األمم المتحدة. اللجنة االقتصادية واالجتماعية لغربي آسيا N A T I O N S U N I E S Commission économique et sociale pour l Asie occidentale

Transcription

1 U N I T E D N A T I O N S Economic and Social Commission for Western Asia األمم المتحدة اللجنة االقتصادية واالجتماعية لغربي آسيا N A T I O N S U N I E S Commission économique et sociale pour l Asie occidentale MICRO-FINANCE IN CONFLICT: STRATEGIES FOR DEVELOPMENT AND PEACE IN THE ESCWA REGION 2009

2 ABSTRACT This report tackles microfinance amid conflict in the ESCWA region through a review of the main issues, such as the provision of microfinance services, the role of microfinance in development and the unique challenges faced by conflict-affected countries concerning microcredit and the development of financial markets. It also surveys microcredit providers in ESCWA s conflict-affected countries, with an overview of the Arab World and a country level analysis of Iraq, Lebanon and Palestine. The report also analyzes effective strategies for microcredit programs amid conflict, while focusing on the role of microfinance both in development and peacebuilding. It concludes with recommendations based on international best practices, and the experiences of different countries in the region and worldwide, specifically those in conflict. 2

3 TABLE OF CONTENTS ACCRONYMS... EXECUTIVE SUMMARY... Part 1. Microfinance in Conflict: A Review of the Main Issues The role of microfinance in development The context of conflict and post-conflict Micro-credit and Peacebuilding... Part 2. Micro-Credit Providers in ESCWA s Conflict-Affected Countries Overview of micro-finance in the ESCWA region Micro-credit in Iraq Micro-credit in Lebanon Micro-credit in Palestine... Part 3. Effective Strategies for Micro-finance amid instability Creating an enabling environment for micro-credit in conflict Institutional Characteristics of Microfinance Institutions Financial Sustainability Efficiency and Productivity Coping Strategies and Risk Maximising micro-credit programmes outreach and social impact for peace Training and Technical Assistance External Support and Donor Standards... Part 4. Conclusions and Recommendations Conclusion Recommendations Iraq Lebanon Palestine REFERENCES... 3

4 ACCRONYMS UN ESCWA MFI IMF GDP NGO MDG USAID ACSI WWI CHF CAP IMMDF ACNI ICBG IFC UNOPS LSC MIS AMEEN ESFD PARC MSEs CWEP CGAP GTZ United Nations Economic and Social Commission for Western Asia Microfinance Institution International Monetary Fund Gross Domestic Product Non-Governmental Organisation Millennium Development Goals United States Agency for International Development Access to Credit Services Initiative Women for Women International Cooperative Housing Foundation Community Action Programme Iraq Middle Market Development Foundation Access to Credit in Northern Governorates of Iraq Iraqi Company for Bank Guarantees International Finance Corporation United Nations Operations Support Services Local Steering Committees Management Information System Association d Aide au Developpement The Economic and Social Fund for Development Palestinian Agricultural Relief Committees Micro and Small Enterprises Center for Women s Economic Projects Consultative Group to Assist the Poorest Deutsche Gesellschaft für Technische Zusammenarbeit 4

5 EXECUTIVE SUMMARY This report examines Microfinance in general and the provision of microfinance services in conflict afflicted areas in the ESCWA region in particular, and offers recommendations on the best practices of microfinance during and post-conflict, specific to this region. Information in this report was compiled from secondary reports and data from different national and international institutions, think tanks and UN agencies as well as the MIX Markets database which contains detailed microfinance indicators. The first part of the report tackles microfinance amid conflict through a review of the main issues. It starts with stating the role of microfinance in development, and placing the context of post conflict and the microcredit challenges during conflict situations. As stressed by the United Nations Secretary General in his report on the role of microcredit and microfinance in the eradication of poverty 1, the well targeted provision of microcredit to the poor has a direct positive impact on their lives. Indeed, it is widely recognised that countries with low income would benefit from microfinance services in order to achieve the Millennium Development Goals. Microfinance gives access to financial services such as savings, credit, insurance and money transfer to people that otherwise would remain underserved. This definition of target beneficiaries differs between one institution and another. While some benefit the entrepreneurial poor which can sustain themselves, other benefit the upper poor or even the lower poor which can be targeted by different mechanisms before they are ready for the financial services which regular microfinance institutions offer. Microfinance contributes to micro-and small-scale enterprise development, which in turn is conducive to economic growth and therefore sustainable development, thus making the poor economically active in the societies they belong in. It has been noted that only sustainable Micro Finance Institutions (MFIs) that can attract commercial sources of funds will be able to grow and serve more poor people. The ESCWA region in particular is full of experiences; both positive and negative, on how institutions, mainly MFIs, coped with harsh conditions of conflict. The constraints facing the micro and small enterprises industry during conflict are mainly those than stem from the instability and the political turmoil. This drives up risks and increases uncertainty which has negative effects on investments and especially on credit institutions. Compared to countries which are not affected by conflict, those emerging from conflict face unique challenges in developing their financial markets. Post-conflict countries need institutions which can work in an initial environment characterized by lack of security, trust and infrastructure, psychological distress of the refugees and war returnees, and high population mobility. The second part of this report surveys microcredit providers in ESCWA s conflictaffected countries. The analysis provides an overview of the Arab World and a country level analysis of Iraq, Lebanon and Palestine. Providing credit to the micro-enterprises in these countries will develop human resources; improve the poor s ability to generate income and thereby improve their livelihood. The microfinance industry in the ESCWA region has witnessed much progress, mainly with regards to market penetration which has increased remarkably, with the active clients almost up by five times between 1997 and 2002 (source). The sector is said to have good exposure and a good understanding of good practices and regulation which are largely applied in the region. To promote the microfinance culture in the region, governments, NGO s and the general public need to have more information about this sector. A further step is to 1 United Nations Report of the Secretary General on the Role of Microcredit and microfinance in the eradication of poverty, General Assembly, A/63/159, 29 July

6 encourage commercial banks participation in micro-lending. In addition to that, there is a need to empower women and increase their productivity, as the region has the one of the lowest rates of female labour force participation. The main challenges in the region remain however the absence of stability and the increased uncertainty of ongoing and protracted conflicts. The report proceeds to analyze effective strategies for microcredit programs amid conflict, while focusing on the role of microfinance both in development and peacebuilding. From essential and preferred environmental conditions to governance and institutional characteristics of MFIs to outreach, financial concerns, efficiency and productivity issues. The report also discusses how MFIs coped and should cope with default risk especially in conflict situations, and how technical assistance and training needs are crucial during conflict. Also in this section is a discussion on donor policies and criteria. The report concludes in Part four with recommendations based on international best practices, and the experiences of different countries in the region and worldwide specifically those in conflict. 6

7 Part 1. Microfinance in Conflict: A Review of the Main Issues 1.1 The role of microfinance in development Microfinance is the offering of financial services to the entrepreneurial poor. Although the most notable of these services is the provision of credit, many other offerings are a part of microfinance including credit for business activities and credit for emergency and life cycle needs. Savings and deposits services are also an important service which microfinance facilitates for the poor and a source of funding which is crucial for microfinance institutions to promote their sustainability, decrease their dependence on donor money, and strengthen their resilience. While microfinance was originally conceived to target the poor, an in-depth study by the Consultative Group to Assist the Poor of the client base of seven microfinance institutions in Asia and Africa, found that a large majority of microfinance clients were moderately poor (those in the top 50 percent of households below the poverty line), few were from extremely poor households (those in the bottom per cent below the poverty line) and none were destitute (those in the bottom 10 percent) 2, hence reference above to the entrepreneurial poor. The United Nations Secretary General s report on the role of micro-finance in the eradication of poverty in 2008 clearly states that there is ample evidence that access to credit has given many poor people the means to increase, diversity and protect their sources of income to come extent 3. This view was reiterated by the UN General Assembly in a resolution adopted in March 2009 stating that microfinance, in particular microcredit programmes, has succeeded in generating productive self-employment and proved to be an effective tool in overcoming poverty and reducing the vulnerability of poor people to crisis and has led to their growing participation, in particular, the participation of women, in the mainstream socio-economic and political processes of society. 4 Indeed, microfinance efforts directed towards the financing of women help poor women increase their incomes and savings, improve nutrition and health, and increase their empowerment. This explicitly satisfies the objectives of three MDGs related to poverty eradication, maternal health, and women empowerment, and trickles down to affect other goals. Through microfinance, developing countries will help their local private sector to grow and sustain itself, and create wealth for people with low income. As highlighted by the UN Millennium Project, the recommendations related to microfinance seek to direct countries focus towards building inclusive financial sectors that will help these countries reach the MDGs 5. Microfinance gives access to financial services such as savings, credit, insurance and money transfer to people that otherwise would remain underserved. These people are usually denied access to commercial loans because they do not have enough means to be able to repay 6. This is where microfinance comes in to provide this part of the population which is underutilized, and jumpstarts their productivity through offering services that would help them increase their 2 Helms, B. Access for All: Building Inclusive Financial Services. Consultative Group to Assist the Poor, World Bank Publications, 2006, p.20 3 UN SG s report on Microfinance, Op Cit, para. 15, p.6 4 United Nations General Assembly Resolution A/RES/63/229, Role of microcredit and microfinance in the eradication of poverty, 10 March 2009, p.1 5 UNCDF. Microfinance and the Millennium Development Goals. UNCDF, Elia, Marco. Microfinance: Text and Cases. Turin, Italy: SAA, School of Management University of Turin,

8 household income and employment opportunities and consequently create demand for other goods and services including education, nutrition and health 7. This is true in the case of the entrepreneurial poor who, unlike the extremely poor, have the ability to sustain themselves but only lack the means by which they can increase their income and improve their business activities. Clearly, Micro Finance Institutions (MFIs) do not only serve in raising the living standards of the poor, they also generate employment and eventually add to GDP growth and the economic cycle as a whole. 8 Core principles of good microfinance include providing financial services beyond credit and savings facilities; improving the regulations regarding the legal form of the institutions permitting the transformation of non-regulated MFIs into specialized, regulated, or licensed rural finance and microfinance intermediaries. In addition to that, services include promoting awareness towards transparency in financial accounting and transaction reporting and encouraging the exchange of clients credit histories. Through providing an access to credit and savings, MFIs help poor people take on productive activities, and cross the poverty line. This explains the popularity of microfinance among donors. Nevertheless, according to the IMF, this approach involves the risk of funds being deviated from other prominent investment areas such as education and healthcare projects 9. For example, if a donor institution is interested in development work in a certain community, it has different options to choose from, and choosing microfinance has an opportunity cost which derives from other choices to help a community such as building a school or a hospital. It is worth noting that having access to finance is not always synonymous with generating income. Nevertheless, micro-credit is a crucial input in developing small enterprises. Microfinance triggers the efficient use of underutilized resources kept idle in poor societies due to the lack of knowledge and capabilities essential to properly invest in them. These resources could include both labour and capital. MFIs are not only working on allocating resources which could have otherwise been used on other projects, they are utilizing resources which were neglected both by the public sector and by big financial institutions. 10 Only sustainable MFIs that can attract commercial sources of funds will be able to grow and serve more poor people. Profitability is seen as evidence that microfinance is a successful practice, and self-sufficiency is essential for the industry to grow without the burdens tied with donor-dependency. After years of experience with microfinance, there is no comprehensive data on the sector. The industry has a very large number of institutions but they only serve a very small number of clients, and the percentage of borrowers out of the market potential is still extremely low. Most activities are concentrated in a few countries where a few large institutions engage in the bulk of the transactions Brandsma, Judith, and Laurence Hart. Making Microfinance Work Better in the Middle Ease and North Africa. World Bank, Brandsma, Judith, and Deena Burjorjee. Microfinance in the Arab States: Building Inclusive Financial Sectors. United Nations Capital Development Fund, IMF. "IMF Survey." International Monetary Fund-IMF. March 21, (accessed August 19, 2009) Boynioughnian, Hagop Krikor. "Microfinance in Lebanon." American University of Beirut, IMF 2005, Op Cit. 8

9 1.2 The context of conflict and post-conflict Today, several environmental factors affect the functioning of microfinance institutions worldwide in general, and in the ESCWA region in particular. Internal conflicts and intercountry wars have been detrimental to economic activities and have resulted in incurring developmental losses. The region is full of experiences; both positive and negative, on how institutions; mainly MFIs, coped with harsh conditions of conflict. Functioning in a conflict environment can be very stressful, difficult and costly. This section identifies some trends specific to conflict economies and the constraints MFIs are faced with during these specific conditions. Conflict and post-conflict environments can be defined by three main characteristics, first in the psychosocial context, there is loss of trust, geographic separation from families and fear of violence. Secondly, the economic situation is weak and distorted, there is a loss of household and business assets, lack of trust in the financial system and a small pool and high cost of skilled human resources; and thirdly, the infrastructure is damaged while many have lost access to basic services such as schooling, sanitation and healthy care. 12 There are microfinance trends which are specific to post-conflict situations. Most MFIs attempt product modifications and alter certain procedures for example rescheduling loans or providing new products that would be suitable for reconstruction after conflict, which can sometimes highly increase risk and cost. Post-conflict MFIs are faced with major human resource limitations and therefore as opposed to non-conflict situations where MFIs compete with the private sector to attract talented staff, the limitations of post-conflict situations with regards to human resources accelerate operational costs as a result of hiring foreign staff, or training locals 13. Security considerations also affect post-conflict MFIs by limiting operations and raising costs. These include both the staff s security as well as that of the clients. In addition, conflict environments limit the opportunities for entrepreneurship and launching of new ventures, which are highly risky and costly. These factors which are specific to conflict affected economies impede the sustainability of MFIs at both the financial and institutional level. The constraints facing the micro and small enterprises industry during conflict are mainly those that stem from the instability and the political turmoil. This drives up risks and increases uncertainty, which has negative effects on investments and especially on credit institutions. Furthermore, increased operational risk can also result from parallel relief-oriented programmes, short-term oriented micro- finance projects, often implemented by humanitarian organisation, and political or self-interested motivations of local officials. The reason for the increase in administrative and operational costs could be attributed to rising monitoring expenses to maintain high-quality portfolio, additional security precautions, higher labour costs, additional investments in advocacy work, and training and re-training efforts. Challenges during conflict increase MFI s overall risk especially that related to their balance sheet. Conflict also lowers the returns of investments. This is due to weakened repayment since the clients are displaced and suffer from a reduction in their productive and operational capacity. Furthermore, loan funds are decreased since deposits or lending resources 12 CGAP Supporting Microfinance in Conflict Affected Areas, Donor Brief no.21, 2004, p.1 13 USAID and DAI, Environmental Preconditions for successful post-conflict microfinance Microenterprise Best Practices Project Brief no. 5 9

10 are frozen or reduced, and equity values decline as a result of inflation and currency devaluations. 1.3 Micro-credit and Peacebuilding Microfinance can be a useful tool in post-conflict recovery, both for development and for building sustainable peace. By providing access to financial services, it can restart and boost local economic development. In addition, it can play a major role in immediate post-conflict rehabilitation assistance. Beyond these economic benefits, microfinance can be highly effective at social mobilization, empowerment, stabilization and enhancing solidarity, through social capital enhancement. 14 One of the five core objectives to achieve peace and post conflict recovery, according to the 2009 Report of the UN Secretary General on Peacebuilding in the Immediate Aftermath of Conflict in 2009 to support economic revitalisation, including employment generation and livelihoods particularly for youth and demobolised former combatants, as well as rehabilitation of basic infranstructure. 15 All areas of development which benefit from microfinance. As stated by Marino (2005), violent conflicts mostly affect the poor because they are physically vulnerable, live in hazardous conditions, and lack strong social safety nets. The social capital of the poor is eroded as a result of the constant feelings of insecurity that come after conflict. Conflict also weakens the poors organizations, constrains their social and physical mobility, and prolongs poverty s vicious circle. 16 Most importantly, studies show that microfinance encourages reconciliation and conflict resolution 17 by involving cross-ethnic cooperation; for example producers and consumers interact across ethnic borders. According to Larson (2001), microfinance efforts smooth the transition to a normal life after conflict by developing social capital through solidarity mechanisms. 18 In addition, microfinance can encourage the reintegration of refugees, returnees and demobilized soldiers, by facilitating the development of economic activities, collaboration with local populations and fulfillment of entrepreneurial spirit. Indeed, when people need to earn a living to survive, conflict becomes secondary. 19 By empowering members to establish their own organizations, microfinance integrates democratic procedures that help people surmount conflicts. For communities divided by conflict or caste, developing credit and savings associations could be a way to bring people together, focusing on economic activities and cooperation rather than differences. Providers of microfinance services have found that group-based activities contribute to empowerment by allowing people to regain trust and confidence in each other. Groups can also discuss issues of tolerance and conflict resolution, and become catalysts in wider peacebuilding. Thus, the benefits 14 Marino, Pascal. Beyond Economic Benefits: The contribution of microfinance to postconflict recovery in Asia and the Pacific. Brisbane, Australia: The Foundation for Development Cooperation, UN Report of the Secretary General on Peacebuilding in the Aftermath of Conflict, A/63/881, 11 June 2009, para. 17, p.6 16 Ibid. 17 See Doyle, Karen. Microfinance in the wake of conflict: challenges and opportunities. Microfinance Best Practices, Larson, Dave. Microfinance Following Conflict, Briefs. Microfinance Best Practices, Marino 2005, Op Cit. 10

11 of microfinance in post-conflict situations go well beyond the economic, to the intangible, enhancing social capital and empowerment, and ultimately, contributing to peacebuilding and reconciliation. 20 Part 2. Micro-Credit Providers in ESCWA s Conflict-Affected Countries 2.1 Overview of micro-credit in the ESCWA region While there is a significant lack of accurate and timely data on micro-credit at the regional level, some studies show that in 2005, more than 60 active microfinance programs were implemented in the region, of which 40 have been run by non-governmental organizations (NGO s) with microfinance activities lodged as part of their larger social operations and quasigovernmental organization- including state-owned banks operating under government oversight and serving merely as windows for credit delivery 21. Country Table1: Number of Borrowers, Volume and Average of Loans by Country Number of Participating MFIs Number of Active Borrowers Loan Portfolio (USD) Average loan balance per borrower (USD) Egypt , ,602, Jordan 6 100,206 93,595, Palestine 6 24,699 43,616, Yemen 5 18,354 2,079, Lebanon 3 17,730 15,260, Syria 2 16,297 14,050, Sudan 2 6,858 1,708, Iraq 1 5,268 8,341, Source: Microfinance Information Exchange, Inc., 2007 Benchmarks Taken from the MIX Market benchmarks of 2007, the country level data on the number of firms participating in the study, the number of borrowers, loan portfolio and average balance per borrower in Table 1 reveals that the highest number of active borrowers is in Egypt which also has the highest loan The highest average loan balance goes for Palestine with USD per borrower, while the lowest figure is in Yemen with USD per borrower which can be explained by the fact that Yemen is one of the two least developed countries (with Sudan) in the ESCWA region and therefore has significantly lower living standards and GDP per capita. 20 Marino 2005, Op cit. 21 Boynioughnian, Op Cit 11

12 The microfinance industry in the Arab region has witnessed much progress since the first microfinance survey in , whereas market penetration has increased remarkably, with the active clients almost up by five times between 1997 and The sector has had good exposure and an increased understanding of good practices and regulations which are largely applied in the region. The industry contains a high number of fully financially sustainable institutions which are providing services to a large part of the market. According to Brandsma and Burjorjee (2004), signs of product diversification are starting to appear in the industry as MFIs are tending to be more oriented towards the clients and increasing competition 23. The market has also been entered by some commercial banks and new MFIs which are transforming into single-purpose MFIs depending on their countries legal framework and regulation that permit this kind of organizational change. Numerous initiatives have been taken to promote the need for specialized laws and regulatory frameworks regarding microfinance, which is essential to the development of the sector. These laws also include effective regulation by the Central Banks of the respective countries. In addition to these initiatives, a regional network dedicated to advocacy and capacity building for good practice microfinance is facilitating learning and exchange of know-how in the region. Applying microfinance is a easier than ten years ago due to the massive empirical experience which many countries in the region underwent. Considerable work still needs to be done to move the microfinance industry in the Arab region from the infancy stage it is in to more maturity and consolidation. The challenges the industry had to face were inefficient systems and procedures, excessive donor and reporting requirements and the lack of management information systems. Today, there is a need for product diversification: introducing savings, leasing, insurance and for considerable capacity building since MFIs are becoming more service oriented, and are offering a wider range of products while other MFIs progressively seek transformation to overcome the legal constraints brought about by the NGO laws in their countries since for example, NGOs are not granted rights to hold savings. In addition to these challenges, donor dependency continues to be an issue, as only few microfinance institutions have been successful in gaining access to commercial capital in the ESCWA region. This also stresses on the need for enhancing the regulatory framework. Programs subsidized by the government are providing cheap credit to big numbers of people among the region, and this has a distortionary effect on the industry s overall performance Micro-credit in Iraq Before 2003 the Iraqi banking system was dominated by two state-owned banks, the Rafidain and Rasheed banks. The two banks provided basic banking services and their main focus was to provide cash payments for government employees, pensioners and welfare recipients. Some small private banks were registered with the Central Bank of Iraq but these banks had few branches and provided very few services with almost no lending. 22 Brandsma and Burjorjee 2004, Op Cit 23 Ibid. 24 Ibid. 12

13 In 2003 the United States government provided grants worth $30 million so that two international NGOs could develop microfinance institutions (MFI) across the country. One NGO received $21 million and operated in the north of the country, the other NGO received the remaining $9 million and operated in the south. USAID contributed a further $20 million in 2005 through the Izdihar project so that the microfinance industry could be further rebuilt through training and technical assistance 25 Demand for microfinance has continued to grow ever since. By June 2007 the total loans surpassed the $100 million mark of funds disbursed for the first time since microfinance activities were launched in Iraq. On the whole MFIs operating in Iraq had over 19,000 active clients and managed an outstanding loan portfolio of $26,800,000 by mid While the majority of loans were made to men, approximately 13% of the loans were made to female clients 27. This percentage of loans made to women is however significantly lower than in other countries in the region with more developed and consolidated microfinance industries like Morocco or Egypt. Some experiments involving women have however already been implemented. Women for Women International for example established a microfinance program with the help of Global Giving funds. The program promotes basic lending policies and practices, offers business planning training for potential clients and makes zero-interest equipment and raw materials loans to program participants. The objective of the program is to provide the training required for 100 women which would enable them to develop an incomegenerating activity. The program focuses on the importance of solidarity: in order to join the program a client must form a group of three to seven women, all of whom must agree to make any missed payment of any member of the group. Women for Women International (WWI) considered that loans for equipment and raw materials constitute the best ways to stimulate during the initial phases of the microfinance program: loan recipients make regular payments to WWI for the value of the equipment or materials, which are purchased on their behalf. Business plans are assessed and approved by the program manager and loan officers. Graduates of the plan are encouraged to develop income-generating plans using the new skills learned. The Iraqi Widows Organization also received a grant with similar purposes. The grant achieved its objective of improving 120 widows ability to recover their economic capacities by providing micro-credits with an overall success of 116 micro-credits (97%) 28. CHF (Cooperative Housing Foundation) 29 began working in Iraq in June 2003 at the request of USAID. CHF has been carrying out three main projects: the Community Action Program (CAP), the Access to Credit Services Initiative (ACSI) and the Iraq Middle Market 25 The Iraqi Microfinance Strategy, publication produced by the United States Agency for International Development (prepared by the joint venture of The Louis Berger Group Inc and The Services Group), February 27 th, Section 2 Iraqi Microfinance 26 Greg. G.Howell Microfinance in Iraq: a surge in Lending to Iraqi Entrepreneurs, Sept.17 th, ACDI/VOCA. For an explanation on ACDI/VOCA see footnote 34 below 28 State- and Peace-Building Grant Database, Micro Credit to Iraqi Widows 29 CHF International was originally established as the Foundation for Cooperative Housing (FCH) in 1952, a 501c(3) non-profit corporation seeking to help low- and moderate- income families in rural America and lowincome urban neighborhoods to achieve improved economic standing and quality of life through the construction of affordable housing. Information on CHF International can be found at CHF/Iraq employs 460 locally-hired and trained Iraqis. 13

14 Development Foundation (IMMDF). The CAP program directly engages Iraqi community leaders and elected local councils in restructuring essential infrastructure in their own cities and towns. This represents a holistic effort that apart from creating new employment serves to build a foundation for democracy. CAP I and II focused mainly on building the capacity of community action groups to fill the gap of local government. The newest version of the program, CAP III is based on the premise that local community needs are best met by ensuring active participation of all stakeholders in identifying priorities and setting out courses of action 30 The ACSI initiative provides low-income Iraqis access to capital and financial services. ACSI hands out loans to Iraqi individuals that do not otherwise have the same capital. These loans are used for home improvement or to expand small-businesses. They may also be used to restock or repair equipment or to open stores. ACSI has ten branch offices in Baghdad and seven other cities in southern Iraq. Loans are compliant with Islamic principles which prohibit the taking of interest when lending money 31 As a policy goal ACSI seeks to assist entrepreneurs in strengthening their businesses, create and sustain jobs and contribute to the economic revitalization of Southern Iraq. ACSI has become the largest microfinance program in the country and has also become a self-sustaining local institution. ACSI has over $25 million in portfolio outstanding 32. The USAID-funded Izdihar project has provided technical assistance and funding to several projects. The Al-Thiqa program was created in 2004 and has already become operationally self-sustainable, and thus has been able to cover costs through its revenue. Since its inception Al-Thiqa has disbursed more than 32,000 loans at over $84 million. 16 percent of its recipients are women. The institution has had an all-iraqi management since January Another similar project is the Al-Takadum project, which concentrates in the province of Al- Anbar 33. ACDI/VOCA 34 also has implemented the Access to Credit in Northern Governorates of Iraq project (ACNI). Through six strategies the Izdihar program has tried to promote outreach and sustainability. The six strategies are the following: 1. Promotion of awareness of microfinance and its benefits. 2. Creation and strengthening of a legal and regulatory environment that supports the establishment of new MFIs and the integration of MFIs into the financial community. 3. Capacity building 30 This information can be found on CHF s webpage 31 In order to be compliant with Islamic principles, the institution charges fees on all loans up front. 32 According to CHF International ACSI represents approximately 80% of the microfinance market in Iraq. See website reference above 33 See article Iraq reconstructs thanks to Microfinance industry. August 20 th, IMFI (Iraq Micro-finance industry) website ACDI/VOCA is a private, nonprofit organization that promotes broad-based economic growth and the development of civil society in emerging democracies and developing countries. According to its website ACDI/VOCA fosters broad-based economic growth, raises living standards and creates vibrant communities. Its practice areas are agribusiness, food security, enterprise development, financial services and community development. ACDI/VOCA was founded in 1963, as a 501c(3) non-profit corporation and it has 792 employees, 132 in the US and 660 overseas. It currently runs 80 projects in 42 countries. More information can be found in the website 14

15 4. Emphasis on transparency 5. Support of industry development through formal and informal networking opportunities 6. Increase of business opportunities with the banking industry in order to provide MFIs with needed banking services and promote partnering arrangements between MFIs and banks 35. Particularly important among these strategies has been the enhancement of the legal framework. The key legal and regulatory issues affecting microfinance are the Central Bank of Iraq Law of 2004, the Banking Law of 2004, CPA Order No.45 and Company Law No.21 of Burdensome requirements remain under the Company Law, like the difficulties revolving around the registration of a company that is not 100% Iraqi-owned. Difficulties also exist when registering a MFI with the NGO Assistance Office or when registering a for-profit MFI with the Trade Ministry. Cumbersome reporting and registration requirements under the NGO law and Company Law and the inconsistent application of law from region to region constitute additional problems. Some suggestions for overcoming these shortcomings may be proposed. Development of the industry could be promoted with a clear mandate from the Central Bank of Iraq concerning MFIs. The sensitivity of the legal and regulatory issues affecting microfinance should also be promoted at the Central Bank and within the government. The base of products MFIs could offer should also be expanded to include savings products, equipment leasing, secured financing or real estate lending. Anti-money laundering, information sharing and Islamic financing could also be further developed 36. With respect to capacity building (Strategy 3 of the Izdihar project under the Iraq Microfinance Strategy) the brain drain to neighbouring countries has created the need to promote trainings of competent staff. Trainings should be conducted in MFI growth planning and strategic development, product development and marketing, financial and risk management and corporate governance. Transparency (Strategy 4) would make the gathering of useful information possible that would serve to increase the efficiency of the industry. Outreach indicators such as gender, age or location would permit an assessment of which target groups are being served. This would serve to collect reliable information on poverty reduction, employment generation or community stabilization. Information should be transparently collected about MFI Financial and Portfolio performance and on the expenditure of grant funds. External and internal audit capacities should also be strengthened. The development of a microfinance network (Strategy 5) would help serve as an advocate to disseminate information about microfinance practices. Microfinance networks have the potential to be important in crisis-affected environments. They serve to overcome issues like lack 35 The Iraq Microfinance strategy, 25 February 2007 supra 36 Elbayar, NGO Laws in Selected Arab States, International Journal of Not-for-Profit Law, Vol 7, Issue 4, September 2005, pages 11-12, citing Shea, Comments on the Regulation of NGOs Issued by the Coalition Provisional Authority, Order Number 45, International Center of Not-for-Profit Law, page 1, as cited in The Iraq Microfinance strategy, 25 Feb. 2007, supra. 15

16 of information, uneven application of best practices, an inappropriate policy environment or uncoordinated donor intervention, deficiencies which tend to be exacerbated in crisis situations. Strategy 6 proposes to increase the relationships between MFIs and banks in Iraq. MFIs offer products not offered by banks and conversely banks offer many products not offered by MFIs. Thus several types of linkages could be considered. The Izdihar project proposes several initiatives to increase the collaboration between banks and MFIs. These would include the loancapital financing, the partnership model between MFI and banks, the bank outsourcing model, the MFI-Bank correspondent model or the possibility for the Iraqi microfinance industry to consult with the Iraqi Company for Bank Guarantees (ICBG) about developing a guarantee program that would support loan capital financing for MFIs. The United Nations has also been involved in microfinance activity. In 2008 a survey conducted by the ILO and UNOPS showed that a majority of Iraqi entrepreneurs considered limited access to credit as the major barrier to economic development. To address this shortcoming ILO and UNOPS launched three programs to provide micro-loans to MSEs in the Marshlands, Hillah and the rural areas of Sulaimaniyeh 37. International NGO Cooperative Housing Foundation was selected as the implementing partner. The Local Steering Committees were briefed about the activities under consideration and about the terms and conditions of loans disbursement and repayment procedures. The LSC provided recommendations on target districts and groups of local population to be given preferential access to loans. As a result of the program 960 small Iraqi entrepreneurs received average loans of $1, % of the recipients were women. The program created almost 150 new jobs in economically depressed areas and the payback rate was 100% 38. The average loan size in Iraq amounts to $1,350, which is substantially larger in Iraq than in other countries. The nominal interest rate of 16% is about half the global average of 35%. It is quite likely that because MFIs in Iraq have higher cost structures than their counterparts in other developing countries, fees will increase in the future. A major issue for the development of the industry is that Iraqi MFIs will need to strike a balance between alienating their customer base and reaching operational and financial sustainability. The repayment rate for microloans in Iraq has been as high as 98 % 39. In terms of the legislative framework the only requirement for MFIs in Iraq is that they are officially registered as NGOs. However some authors 40 consider that the lack of legal guidance from the Government of Iraq has likely contributed to the impressive growth of microfinance in Iraq as the general laissez-faire political environment has allowed the industry to expand and mature. Many actions have also taken place at the local level, as managers and technical advisors have been educating local officials (mayors in cities where branch offices are located) on the objectives and achievements of microfinance in Iraq. Thus courses have been conducted in areas such as financial analysis, accounting and auditing or risk management. 37 The value of the loans was of $700,000 in the first case and $400,000 in the last two. 38 UNDG ITF 2009 Third Quarter Newsletter July-September 2009, p.6 39 Data borrowed from Howell Discussed at The Iraqi Microfinance Strategy, supra. Section 2.7. The Legal and Regulatory Environment 16

17 Four problems remain however for the development of this industry in what concerns the government of Iraq. First, the registration requirement of entities as NGOs through the Ministry of Civil Society remains long and cumbersome. Secondly, because of the still unstable security situation many MFI offices do not want to hold cash. As a consequence MFIs hold their funds in accounts with state-owned banks in Iraq and this creates many logistical challenges (since sometimes the banks run out of cash). The lack of customer service at these banks also leads to inefficiencies: the ability to transfer funds electronically between Iraqi banks remains low, which further limits the scope of MFI s operations. Thirdly government intervention through the development of a legal framework could impose excessive regulatory constraints, which may hamper the growth of the industry in Iraq. The last issue remains the need for donor diversification 41. Lastly good governance will remain a top priority in post-conflict Iraq. Governance policies will need to be directed at fomenting entrepreneurship, balancing economic activity and enforcing market mechanisms. The most critical part of good governance with respect to MFI operations will involve the banking system 42. It will be necessary that participants in the MFI trust the banking system. The main problems thus facing the microfinance industry remain the enhancement of the legal framework, capacity building and training, transparency, standards and reporting, the development of a microfinance network and increasing bank linkages as well as the ongoing instability in Iraq. 2.3 Micro-credit in Lebanon Since the early 1990s, Lebanon has been in a reconstruction phase after a 15-year civil war, which paralyzed the Lebanese economy and devastated local businesses. Yet, Lebanon has succeeded in fostering one of the most advanced commercial banking sectors in the region. Over the past few years, many commercial banks in Lebanon have begun to offer microfinance products either through strategic alliance with microfinance institutions (MFI), by developing their own microfinance products, or by offering loans to small enterprises with partial guarantees provided by specialized domestic and/or international funds. The use of formal banking services among micro and small entrepreneurs is quite high, especially in Beirut 43 The concepts of microfinance and microcredit were introduced to Lebanon in the mid- 1990s. The microfinance sector has seen substantial growth in recent years in Lebanon, and is expected to continue to expand. Yet the industry remains underdeveloped and suffers from lack of regulation. Measurement problems and lack of reliable data make matters worse. Some of the only reliable and recent figures were published in Lebanon: A Diagnostic Study on the Demand for Financial Services by Micro and Small Enterprises (henceforth referred to as the IFC study), a study released by International Finance Corporation (IFC), a member of the World Bank Group and Grameen-Jameel Pan-Arab Microfinance Limited. According to this study, 41 An example could be the partnership created between an Iraqi MFI and Kiva.org, a website linking microfinance clients directly with individual lenders which allows anyone to send funds to Iraqi entrepreneurs online. 42 This is discussed in the paper Sameeksha Desai, Post-conflict Microfinance: Assessment and Policy Notes for Iraq, Jena Economic Research Papers, (International Finance Corporation (IFC)/The World Bank Group and Grameen-Jameel Pan-Arab Microfinance Limited 2008). 17

18 Lebanon s microfinance market is relatively small (about $286 million), yet only 11.5 percent of the demand is met by existing financing sources. 44 A recent study indicated that the total supply of micro credit in Lebanon has been steadily increasing over the years, and reached approximately $27 million in Despite the increasing supply, there is a large gap in the market. In order to address this gap, the microfinance industry in the country needs to build capacity, which would entail an increased number of employees, staff training, and the development or improvement of Management Information Systems (MIS). The microfinance industry in Lebanon is increasingly dominated by three institutions: Al Quard al Hassan Association, Access to Microfinance and Enhanced Enterprise Niches (AMEEN), and Al Majmoua. Other major players are: Association d Aide au Développement Rural, Association d Entraide Professionelle, Al-Tamkeen, Hariri Foundation, Makhzoumi Foundation, and the United Nations Relief and Works Agency. According to the IFC study, as of September 2007, approximately 29,420 microfinance clients were being served by NGOs, microfinance programs, and MFIs; together, they had an outstanding portfolio of roughly $23.9 million, with an average loan size of $1, These institutions are not licensed to accept deposits. Most Lebanese microfinance providers offer individual loans; group loans do not appear to conform to local cultural norms, as Lebanese people generally do not like sharing information or talking about financial problems. The study also shows that, as result of the July war, about 5 percent of business borrowers experienced direct losses, and 50 percent of all borrowers experienced indirect losses. Various donors and multilateral development organizations provided emergency loans and other funding to Lebanese banks and small businesses following the conflict in order to rehabilitate, refinance, and reschedule destroyed businesses. Though greatly affected by the war, MFIs in Lebanon contributed to providing loans to finance the reconstruction efforts, and showed that MFIs can be resilient and function properly under conflict: they were able to remain in the market, provide needed services, modify their products to meet the needs of their clients and sustain themselves 47. The Lebanese government adopts a laissez-faire attitude concerning microfinance. There are no laws concerning the microfinance industry, and the government has no clear role in the sector (Mamari and Ghaleb, 2002). The only form of government support has come from the Central Bank, which issued a directive allowing local banks to use 5 percent of their required reserves for microfinance initiatives. However the Central Bank has been unresponsive to requests to use this liquidity This study is part of IFC s overall strategy to create a commercially viable microfinance sector in the Middle East and North Africa. It is also part of Grameen-Jameel s efforts to ensure that demand for microfinance services in the Arab world is met. The study was funded by IFC and Grameen-Jameel and conducted by the Frankfurt School of Finance and Management, Bankakademie HfB. This initiative is part of an agreement signed with Grameen-Jameel and CGAP (the Consultative Group to Assist the Poor) in May 2007, to help the Lebanese government scale up microfinance and microenterprise development (IFC, 2008). 45 Microfinance Institutions in Lebanon - SME Inception Plan 2007, p.1) 46 IFC 2008 Op Cit 47 Ibid, 48 Financing Cedar Seedlings Access to small-business credit could lift thousands of Lebanese out of poverty, in A Special Report on Microfinance, Executive, Issue 123, pp October

19 Relatively recently, however, the government has implemented two initiatives: the Economic and Social Development Fund, and Kafalat. The Economic and Social Fund for Development (ESFD), which was established in 2005, is funded by the European Union. The ESFD stimulates the outreach of Lebanese MFIs and supports income generation, employment creation, and poverty reduction. Among other activities, ESFD funds contractor banks to grant loans to unbankable entrepreneurs, which may be used for start-up or business development purposes. ESFD has also mobilized two microcredit funds; one is managed by non-governmental organizations and the other is managed by banks 49. Kafalat is a Lebanese financial company with a public concern, established by the Lebanese government in 1999, that assists SMEs in accessing commercial bank funding. Kafalat s loan guarantees help SMEs in Lebanon to access commercial bank debt financing. However, the establishment of Kafalat does not address the structural problems of banks and their policy-makers. 50 Non-governmental organization (NGO) have inherent weaknesses in terms of microcredit providers. They are bound by the legal provisions and restrictions applied to charities, and consequently have limited access to funds since Lebanese charities are not allowed to take deposits. Their legal structure also makes it difficult to access funds from the financial sector in the form of loans. NGOs therefore depend greatly on donor funds, which translate into lack of stability in access to credit, and they face a greater financial risk in case of default with the lack of regulation. These factors greatly contribute to their limited of their growth potential. 51 The environment is made even more ambiguous by the fact that micro lending is not explicitly regulated by any legal text of authority 52. No law has been passed by any government in Lebanon to allow the industry to be regulated. The Ministry of Interior, rather than the Ministry of Finance or the Central Bank currently supervises all NGOs that work in the sector 53. Due to the high and growing poverty rate and the fact that 30 percent to 40 percent of the population is unbanked, microfinance would seem like a good sector to invest in 54. However, it remains undernourished. Several main factors impede growth prospects of the microfinance industry in Lebanon: The sector is hampered by lack of legislation specific to microfinance, and, with some exceptions, is generally inefficient. Donor money is in short supply due to the global economic downturn. It is therefore becoming increasingly difficult for MFIs which depend on donations to get money. The number of international investors has plummeted, therefore MFIs are now looking more to the local banking sector. Unfortunately banks are not very interested in adopting 49 IFC 2008, Op Cit 50 Mamari, R. and Ghaleb, J. Micro-Finance in Lebanon Al Majmoua, presented at the WBI MENA Debates, Session 4: Making Markets Work for the Poor (microfinance). March Ibid, 52 Ibid 53 IFC 2008, Op cit 54 Special Report on Microfinance, Executive, Op Cit. 19

20 microfinance programs, mostly because it requires labor and management intensive work, which means high overhead costs (5 to 8 percent as opposed to the overhead of a normal loan which is 1.75 to 2.5 percent). 55 Many of the organizations in the market have a political slant. For instance, the Hariri Foundation, and Al Qard Al Hassan, which is funded by Hizbullah. MFIs supported by political parties and/or subsidized by international institutions have lower interest rates than other MFIs, and may push the latter out of the market Micro-credit in Palestine The constraints facing the micro and small enterprises (MSEs) industry in Palestine could be divided into two categories; internal and external. With internal constraints, we can differentiate between impediments on the entrepreneur and those on the enterprise. The Palestinian entrepreneurs, the young in particular, are pressured to emigrate in search of work opportunities and stability due to the ongoing occupation and ensuing deterioration of the economy in the occupied Palestinian territority. Their mobility is severely impeded by Israeli checkpoints, which also affect their access to markets and halts their entrepreneurial spirit placing a large burden on their employment or venture launching activities, although a general spirit of determination and perseverance exists mainly in the youth. 57 The enterprise is characterized by a low level of organization, technology, quality of assurance and control, has small capital investment and lacks capital accumulation as well as proper work place and space. As for the external constraints, the Palestinian MSEs suffer from the lack of finance, supporting policies, information, training programs, an increasing economic hardship and decreasing demand, the lack of proper infrastructure especially in camps (electricity, transportation), as well as difficult access to raw materials. The sector is faced with increased competition, which forced enterprises to decrease their prices in order to maintain their competitive power. The main issue of concern to the enterprise remains the political instability and the occupation, which affects the overall enterprise performance. 58 Given the importance that the informal sector and micro-enterprises have played in preventing the onslaught of absolute poverty among Palestinians, the development of this sector 55 Harout Samuelian, vice governor of the Lebanese central bank, said one of the main challenges to the microfinance industry in Lebanon is that banks usually do not like these kinds of programs because they are very expensive. But, he added, the technologies that are available in banks nowadays make it easy for them to perform a variety of transactions in seconds. Fadi Asrawi, dean of the faculty of business administration and economics, said rapid innovations have made it possible to conduct banking operations via mobile phone and this means a real breakthrough for microfinance. "Operational costs can be as high as 15 to 20 percent of loans, compared to less than 5 percent for banks in industrialized countries. The introduction of mobile-phone banking now makes it possible to reach millions of people in the fraction of a second and without the high costs of establishing an extensive network of offices. Such cost savings are important for microfinance institutions, as they allow them to reduce interest rate margins while not impairing profitability," he added. (Hallawi, 2009 DS Staff writer) 56 Special Report on Microfinance, Executive, Op Cit 57 USAID. "Microfinance, Youth and Conflict: West Bank Study." microreport # 41, "Microfinance in Palestine." Micro Finance at the University. 20

21 currently represents the most important source of employment for poor Palestinians, a trend which is expected to continue. 59 Development in the MF industry in the occupied Palestinian territory can be evaluated in the context of the Second Intifada, which began on September 28, The following period was characterized by intermittent clashes, invasions, closures, and curfews, resulting in the widespread restriction of movement, massive destruction of personal property, lack of access to markets, and severe curtailment of economic activity. While to this date, the micro-finance sector has shown the ability to cope despite periods of crisis, the magnitude of the current crisis which affects the whole society has begun to impact the capacity of the institutions to sustain operations and continue to lend 60. Many of the MFIs have reduced their levels of lending or even nearly stopped making new loans 61. According a 2007 IMF microfinance market survey in West Bank and Gaza, the Palestinian microfiance sector unlike others in the middle east has not been able to continue its growth in the last years; ongoing military occuption and current political and economic crisis have prevented it from increasing its portfolio. Unlike other arab countries where the microfinance sector has shown in many cases remarkable expansion, consolidation and evolution, microfinance in the Palestinian territories has somewhat diminished, calling into question the sector s ability to work effectively in such difficult context and in its current form 62 The key challenge for the Palestinian MFIs is how to survive and grow in an environment lacking peace and stability. If peace is not forthcoming in the near future, MFIs may wish to consider whether credit is still the appropriate response. 63 The Palestinian microfinance market hosts many initiatives. CHF's Ryada is considered one of the first credit programs in the Palestinian territories. The program has worked throughout Gaza since its inception in 1994 with support from the United States Agency for International Development (USAID). The program expanded in 2001 to three governorates of West Bank, added additional services in Gaza in 2003, and in 2005 expanded to three additional cities in the West Bank. In 2006 Ryada experienced significant difficulties- when the Palestinian Authority, whose employees were Ryada's main client base (either directly as clients or indirectly as guarantors), were no longer able to pay salaries. The portfolio at risk over 30 days shot up to over 76%. Despite this, Ryada overall continues to improve. The portfolio recorded a substantial annual growth by 66% in terms of outstanding gross portfolio & 40% in terms of active clients, while the portfolio at risk over 30 days at the end of the Sept 2008 was 11%, down from 35% by December 2007, and down from 47% by the end of September 2007 and this trend is expected to continue. Ryada has also been able to recover 54% of the written off loans as of Sept 2008 (MIX Markets 2009). Next, PARC, the Palestinian Agricultural Relief Committees is a cooperative union of cooperative savings and credit associations presenting the legal umbrella that covers all licensed cooperatives in Palestine which have been working in the field of savings and credit according to 59 IFC and PNSMF Microfinance Market Survey in the West Bank and Gaza Strip International Finance Corporation, Washington DC, May 2007, p IFC market survey WB G, p Ibid. 62 Ibid 63 Brundsma and Burjorjee 2004, Op cit 21

22 the principles and values of the cooperation. PARC aims at developing and protecting these associations by empowering and enhancing their economic and social role in achieving sustainable development in rural and urban areas. PARC s services include loans and voluntary savings (MIX Markets 2009). Another player in the market is ASALA The Palestinian Businesswomen s Association which has been active providing loans to women since 1997 when it was first established under the name of the Center for Women s Economic Projects (CWEP). In January 2001 it was registered with the Palestinian Ministry of Interior as Non-Profit NGO under the name: Palestinian Businesswomen s Association (ASALA). ASALA s main chalenge is working in unstable political environment and unfair competition (Best practice is not followed in Palestinian other MFI's) (MIX Markets 2009). At present, Palestinian MFIs are not regulated as financial intermediaries by the financial authorities and therefore limited in their product offer, which includes individual and group mico-lending for microentrepeneurs, agricultural loans, Islamic loans and consumer and housing loans. Due to the regulatory environment, Palestinian MFIs may not offer saving products to the general public or services linked to remittances and payment transfers. The provision of savings products is legally restricted by PMA authorised institutions, i.e. to banks. The regulatory environment has however been subject to reform since 1994 in an effort on legal harmonisation regarding the Law on Palestinian Monetary Authority, the Banking Law, the Law on the Capital Market Authority and the Securities Law. 64 Part 3. Effective Strategies for Micro-finance amid Instability 3.1 Creating an enabling environment for micro-credit in conflict Before engaging in microfinance activities, one should study the environmental propensity to absorb these financial products. This should include market research, demand studies as well as a comprehensive analysis of the operating environment. MFIs can only function if certain environmental conditions are met. This section enumerates these conditions and explains their prominence in making microfinance work better and more effectively. The list of conditions to a successful implementation of Microfinance in post-conflict environments is not a long one. Post-conflict microfinance can prove to be a viable choice particularly if the implementing institution is willing to face higher costs and higher risks. The essential conditions for a post-conflict microfinance environment include three main points. Political stability is a must. Areas where the programs are operating should offer a certain degree of security and safety to potential MFIs and their clients. The area should not be suffering from chaos, and clients need to be assured that it is both safe and profitable to take on their business activities. On the other hand, MFIs must feel that they are able to operate without any threats to their staff, assets and clients. From another direction of causality, microfinance and other developmental approaches may help in obtaining stability after conflict. Jumpstarting 64 Ibid. p

23 people s economic activity will create opportunities, and reduce unemployment hence decreasing people s motives to engage in conflict; mainly poor people 65. Another essential condition is the presence of economic activity and the existence of demand for financial services. As mentioned in the previous sections, microfinance only works when people are already engaged in business activities. This is not always the case in environments immediately following conflict. Conflict could result in migration and population displacement. These people may lose access to their physical assets or their rights to engage in economic activities. The way to deal with this is through the rule of thumb : if local markets are active, then the population is economically active enough to benefit from appropriate credit products 66 The third essential component is population stability. The key goal to any functioning MFI should be loan recovery for them to become part of the permanent fabric of an emerging post-conflict economy. This goal is hard to reach with mobile populations who may at any time abandon their loans. Thus, it proved better to work on stable populations which led to increased focus on returnees than on refugees. The benefits derived from this include: higher proportion of repeat customers, higher likely repayment rate, and longer period over which to spread fixed costs 67 In addition to the list of essential conditions, experience has shown that there are some conditions which are preferred though not as vital to the microfinance industry. The presence of these conditions definitely makes the post-conflict work easier, but their absence could be overcome. The first condition is the presence of functioning commercial banks to provide MFIs with financial services such as storing loan funds, moving money electronically and thus reducing costs and risks facing MFIs. The second condition is the presence of social capital or trust. Although not impossible to function without, microfinance could be impeded by distrust developed by internal conflict. Last but not least, the presence of macroeconomic stability including a steady currency facilitates the business of MFIs. The key to success is not the MFIs willingness to work in high-risk and high-cost environments, but their institutional commitment to sound principles and practices of MF 68. The development of financial institutions in conflict-affected countries is challenged by the macro, meso and micro economic conditions that prevail in a country immediately after a long and widespread conflict. At the national level, macro conditions affect the supply and demand for financial services. These include the lack of confidence in the economy as a result of the weak government and the lack of security which negatively affects investments, decreased level of financial capital at the government level dedicated to institutional development, increase in donor funds which are available as grants. In addition to that, there is a large capital flight and dollarization resulting from the low confidence in the local currency coupled with human flight and people looking for safer and better opportunities. Destroyed infrastructure hampers growth and blocks market access 69. Meso conditions are those affecting intermediaries (e.g. financial intermediaries). Financial intermediaries are ineffective in mobilizing resources and raising capital through 65 USAID and DAI, Microfinance Following Conflict Microenterprise Best Practices Project Brief no Ibid 67 Ibid 68 Ibid 69 Nagarajan, Geetha. Developing micro-finance institutions in conflict-affected countries:emerging issues, first lessons learnt and challenges ahead. International Labor Organization,

24 lending. Increased non-performing loans mainly to the public sector to finance the conflict render formal financial institutions dysfunctional. As for the semi-formal institutions, they are mostly NGOs which, although have resources to provide grants and credit, and are often trusted by the community, have a problem with the mentality of staff. These organizations usually provide humanitarian relief services, and their clients will not expect them to be tough with loan recovery. There is no strong supervisory and regulatory agency to monitor microfinance in particular 70. As for the Micro conditions, these directly influence the demand for financial services like the lack of confidence and trust in institutions and society, lack of productive activities and weak local labor, product and input markets, endangered life and safety and diseases which hinder incentives to enter long term investment contracts, difficulty in acquiring fixed assets to use as collaterals mainly due to client displacement which also gives rise to issues related to women and children who need particular outreach efforts 71. The box below reflects an experience from Bangladesh and how adverse conditions led to the establishment of Grameen Bank Project and how this institution actually serves the extremely poor. Clearly, is no golden rule to follow when choosing microfinance clients, but rather a convenience approach to ensure the institution's survival and sustainability. Box 1: We Serve the Poorest: Grameen Bangladesh Responding to a devastating famine in 1974, professor Muhamad Yunus founded the Grameen Bank Project in Bangladesh aiming at providing financial services to the poor by This segment of society which has no access to institutional credit as it can not provide collateral. As such, Grameen bank followed certain principles to help change these facts. The bank only lent money to the poorest of the poor in rural areas without collateral. The activities of the bank tried to focus on women (94% of its customers) and the bank granted the borrowers the right to decide the business activities for which the loans will be used for. The bank only charged interest rates to keep it self-reliant as opposed to dependant on donor funding, and used solidarity groups as one of the tools to ensure repayment. Professor Yunus sees that development should target the bottom half of the population and specifically the bottom half of those below the poverty line. Poor people have the potential to grow and overcome poverty if given access to credit and guided to succeed. Yunus was awarded the 2006 Nobel Peace Prize, along with Grameen Bank, for their efforts to create economic and social development. Sources: Bakhtiari, Sadegh. "Microfinance And Poverty Reduction: Some International Evidence." International Business & Economics Research Journal, 2006 and 70 Ibid 71 Ibid 24

25 3.2 Institutional characteristics of Microfinance Institutions All components of the financial system share the same core objectives for the regulatory framework including microfinance activities and institutions. The key principles and standards for the design of a regulatory framework for institutions providing financial services to the rural finance and microfinance sector are likely to be different from those for formal banking and finance institutions, because the design must consider the operational, market, and client characteristics of the microfinance sector. A good microfinance program committed to providing quality financial services to a growing number of poor people on an ongoing basis should be able to reach a large number of clients, provide financial products and services at competitive prices which implies high operational efficiency and the lowest possible transactions costs to client, and mobilize the financial and technical resources required to achieve its goals. To perform these functions, a microfinance program must have dedicated and competent managers, well-trained and motivated staff, and internal procedures and systems that enable it to achieve self-sufficiency while providing affordable financial products. A microfinance program constantly needs to build its institutional capacity through internal and external training, learning by doing, and technical assistance. A microfinance program s learning needs evolve from basic bookkeeping, portfolio management, and loan officer training and incentives to fraud control, internal and external auditing, financial and treasury management, diversification, and accessing commercial funds. Learning needs change but never stop. Due to the broad range of various types of institutions, it is difficult to make general statements about the specific characteristics of MFIs. These institutions differ significantly from traditional financial institutions in terms of client features, lending technology, loan portfolio features, culture or ideology and institutional structure. According to Gallardo and Randhawa, MFIs can be classified into three rough categories depending on the structure of the liabilities side of their balance sheets. 72 Category A comprises all MFIs which depend on other people s money to finance their lending business. This is made up mainly of grants and concessionary loans from donors which can be supplemented by commercial bank loans or also securities issues. These MFIs are described as credit-only institutions as well. They include financial NGOs. MFIs stemming from and still dominated by NGOs with a welfare bias have serious problems with their governance structure. Setting up a viable MFI for the long term requires strict financial discipline. Especially for the microfinance sector the following arguments favor regulating credit-only institutions as well: regulation can act as a signal to prospective investors that a financial institution is financially sound. Access to certain lines of refinance can be contingent on regulation (e.g. donor funds channeled via second-tier institutions to MFIs). Neither argument necessarily justifies government regulation. At issue here is the self interest of MFIs, which does not involve consumer protection or safeguarding the safety and soundness of the financial system. Nevertheless, regulation may make sense for promoting sustainable financial institutions. In this case, its aim is to raise standards in microfinance and thus contribute to financial systems development. Particularly in countries where the microfinance industry is at a rudimentary stage, 72 Staschen, Stefan. Regulation and Supervision of Microfinance Institutions:State of Knowledge. Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ) GmbH,

26 for example, there is a danger that MFIs may abuse their monopolistic power and resort to exploitative practices, such as usurious interest and improper methods of debt collection. The collapse of individual institutions can also result in credit shortages on the market 73 (Staschen 1999). In category B, member s money is used to grant loans exclusively to members. Classic examples of this are Rotating Savings and Credit Associations RoSCAs, savings and credit cooperatives and/or credit unions. As for category C, it comprises all MFIs that use the public's money to finance their lending business, i.e. fully-fledged financial intermediaries. These do not include financial institutions that employ forced savings components to secure their lending transactions, however, as long as their clients are net borrowers. Another type is formal banks with a microfinance window. The regulations of banking legislation automatically apply to their microfinance portfolio, but these are usually poorly adapted to the requirements in this area Financial Sustainability Financial concerns include standardized information and reporting and accountability. These concerns become more necessary in conflict environments since conflicts bring about a certain level of uncertainty and a good financial institution will be able to address these concerns to prove its resilience and ensure its sustainability. Financial performance of MFIs is evaluated based on the use of appropriate pricing policies which include offering loans at rates which cover the full costs of efficient lending on a sustainable basis, recognizing that poor entrepreneurs are able and willing to pay what it costs an efficient lender to provide sustainable financial services. Interest charges by the retail unit should be set to cover the costs of capital (at the opportunity cost, including inflation), administration, loan losses and a minimum return on equity. Another indicator of sound financial practices is the loan portfolio quality. A loan portfolio is an MFI s most important asset. Its quality reflects the risk of loan delinquency and determines future revenues and an institution s ability to increase outreach and serve existing clients. A good quality portfolio means that an MFI is maintaining a portfolio with low arrears so that late repayments and defaults do not threaten the institution s viability. For example, organizations with loans in arrears over 30 days below 10 percent of loans outstanding and annual loan losses under 4 percent of loans outstanding satisfy this condition. This is not the case if we take for instance the Palestinian Agricultural Relief Committee (PARC). PARC s estimated portfolio at risk (>30 days) is 72% while the Lebanese AMEEN has a portfolio at risk (30 days) of 1.41% coupled with a write off ratio of only 0.42% (MIX Markets, 2009). Clearly this measurement of risk increases with the incidence of conflict. In addition to loan quality, self sufficiency is also a pillar to financial performance. It reduces the institutions dependence on subsidies in order to move toward financial selfsufficiency and achieving operational efficiency, which is covering all administrative costs and loan losses with client revenue within a reasonable time period, given local conditions. International experience shows that successful intermediaries have achieved operational efficiency in three to seven years, and financial self-sufficiency [defined as covering all administrative costs, loan losses, and financing costs at non-subsidized rates from client revenues] within five to ten years. Examples of institutions with high sustainability rates are the Palestinian institution FATEN with an operational sustainability of 84% and a financial 73 Ibid 74 Ibid 26

27 sustainability of 72% up to Self sufficiency also means that if a conflict erupts, an MFI would be able to address its own concerns a lot faster; not having to wait for aids or donor funds to resume its operations. MFIS should work towards financial independence; building a solid and growing funding base with clear business plans, backed by operational capacities that lead to mobilization of commercial funds from depositors and the financial system, and eventually to full independence from donor support. Financial performance standards apply only to activities that are an integral part of providing financial services. If programs also provide non-financial services, such as business advisory services, health, or education, they should account for such services separately from financial services. Standards for financial self-sufficiency do not apply to such services, and defining appropriate standards for non-financial services is beyond the scope of this document. MFIs earn financial revenue from loans and other financial services in the form of interest fees, penalties, and commissions. Financial revenue also includes income from other financial assets, such as investment income. An MFI s financial activities also generate various expenses, from general operating expenses and the cost of borrowing to provisioning for the potential loss from defaulted loans. Profitable institutions earn a positive net income (i.e., operating income exceeds total expenses) Efficiency and productivity Efficiency in MFIs is mainly derived from reduced costs of service delivery. According to the CGAP definitions, efficiency and productivity indicators reflect how efficiently an MFI is using its resources, particularly its assets and personnel. MFIs use different efficiency and productivity indicators, tailoring them to reflect their own organizational structure, product lines, and monitoring priorities. In calculating these indicators, MFIs need to select which denominator they will use. The most common denominators related to assets are (i) average gross loan portfolio, (ii) average total assets, and (iii) average performing assets loans, investments, and other assets expected to produce income. Using average total assets as the denominator for efficiency/productivity ratios is more relevant for MFIs that manage deposit and/or share accounts in addition to loans. Regardless of the denominator selected, the MFI should be consistent in its use. MFIs must also decide if they wish to use the number of personnel or number of loan officers as their benchmark for human resources. The reason for considering loan officers a separate category is that, in contrast to other personnel, they are usually directly involved in revenue-generating tasks that result in income (i.e., they make and collect loans). However, there is a trend toward using total personnel in productivity calculations, in recognition of the fact that loan-officer tasks may overlap with the tasks of administrative staff. The efficiency variable cost per borrower determines the average cost of maintaining an active borrower or client. It is also useful to compare to GDP per capita to assess an MFI s efficiency in the local context. Because they count clients rather than amounts, these indicators have the advantage of not prejudicing MFIs which offer smaller loans. When analyzing costs per borrower, the highest numbers go to the Iraqi MFI Al Thiqa, with $298 while the lowest go to the Palestinian PARC with $19 signifying high efficiency levels, although the quality of its portfolio is bad with 72% portfolio at risk (>30 days). A comparative analysis of the Palestinian PARC and the Iraqi Al-Thiqa is provided in Table3 below. The table compares the two MFIs, ranking them based on their performance in the variable costs per borrower. Other variables 27

28 included are borrowers per staff, assets and deposits. Clearly, the borrowers per staff in Al Thiqa are more than twice those of PARC 122 to 53 which either signifies higher productivity in Al Thiqa employees or a shortage in staff in PARC. Al Thiqa s assets are roughly 9 million USD which is more than triple those of PARC (roughly 3 million USD), but it is evident that Al Thiqa does not have any deposits. If we compare them to our sample of 15 MFIs from 5 different countries, PARC performs a lot better than average 19 to USD, while Al Thiqa a assets outperform PARC and the average 9 to 4 million USD (MIX Markets 2009). Table 2: Comparative Analysis of Performers Cost per Borrowers per MFI Borrower* staff member Assets* Deposits* Best Performer PARC- Palestine ,005, ,714 Worst Performer Al-Thiqa- Iraq ,119,030 0 Average in Sample 15 MFIs ,027, , Source: MIX Markets Database- Sample includes MFIs from Iraq, Lebanon, Palestine, Sudan and Yemen *Costs, Assets and Deposits in USD Best and worst performance based on the first variable; cost per borrower Another variable measuring efficiency is operating expenses which includes all administrative and personnel expenses. Although, analysts must be careful when comparing this ratio among MFIs since MFIs that provide smaller loans will compare unfavourably to others, even though they may be serving their target market efficiently. Also, MFIs that offer savings and other services will also compare unfavourably to those that do not offer these services. Analyzing operating expenses suggests that the Yemeni Aden is the least efficient with 40.83% operating expenses/assets and 62.32% operating expense/loan portfolio while the Palestinian PARC, validating the previous conclusion, has 1.44% and 1.86% respectively (MIX Markets 2009). As for productivity, it is a combination of outreach and efficiency. Productive MFIs maximize services while using the least resources, including staff and funds. Although different MFIs offer differentiated products, we will take on the analysis and compare the productivity measures of different Arab MFIs. With regards to staff productivity, the variable borrowers per staff member suggests that the Yemeni Aden is the least productive with a figure of 26. This number alone is insignificant as we need to look at the total number of personnel and the number of active borrowers which happens to be 77 and 1,967 respectively which signifies a high number of staff for a small number of clients. Conversely, the Palestinian PASED's (profiled in the Appendix) borrowers per staff member are 200 with 21 staff members and 4,200 active borrowers. This signifies a high level of productivity within the institution. On efficiency grounds, microfinance may provide an alternative to alleviate frictions in financial markets. It is widely recognized that financial markets are especially vulnerable to failures resulting from information asymmetries between the parties involved in financial contracts. As a result, financial markets may fall short of the socially-optimal outcome, failing to exploit otherwise efficient transactions. Such problems are exacerbated in developing countries, 28

29 and disproportionately affect the poor since their lack of collateral worsens the effects of information asymmetries. By developing new lending and saving technologies, MFIs may help alleviate these market failures and increase the reach of financial services to the poor. Efficiency arguments imply that the private sector has an incentive to develop commercially-viable microfinance activities, but this has proven to be a challenge. To the extent that microfinance activities provide a way to circumvent imperfections in financial markets, they have the potential to become self-sustainable. At the same time, if MFIs have a technological or informational advantage over traditional financial institutions, they should have been able to obtain access to private funding, perhaps including through various forms of cooperation or vertical integration within the financial system. In fact, enhanced cooperation between existing financial institutions and MFIs could contribute to foster the development of local financial markets. However, most of the external funding to the microfinance industry comes from donor sources, and the integration of MFIs with traditional financial institutions is not widespread Coping Strategies and Risk MFIs are faced with various forms of risks. Clearly, these risks, which occur under nonconflict conditions are higher and more striking in conflict environments which are characterised by uncertainty and chaos. Credit risk is the danger that a borrower is not capable of or not willing to service the interest or repay the principle. Credit risk is particularly volatile, as collateral substitutes depend a great deal on confidence, there is a heavy sectoral and geographic concentration of loans and the portfolio turnover rate is higher. The large-scale credit risk is usually low because micro loans are granted. Another risk is associated with interest rates and stems from the diverging fixed-interest terms in lending and deposit business when the commercial interest rate changes. This risk is particularly large when rising commercial interest rates on the deposit side cannot be offset because of interest caps in lending business. This is more often the case with MFIs due to their higher interest rates. Liquidity risk is the risk of a temporary cash flow problem because assets can only be liquidated by large discounts. This is high in many MFIs due to poor liquidity management and lack of access to liquidity pools or lender of last resort. This has huge effects on credit risk as access to subsequent loans is often the major repayment incentive. Management risk is the risk of portfolio deterioration due to management defects (inadvertent due to insufficient qualification and wilful as opportunistic behaviour of fraud). The success of an MFI is particularly dependent on the qualification and the proper conduct of management and staff. New industry risk is the risk of trying out new, innovative finance technologies. This risk is relatively high because of new products, technologies, markets and institutional design. Ownership and governance risk stems from the fact that an MFI's solvency is dependent on ownership relations and governance structure. This is important due to the frequent lack of external regulation and supervision. Risk can be very high in NGOs and cooperatives. Subsidy dependence risk is the risk of dependence on subsidy donors and a sudden stoppage in subsidies. One of the most pressing kinds of risk that can impede the healthy functioning of an MFI is default risk, and coping with it has been the target of all financial institutions in general and MFIs in particular. Thus, NGOs and other MFIs should be very cautious in offering credit 29

30 because they cannot take a chance on non-payments, late payments, complete defaults, or other risks (Doyle 1998). Microcredit advocates need to see the contradiction between doing everything to build peace (helping returning soldiers) versus economic development. Programs could do so through giving individual loans to micro entrepreneur who have qualified guarantors in case of default. It is also notable that healthier clients mean stronger MFIs, and over time, reduced poverty. They can ultimately lead to reduced portfolio losses because fewer clients may be absent or drop out due to illness, or default due to death. Thus, insurance policies may offer emergency loan collateral, as in the case of fires or droughts. Compulsory savings could be required from all micro entrepreneurs so that if something occurs and results in destroying one s crops, default on one s microloan may be lessened, especially if the amount of savings is significant. Thus, poor peasants would at least have their own resources to fall back on. This also would protect the MFI s portfolio. 75 Built-in loan flexibility is another option for coping with difficult settings especially in conflict situations. This might take the pressure off of clients who, because of a crisis, do not want to move up to the next cycle of a larger loan, with its resulting pressures. Instead, one could take a rest or a break, and then re-enter the microcredit system when feeling ready, without pressure to take on loans the individual may not be able to afford. New insurance tools may be designed and implemented by the MFI, as mentioned earlier: Life insurance, health insurance, credit insurance, funeral insurance, and so on. This is mutually beneficial for both the borrowers and the institutions. As in the case with other adverse environments like droughts for example, conflict situations need specific measures and efforts on behalf of MFIs. These efforts include tracking the problem s evolution, the number of client dropouts, evaluating client performance and changes, conducting exit interviews and tracking arrears and defaults. All these steps may lead to decreasing the impact of conflict and to better more consistent measures that would make the MFI more sustainable and more resilient against future shocks. 76 These activities need good risk management as well as efficiency in operation on behalf of MFIs.. Another factor is the need to consider the greater costs of MFI work in post conflict situations items such as increased security, steeper travel costs and higher compensation for staff. It is important to partner with other NGOs and perhaps government agencies that can give the new MFI insight and the benefits of experience. Not reinventing the wheel may save time and money, as well as help to avoid pitfalls after the conflict has subsided so that potential borrowers are not confused, assuming that microcredit is just one more handout. Another concluding observation is that good MFI practices are even more essential in times of war than times of peace. MFI should charge market rate interests, build a highly-skilled staff with multiple organizational efficiencies, work toward becoming sustainable, and operate superb portfolio quality. It will not succeed if it is confused with post-war humanitarian aid. Portfolio risks need to be assessed and strategically planned for. Client ambiguity needs to be eliminated and delinquent clients should experience sanctions they were warned about, or the program may quickly unravel. Ground rules must be imprinted on all potential clients in order to ensure complete and on-time repayment rates, and the successful growth of the MFI. 75 Woodworth, Warner. "Microcredit in Post-Conflict, Conflict, Natural Disaster, and Other Difficult Settings." 76 Ibid 30

31 According to CGAP definitions, variables associated with an MFI's default risk include PAR; portfolio at risk, which is the most accepted measure of portfolio quality. Portfolio at risk is the outstanding amount of all loans that have one or more instalments of principal past due by a certain number of days. When referring to PAR, an MFI should always specify the number of days for example (PAR >30 days) 77. The write-off ratio represents the percentage of an MFI s loans that have been removed from the balance of the gross loan portfolio because they are unlikely to be repaid. A high ratio may indicate a problem in the MFI s collection efforts. However, write-off policies vary, which makes comparisons among MFIs difficult. As a result, analysts may present this ratio on an adjusted basis to provide for uniform treatment of write offs. The adjustments to the write-off ratio may increase or decrease the value of loans written off by removing or adding back delinquent loans to the gross loan portfolio in accordance with an international or national standard for writing off loans. Lastly, we have the risk coverage ratio which shows how much of the portfolio at risk is covered by an MFI s loan-loss allowance. It is a rough indicator of how prepared an institution is to absorb loan losses in the worst case scenario. MFIs should provision according to the age of their portfolio at risk: the older the delinquent loan, the higher the loanloss allowance. For example, a ratio for PAR > 180 days may be close to 100%, whereas the ratio for PAR > 30 days is likely to be significantly less. Thus, a risk coverage ratio of 100% is not necessarily optimal. 78 Table 3: Risk Indicators for Selected MFIs* Country MFI Provision for loan Portfolio at risk > impairment/ assets 30 days Write-off Ratio Iraq Al-Thiqa 6.11% 3.26% 13.06% Lebanon Al Majmoua -0.71% 3.96% 3.63% Lebanon Ameen -1.28% 1.41% 0.42% Lebanon Makhzoumi 0.22% 6.40% 0.25% Palestine ASALA 15.38% 58.30% Palestine FATEN 1.67% 6.33% 0.76% Palestine PARC 0.03% 72.00% Palestine Ryada 14.95% 46.55% 31.68% Source: MIX Markets Database * Refer to Appendix 3 for a profile of the mentioned MFIs Table 3 above provides data on a sample of MFIs in Iraq, Lebanon and Palestine, An expense set aside as an allowance for bad loans (customer defaults, or terms of a loan have to be renegotiated, etc). To cope with risk, MFI should most importantly monitor their activities through keeping track of the following indicators and making sure they are employing their efforts towards minimizing any risk related factors which hinder their performance. 77 CGAP. "Good Practice Guidelines For Funders of Microfinance." /donorguidelines.pdf 78 Ibid 31

32 3.3 Maximizing micro-credit programmes outreach and social impact for Peace Outreach is defined as the efforts put in extending microfinance services to those who are not served by financial institutions. It can be measured in two ways; breadth which is the number of served clients and the volume of services (for example total portfolio), or depth which is the socioeconomic level of clients which the MFI can serve 79. Figure 1: Outreach of different institutions When it comes to outreach directed towards the poor, figure 1 suggests that the bulk of the world population which earns less than 1,500 USD/year including the upper poor, poor and destitute do not get any financing through the traditional practices of commercial banks and credit unions since these institutions only finance people who have means to repay their loans.. Clearly, microfinance can reach the lower levels of income which commercial banks are either not interested in or are not willing to take the risk of financing. Microfinance gives this underserved component of the population access to financial services to help them retain their economic activities, generate income and sustain themselves. When it comes to the Arab region, as mentioned earlier, there is no clear definition to the targets of MFIs. Different institutions have different targets some targeting upper poor others focusing on poor and others even 79 Lafourcade, Anne-Lucie, Jennifer Isern, Patricia Mwangi, and Matthew Brown. "Overview of the Outreach and Financial Performance of Microfinance Institutions in Africa."