The National Bank of Ethiopia (NBE) has increased the minimum capital requirements for microfinance firms (MFIs) by over seven folds as of January 16, 2023.
This came as no surprise to existing Microfinance institutions or those under establishment, as the Bank has indicated a capital requirement increase is imminent.
The directive outlines that “there is a need to raise the minimum paid-up capital of microfinance institutions operating in the country so as to improve their capacity to serve the growing needs of their customers.”
Existing MFIs, whose capitals fall below 75 million Birr, have five years to increase their capital.
Institutions that sell shares can be established with an initial capital of 10 million Birr if they submit their application to the NBE within six months; that is, July 2023. After establishment, these MFIs have seven years to meet the requirement.
The new directive comes into effect over a year after the deadline set by the previous threshold.
When the central bank began issuing regulatory frameworks to govern Microfinance institutions in the mid-1990s, the capital required to establish such organizations was set at 200,000 Birr ($21,000), compared to the requirement for banks, which was 75 million Birr.
By 2013, the capital amount required to be established as MFI was increased by 10 folds to two million Birr. Five years were provided for existing MFIs to tenfold their capital. However, in 2015, the Bank decided to further increase the requirement to 10 million Birr, to be met by 2021. Three dozen MFIs that are operational were given yearly milestones, where they have to increase their capital every year to reach the 10 million limit.
Paid-up capital is required to be deposited into a bank account under the name of the MFIs upon establishment. Under the new regulation, MFIs are required to present a strategy demonstrating how they plan to increase their capital within five years.
NBE demands frequent reports from the firms to ensure the requirements are met on timely bases.
Role & performance of MFIs in the financial sector
MFIs are generally portrayed as an instrument for financial inclusion and bridging the gaps of the underserved.
This is because MFIs are available in rural areas and are generally designed to provide financial services, particularly micro-loans, to low and medium-income individuals as well as small businesses.
Currently, there are 45 MFIs in Ethiopia, excluding the four that transitioned into full-fledged banks – Sinqee, Shebelle, Sidama, and Tsedey. Omo MFI will be the fifth MFI to graduate into a bank.
According to a report presented by the NBE to the parliament detailing the performance of MFIs in the 2021/22 fiscal year, 40 MFIs serve 19.5 million account holders and over four million borrowers who have taken an outstanding credit of 73 billion Birr (a 14% annual increase). (This data includes the portfolios of MFI that transitioned into a bank.)
The report details two of these (Rays Microfinance and Wasasa) are running mobile banking and agent banking operations, reaching over 200,000 customers through 1,452 agents.
With a combined 2,080 branches across the country, the MFIs manage 56.7 billion Birr in saving deposits. As of June 2022, the aggregate capital of the MFIs reached 15.5 billion Birr (an average of about 300 million Birr per MFI) and made a net total profit of 1.3 billion Birr in a year.
Why increase the capital of MFIs?
Cover Growing Cost
The rising demand for financial services (in amount and number) and the increasing operating expenses of MFIs necessitate more capital.
Professionals working in the industry say the current prices for establishing a strong MFI require` a firm capital base.
The major costs of establishing a Micro-Finance institution include:
1. Start-up costs: Associated with incorporating the institution, obtaining licenses and permits, and setting up an office space.
2. Technology costs: Microfinance institutions are growingly relying on technology to manage client information, process transactions, and track performance. These costs include computer hardware and software. Last year, the NBE last year obligated all MFIs to automate all their core processes (Core banking system) within 3 years.
3. Human Capital: The institutions require skilled workforce to manage operations and provide services to clients. Costs include salaries, trainings and other benefits.
4. Operational costs: These costs relate to utilities such as rent, electricity, and other daily expenses.
According to experts operating in the sector, setting up a single MFI branch will require no less than a quarter of a million Birr. Running a main office with a few branches could go as high as a million Birr in monthly expenses.
For existing MFIs, technological development, human capital and branch expansion continue to be permanent costs.
Growth: Having higher capital would grant MFIs the capacity to accommodate more customers. These institutions have vast coverage of lower and middle-income individuals and businesses.
Expand Loan portfolio: Ability to extend higher loans for MSMEs and individuals: The Ethiopian MFI law prohibits institutions from extending loans that are more than one percent of their capital to a single borrower and not more than four percent to a group of borrowers. An increased capital would allow MFIs to lend higher amounts, which is especially useful for MSMEs.
Remain competitive: With the banking sector crowded, and the impending entrance of foreign banks, existing banks may scramble to expand their customer bases. This will also require MFIs to enhance their onboarding efforts, maintain their customer base, and gain ground. But this requires capital.
About 18 MFIs have already surpassed the 75 million capital requirement as of June 2022.
The establishment structure of MFIs affects their capitalization rate. There are three types of MFIs in Ethiopia based on their structure of ownership. The first ones are established by regional administrations and have administrative bodies as shareholders. The second are supported by NGOs and the rest are commercial MFIs owned by private entities.
MFIs supported by regional administrations can have NGOs and individuals as shareholders.
Institutions supported by regional administrations, including Amhara credit & saving, Oromia credit & saving, Sidama MFI, Omo MFI, Somali MFI, and Addis saving & credit, are transforming into banks. These types of MFIs are well performing and mostly serve the communities in their respective regions.
While completing their transformation, the NBE ordered the government-owned shares to be diluted, allowing regional administrations to own only as high as 70%.
NGO-supported MFIs are run by symbolic shareholders and are often created for the purpose of carrying out projects implemented by foreign development organizations. These include Eshet, Ghion, Gasha.
NGO-supported MFIs do not payout dividends, and they continue to capitalize every year, being better positioned to reach their milestones.
However, assuming a maximum of 60 million Birr has to be raised in capital; MFIs will need to raise 12 million Birr a year or re-invest from their profit for the next five years.
There are about five dozen MFIs under establishment. Although the NBE has reportedly said a lot of them are trying to enter the market with more than 10 million Birr, it could be challenging for some to finalize selling their shares to meet the requirement in 6 months, in which case they’ll have to wait and raise 75 million Birr to be established an institution.
“Since it is difficult to raise new equity capital in Sub-Sharan Africa (SSA) and MFIs do not generally make dividend payments, profitable MFIs could rely on internal financing to external financing to meet their funding needs,” reads research titled “capital adjustment process and credit growth of microfinance institutions: evidenced from SSA”.
The same approach was used by the central bank when it made the decision to raise the capital requirements of banks by tenfold in 2021. Existing and new banks at the time had five and seven years respectively to comply with the regulation.
Under formation, banks were also given a six-month window to be established with the previous capital of 500 million Birr. But most that couldn’t raise the amount were forced to dissolve, modify their business line, or keep on selling shares in an attempt to raise five billion Birr.
Outlook for upcoming MFIs
As large state-backed Microfinance organizations successfully convert into banks, a vast market is open for current and new institutions.
Midway through 2022, when the transformation of Oromia Saving & Credit (Sinqee Bank), Somali Microfinance (Shebelle Bank), and Amhara Saving & Credit (Tsedey) were completed, total savings deposits shrank by 44.6% and outstanding credit by 40%.
The NBE issued a directive that would allow MFIs to transform into a bank in 2020. Subsequently, several MFIs, mainly backed by regional administrations, have begun their transition.
Although these institutions are meant to continue serving their microfinance customer base, a huge gap is evident in the sector.
This, coupled with the growing trend of carrying out development work and cash support in rural areas through MFIs, give a sizable market to the institutions and areas to innovate in order to reach the unbanked.
NGO-backed MFIs are mostly established to facilitate operations which include access to financial services and cash donations, among other direct cash support.
By regional comparison, Ethiopia’s Microfinance sector has some way to go. Nigeria, with a population of 213 million people, has over 800 Microfinance firms, while Tanzania has over 500.
Opportunity for MFIs also exists in the growing popularity of digital financial services. Sahay mobile wallet, created by Rays Microfinance, has become widely used in eastern Ethiopia. Its predecessor, Somali MFI, was also known for utilizing Hellocash mobile money service.
1 The report omits which MFI owns mobile wallets platform and agent networks. By K-flip’s assessment, Rays Microfinance has a mobile wallet named Sahay. Wasasa MFI runs its own agent network.