MICROFINANCE PAPER WRAP-UP: Global Recession and Sustainable Development: The Case of Microfinance Industry in Eastern Europe by Dr. Dragan Loncar, Mr. Christian Novak and Dr. Svetlana Cicmil

Written by Dr. Dragan Loncar, Mr. Christian Novak and Dr. Svetlana Cicmil, published September 2009, 10 pages, available at http://www.microfinancegateway.org/gm/document-1.9.39138/MICROFINANCE%20PAPER-%20FINAL%20VERSION.pdf

This research paper attempts to answer why the microfinance industry in Eastern Europe in particular is more vulnerable to contemporary economic trends and why, unlike microfinance industries of other countries, it performs cyclically. It is divided into three sections: the first discusses microfinance and general trends within the industry; the second narrows in on trends within the microfinance industry in Eastern Europe; and the third analyzes the impact of the current global recession on microfinance in Eastern Europe.

According to the paper, the microfinance industry is considered to be “resilient to the economic cycles.” Since the poor are less dependent on global economic trends, repayment rates have remained relatively stable, with “top-tier microfinance institutions (MFIs) [reporting] repayment rates well above 90 percent on average.” From 2003 to 2007, the microfinance sector expanded its customer base by about 25 percent per year, reaching more than 100 million clients globally by the end of 2007 with an estimated loan volume of USD 25 billion. This rapid growth has attracted institutional investors, development agencies and NGOs, all seeking to make socially responsible investments (SRIs) while enjoying a high rate of return. “Due to the nature of the microfinance business and [its] trends, top-tier MFIs have been reporting more favorable results than conventional commercial banks in many countries.”

The authors point out, however, that the countercyclicality of the microfinance industry does not apply to Eastern Europe. Repayment rates were at 98 percent in 2007, but fell to 80 percent in 2009. It is expected that women, who make up over 80 percent of MFI clients in the region, will be the hardest hit. This is partially due to large loan sizes (averaging around USD 1,600) and a preference for individual lending instead of lending groups, which help mitigate delinquency and default risk. Furthermore, in the majority of countries in the region, microfinance is not fully integrated into local financial systems due to lack of adequate legal and regulatory frameworks. In Serbia, for example, “the Law on Banks allows only the traditional commercial banks to lend money,” forcing MFIs to operate via commercial banks, thus increasing their administrative costs and interest rates.

“The root of the emphasized sensitivity,” the authors claim, “predominantly lies in the macroeconomic structure of the Eastern European economies.” The authors list the following points as the main reasons for cyclicality in the microfinance sector of Eastern Europe:

· Incomplete economic transition in the former communist countries

· High inflation (sustained high food prices) and drop in real income

· Higher cost of capital after a long period of unreasonable cheap funding made available to MFIs

· Dominance of individual lending (as opposed to group lending), which increases the cost per borrower and risk of default

· High average size of micro-loans, which increases concentration of credit risks and in many cases puts MFIs as direct competitors to conventional commercial banks

· Lack of local deposit base due to incomplete regulation of the microfinance business in many countries

· Withdrawals of the existing deposit base over the recent months due to collapse of public banking systems in the 90s

· High dependence on foreign funding in hard currency coupled with the local currency permanent depreciation

· High dependence of borrowers on remittances from abroad, whose volumes have decreased

· Unstable internal organizational structure of MFIs and poor networking between local MFIs (within national associations), which result in low negotiation power

· Relatively underdeveloped MFIs´ management and lack of adequate risk management

Despite the negative outlook for the microfinance industry in Eastern Europe, the authors remain optimistic that MFIs will “probably emerge as stronger organizations.” They suggest that MFIs should slow their growth plans, reward clients who have paid on time with further loans, improve internal efficiency and turn to a deposit-led approach. Many of these suggestions, however, would require the governments to change existing regulations.

Dr. Dragan Loncar, co-author of this research paper, is an Assistant Professor at the University of Belgrade, Serbia, in the Faculty of Economics. He holds a PhD from the Faculty of Economics in Belgrade and an MA in Management Studies at the University of Cambridge, United Kingdom. Mr. Christian Novak is an emerging market consultant with experience with JPMorgan, ING and Morgan Stanley. He received a BBA from the Catholic University of Argentina. Dr. Svetlana Cicmil leads the Research Group for the Management of Projects, Risks and Collaboration in Global Operations at Bristol Business School, United Kingdom. She received a BSc in Civil Engineering from the University of Belgrade, and an MBA and PhD from De Montfort University in Leicester, United Kingdom.

By: Stefanie Rubin, Research Assistant

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