Microfinance in Eastern Europe and Central Asia
According to the Asian Development Bank, microfinance is the provision of a broad range of financial services, including deposits, loans, payment services, money transfers and insurance, to poor and low-income households and their micro-enterprises. The 2006 Nobel peace prize was jointly awarded to Grameen Bank, a microfinance organization and its founder, Muhammad Yunus, for their efforts to create economic and social development from below. This acknowledges the power of microfinance and the impact that it can create in the coming years. Eastern Europe and Central Asia (EE&CA) provide a ripe opportunity for the use of microfinance to uplift the poorer section of society in this region.
The microfinance sector in EE&CA has a tremendous scope of development. EE&CA presents one of the best opportunities for the integration of microfinance services with the formal financial sector.
The major institutional types of MFIs in EE&CA are:
Credit unions tend to be small, localized institutions with limited outreach. They are most active in central and eastern Europe (especially in Poland and Romania). Here credit unions boast of the largest share of the loan portfolio. Russian and Ukrainian credit unions are also quite active although the loans their clients take are relatively small.
Of all MFIs in EE&CA, credit unions are the leaders in collecting deposits. They also attract clients by providing the lowest value of one-time loans. However, many credit unions have lost money in the past few years in EE&CA. This was primarily due to high financial expenses, particularly in Russia where high deposit rates and inflation have collectively raised the cost of funds.
Credit unions reach the highest number of borrowers than any other form of MFIs in EE&CA. The depth of outreach of credit unions is good due to the fact that the majority of them offer very short-term consumer loans, usually to salaried workers. However, the loan is often used for entrepreneurial activities of family members.
The total portfolio managed by NGOs and NBFIs is the smallest among all MFI types in EE&CA. The region with the largest NGO and NBFI presence is the Balkans. Almost half of the whole NGO and NBFI portfolio and one-third of all active borrowers are located here. Balkan NGOs and NBFIs are also comparatively larger than their peers in other sub-regions in the ECA.
NGOs and NBFIs chiefly rely on donor grants (which are becoming less available) or on borrowed funds from international investors (which are limited too). In most parts of EE&CA, NGOs and NBFIs do not use the local financial markets for funding on a large scale. Therefore, only very few institutions manage to leverage their own resources. The majority use mainly equity grants from donors.
Like all the other MFIs in EE&CA, NGOs and NBFIs have a strong sustainability focus and therefore in most of the cases they are operationally self-sustainable. However, the role of NGOs and NBFIs would diminish in the future as many of them would transform into regulated institutions within the coming years, either because of changes in local microfinance legislation or due to their own will.
NGOs and NBFIs have the second largest number of borrowers after credit unions in EE&CA. They target mostly low-income micro entrepreneurs. Due to the competition from banks, many NGOs and NBFIs have moved towards serving lower-end clients and have started looking for new market niches among under-served low-income populations.
Microfinance banks dominate the region with respect to attracting a vast majority of commercial investment. They are the most active in the Balkans. The largest part of their loan portfolio and savings is located there. The microfinance banks usually have big active borrowers.
A large portion of the assets of an average microfinance bank is funded from deposits collected from clients or from financial institutions. Some part also constitutes shareholder capital and borrowing, which in many cases is provided by the shareholders themselves or by other international financial institutions (IFIs). Microfinance banks in EE&CA are profitable in most cases but they operate on a very thin profit margin. Because of the large scale of operations and the large average loan size, their expenses are quite low. However, their revenues are low too as these banks target high-end markets but have not been able to increase their outreach significantly.
As per Microfinance Information Exchange, 2005 Benchmarks, microfinance-focused banks in EE&CA reach a higher-end target market as compared to the global benchmarks, with average loan balances more than three times global medians. Approximately 50% of the banks included in the sample have average loan balances below 250% of GNI per capita, which is the most common dividing line as to what constitutes microfinance rather than SME financing.
The growth of the outreach of the microfinance banks in the past few years in EE&CA was because of both the increase in the number of depositors as well as the increase in the volume of deposits.
As of figures available from the 2004 Microfinance Sector Development in Eastern Europe and Central Asia, the share of gross loan portfolio (as a percentage of total loan portfolio for EE&CA) for the major microfinance banks was 34% while the share of active borrowers (as a percentage of total borrowers in EE&CA) for these banks was 13%.
The following major funding sources are used by MFIs in EE&CA:
The extent to which MFIs use various sources in EE&CA depends on each MFI’s legal status, age, size, country of operations and donor landscape.
Unregulated NGOs and NBFIs in ECA are not allowed any deposit taking activities and thus have a very different funding structure compared to that of licensed microfinance banks or credit unions.
Microfinance banks, like regulated financial institutions, have a clear ownership structure. This gives them more potential to access external funding. In EE&CA, for an average microfinance bank, the level of debt (including deposits) to equity exceeded seven (as of 2004). This indicates that they attracted seven times as much external fund as their equity base. This leverage has remained the same compared to the previous years, which may indicate that the banks have found the optimal balance between borrowed and own funds.
Vast majority of credit unions are engaged in deposit taking where a large chunk of total assets are funded from members’ savings. On the other hand, there are credit unions (particularly some of those established by international agencies) that have more limited deposit-taking activities and are funded from international commercial or subsidized sources.
NGOs and NBFIs rely chiefly on equity. Grants remain the main funding source for them. On average, funding in an NGO or NBFI is structured as follows: 66% funded from equity and 34% from liabilities. The capital/asset ratio is usually correlated with age and size and decreases with the growth of an institution. It has been seen that larger and older MFIs predominantly use borrowed funds while the small ones rely on donor equity.
With age, MFIs gain experience, learn liability management and start using borrowings. In EE&CA a visible increase in leverage happened, on average, after five years in operation. At that stage MFIs usually utilize subsidized loans, which were long-term and carried a lower price, allowing these MFIs to grow without significantly affecting their profitability. MFIs that have been operating for more than eight years have on average the highest leverage and already fund one-third of their portfolio from commercial sources.
Larger MFIs are better positioned to attract investors. They tend to be more professionally managed, have better internal controls and can absorb larger amounts of funding. In EE&CA, many investors limit their interest to those MFIs that have portfolios larger than US$3m or US$5m. The scale and experience of these MFIs allow them to run the operations cost-effectively and therefore absorb higher financial costs.
However, one of the largest NGOs and NBFIs in EE&CA (over US$10m in loan portfolio) remains predominantly funded from donor equity and concessional loans, while its use of commercial funds is very limited. It was able to achieve such size thanks to strong support from development organizations, which continues to finance it despite its capacity for more commercial exposure.
Large differences can be observed among MFIs in sub-regions of EE&CA. In more economically advanced countries that have higher financial depth, the institutions are better leveraged. These MFIs generally operated in the Balkans and Central and Eastern Europe and were often registered as non-bank financial institutions. This means that they can operate on a commercial basis and can attract funds from formal financial institutions.
It is vital to note that there are a number of MFIs in the ECA region that do not follow the general path of moving from grant funding to private borrowing through an intermediate phase of using concessional funds of non-commercial investors. There is a scarcity of public funds and hence some younger and smaller but profitable MFIs are using commercial debt as a source of funding more often.
The development of microfinance in the ECA region demonstrates few of the potential tradeoffs between outreach, source of funding and financial performance. Higher-end MFIs (that target high end customers and are bigger in size and experience) are more leveraged with funding primarily from commercial funds. Those institutions focusing on lower-income populations are funded through donated funds and retained earnings. As loan balances increase, there is a sharp drop in returns. Both revenues and expenses fall as loan size increases and institutions move up-market. The margins are tightened and this further makes the situation tougher for the MFIs who are already facing the competition with the formal financial sector.
References:
Micro Finance Information Exchange – Benchmarking Microfinance in Eastern Europe and Central Asia 2005
Micro Finance Centre – 2004 Microfinance Sector Development in Eastern Europe and Central Asia (ECA)