Microfinance Institutions in Ethiopia

Abstract
Microfinance promises to reduce poverty. To achieve this amazing objective
Microfinance institutions have to become strong enough in financial performance
because donor constancy is not a given. In this paper we tried to see the overall
purpose of microfinance institutions as well as the impacts and challenges
microfinance institutions face in this country currently micro financing is one of the
most powerful tools for combating poverty primarily by providing loan to the poor
section of the society. The numbers of micro financing Institutions serving the poor
in Ethiopia have grown to over 39 with in short period of time the steady growth in
the sector has created a competition for scarce funding among Institutions. Hence,
recent years have seen a growing push to measure performance of micro financing
institutions in order to be able to compete and achieve their objectives. In light of
this, the paper attempted to look at the performance of MFIs by taking six
institutions as a Case from Profitability and Sustainability; Asset and Liability
management; and Efficiency and productivity perspectives.

Introduction

Limited access to financial services is among the major problems impeding rural
livelihood development (Hermes and Lensink 2007; Wijesiri et al. 2017). The
problem is particularly severe in developing countries, such as Ethiopia, mainly for
two reasons. First, most of the conventional banks in the country are concentrated in
urban areas, while more than 80% of the population is rural. Second, whenever
available, the formal banking sector systematically excludes the rural poor due to the
higher screening, monitoring, and enforcement costs of providing a small loan.
Moreover, most poor have few or no assets that can be secured by a bank as collateral
(Shu and Oney 2014; Hermes and Lensink 2007; Cull et al. 2011). Thus, a
considerable number (more than 80%) of the poor in Ethiopia obtain financial
services from informal lenders, who are able to enforce loan contracts but at a high
interest rate (Demirguc-Kunt et al. 2018; Wolday 2004). However, the government is
making efforts to curb the role of informal lenders through the support of
microfinance institutions (MFIs). In recognition of this, the Ethiopian government

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issued the first microfinance legislation in 1996. Since then, the number of clients,
volume of the loan portfolio, and savings of MFIs have been increasing (Wolday
2004).

Objective
The main objective of this paper is to assess the role and performance of
Microfinance institutions (MFIs) operating in Ethiopia. Specifically, it ensures the
need and importance and also administration of MFIs. Further, to assess some of the
problems and prospects of MFIs and finally, put forward possible solutions to the
problems…….

Initially, microfinance was introduced to the globe by Muhammad Yunus in 1976 in

Jobra's village in Bangladesh. It has currently been an effective instrument for
poverty reduction. However, the contribution of microfinance services in poverty
reduction got more attention in 2005, after the United Nations (UN) announced the
year of international microcredit. Many microfinance institutions have arisen and
have attracted the poorer communities and have developed new strategies to realise
their vision. Since then, most developing countries have been using microfinance as
the best strategy to eradicate poverty.

Several microfinance institutions (MFIs) emerged in Africa to fulfill the limitless

need for financial services and provide different benefits in the past decades. For
instance, some of these microfinance institutions successfully address material
shortage, the tangible materials like goods, intangible (services) to realize them.
Once properly managed, micro financing’s materials benefits can range beyond the
household into the community. However, some scholars describe that few of these
microfinance institutions focus on offering loans, whereas others offer both credit
facilities and gather the deposit.

In Ethiopia, microfinance was introduced in 1995 to reduce poverty, and since then,
Ethiopia's government has stimulated the expansion of modern financial services in
the country. Presently, around 31 licensed microfinance institutions are operating
throughout the country. In recent times, the government of Ethiopia developed
various developmental strategies such as a poverty reduction strategy paper which is

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aimed at enhancing and supportable growth, among other documents, considered
microfinance as the best reference in achieving the intended development objectives
and limiting the risky trends in poverty problem and meeting the millennium
development goals. Normally, most of Ethiopia's microfinance institutions have
common goals: poverty reduction by providing loans and saving services by using the
group-approach lending system.

Microfinance can be effective in poverty reduction if it is integrated with other

developmental strategies that work to meet the poor's basic needs to take them from
poverty [5, 32, 33]. Several studies in different disciplines used different approaches
to assess the impacts of microfinance in poverty reduction. For instance, the
interventions of the microfinance program influence social associations somewhat
through their economic impacts. In various examples, credit systems implementers
have demanded that the work leads to advanced social transformation, by
authorizing women and shifting gender relations in the household and the
community.

Although many of the microfinance institutions in Ethiopia are established as private

share companies. All types of micro-finance institutions are under the supervision of
the National Bank of Ethiopia (NBE). The National Bank of Ethiopia issues the
license for the establishment of micro-finance institutions and they have an
obligation to hand in monthly reports to the bank. Also, the NBE provides annual
operational guidance to the institutions (Embassy of Japan in Ethiopia, 2008).

What Is Microfinance?

Microfinance has been defined as: - the means by which poor people convert small
sums of money into large lump sums (Rutherford 1999). Microfinance services may
be seen in terms of four main mechanisms:
Loans: which allow a lump sum to be enjoyed now in exchange for a series of
savings to be made in the future in the form of repayment installments.
Savings: which allow a lump sum to be enjoyed in future in exchange for a series of
savings made now.
Insurance: which allows a lump sum to be received at some unspecified future time
if needed in exchange for a series of savings made both now and in the future.
Insurance also involves income pooling in order to spread risk between individuals

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on the assumption that not all those who contribute will necessarily receive the
equivalent of their contribution.
Pensions: which allow a lump sum to be enjoyed as a specified and generally distant
date in future in exchange for a series of savings made now. In the literature the
terms micro credit and microfinance are often used interchangeably, but it is
important to highlight the difference between them because both terms are often
confused. Sinha (1998) states "micro credit refers to small loans whereas
microfinance is appropriate where NGOs and MFIs supplement the loans with other
financial services (savings, insurance, etc.). Therefore micro credit is a component of
microfinance in that it involves providing credit to the poor, but microfinance also
involves additional non-credit financial services such as savings, insurance, pensions
and payment services (Okio credit,2005).

Evolution of the MFIs Industry in Ethiopia

Initially, micro credit started as a government and non-government organizations
motivated scheme. Following the 1984/85 severe drought and famine, many NGOs
star started to provide micro credit along with heir relief activities although this was
on a limited scale and not in a sustained manner (IFAD 2001). The Government also
sporadically provided loans largely for the purchase of oxen through its Rural finance
Department of the Ministry of Agriculture and cooperatives. But these loans were not
based on proper needs assessment and no mechanism was in place to monitor their
effectiveness. In many cases, these loans were not to be repaid and might have
fostered a culture of not repaying loans.
During the command economic system (1974-91), the Development Bank of Ethiopia
(DBE) and he commercial Bank of Ethiopia (CBE) were also involved in extending
loans to cooperatives largely in response to the government’s pressure. A massive
default by the cooperatives following the demise of the command economy along
with its extensive control systems, however, forced 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.
This scheme was, however, based on donors fund designed in the form of revolving
fund, and essentially based on a limited scale in terms of the number of clients
covered. Funds were simple been given from the DBE to clients identified and
screened by the Trade and Industry Breaux of regional Gove rally led to a low loan
recovery rate (DBE 1999). In line with this, the early formal microfinance activity is
the DBE (Development Bank of Ethiopia)

Impacts of microfinance at the beneficiaries’ level

Impacts on beneficiaries’ income
One of the measures of microfinance institution loan effectiveness is its ability to
generate income for its beneficiaries. An increase in income can be a component of a

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better life. In other ways, the major objectives of microfinance are to help in
generating income for low-income households and help in alleviating poverty.

Impacts on education
A service provided to the beneficiaries is believed in one way or another way to
promote the education status of children.

Impacts on nutrition improvement

Access to microfinance can create improvement in the nutritional intake of the
beneficiaries and their families based on their effectiveness in the program.
Microfinance programs have a significant influence on the improvement of
nutritional position as well as on the well-being of the women participants and their
families.

Impacts on the beneficiaries saving attitude

In most cases, knowledge of microfinance improved attitude toward microcredit and
the saving behavior of its beneficiaries had a major role to improve the saving habits
of the beneficiaries which are the source of capital and finally a key for the economic
development of the country.

List of microfinance institutions in Ethiopia

1. Dedebit Credit and Saving Institution S.C. ...

2. Oromia Credit and Saving Institution S.Co. ...
3. Omo Micro Finance Institution S. ...
4. Gasha Micro Financing S. ...
5. Vision Fund Microfinance Institution S. ...
6. Sidama Micro Finance Institution S.Co.
7. Africa Village Financial Services S. Co.
8. Dire Micro Finance institution S. Co
9. Aggar MicroFinance s.co
10. One Microfinance institution share company

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11. Digaf Micro Credit Provider S, Co.
12. Tesfa Micro Finance Institution 5. Co.
13. Somali Micro finance Institution S.Co.
14. Lideta Micro Finance Institution S.C.
15. Adaday Micro finance Institution S.Co.
16. Gambella Micro Financing S. Ce
17. Kendil micro finance institution
18. Kershi Microfinance Institution S.C
19. Sheger Microfinance Institution S.C
20.Grand microfinance institution
21. buusaa Gonofaa Micro & handing S.Co.
22. Meklit Micro Finance Institution S. Co.
23. Addis Credit and Saving Institution S. Co.
24. ESHET Micro Finanance institution s. Co.
25. Wasasa MicroFinance institutionS.Co.
26. Benishangul-Gumuz Micro Financing S.Co.
27. Metemamen Micro Financing Institution S. Co
28.Harbu Micro Financing Institution S. Co.
29. Harar Microfinance Institution S. Co.
30.Lefayda Credit And Saving S. Co.
31. Dynamic Microfinance S. Co.
32. Specialized Financial and Promotional Institution S. Co.
33. Nisir Microfinance Institution S. Co.
34. Peace Microfinance Institution S. Co
35. Afar Micro Finance Institution S. Co
36. Debo Micro Finance Institution S. Co
37. Yemisrach Micro Finance Institution S. Co
38.KAAFI Micro Finance Institution S.C
39. Kalub Microfinance Institution S.C

Challenges faced by Microfinance Institutions

● Cost of outreach - reaching the unbanked populations of the world means
servicing small loan amounts and servicing remote and sparsely populated

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 areas of the planet, which can be dangerously unprofitable without high rates
of process automation and mobile delivery.
● Lack of scalability - smaller microfinance systems often struggle to preserve
the profitability and performance in these markets, as FI's experience high
growth rates that result from getting the service delivery right. This results in
thwarting the growth of these organizations.
● Geographic Factors - Geographic factors make it difficult to communicate with
clients of far-flung areas which create a problem in growth and expansion of
the organization.
● Diverse business models - Supporting a very wide range of features and
lending activities is difficult and requires a considerable amount of cost and
effort.
● High Transaction Cost - High transaction cost is a big challenge for
microfinance institutions. The volume of transactions is very small, whereas
the fixed cost of those transactions is very high.
● Security challenges – The customers serviced by Microfinance instructions are
usually the ones having none or very limited official identification or able to
provide tangible security, this makes it extremely difficult for institutions to
offer any banking services.
● Limited budgets – limits their capability to fulfill their requirements and
support their growth targets.
● Lack of capital is the main obstacle to increasing outreach. Even though the
MFIs obtain funds from various sources such as donation from Ireland head,
Oxfam and getting loan from RUFIP (Rural Financial Intermediation
Program) under Development Bank of Ethiopia (DBE), it is not sufficient to
meet the demand of the large population.
● Almost all MFIs in Ethiopia face lack of good infrastructure
● Lack of experienced man power. In addition to this because most of the board
members of MFIs are not real investors, there is a carelessness to see and
control the operations seriously..
● The legal environment does not allow MFIs to sell assets which are taken as
collateral without declaring to the court.
● Low saving habits of the society.

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Role of Microfinance Institutions
A main goal of many microfinance institutions is to provide sustainable microfinance
facilities to the poor to facilitate income generation and reduce poverty (Baumann,
2001). Access to credit can play a pivotal role in economic growth. Banks and lending
institutions provide the services that allow people to save and invest available assets
and resources, which further support and strengthens economic activity. Within
underdeveloped communities, the role of microfinance institutions provides the
credit access and financial services needed to develop income-earning businesses
(Jacquelyn Jeanty, Demand Media). MFIs fill a needed gap within the financial
services industry by offering small loans, or microloans, to people unable to access
conventional loan services. Microfinance institutions vary in size and function with
some organizations focusing entirely on microfinance, while others work as
extensions of large investment banks.

MFIs provide a reliable source of financial support and assistance compared to other
sources for financing. MFIs typically work alongside government organizations and
also have ties with larger global organizations. To meet unsatisfied demand for
financial services, a variety of microfinance institutions (MFIs) has emerged over
time in Ethiopia.

The emergence and development of modern microfinance institutions in Ethiopia is

a recent phenomenon that happened because formal financial systems like
commercial banking systems were very limited and could not address the financial
need of poor households for the fact that they are not their ultimate target client
(Derbew Kenubeh, 2015). The international monetary fund (IMF) ranks Ethiopia as
among the five fastest growing economies in the world. For this economic
improvement microfinance institutions have a lion’s share and the government has
well recognized MFIs as one of the important tools for achieving the first millennium
development goal.

Prospects of Ethiopian MFIs

Based on information obtained from AEMFI,(Association of Ethiopian Micro
finance) the Ethiopian MFIs have a prospect to give advanced and quality service by
expanding their operation to meets the needs of unbanked society and to increase a

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number of women clients. It is planned that the existing MFIs to deliver variety types
of services like saving, insurance and money transfer. New MFIs will be launched
that will respond to new market in the economy, these include creating institutions
specialized in providing financial service to Muslim community and women.
Moreover commercial banks will participate in giving on lend fund to MFIs and
research and development will be promoted by the MFIs and government
institutions.

CONCLUSION
Based on the analysis made in previous part of the paper it is found that the
performance of Ethiopian microfinance from outreach point of view that was
measured by number of active client, gross loan portfolio and percentage of women
participation, the growth pattern is encouraging but it increases at decreasing rate.
Especially since the concept of women empowerment is a critical role of
microfinance, the percentage of women participation in Ethiopian microfinance
sector is still not satisfactory which under 50%.
From sustainability angle, all institutions are not financial self- sufficient. During the
study period, Even though it is not continuously improved some MFIs could cover
their operational cost but they are not financially sustainable. This indicates that,
most of them are in difficulty of fund, that means the subsidy they get from donors
and the existed sources of capital are not sufficient. The result of the study
discovered that outreach and operational self- sufficiency are positively correlated.
The major challenges that the MFIs in the country face include minimum paid up
capital, efficient and competent team, and organizational structure of the institutions
and lack of infrastructure like electricity, management information system and
communication network.