Addis Fortune (Addis Ababa)

Ethiopia: Microfinance At Crossroads

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Microfinance is, at its heart, an effort to provide financial services to people who are not served - or are under-served - by the formal banking system. With appropriate, accessible and fairly priced financial services, people can build their savings, cover the costs of unexpected emergencies and invest in their family's health, housing and education.

The International Finance Corporation (IFC) estimates that microfinance has reached some 130 million people worldwide in the last 15 years. Over this period, microfinance has been lauded for its potential to advance financial inclusion and enable people to escape poverty. But it has also faced harsh criticism, with some lenders being accused of profiteering.

Despite the industry's widely publicised pitfalls, its potential to improve the lives of the poor cannot be ignored. The question now is how to ensure that microfinance becomes the industry that the world needs. Some important steps must be taken to do this.

An important step is better regulation. Microfinance institutions (MFIs) come in many forms - mainstream banks, specially licensed banks, non-financial companies, finance and leasing companies, non-governmental organisations, cooperatives and trusts - and follow a variety of business models. All of these intermediaries must be recognised and regulated according to the needs of the economies in which they operate.

Governments must design regulations that foster a sustainable financial inclusion model; one that enables MFIs to offer long-term support to borrowers. At the same time, regulation must deter MFIs from behaving recklessly with a vulnerable client segment. And regulation should be based not on past experience, as it is now, but on future possibilities; in other words, the regulatory framework must be flexible enough to accommodate new innovations.

The microfinance industry should create effective mechanisms for assessing the industry's impact. As it stands, some governments and academics are uncomfortable with the fact that MFIs, which are supposed to be providing a public good by advancing financial inclusiveness, are pursuing profits.

But the failure of some MFIs to differentiate between profit-seeking and profiteering does not mean that sustainable microfinance should not yield returns above costs. The business of providing financial services to the poor requires commitment. Without profits, MFIs are unable to invest in the talent and product development needed to serve people for the long-term.

Many governments have now implemented interest-rate ceilings and margin caps to curtail excessive profits for MFIs, while ignoring the margins of the market's non-organised alternatives, like pawnbrokers. In order to provide a more balanced perspective on the microfinance industry compared to other kinds of financial service providers, MFIs need to do more to measure and explain their social and economic value.

The good news is that industry bodies, investors and governments have already introduced metrics for factors ranging from pricing to conduct. While this has resulted in a rather disparate set of indicators, which must be standardised, such efforts are an encouraging sign of the microfinance industry's commitment to securing its role in the financial-services ecosystem.

An equally important factor is technology. Mobile connectivity is transforming the global financial system by enabling remote, rural populations to access financial services for the first time. Mobile-payment systems, such as M-Pesa, are changing how people transfer, receive and save money in many developing countries.

For the microfinance industry, such systems represent an important opportunity, as they enable borrowers to apply for, receive and repay loans on their mobile phones, using a network of local agents to deposit and withdraw cash. But, without robust regulation, MFIs cannot make the most of these developments.

Moreover, the mobile-payments revolution has so far been led largely by telecom providers. If it is to deliver real benefits to the financially excluded, the financial services industry will need to play a much more active role.

Of course, microfinance alone will not eliminate poverty, or even financial exclusion, regardless of how well it functions. To have a truly transformative impact, MFIs' operations must be supported by government-led efforts to improve access to education, training and employment.

Although microfinance has already helped countless people worldwide, the World Bank estimates that some 2.5 billion adults still lack access to financial services. It is the responsibility of all stakeholders - including governments, regulators, banks and civil society - to ensure that microfinance continues to be part of the solution.

 Prashant Thakker Is the Global Business Head of Microfinance At Standard Chartered Bank. This Commentary Is Provided to Fortune By Project Syndicate.

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