Microfinance matters, now and for the future

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By Deepak Khanna

Recent events in Egypt and across the Middle East and North Africa (MENA) have demonstrated the urgent need for sustainable job creation and employment in the region.

Microfinance is one way to help the self-employed by providing entrepreneurs with the financing they need to grow their businesses and extra cash to help families stay above the poverty line when adversity strikes.

Broadly speaking, microfinance is the provision of a range of financial services to poor and low-income clients that support their income-producing activities, build assets, smooth consumption, and protect against uncertainty. These services typically focus on credit, but also include savings, insurance products, and money transfers and are provided by “microfinance institutions” (MFIs).

These MFIs deliver very small loans — averaging between $250 and $600 in the MENA region — to unsalaried borrowers, usually without collateral, and typically promise future loans if previous ones are repaid in full and on time. MFIs try to build strict repayment discipline and charge interest rates that cover the costs of credit delivery so they can remain sustainable and expand their services over time.

People who would be denied financing from commercial financial institutions make up most microfinance customers, and they are typically self-employed in home-based activities like handicraft production or sewing and embroidery. They might also operate small retail shops like beauty salons or barbershops, or street stalls as fruit and vegetable vendors.

Borrowers generally use the loans as working capital for their businesses, but also to build assets like buying property. Of course, sometimes such funds are simply used to manage household cash needs and stabilize consumption, and for large outlays like education, medical expenses, as well as funerals and weddings.

Currently, more than two-thirds of all microfinance borrowers in MENA region are women, and their importance and standing in the household have been shown to grow as their activities contribute to income earned by the family.

While most MFIs, including those in the MENA region, began as non-governmental organizations (NGOs), the past decade has seen increasing commercialization in the sector and many are now transforming into for-profit entities able to offer savings and deposit services. This change has come as demand has grown so large that donor and government-sourced funds are not enough, and some MFIs have successfully attracted unsubsidized financing from commercial banks and institutional investors to maximize their outreach.

Currently in Egypt, over 400 NGO associations and foundations provide microfinance services. Other legal forms of MFIs include commercial banks, service companies, credit unions, cooperatives and public development banks and postal savings banks. In addition to financial services, some MFIs also provide non-financial services in the realms of health, literacy, and business development.

As more and more customers take advantage of microloans, however, more and more questions are being raised about the interest rates that MFIs charge their clients, rates that are usually higher than those charged by the commercial banks. The reasons for this are several, the main one being the high delivery costs to the MFIs. For example, the staff cost of making 1,000 small loans of $100 each is far higher than the cost of making one large loan of $100,000.

Apart from the small loan sizes, the absence of required collateral, and the delivery of the loan to the doorstep of the borrower, requires substantial investigation and time on the part of the MFI loan officer to accurately gauge the risk of making the loan. Over time, as MFI operations become more efficient, competitive pressures grow and the market matures, experience shows that interest rates charged by MFIs typically fall.

In the near term, however, amid concerns about borrower over-indebtedness, there is growing focus on consumer protection measures, including transparency and disclosure, complaint handling procedures, prohibitions on abusive lending practices and consumer education. Credit bureaus such as I-Score in Egypt can also help share the credit histories of borrowers to reduce the risk of over-indebtedness in the future as MFIs become members.

Despite microfinance’s growing importance for the world’s poor, Egypt’s microfinance penetration rate remains a mere five percent of potential clients, with about 1.3 million borrowers and approximately $375 million in loans outstanding.

Today, authorities in Egypt and around the MENA region have an important role to play in the continued growth and sustainability of microfinance. They can do this by pursuing sound macroeconomic policies that create stable operating environments, avoiding interest rate ceilings that result in rationing credit to the needy, and reforming the legal and regulatory framework to promote the transformation of more NGOs into microfinance banks.

Deepak Khanna is a Chief Investment Officer in IFC’s Global Financial Markets department. Based in Dubai, he works to develop micro and small business banking operations in Europe, Middle East and North Africa. Previously, Mr. Khanna served as IFC’s Regional Manager for Vietnam, Laos and Cambodia and as IFC Country Manager for the Republic of Korea. He has both industry and financial markets experience and has served on various boards of directors for financial institutions and other companies. This article was written exclusively for Daily News Egypt.

The findings, interpretations and conclusions expressed in this article are the author’s own and do not necessarily reflect the views of IFC, a member of the World Bank Group.


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