THE IMPACT OF MICROFINANCING INSTITUTIONS ON THE LIVELIHOOD OF THE RURAL POOR

Abinet Gebrekidan

ADAMA UNIVERSITY

DEPARTMENT OF BUSINESS MANAGEMENT

May, 2006

ADAMA

CHAPTER ONE

INTRODUCTION

Poverty is not uncommon problem of almost all developing countries. Ethiopia is one the leading less developed countries (LDCs) that has been experiencing the bad consequences of poverty. As the result, the socioeconomic crises that occurred in different periods have been beyond what the country could resist. Above 85 % of the population is living on agriculture which is rain fed. The fate of the country’s exports earnings and household consumption directly depend on the performance of agricultural sector. Even though this sector is the mainstay of the economy, it couldn’t fully support the massive dependents in a sustainable way. The natural catastrophes, declining size of land holdings, inadequate supply of farm technologies etc are the factors that limit the agricultural production in the country and farm level.

Due to the above fact, the country’s main and immediate objective is to strive to break the vicious cycle of poverty and to alleviate and/ or reduce the magnitude and extent of poverty. In this struggle, as to all poor countries, the binding constraint is capital formation (i.e. investment from domestic saving and external injection) to alleviate poverty and encourage investment by poor. In this regard, the micro-finance institutions (MFIs) recently gain more and more acceptance.

In addition to banks and insurance companies, micro-financing institutions have continued to play an important role in giving credit and saving facilities to micro sectors of the economy. As of June 2002, 21 micro-financing institutions, with paid up capital of more than birr 38 million are operating in different regions of the country. They mobilized Birr 255 million deposits, from small holders and gave loans amounting to Birr 349 million by end of June 2002. Accordingly, over half a million people, particularly those living in rural areas are estimated to have become beneficiaries of the services of micro-financial institutions. (NBE, Annual Report).

1.1. Statement of the Problem

Micro finance institutions are increasing in number and area of coverage in our country. But the problem is dealing with the poor (especially with credit related issues) is not as easy as poverty alleviation so that this may challenge their contribution to development. That means the rural poor have less organized way of living, widespread illiteracy and the like which hinders from participating in credit and saving programs; and hence the effort of those programs may be challenged.

A recent annual report of NBE tell that the number of MFIs has reached 22 at the end of fiscal year 2002/03. Their total capital stood at Birr 299 million and mobilize deposits of Birr 302 million. Of the total MFIs, 10 were operating in Addis Ababa and 5 in Oromia. Three MFIs jointly accounted for 31 percent of the total capital, 12.1 percent of total savings mobilized, 21 percent of total credit allocation and 20.4 percent of total assets. The two biggest MFIS namely, Amhara and Dedebit Credit and Savings institutions alone accounted for 59 percent of the total capital, 80 percent of the savings, 71 percent of the credit and 71 percent of the total assets of MFIs.

1.2. Objectives of the study

The study has the following major objectives:

1. To assess the role and impact of micro-finance institutions on the livelihood of rural poor.

2. To assess factors that hinder the rural poor from participating in Micro finance Institutions

3. To draw conclusion and give some policy recommendations for the successful implementation and development of micro financing programs.

1.3 Methodology of the study

Secondary sources are used in this study. These sources are obtained from different organizations like Association of Ethiopian Micro-finance Institutions (AEMFI), the National Bank of Ethiopia, different journals, annual reports and books, etc.

1.4. Limitation of the study

The main limitations of this study are: shortage of time and the types of the data used i.e. the study solely depends on secondary data from different sources.

CHAPTER TWO

LITERATURE REVIEW

2.1. The Need For Micro-Financing

According to Khandker (1998), the alleviation of poverty requires diverse measures. The most important being those, which expand the income and employment opportunities of the poor, enabling them to enhance their living standards providing the poor with access to financial services is one of the many ways to increase their income and productivity.

Binswanger and Landell-Mills (1995) states that constraints in relation to suppliers.i.e. Private Banks excludes the poor because small transactions are unprofitable. Providing financial services to the poor and women is not easy. Many borrowers are not credit worthy and don't have profitable projectors. Thus, that the need for micro financing is an undeniable fact.

According to Yanor, Benjamin and Pipren (1997), the issue that should be raised in this context is the importance of the informal sector in LDCs economy and its constraint to develop by lack of credit. On top of that, Salad vine and checkering (1991) confirmed this fact by noting that, “the informal sector” which contributed about 35% to 65% and 20% to 40% to employment and GDP in most LDCs respectively, is constrained by lack of credit.

Micro financing programs are developed to fill this gap. The rural poor in LDCs are in desperate needs of credits, microfinance programs are supposed to make available this credit needs and keep the poor to increase their living standard. Lack of saving and capital make it difficult for many poor people who want jobs in the formal and informal sectors to become self employed and to undertake productive employment generating activities, providing credit seems to be a way to generate self-employment opportunities for the poor.

In this regard, MFIs in relation to other financial intermediaries has special role and distinguishing features which are given as follows:

Ø The primary objective of MFIs is to address the credit needs of those who are willing and ready to reduce their chronic poverty by engaging in farming and small scale production and service activities (Getahun, 2001).

Ø Besides provisions of credit facilities, MFIs render managerial, marketing technical and administrative advise to borrowers by reaching borrowers at there place of work.(ibid)

Ø MFIs do not require collateral to extend credit in cash or kind to peasant farmers and small entrepreneurs. Instead peer group-leading scheme, character based loans and the promise of subsequent loans is main motivations for repayment (Marguerite, 2001).

Ø Saving requirement is introduced as a compulsory feature of lending activity and this saving requirement seems to serve as a motivator for repayment of loan since borrowers choose to repay the loan than losing the amount they saved (Getahun, 2001)

2.2 Country Experiences on Micro-financing

2.2.1 Experience of Bangladesh

Why it is that micro-finance becomes a great concern for the whole world as an instrument for poverty reduction in rural areas? It seems because it has recorded success in countries where it has been implemented Abiy (2000). A brief look at this success stories is as follows.

One of the most successful countries often mentioned in the development of microfinance is Bangladesh. Micro finance organizations like Grameen Bank, Bangladesh Rural Advancement Committee (BRAC), Proshika (PK), Association for Social Advancement (ASA), largest 20 credit NGOs (not including Grameen Bank), and Bangladesh Rural Development Board (BRDB) are operating in the country mentioned

For instance, the Grameen Bank, which was established in 1983 as a challenge to existing collateral-based financial system, has had a promising result. It operates exclusively for the poor on the promise that rural people, who won too little land, support themselves as farmers, can never the less make productive use of small loans and repays them on time. The bank also promotes social development by making the poor accountable to individually and socially. Such intermediation improves productivity and income of the poor. This, in turn, also improves their loan payment rate and hence contributes to the Grameen Bank’s financial Viability. As the result it is the most successful credit program for poor and this may be seen from the outreach status and loan recovery so that the bank’s loan recovery rate has consistently remained above 90 percent Pit and Khandker (1998).

2.2.2 Experience of some African Countries

Formalized micro finance institutions’ in Africa is a more recent phenomenon. The 1950s and 1960s led to a proliferation of rural leading programs that focused on the provision of subsidized credit by government development banks. After this period in 1980s, the replication of Bangladesh’s Grameen Bank began to be tested using primary donor funds to provide credit to a wide number of solidarity group members (Paxton and Fruman, 1998).

For our purpose, however, we will look only two countries Kenya and Burkina Faso- the former representing relatively densely populated region and the latter is less densely populated.

For example, in Kenya KREB (Kenya Rural Enterprise Bank) is a micro finance institution serving the poor in rural and urban areas of Kenya. It was established as an intermediary NGO to provide financial and technical assistance to NGOs in Kenya that are involved in developing or promoting the development of micro and small enterprises.

Since 1990, KREB has successfully transformed grants from its development partners into loan capital for nearly 30,000 businessmen and women. It has been able to do so at a positive return since 1994. KREB has distributed over Kenyan shilling 300 million each year since 1995 and has never run short of new customers.

The PPPCR (Le project de promotion du petit credit rural) has been particularly innovative in adopting the Grameen style of group lending to the conditions in Burkina Faso. Certainly the sahelian region represents one of the most challenging environment for micro finance due to the combinations of failed prevails efforts low population density, poverty and illiteracy. To overcome some of these obstacles, PPPCR has departed from a pure Grameen replication and has adapted its own financial services and organization.

Like the Grameen Bank, PPPCR has grown quickly, but cannot be compared in member of clients. By the end of 1994, PPPCR had served 10,000 clients, and two years later it had reached about 25,000 clients. Despite all of the careful modifications of the Grameen model to the Burkina Faso context, the provision of micro finance services has proved to be quite costly in the Sahel. The reasons for these high costs are more related to the environment (low population density, poor infrastructure, poverty, illiteracy etc.) than to the methodology of group lending itself. The PPPCR has experienced greater efficiency in the past couple of years as it continues to learn from its early experience & achieves economies of scale.

Generally, the results in this study have shown that none of the institutions have been able to cover the cost of subsidies despite in roads towards financial viability. Most of micro finance institutions limit their ability to achieve high volumes of loan advances and savings. In sum, the most important lesson is that a wide variety of market niches exist in the field of micro finance.

MICROFINANCING INSTITUTIONS IN ETHIOPIA

In Ethiopia, the origins of Micro-Finance Institutions (MFIs) is largely rooted in their non-governmental organizations (NGOs) past with a clearly defined mission of rural poverty eradication. Proclamation No. 40/1996 established the licensing and supervision of MFIs as 'share companies' in accordance with the Commercial Code of Ethiopia. In addition to banks and insurance companies, Micro- Finance Institutions (MFI's) have continued to play an important role in providing credit and saving facilities to the various micro-sectors of the economy. Over half a million people, particularly those living in rural areas have become the prime beneficiaries of the services of these institutions. The number of Micro-Finance Institutions (MFI's) that operate in the country has reached 22 at the end of fiscal year 2002-2003.

Microfinance has evolved as an economic development approach to benefit low-income women and men. Microfinance clients are typically self-employed, low-income entrepreneurs in both urban and rural areas. Clients are often traders, street vendors, small farmers, service providers and artisans and small producers, such as blacksmiths and seamstresses. Usually their activities provide a stable source of income (often from more than one activity). Although they are poor, they are generally not considered to be the "poorest of the poor".

Micro-financing institutions in Ethiopia are formed as share companies in line with the provisions of Commercial Code of Ethiopia. These institutions owned by regional governments, NGO’s, associations and individuals of Ethiopian origins. However, the coverage of financial services of micro-financing institutions in Ethiopia to day is not as their numbers. This is because of the face that the operation of micro-financing business is very challenging mainly because of prevalent limited financial and human resources in the country, lack of adequate infrastructure in the rural areas of the country, lack of business awareness by the borrowers particularly in the rural areas and frequently happening drought. The existing micro-financing institutions played important role in improving living standards of their clients. Because the small holders in the rural as well as the urban area do not have access to Commercial Banks due to lack of collateral to secure the loan to be granted. The small holders in Ethiopia are in fact living under the poverty line, which constituted not less than 45 per cent of the total population of the country. Hence, micro-financing institutions can play the greatest role in realization of the need for financial services for the poor society to promote their living standards.

Micro-financing institutions operating in Ethiopia are an infant industry. The history of Ethiopian micro-financing institutions is limited to only about seven years. The objectives of the establishment of the institutions are to support certain section of the population who are beyond the view of the commercial banks. The primary motive of these institutions is to achieve social objectives as well as to generate adequate profit so as to stay in business and reach poor segment of the society to a large extent as possible.

Functional Spread of MFI's:

Functional spread has two aspects. It encompasses mobilization of deposits and deployment of credit. MFI's are required to mobilize untapped savings of the economy in the form of deposits and channels such deposits for the purpose of delivering financial services to the urban and rural poor. Deposits are the basic raw materials for the MFI's. It helps the MFI's to channels credit for the betterment of the working poor. Higher is the deposit mobilization; larger is the scope for deployment of funds. The performance of MFI's in the field of deposit mobilization and deployment of credit is seen in table 1.

TABLE 1

FUNCTIONAL SPREAD OF MFI's (Amount in '000 of Birr)

Years	Savings (Deposits)	Loans	Deposits to Loan Ratio (%)
2000	176,113	287,868	61
2001	252,723	352,721	72
2002	281,612	398,997	71
2003	327,509	593,927	55
2004	431,000	994,000	43

Source: Supervision Department, NBE.

It can be observed from the above table that the ratio of deposits to loans outstanding has shown a significant growth. This indicates that Micro-Finance Institutions are capable of mobilizing savings for financing the delivery of financial services to meet their businesses. However, it is not encouraging sign that the said ratio has been decreased from 71 per cent in 2002 to 43 per cent in 2004.

Components of Capital:

Total capital structure is composed of finance provided by the shareholders, donated capital, other capital account and earnings of the sector. The composition of capital of MFI's is seen in table 2.

TABLE 2

CAPITAL STRUCTURE (Amount in '000 of Birr)

Composition of Capital	2000	2001	2002	2003	2004
Paid Up Capital	17,690	38,323	50,803	58,219	128,000
Donated Capital	143,750	141,016	161,157	174,213	191,000
Other Capital Account	3,228	4,5280	5,2745	75,064	137,000
Retained Earnings	-1,939	-6,732	-9,265	-1,979	9,000
Profit/Loss	11,748	10,018	12,779	30,568	55,000
Total Capital	174,477	227,905	268,219	336,085	521,000

Source: Supervision Department, NBE.

As it can be observed from the above table that the total capital of the sector has steadily been increased from birr 174,477 in 2000 to birr 521,000 in 2004. The increase over the period was 3.8 times. Profit has declined slightly in the year 2001owing to excess expenses over earnings.

A condensed comparative balance sheet of MFI's with vertical analysis is seen in table 3.

TABLE 3

COMPARATIVE BALANCE SHEETS OF MFI's FROM DEC 2000TO DEC 2004. (Amount in ' 000 of Birr)

Items	2000		2001		2002		2003		2004
Items	Amount	Percent	Amount	Percent	Amount	Percent	Amount	Percent	Amount	Percent
Assets Current Assets	524,521	97.2	626,203	97.0	698,580	97.5	863,139	97.9	1,383,000	98.3
Long-Term Investments	0	0	0	0	0	0	2,005	0	2,000	0.2
Fixed Assets	14,892	2.8	19,683	3.0	17,761	2.5	16,608	1.9	21,000	1.5
Total Assets	539,413	100.0%	645,886	100.0%	716,341	100.0%	881,752	100.0%	1,406,000	100.0%
Liabilities Current Liabilities	352,049	65.2	399,881	61.9	430,115	60.1	413,431	46.9	734,000	52.2
Long-Term Liabilities	12,888	2.4	18,101	2.8	18,006	2.5