Innovations in Addressing Rural

Finance Challenges in Ethiopia

Presentation
by
Berhanu Taye

Addis Ababa
July 2008

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 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

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I.  Background
1.1   Overview of the Rural Sector
Ethiopia
 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.

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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.

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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

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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.

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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.

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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.

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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.

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• 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.

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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.

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•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 1996. 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.

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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

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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
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.

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2.2 Growth, Achievements and Lessons
Achievements
 The Ethiopian MF industry manifested a remarkable growth since
the early 1990’s:
                      June 2001    March 2008      growth
1. No. of clients 461,326      1,834,007             4 fold
2. O/S Loan        Birr 308.6 million         Birr 3,5 billion       11 fold
3. Client saving        Birr 243.3 million         Birr 1.2 billion         5 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 .
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Financial performance- Country Average
2003 2006
1.Operational sustainability 104% 131%
2.Financial sustainability 77% 92%
3.Return on assets -5% 3.6%
4.Portfolio at risk <30 days 7.6 5.4
Source: AEMFI 2008.

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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

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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.

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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.

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…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.

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3. Factors that Contrbuted to MFIs’ Rapid Growth
o 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
i. Grant fund for capacity building
ii. Technical assistance

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 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.

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

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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:
…Continued Challenges of Rural Finance

a. Outreach – reaching the poor in terms of both number and depth

b. Financial sustainability – meeting operating and financial costs over
the long-term
c. 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
5. Best Practices/Innovations
 The following key innovative approaches are
effective tools for addressing rural finance
challenges:
a. Firm vision/mission to reach the poor – increasing outreach
with the ultimate goal of reaching large number of clients and
poverty reduction

b. Simple and innovative products, i.e. development of demand

driven financial products

c. Cost effective MFI for attaining operational & financial

sustainability – control over administrative expenses and
effective use of resources

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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

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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.

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Thank You!

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