1. Innovations in Addressing Rural Finance Challenges in Ethiopia
Presentation by
Berhanu Taye
Addis Ababa
July 2008

2. Outline
1. 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

3. I. Background Ethiopia 1.1 Overview of the Rural Sector
Population 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.

4. 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.

5. 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

6. 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.

7. 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.

8. 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.

9. Formal sources of rural credit in Ethiopia are:
the banking system
MFIs
SACCOs/RUSACCOs
2.2 Importance of Rural Finance
Rural 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.

10. 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.

11. 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.

12. 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 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.

13. 2.2 Financial Products
Microfinance 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

14. 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

15. Lending Methodologies
Group 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.

16. 2.2 Growth, Achievements and Lessons Achievements
The Ethiopian MF industry manifested a remarkable growth since the early 1990’s:
June March growth
No. of clients 461, ,834, fold
O/S Loan Birr million Birr 3,5 billion fold
Client saving Birr million Birr 1.2 billion 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.

17. Financial performance- Country Average
1.Operational sustainability 104% 131%
2.Financial sustainability 77% 92%
3.Return on assets -5% %
4.Portfolio at risk <30 days
Source: AEMFI 2008.

18. 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

19. 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 products
The ability to reduce transaction costs
Monitoring mechanisms and to manage environmental,
socioeconomic, cultural and other risks
Allocate scarce resources efficiently
Make their resources grow continuously.

20. 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.

21. …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.

22. 3. Factors that Contrbuted to MFIs’ Rapid Growth
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 Government
ii. Regulatory and supervisory framework
iii. Institutional capacity building support
iv. Support in linking MFIs & commercial banks
v. Design & implementation of donor financed special support programs like RUFIP, etc
Donor support
Grant fund for capacity building
Technical assistance

23. 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.

24. ….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

25. 4. Challenges of Rural Finance
Shortage of loanable fund to address the growing demand
Limited capacity for smaller MFIs in expanding outreach to new areas
Weak linkage between MFIs & banks
Poor saving culture – (like depositing in the morning and withdrawing in the afternoon)
Underdeveloped credit culture - belief that credit should be donation
Growing drop out rate due to poor group formation and preparation
High illiteracy lends making training & awareness very costly
Lack of adequate information for loan processing
Absence of bank branch network and hence high travel cost
Involvement in several credit programs by clients leading to the case of borrowing from X MFI to repay Y MFI.
HIV/AIDS & other related problems

26. 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:

27. Outreach – reaching the poor in terms of both number and depth
…Continued Challenges of Rural Finance
Outreach – reaching the poor in terms of both number and depth
Financial sustainability – meeting operating and financial costs over the long-term
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

28. Best Practices/Innovations
The following key innovative approaches are effective tools for addressing rural finance challenges:
Firm vision/mission to reach the poor – increasing outreach with the ultimate goal of reaching large number of clients and poverty reduction
Simple and innovative products, i.e. development of demand driven financial products
Cost effective MFI for attaining operational & financial sustainability – control over administrative expenses and effective use of resources

29. 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 governance
Human resource development
Portfolio quality improvement
MIS strengthening
Loanable fund/savings mobilization
Quick 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

30. 6.Conclusion
The building cornerstones for achieving MFIs’ financial success
are:
efficiency & effectiveness of processes
Development of quality services
Support for innovation in operation and services
Responsiveness 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.

31. Thank You!