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Innovations in Addressing Rural Finance Challenges in

Ethiopia

Presentationby

Berhanu Taye

Addis AbabaJuly 2008

Outline1. Background

2. Trends of Rural/Microfinance Development in Ethiopia

3. Factors Contributed to MFIs’ Rapid Growth

4. Challenges of Rural Finance

5. Best Practices/Innovations

6. Conclusion

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I.  Background1.1   Overview of the Rural Sector EthiopiaPopulation in 2008 = about 80 million.GDP per Capita = USD 180 in 2006.One of the poorest countries of the world.Poverty is endemic to the country the poor makes

insufficient money to cover daily meal, health, education and other services.

Poverty reduction is the central element of the Governments’ development agenda and hence, rural financial policies, goals and objectives focus on targeting primarily the poorest and disadvantaged rural households.

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The Rural Sector

The rural sector involves all villages and rural towns where the majority of the population lives.

About 80% of the country's population lives in rural areas and the majority of the rural population is engaged in agricultural production.

Apart from agriculture, sizeable portion of the rural population is engaged in non-farm activities that have gradually increasing in recent years.

In Ethiopia, the rural sector plays a decisive role in the growth and development of the national economy. Agriculture is the dominant economic activity of the economy that accounts for nearly 50% of the GDP.

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Characteristics of the Rural Sector Agricultural activities are the main stay Low level of productivity Constitutes an emerging rural non-farm activities High level of poverty Underdeveloped infrastructure Poor entrepreneurial development Natural resource degradation Shortage of capital & poor saving habit leading to seasonal income fluctuations Weak local government institutions

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The level of development of the rural economy in most of development countries like Ethiopia has got a direct influence on the overall national economy.

Thus, efforts and resources allocated in these countries to promote accelerated economic development largely focus on the transformation and modernization of the rural sector.

A prominent obstacle to rural development is the problem of mobilization of resources, which is crucial in achieving rapid economic growth of the rural economy.

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The initial step in resource mobilization for development purposes is the mobilization of financial resources that leads to capital formation

Since the rural economy represents a substantial proportion of the country's human and natural resources, large amount of capital is needed to help transform and modernize this sector.

Rural financial institutions, i.e. microfinance institutions (MFIs) are, thus, relevant important financial institutions which are designed and expected to encourage and mobilize savings and also channel such savings into income generating activities in the rural areas.

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1.2 The Financial Sector As in the most developing countries , the financial system of

Ethiopia is characterized by the co-existence and operation side by side of a formal sector and an informal financial sector.

The informal financial market, for the most part, is outside the framework of national accounts and statistics. However, the majority of the rural population is considered to be the direct beneficiary of the informal credit sources.

Formal credit sources have got institutional form and they are organized based upon the economic policy of the country.

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Formal sources of rural credit in Ethiopia are: the banking system MFIs SACCOs/RUSACCOs

2.2 Importance of Rural FinanceRural finance covers provision of credit, savings mobilization,

activities and providing other essential financial services such as money transfer.

Rural finance is an effective tool of poverty reduction and rural development. Its impact is fully observed only when conducive policies are in place, markets are functional and non-financial services are available.

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• Rural credits are considered as very important means of increasing investment capacity of farmers for increased employment and food production thereby alleviating poverty, famine and hunger.

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2.TRENDS OF Rural/Microfinance Development in Ethiopia

2.1 Development &Role

In Ethiopia, formal rural credit service has been subject to government policy intervention during the last two-three decades.

DBE was the main source of agricultural credits.CBE has been providing input credit since the 1986

NBE’s Rural Credit Policy Directive that permitted CBE to participate in the rural credit market.

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•As part of NGO relief and development efforts as well as to address the growing demand for credits in the rural sector the microfinance credit scheme was launched in early 1990’s.

A proclamation for licensing and supervision of microfinance business was issued by NBE in 1996. Currently, more than 27 MFIs are registered by NBE.

•One of the most important innovations in development finance in recent years has been the emergence of microfinance.

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2.2 Financial ProductsMicrofinance is the provision of financial services to the entrepreneurial poor. Most MFIs provide limited range of financial services. The financial services include:

Micro loans Micro savings Micro insurance Money transfer (payment) Pension fund management

•Moreover, they also provide non-financial services including: Training Sensitization of clients on mainstream issues like HIV/Aids

Microfinance activities usually involve:

•Small loans, typically for working capital•Group guarantee or compulsory savings as substitute for collateral•Access to successive larger loans based on repayment performance•Streamlined loan disbursement and monitoring•Secure voluntary savings products•Informal appraisal of borrowers & investments

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Lending MethodologiesGroup solidarity loans – main method, usually small loans, members cross-guarantee each other

Individual lending – larger size, loans to small business graduated from MFIs loans to employee

Members owned & managed lending – SACCOs/RUSACCOs

Microfinance in Ethiopia is an infant Industry, but the sector is tremendously growing in terms of number of MFIs, both geographical and client outreach, loan outstanding, saving mobilization, capital, assets, etc.

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2.2 Growth, Achievements and Lessons

Achievements The Ethiopian MF industry manifested a remarkable growth since

the early 1990’s:

June 2001 March 2008 growth

1. No. of clients 461,326 1,834,007 4 fold

2. O/S Loan Birr 308.6 million Birr 3,5 billion 11 fold

3. Client saving Birr 243.3 million Birr 1.2 billion 5 fold

Moreover, as at March 31,2008 MFIs recorded: Total assets = Birr 4.5 billion Total capital = Birr 1.2 billion

Source: AMFI Reports 2007 & 2008.

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Financial performance- Country Average

2003 20061.Operational sustainability 104% 131%

2.Financial sustainability 77% 92%

3.Return on assets -5% 3.6%

4.Portfolio at risk <30 days 7.6 5.4 Source: AEMFI 2008.

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Available evidences from various studies and reports show that microfinance services in Ethiopia will:

Reduce poverty through increasing income, smooth consumption flows, expand asset base, and improved living conditions

Improve health care & nutrition Women’s empowerment Improve children's education, etc.

The ability to borrow, save and earn income reduces economic vulnerability particularly for women and their household.

Successful MFIs have manifested that the poor are bankable and banking with the poor can be profitable and sustainable.

MFIs have proved that it is possible to achieve both objectives of reaching the poor as well as be financially sustainable

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Only sustainable MFIs can reliably provide adequate financial services and continously increse their outreach to the poor.

The strength of MFIs lies in:The ability to develop demand driven productsThe ability to reduce transaction costsMonitoring mechanisms and to manage environmental, socioeconomic, cultural and other risksAllocate scarce resources efficientlyMake their resources grow continuously.

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Lessons

Poor women and men have shown that they are bankable and responsive to MFI financial services.

MFIs need to be cost effective so as to reliably provide adequately provide financial services and increase their outreach.

Simplification of loan process and reduction of loan disbursement lead time will make clients confident of being funded on time.

Linkage of MFIs with the banking system requires timely action.Rural households need to be linked to markets as well as rural

credit and other support systems. The interdependence of credit and product/input markets is very important and would remain critical for rural development.

Support in areas of capacity building, technical assistance, marketing information is critical for the rapid growth of the microfinance industry.

Collection of reliable client information will help careful screeninig & timely loan disbursement.

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…Continued lessons

• Close monitoring of loan performance results in high on-time collection rates and reduces loan losses.• Introduction of regulations of new instruments like warehouse receipt (voucher) system & contract farming/out grower scheme and assurance to clients based on the socio- economic setting of the country would have considerable contribution. • Training of clients need to be strengthened.• Beneficiaries’ participation should be pursued at design and implementation• There is considerable and sharply growing unmet demand for credit• Credit services should be demand driven.• Provision of repeat loans with a gradual increase of the loan size following good loan repayment.

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3. Factors that Contrbuted to MFIs’ Rapid Growth

o The Ethiopian MF industry has witnessed a remarkable growth in the past years. Both external as well as internal factors contributed to this growth: External factors

• Government support

i. Commitment of the Federal Governmentii. Regulatory and supervisory frameworkiii. Institutional capacity building supportiv. Support in linking MFIs & commercial banksv. Design & implementation of donor financed special

support programs like RUFIP, etc• Donor support

i. Grant fund for capacity buildingii. Technical assistance

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Internal Factors Most MFIs have vision, mission and explicit objective that

make poverty reduction part of their organizational culture. At the same time their operation is geared towards cost

effective way of reaching the poor. Operational self-sufficiency of most MFIs is higher indicating that their revenues would cover their operating costs, costs of loan losses and raising their capital.

The existence of the MF Network (AEMFI), from which they get multi-faceted support like training, technical assistance, etc.

….continued Internal Factors

MFIs ability to strictly operate under the regulatory framework, which make them:

To be healthy financial institutions To stay competitive To install and maintain good governance

Most MFIs undergo continuous transformation process, i.e. Willing to design and introduce new financial products, more flexible enough in light of customer needs

Willing to continuously improve delivery process Continuous human resource development

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4. Challenges of Rural Financea. Shortage of loanable fund to address the growing demandb. Limited capacity for smaller MFIs in expanding outreach to

new areasc. Weak linkage between MFIs & banksd. Poor saving culture – (like depositing in the morning and

withdrawing in the afternoon)e. Underdeveloped credit culture - belief that credit should be

donationf. Growing drop out rate due to poor group formation and

preparationg. High illiteracy lends making training & awareness very

costlyh. Lack of adequate information for loan processingi. Absence of bank branch network and hence high travel costj. Involvement in several credit programs by clients leading to

the case of borrowing from X MFI to repay Y MFI.k. HIV/AIDS & other related problems

Contnued…..Challenges of Rural Finance

•The major challenges of rural/microfinance institutions can be summed to the concept of “Critical Microfinance Triangle” [Zeller and Mayer(2002)], which requires the need for any MFI to manage simultaneously the problem of outreach, financial sustainability and impact as shown below:

…Continued Challenges of Rural Finance

a. Outreach – reaching the poor in terms of both number and depthb. Financial sustainability – meeting operating and financial costs over

the long-termc. Impact – having observable effect upon clients’ quality of life

Based on this concept, MFIs should be able to: Choose their target clients – ensure large number of target clients

are reached using cost-effective means Develop range of products that could meet clients’ needs Set simple and standard loan procedures Reduce transaction and supervision costs

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5. Best Practices/Innovations

The following key innovative approaches are effective tools for addressing rural finance challenges:

a. Firm vision/mission to reach the poor – increasing outreach with the ultimate goal of reaching large number of clients and poverty reduction

b. Simple and innovative products, i.e. development of demand driven financial products

c. Cost effective MFI for attaining operational & financial sustainability – control over administrative expenses and effective use of resources

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d. Diversified funding sources

e. Standardized & Simple delivery procedures/ methodology

f. Linkage of MFIs & banks

g. Continuous institutional capacity of MFIs so as to address:Good governanceHuman resource development Portfolio quality improvementMIS strengtheningLoanable fund/savings mobilizationQuick information on repayment & default

h. Flexible loan terms & conditions, e.g. suitable loan repayment schedule tailored to the client’s cash flow

i. Close & frequent monitoring & follow up

j. Appropriate & standard criteria (ratios) for measuring MFIs’ performance

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6.Conclusion • The building cornerstones for achieving MFIs’ financial success are:

efficiency & effectiveness of processesDevelopment of quality servicesSupport for innovation in operation and servicesResponsiveness to client needs

• The innovations compliment each other. Using a combination/ integration of approaches in providing financial services to the rural households could be a better alternative of doing things effectively.

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Thank You!Thank You!