FINANCE Equitable Growth, Finance and Institutions Notes How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia Salman Alibhai, Mengistu Bessir, Toni Weis 1 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance © 2021 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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The risk of claims resulting from such infringement rests solely with you. If you wish to reuse a component of the work, it is your responsibility to determine whether permission is needed for that reuse and to obtain permission from the copyright owner. Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. >>> Introduction Across the world, small-scale lenders—including of emergency1 in September 2020 has allowed for microfinance institutions, community-based financial a gradual normalization of business activity in most institutions, and other nonbank financial institutions— regions, MSE lending remains depressed. This poses have grappled with uncertainty through the COVID-19 a challenge for firms affected by new spikes of the pandemic as portfolio quality deteriorated and pandemic—such as in early 2021—and is an obstacle capital buffers were drawn down. In many contexts, for a faster return to pre-pandemic levels of growth. the resulting scenario is one in which lending has Drawing on data collected from a panel of major contracted substantially, posing threats to millions of MFIs, this policy brief provides an overview of the borrowers who have historically relied on small-scale microfinance lending squeeze in Ethiopia and credit. outlines ways to overcome it.2 Sections 1 and 2 look Ethiopia’s microfinance borrowers—particularly micro- at the impact of the COVID-19 pandemic on Ethiopian and small enterprises (MSEs)—are currently facing a microfinance institutions and on their borrowers, financing squeeze that undermines their resilience respectively, and show how MFIs responded to during the COVID-19 crisis and threatens to slow their liquidity constraints by cutting off financing to MSEs. recovery. Although Ethiopian microfinance institutions Sections 3 and 4 discuss possible ways out of the crisis, (MFIs) entered the crisis in good financial health, they outlining four concrete ways to “ease the squeeze” soon began to face deteriorating portfolios and a and highlighting new interventions in Ethiopia that contraction in liquidity. Their resulting reluctance provide emergency financing to MFIs and the MSEs to issue new loans adds to the predicament of MSE they serve. The aim of this brief is to shed light on the borrowers who were already struggling as a result of lending squeeze in Ethiopia, and to share lessons for the pandemic. Although the end of Ethiopia’s state post-pandemic microfinance lending globally. 1 As the COVID-19 pandemic started to intensify, the government of Ethiopia declared a state of emergency under Article 93 of the Constitution on April 8, 2020. 2 The authors acknowledge Kenno Itana, Getachew Mekonnen, and Alberto Didoni for the collection of data cited in this brief and they are grateful for the support provided by the World Bank’s Africa Gender Innovation Lab. 3 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance >>> 1. The Impact of COVID-19 on Ethiopia’s Microfinance Institutions Ethiopia’s financial sector is dominated by state- Ethiopia’s MFIs serve a large unbanked and owned banks and microfinance institutions (MFIs) underbanked community. According to NBE data, more and—with the recent exception of the capital leasing than 5 million Ethiopians are currently borrowing sector—remains closed to foreign investment. While from an MFI, compared to just 250,000 who have this has its downsides, this measure has effectively taken out loans from commercial banks (World Bank meant that the industry has been sheltered from 2020a). While MFIs account for no more than 5 percent international financial crises in the past, such as the of total banking sector assets, they serve 20 times the Great Recession of 2007–09 (Mishra 2011). However, number of clients of commercial banks – a statistic the global COVID-19 pandemic is different, and which underscores their systemically important role Ethiopia’s MFIs, in particular, are feeling its sting. in fostering inclusive finance in Ethiopia. About 45 percent of MFI borrowers are women, and the majority Partners for Financial Inclusion live in rural parts of the country where bank branches are few and far between. To serve clients with limited access to collateral, Ethiopian MFIs use group lending Microfinance institutions are an important pillar of mechanisms, and the average loan size of US$300 Ethiopia’s financial sector. The country now has 39 is significantly smaller than the typical amount of a MFIs, although the market is dominated by five quasi- collateralized loan from a commercial bank (World public institutions serving the largest regional states. Bank 2020a). MFIs are regulated by the National Bank of Ethiopia In recent years, MFIs have become an increasingly (NBE) under the revised Micro-Financing Business important source of finance for micro- and small- Proclamation No. 626/2009.3 All registered MFIs are business owners. Ethiopia’s business community is licensed to take deposits, but NBE data shows that highly credit constrained: private sector credit from public MFIs, which have access to concessional funds commercial banks and MFIs amounts to just 13 from regional governments, take on a lower share percent of gross domestic product (GDP), compared to of deposits than their privately owned peers (World an average of 22 percent for the 20 largest African Bank 2020a). Foreign investment in Ethiopian MFIs economies (World Bank 2020a). Micro- and small is not allowed under existing regulation, limiting enterprises (MSEs) face the additional challenge competitive pressure and the adoption of new that commercial banks are hesitant to lend to micro- technology. In line with the overall expansion of the and small businesses and rarely issue loans below Ethiopian economy, the microfinance sector has seen US$50,000 (World Bank 2015). With support from World considerable growth in recent years. Statistics for Bank programs such as the Women Entrepreneurship 2018/19 show that, together, Ethiopian MFIs manage Development Project (WEDP) and the Small and Br 58.7 billion (US$2 billion) in credit outstanding and Medium Enterprise Finance Project (SMEFP), MFIs Br 41.9 billion (US$1.44 billion) in savings deposits, are filling this market gap by issuing single-borrower with year-on-year growth of 30 percent and 26 loans between US$5,000 and US$25,000. percent, respectively (NBE 2020). 3 In addition to MFIs, microfinance services are provided by Rural Savings and Credit Cooperatives (RuSACCOs), which offer agricultural credit, as well as informal savings circles known as iqubs. However, the analysis in this brief focuses only on MFIs licensed by NBE. 4 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance Figure 1.1: Ethiopia’s MFIs at a Glance Number of Market share of five largest MFIs Total number registered MFIs (percent of total credit outstanding) of borrowers 39 89% ≈ 5 mln Percent of female Total credit Total savings borrowers outstanding deposits 45% Br 58.7 bln Br 41.9 bln (US$2 bln) (US$1.44 bln) Source: National Bank of Ethiopia Annual Report 2018/19; authors’ own data 5 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance A Resilient Industry... 88 percent of outstanding loans. A second group of MFIs is affiliated with philanthropic organizations- community-based institutions as well as local chapters Three structural characteristics made the Ethiopian of international nonprofits. Purely commercial MFIs, microfinance sector relatively resilient to the kind of on the other hand, are a relatively new phenomenon shock introduced by the pandemic. First, the sector and account for a small (though growing) share of was in good shape at the time the virus hit the industry capital. Although some industry experts country. Data collected from Ethiopian MFIs showed expect a consolidation of the microfinance industry as an average PAR904 of 5.1 percent for the overall a result of the COVID-19 crisis (CGAP 2020), there are portfolio and 1.8 percent for borrowers under WEDP, currently no indications of this happening in Ethiopia. which provides larger individual-liability loans to female entrepreneurs in urban areas.5 At 1.4 percent, the average cost of risk of Ethiopian MFIs (calculated as the ratio of annual loan loss provisions to total ... Hit by a Global Pandemic loans outstanding) was within the 1 to 2 percent range recommended by the Consultative Group to The combination of strict public health measures Assist the Poor (CGAP 2002), and the average capital during the initial months of the pandemic and the adequacy ratio6 of more than 30 percent was more drawn-out nature of the crisis has put significant than twice the regulatory minimum. strain on Ethiopia’s MFIs. On the one hand, the efforts Second, Ethiopia’s microfinance sector has a strong to prevent the spread of the virus have disrupted rural component. Like the overall population, the the relationship-based business model of the majority of Ethiopia’s MFI borrowers live in small microfinance industry, which relies on group lending towns and villages, and farming households make up and regular face-to-face interactions with loan a large part of the MFI loan portfolio. The spread of officers. Ethiopian MFIs were quick to respond to the COVID-19 in rural regions seems to have been limited challenge: by April 2020, most MFIs were providing to date, though testing capacity is limited. Agriculture masks and sanitizer to staff, instituting shift work was less affected by government measures to contain to reduce office occupancy, and replacing meetings the virus than other industries, although it experienced with phone calls when possible. However, the limited a number of unrelated stressors during the same time adoption of mobile financial services among both period including widespread displacement as a result MFIs and clients has meant that a shift to digital of the conflict in the Tigray region, localized political platforms and communication channels, as witnessed violence in other rural regions, and a locust invasion in other countries, has not yet occurred. that destroyed crops across the Horn of Africa. A At the same time, loan portfolios have deteriorated major disruption of agricultural production would put due to COVID-19. MSEs across the country were hit a major strain on MFI balance sheets—as evidenced hard by public health restrictions during much of by the 2015–16 drought (AEMFI 2020)—but has not 2020, and their ability to serve their outstanding materialized to date. loans suffered (see next section for details). Data Third, commercial viability is not an existential from 11 MFIs—which together account for close to question for many microfinance institutions. Public 90 percent of outstanding microfinance loans—shows MFIs affiliated with regional governments continue to that the percentage of borrowers in arrears increased dominate the industry: in 2019, the five large public significantly for all institutions. The average share of MFIs made up 83 percent of the sector’s capital and loans with payments overdue by more than 30 days 4 “PAR90” is the 90-day portfolio at risk, that is, the weighted percentage of loans that have been overdue for more than 90 days. 5 For more information on this data, see box 1.2. 6 Capital to risk-weighted assets. 6 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance (PAR30) rose from 5.7 percent prior to the pandemic to from 11 MFIs—which together account for close to 8.8 percent in June 2020, while the longer-term PAR90 90 percent of outstanding microfinance loans—shows indicator increased from 5.1 percent to 6.9 percent that the percentage of borrowers in arrears increased over the same period—slightly above the continental significantly for all institutions. The average share of average for African MFIs reported by CGAP (2021). The loans with payments overdue by more than 30 days end of the state of emergency in September 2020 did (PAR30) rose from 5.7 percent prior to the pandemic to not have an immediate effect on portfolio health, with 8.8 percent in June 2020, while the longer-term PAR90 both indicators staying flat or increasing slightly by indicator increased from 5.1 percent to 6.9 percent the end of the year. over the same period—slightly above the continental average for African MFIs reported by CGAP (2021). The At the same time, loan portfolios have deteriorated end of the state of emergency in September 2020 did due to COVID-19. MSEs across the country were hit not have an immediate effect on portfolio health, with hard by public health restrictions during much of both indicators staying flat or increasing slightly by 2020, and their ability to serve their outstanding the end of the year. loans suffered (see next section for details). Data Though all MFIs have seen their portfolios deteriorate, the severity of the impact varies across institutions. Data from the WEDP portfolio indicates that urban MSE Box 1.1. clients were particularly affected: the average PAR30 COVID-19 in Ethiopia (PAR90) for WEDP loans more than doubled from 3.6 percent (1.8 percent) to 7.7 percent (4.3 percent) between December 2019 and September 2020, Ethiopia registered its first case of COVID-19 increasing faster than the rest of the portfolio. This in March 2020. In response, stringent public likely explains why private MFIs—which predominantly health measures such as limitations on serve urban markets that, pre-COVID, saw rapid and public meetings and cross-regional transport sustained growth—have fared worse than their larger were introduced under a five-month state public counterparts. The (portfolio-weighted) average of emergency that lasted from April until PAR90 for public MFIs has increased from 5.2 percent September 2020. The government also before the pandemic to 7.4 percent in September postponed the country’s general election 2020, while the average for private MFIs has jumped until June 2021, triggering a conflict with from 3.7 percent to 7.2 percent. This increase is the government of the Tigray region. Cases particularly challenging because private MFIs, whose spiked during the summer months but larger public competitors not only enjoy economies gradually subsided after September, before of scale but also receive concessional financing and spiking again in March and April 2021. As of in-kind support from regional governments, have early May 2021, the country has registered significantly higher operational costs (13 percent of more than 260,000 cases and close to 4,000 loan portfolio in 2019, compared with 6.7 percent for COVID-related deaths (JHU 2021). However, public institutions) as well as a higher cost of funding limited testing capacity and a high positivity (5.8 percent versus 4 percent). rate suggest a significant undercounting of Because of the widespread use of payment moratoria cases. A vaccination campaign using the in mid-2020, it is reasonable to suspect that the Astra Zeneca vaccine distributed via the actual rate of nonperforming loans during the months COVAX Facility began in March 2021, but previously cited was even higher. Although the only a small percentage of the population Association of Ethiopian MFIs (AEMFI) reported in April has been vaccinated to date. Ethiopia aims 2020 that MFI managers were reluctant to consider to vaccinate 20 percent of its population by concessional measures, this changed as the pandemic the end of 2021 (WHO 2021). dragged on (AEMFI 2020). Of the MFIs surveyed, only one formally rescheduled loans by extending 7 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance Figure 1.2: Portfolio at Risk for Public and Private MFIs 10% PAR as % or loans outstanding 8% 6% 4% Public PAR30 Public PAR90 2% Private PAR30 Private PAR90 0 2-Dec-23 2-Mar-24 2-Jun-24 2-Sep-24 2-Nov-24 Source: Authors’ data their tenure by 6 to 12 months. All other institutions not to categorize rescheduled loans as substandard, instead provided a payment moratorium of three to a considerable segment of struggling borrowers may six months during which partial or nonpayment was not be reflected in the above indicators. In several tolerated and fees were waived. Most moratoria were MFIs, management also seemed unclear about the “silent,” that is, the repayment moratorium was applied full extent of the problem, suggesting uncertainty without notifying the clients, and all MFIs report that around the ultimate impact of the pandemic and a their moratoria ended after September 2020. Because need to support stronger mechanisms for portfolio the NBE has temporarily allowed financial institutions restructuring and crisis management. Box 1.2. Methodology This policy brief draws on two rounds of data collection on portfolio indicators from Ethiopian microfinance institutions in July/August 2020 and December 2020/January 2021. Senior management from 11 microfinance institutions (MFIs), including the five public institutions accounting for more than 80 percent of the industry’s loan portfolio, were also interviewed about the impact of COVID-19 and their institutions’ response to the pandemic. Because of the ongoing conflict in northern Ethiopia, second-round data could not be collected from Dedebit Credit and Savings Institution, the public MFI serving Tigray regional state whose operations have been severely disrupted since November 2020. The brief also draws on data collected from the same institutions for a loan pricing assessment conducted in January 2020. 8 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance >>> 2. The Micro- and Small Enterprise Lending Squeeze The deteriorating portfolio quality of Ethiopian MSEs Are Suffering from the microfinance institutions (MFIs) as a result of the pandemic undermines the progress these institutions Pandemic... have made as pillars for financial inclusion. This is particularly true for micro- and small enterprises (MSEs) that, already under pressure from the fallout of As elsewhere in the world, micro- and small-business COVID-19, have seen their financing options dwindle owners in Ethiopia have been severely affected by at a time when their needs are particularly urgent. COVID-19 and the public health measures put in 9 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance place to control its spread. Also, Ethiopian MSEs sectors at a high risk of business closure. Although experienced a demand shock after the government- these firms showed significant growth prior to the issued state of emergency in April 2002 brought public pandemic, by September 2020 18 percent of them life to a temporary standstill. A high-frequency survey remained closed due to COVID-19 and the average of Ethiopian firms, conducted jointly by the World business reported a 50 percent year-on-year decline Bank and the Ethiopian Job Creation Commission in revenue, according to the results of a high- (JCC), shows that the effect of the state of emergency frequency phone survey of female MSE owners (World was most acutely felt in June 2020, when close to Bank 2020c). More than half of those businesses 40 percent of businesses reported zero revenue with outstanding loans reported missing at least one and nearly all firms (98 percent) indicated that they payment. These findings are supported by similar had been negatively impacted by the pandemic data from World Bank and JCC, which shows that (World Bank 2020b). Primarily as a result of reduced the pandemic widened the gender gap in business demand, firm profits plummeted, with 69 percent of earnings, with female-owned firms experiencing a firms surveyed reporting “significantly lower” profits sharper drop in revenue and profits than their male compared with the previous year. Smaller businesses counterparts (World Bank 2020b). were more likely to be closed, while midsize and larger businesses were more likely to lay off staff—although dismissals were minimized by regulations that restricted the practice during the pandemic. Although ...and the Lending Squeeze Is firm closure and revenue indicators have improved markedly since the end of the state of emergency, Adding to the Hurt the increase in COVID-19 case numbers registered in early 2021 points to continued uncertainty ahead MSEs relying on MFI loans, and female entrepreneurs (World Bank 2020b). in particular, have long been credit-constrained in Data from the World Bank’s Africa Gender Innovation Ethiopia. However, the pandemic has exacerbated Lab (GIL) shows that Ethiopia’s female entrepreneurs this financing gap. With revenue falling faster than were hard hit by the pandemic. Female-owned expenses, firms have depleted their working capital, businesses are concentrated in trade, services, and and owners have often dipped into their personal tourism—predominantly urban, customer-facing savings to cover costs. Concessional financing has been severely limited in the absence of a small-business Figure 2.1: New Loans Made by Ethiopian MFIs 10% Public MFIs Ethiopian Birr, billions 8% Private MFIs 6% 4% 2% 0 2-Dec-23 2-Mar-24 2-Jun-24 2-Sep-24 2-Nov-24 Source: Authors’ data 10 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance grants program, although some grant financing was in the Women Entrepreneurship Development Project provided by the Mastercard Foundation. Informal (WEDP) is even steeper than the portfolio average. financing channels have also dried up over the past The lending restrictions are not just a problem for year, with iqubs—traditional savings associations— new borrowers: scaling up loans over time, as a firm’s dissolving because of a lack of available funds (AEMFI creditworthiness becomes more apparent, is key 2020). As a result, the percentage of firms surveyed to the microfinance process. More importantly, the by the World Bank and JCC that expressed a need for liquidity squeeze poses a risk to kickstarting economic new credit increased over subsequent rounds of data growth post-COVID. Although the risk of a new wave collection (World Bank 2020b). Similarly, close to two of infections remains, public health measures have thirds of female business owners in the September become more targeted in nature, and most economic GIL survey were seeking additional financing (World activities have now resumed. Bank 2020c). Although demand for new loans is high, MFIs currently lack the liquidity to meet it. All MFIs surveyed indicated that they have encountered significant liquidity constraints as a result of the pandemic. This is a consequence of the drop in loan collections, as fewer borrowers were able to make their payments on time, combined with rising administrative costs. Box 2.1. The COVID-19 The growth in savings deposits also slowed, despite MFIs’ efforts to open new accounts, reach new types of Microfinance Squeeze customers such as local associations, and disbursing loans into savings accounts. Because few MFIs were across Africa able or willing to access commercial financing at market rates, they have instead concentrated on reducing the outflow of funds from their institution. Consultative Group to Assist the Poor data As a result, many MFIs turned risk averse and limited shows that Ethiopia’s microfinance lending lending to small businesses. Although MFIs were able squeeze is not an outlier (CGAP 2021). to keep liquidity ratios—liquid assets as a percentage Overall, African microfinance institutions of total deposit—above the 20 percent threshold (MFIs) reported a stark decline in lending in mandated by the central bank, they have done so at a early 2020: monthly disbursements dropped cost for borrowers, and MSE owners in particular, who by an average of more than 80 percent year- are facing a steep drop in new lending. This may have on-year, and more than 50 percent of the perpetuated the asset quality issues discussed above, total outstanding portfolio was covered by as clients lost an important reason to repay existing payment moratoria. Compared with Ethiopia, loans when future lending became uncertain. where a state of emergency continued to restrict business activity until September Figure 2.1 shows the contraction of lending from 2020, other African MFIs recovered more Ethiopian MFIs since mid-2020 (the period between quickly and gradually resumed lending in March and June is the main season for agricultural mid-2020. By the end of the year, monthly credit, which is dominated by the public MFIs and disbursements almost reached pre-COVID has been less affected by the pandemic). Several levels. However, the level of nonperforming MFIs issued a complete stop on new loans during loans has doubled over the same period, this time, while others introduced restrictions on and the profitability of African MFIs has loan size and the number of borrowers. In addition to plummeted much more than the profitability reducing lending overall, MFIs also shifted resources of MFIs in the rest of the world. from urban to lower-risk rural borrowers; the drop in lending to city-based, single-borrower entrepreneurs 11 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance >>> 3. Four Ways to Ease the Squeeze Initial evidence on policy responses to support small four ways to “ease the squeeze” and support Ethiopian businesses during the COVID-19 pandemic indicates microfinance institutions (MFIs) in providing new that improving access to new financing has greater loans, particularly to small-business borrowers. The benefits than allowing for deferred payments on first is focused on providing immediate support, while existing debt (Cirera et al. 2021). Therefore, the low the others take a longer-term perspective geared level of new lending to Ethiopian entrepreneurs toward the future resilience of the sector. remains a concern for a balanced recovery. Below are 12 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance 1. Provide Additional Liquidity 2. Help MFIs Better Understand and Guarantees to MFIs Their Client Base Liquidity constraints are a major driver behind the The COVID-19 pandemic is not affecting all firms financing squeeze, so making new funds available the same way. World Bank data from Ethiopia shows to Ethiopian microfinance institutions has to be part that urban businesses have suffered more than of the response. An infusion of Br 1.2 billion (US$30 rural ones, client-facing service firms more than million) provided as a liquidity facility to MFIs by manufacturers, MSEs more than large firms, and that the National Bank of Ethiopia (NBE) early on in the female entrepreneurs have experienced particular pandemic helped MFIs tide over the initial months of stress. Most Ethiopian MFIs, however, only have a the pandemic. However, these funds have long been rudimentary understanding of their clients’ varying disbursed, and the Ethiopian government is unable needs and lack the technology to properly distinguish to mobilize stimulus funds at the same levels seen between different types of borrowers and risk profiles. in high-income economies. Therefore, new financing An internal World Bank study of the credit pricing is necessary. These funds can be mobilized directly, policies of Ethiopian MFIs, conducted just before in the form of capital increases by shareholders, the pandemic, highlighted that loan terms barely or indirectly through new financing from external vary across borrowers. Supporting MFIs with client sources. The latter include commercial lenders such segmentation and the diversification of their product as local banks or development finance institutions. offering is key to help them prioritize at-risk clients Helping MFIs to de-risk their lending—in the form of during future waves of the pandemic, and to grow concessional lending or guarantee facilities—will also their portfolio in the aftermath. help them to direct the new lending to the micro- and small enterprise (MSE) borrowers they may currently perceive as too risky. The World Bank has launched two such programs to support lending to Ethiopian MSEs, which are highlighted in section 4. 13 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance 3. Strengthen Financial 4. Ramp-up Digital Accounting Standards Finance Offerings Although Ethiopian MFIs have professionalized their Although Ethiopian MFIs have professionalized their operations in recent years, their financial accounting operations in recent years, their financial accounting often remains patchy, with manual bookkeeping often remains patchy, with manual bookkeeping and a lack of systematic reports. As a result, MFI and a lack of systematic reports. As a result, MFI management have incomplete information about management have incomplete information about the performance of their portfolios, and external the performance of their portfolios, and external stakeholders—such as shareholders, regulators, stakeholders—such as shareholders, regulators, and lenders—are uncertain about the validity of and lenders—are uncertain about the validity of the figures communicated. The introduction of the the figures communicated. The introduction of the International Financial Reporting Standards (IFRS), International Financial Reporting Standards (IFRS), formalized by a 2014 law, provides a framework for formalized by a 2014 law, provides a framework for resolving this problem. IFRS adoption may represent a resolving this problem. IFRS adoption may represent a challenge for some MFIs, but the larger, government- challenge for some MFIs, but the larger, government- affiliated MFIs are well placed to lead the initiative. affiliated MFIs are well placed to lead the initiative. Introducing or updating management information Introducing or updating management information systems and adopting accounting practices that follow systems and adopting accounting practices that follow internationally accepted standards will help MFIs to internationally accepted standards will help MFIs to better understand risk, restructure liabilities where better understand risk, restructure liabilities where necessary, and channel scarce liquidity to where it necessary, and channel scarce liquidity to where it can be most effective. It will also increase their ability can be most effective. It will also increase their ability to access financing from commercial sources such to access financing from commercial sources such as domestic banks, thus broadening their financing as domestic banks, thus broadening their financing options in preparation for the next liquidity shock. options in preparation for the next liquidity shock. 14 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance >>> 4. World Bank Support to Relaunch Microfinance Institutional Lending Assisting small-business owners is an important part Both operations leverage their existing networks of of the World Bank’s COVID-19 response in Ethiopia. The public and private microfinance institutions (MFIs)— World Bank has made US$300 million in additional and, in the case of SMEFP, commercial banks and financing available to Ethiopia’s Ministry of Finance via leasing firms as well—so beneficiaries can be reached two projects: the Small and Medium Enterprise Finance quickly. The additional COVID-19 relief financing for Project (SMEFP), which provides loans and business the two projects will support new lending to small- services to small and medium-size enterprises; and business owners while also supporting MFIs in better the Women Entrepreneurship Development Project serving their borrowers at this time. (WEDP), which focuses on smaller, female-led firms. 15 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance Credit Lines for Small-Business Future-Proofing Ethiopia’s MFIs Owners Although additional liquidity is key to get MFIs lending again, increasing their capacity to understand and serve The additional financing—US$200 million for SMEFP, the small-business market segment will help them US$100 million for WEDP—will provide significant emerge from the crisis as stronger institutions. Thus, liquidity to Ethiopian MFIs, using the Development MFIs accessing the WEDP line of credit have access Bank of Ethiopia (DBE) as a wholesale lender. to technical assistance focusing on timely challenges Participating financial institutions can borrow from such as restructuring loans, assessing the repayment DBE’s revolving line of credit to issue new loans to capacity and existing debt load of borrowers, and small-business owners. Eligibility is restricted to tailoring credit products to specific clients, as well viable firms that were not in distress prior to the as stress testing and liquidity management.7 SMEFP COVID-19 pandemic, and MFIs set their own loan offers similar support for financial institutions in its terms to ensure their lending is commercially feasible. network, while also continuing its work on building a With an average size of US$10,000 for WEDP and strong infrastructure for SME lending in Ethiopia, such US$48,000 for SMEFP, these loans are well above the as a movable collateral registry. This assistance is typical maximum of US$1,000 to US$2,000 offered designed to help Ethiopia’s MFIs—and particularly the by Ethiopian MFIs—although smaller working-capital budding private institutions which have been severely loans may be made to help firms deal with the impact affected by the COVID crisis—to professionalize their of COVID. Experience shows that participating financial operations, realize productivity gains by introducing institutions are able to mobilize their own funds to new technology, and diversify their financial base serve small-business clients once the business case towards a sustainable, market-based approach. is proven. A second focus is on the digital readiness of Ethiopia’s The two programs also introduce new features to microfinance sector. This includes the introduction of address the distress brought on by the COVID-19 new lending technologies that help MFIs to circumvent pandemic for both financial institutions and the need for traditional, fixed-asset collateral—a entrepreneurs. WEDP has established a Rescue Facility major constraint for borrowers, especially women. that allows MFIs to provide payment holidays, loan SMEFP provides technical assistance to MFIs on extensions, and interest rate reductions to existing simplifying loan processes and reducing turnaround borrowers that have been affected by the pandemic. times through the use of alternative data, including SMEFP, on the other hand, has created a De-risking credit bureau information. Similarly, WEDP includes a Facility that shares in the default risk associated with separate “WEDP X” financing window that harnesses lending to SMEs at this time and stops the “flight to financial technology innovations and a new movable safety” that has limited financing options for small collateral registry to enable borrowers to access loans businesses. Both projects also aim to lower the without fixed asset collateral. Collateral-alternative wholesale lending rate and allow for an increase in products will include tablet-based psychometric tests the provision of shorter-term bridge financing for that predict the ability of borrowers to repay a loan, viable firms, in addition to the long-term loans for point-of-sale readers that capture transaction data in those firms that are ready to invest. a business to generate a credit score, and revenue- based financing models that better distribute both risk and upside between lender and borrower. Future- proofing Ethiopia’s microfinance institutions not only helps to mitigate the impact of the COVID-19 pandemic on SME financing, but also puts them in a better position to weather the next crisis. 7 This work is supported by a €1.6 million grant from the European Investment Bank. 16 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance >>> REFERENCES AEMFI (Association of Ethiopian Microfinance Institutions). 2020. “Effects of the COVID-19 Induced Crisis on Ethiopian MFIs and their Clients.” Addis Ababa. CGAP (Consultative Group to Assist the Poor). 2002. “Microcredit Interest Rates.” Occasional Paper no. 1, CGAP, Washington, DC. CGAP (Consultative Group to Assist the Poor). 2020. “Microfinance and COVID-19: A Framework for Regulatory Response.” COVID-19 Briefing: Insights for Inclusive Finance. CGAP, Washington, DC. CGAP (Consultative Group to Assist the Poor). 2021. “Microfinance Institutions Maintain Rebound, but Solvency Questions Loom.” Snapshots: MFIs during the COVID-19 Crisis. CGAP, Washington, DC. Cirera, Xavier; Marcio Cruz, Elwyn Davies, Arti Grover, Leonardo Lacovone, Jose Ernesto Lopez Cordova, Denis Medvedev, Franklin Okechukwu Maduko, Gaurav Nayyar, Santiago Reyes Ortega, and Jesica Torres. 2021. “Policies to Support Businesses through the COVID-19 Shock: A Firm- Level Perspective.” Policy Research Working Paper 9506, World Bank, Washington, DC. JHU (Johns Hopkins University). 2021. COVID-19 Data Repository, Center for Systems Science and Engineering, Johns Hopkins University. https://github.com/CSSEGISandData Mishra, Deepak. 2011. “Ethiopia: Sustaining Rapid Growth amidst Global Economic Crisis.” In The Great Recession and Developing Countries: Economic Impact and Growth Prospects, edited by Mustapha Nabli. Washington, DC: World Bank. NBE (National Bank of Ethiopia). 2020. Annual Report, 2019/20. Addis Ababa. WHO (World Health Organization). 2021. “2.2 Million COVID-19 Vaccines Allocated by the COVAX Facility Arrive in Ethiopia, Marking the Start of the Country’s COVID-19 Vaccination Campaign.” Press Release, March 7, 2021. www.afro.who.int/news/22-million-covid-19-vaccines-allocated-covax-facility-arrive-ethiopia- marking-start-countrys World Bank. 2015. “SME Finance in Ethiopia: Addressing the Missing Middle Challenge.” Working Paper 94365, World Bank, Washington, DC. World Bank. 2020a. “Ethiopia: The Path to an Efficient, Stable and Inclusive Financial Sector.” Internal report, unpublished. World Bank, Washington, DC. World Bank. 2020b. Phone Survey Data: Monitoring COVID-19 Impact on Firms and Households in Ethiopia. World Bank, Washington, DC. Data for all eight rounds of data collection can be accessed from https://www.worldbank.org/en/country/ethiopia/brief/phone-survey-data- monitoring-covid-19-impact-on-firms-and-households-in-ethiopia World Bank. 2020c. The Impacts of COVID-19 on Women-Owned Enterprises in Ethiopia: Findings from a High-Frequency Phone Survey. World Bank, Washington, DC. 17 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance 18 How to Escape the Microfinance Lending Squeeze: Evidence from Ethiopia | EFI Note – Finance