ethiopia
5.3 Major Financial Product Services
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.
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.
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:
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.
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.
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.
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.
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.
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.
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)
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.
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).
The cooperative Bank(Public or that of the cooperatives themselves) would be responsible
The MFIs – CBs linkage requires a supportive and encouraging regulatory environment.
Banks need to be motivated to be involved in the small loan operation through the MFIs and even on their own.
Incentive systems such as the relaxation of the regulatory rules with regard to MFIs and MSE looks essential to encourage their involvement in providing banking business to the small scale operators.
The provision of financial services meant to economically empower the poor which has been at the center of the government’s Poverty Reduction Strategy.
The recent rapid growth of the MFIs industry is a clear testimony to the amount of attention given to the development of rural financial services in the country.
In the last ten years alone, the MFIs have managed to reach about 10% of the rural households.
The financial and operational sustainability is the key issue for the MFIs.
All MFIs depend on donor funds the duration and amount of which is less predictable.
Another feature in the financial sector is the coexistence of large excess liquidity in the formal financial sector along with liquidity constraints in the MFIs sector
This should be bridged through developing a workable modality if a sustained financial intermediation, is to get depth throughout the economy.
The key issue for a sustained service delivery to the small operator both in the rural and urban areas would certainly require the involvement of the CBs which have large idle funds.
1. There could be several mode of involving the CBs: But the institutionalization of a Rural creditguarantee fund that is managed by the central bank would be an important breakthrough
This would encourage the formal banking sector with strong resource base to extend loans to the MFIs, partly relying on the guarantee fund and partly on their assessment.
The regulatory framework need to be reconfigured in such a way that it encourages the formal banks to involve in the MFIs business.
An apex institution (Bank) for the MFIs may also be considered to coordinate donors; government’s CBs funds, as well as their own funds.
The fact that there are about 26 MFIs in the country, growing from year to year, may necessitate that donors’ intervention be coordinated.
Currently, the DBE is serving as a partial apex bank as it manages the funds from the IFAD and AFDB, but should be extended to all other donor funds so that all funds would be managed in a standardized way.
There is a need to properly price donors funds extended to the MFIs in such away that they do not discourage deposit mobilization from the MFIs target population.
The government may establish a cooperative bank at national level through which Funds from CBs can be channeled or encourage the cooperatives to form their own cooperative Bank.
The government need to encourage the business relationship between the CBs and MFIs that has been started recently, the on lending facilities to MFIs by
Undertaking a public awareness campaigns to popularize MFIS, as a line of business and a viable poverty reduction tool, to help the CBs provide financial services to the poor either directly or indirectly through.
Providing incentives to the CBs to attract them in rural/micro finance services.
The CBs could be encouraged to consider equityinvestment/shareholding as a means of involving them into the micro-finance market,
The governance issues including the institutional and managerial capacity of the MFIs must also be strengthened so that they would be attractive investment ventures.
The MFIs need to be managed on commercial basis with adequate financial transparency in their activities.
The establishment of Regional Rural Banks could also be another option through which the CBs can be linked to Rural Financing, as the Regional rural Bank could have strong support from the Regional governments.
The National Bank can encourage the CBs to allocate certain percentage of their loan portfolio to Agricultural finance, thus participate in poverty reduction.
Considering loans against crop and livestock also looks a better option though the missing market for crop and livestock insurance would be a limiting factor on the extent of this option.
The existing direct financing effort of CBE to cooperatives, cooperatives Unions and MSE need to be encouraged.
Figure – I Linkage Models in Reaching the Poor in India
Source: Hema Bansal SHG-Bank Linkage Program in India
Figure – II Linkage Model in Reaching the Poor by Raffeissen Bank of Nepal
Source: Tulasi Prasad Uprety, Linkage between CBs & MF, center for Micro fiancé, Foundation for Development Cooperation, 2004-02-27 Kathmandu, Nepal
National Bank of Ethiopia
Non - bank