The Role of Microfinance in Developing a Loan Market

Teimuraz Khomeriki, Professor, Georgian University

The truth is that financial service is not available for the majority of the world’s poor people: deposits, crediting, insurance etc., the major goal of an international society is to cancel barriers in financial sector that face people… with joined efforts we will create and we are obliged to create financial sector available for everyone, that will assist people to improve their living quality’
Kofee Anan,
former UN Secretary General

The social function of micro-loans (finances) exceeds their economic function, although the latter bears a big importance. Millions of people use MFO (microfinance organizations) services round the world that has a history of about thirty years and is widely spread in developed, as well as developing countries. Micro financing originated on the basis of micro crediting: Muhammad Yunus founded ‘Grameen Bank’ in 1976 issuing micro credits to the poor of Bangladesh.
Activation of micro finance sector by the end of XX century and during the current period of time is definitely a banking sector reaction to globalization: more and more people have the demand to unite their savings in risky environment with the purpose of helping and financing each other.
New mechanisms of distributing money resources, new financial relations were formed during the period of market economy transaction. The structures that distribute finances on securities and money capital market have been formed. The baking as well as financial institutions role has been shaped in this relations. In modern economy financial relations cover monetary sources movement in the sphere of crediting as well, as it has become difficult to draw a sharp borderline between micro finances and micro credits – they fill each other naturally.
Although a loan and a credit are different with means’ forming sources and with the type of issuing. Credit usually implies issuing monetary means formed on the basis of individuals and legal persons input that is related to financial intermediating by means of banking institutions. As for a loan, it covers issuing private and state sources that does not always imply cost for using it and is considered to be an ordinary economic operation. A legal person having corresponding license for implementing banking operations is authorized to issue credit. Microfinance institutions are authorized to implement their activities following the NBG voluntary registration. According to the above mentioned, a micro credit will be issued fro attracted resources, as for a micro loan – it will be issued from finance institutions and individuals (physical persons) own (or donor) resources. Unlike commercial banks, that aim to get profit, microfinance institutions are of non-commercial character and status; they deal with entrepreneurial activities as it serves the implementation of goals formed while their creation. The programs they finance aim to mobilize and develop entrepreneurial initiatives of certain social levels (like women, unemployed, agricultural cooperatives etc., ).
Business loan market development in Georgia does not correspond to the economic growth rates. Banking assets have increased twice during the last 3 years and they made up 42, 6% of GDP. / This correlation is far behind the one of developed countries’/. Although the own capital share is still small in commercial banks’ assets and deposit Dollarization level remains high. In spite of finance sector institutions’ development, their number per person is less than in other leading countries (there are 124 commercial bank branches and 416 service centers; 806 registered places to exchange currency, 15 insurance companies, 1 stock exchange etc).
Although population’s demand for low interest credit is high, their vast majority apply banking sector for paying communal bills.
As for micro financing, its structure does not significantly differ from the one existing in post soviet space: developing venture investment funds, financial leasing and franchising, support of small structures and self financing by means of credit unions and other self financing systems (credit unions, funds, insurance etc.), micro financing, state guarantees’ mechanisms of loans and other forms. According to experts, non- bank microfinance institutions and commercial banks in Georgia covered only 1/3 of potential customers. Other micro-enterprise institutions meet their needs through cash payment.
Credit as well as deposit interest rates had a reduction tendency till the year of 2005. The opposite took place from 2005, interest rate for deposits in foreign currency is 10,1%, for credit it is 16,7%. It’s obvious that entrepreneurs find it difficult to cover high interest credits.
Investment activities of small enterprises require further support and promotion, including the availability of micro finances and micro credits. The non-bank sector, especially microfinance institutions are of utmost importance in this case. Micro financing enables entrepreneurs to get corresponding means with simplified documentation and procedures, besides all the above mentioned is implemented in a short period of time and with available regime. It does not require expensive methods of guarantees and difficult conditions of mortgaging (group guarantees and other forms are used for maintenance). Creation of credit unions also requires support. The unions, among many other advantages, give opportunity of mutual financial assistance to individuals (physical persons) and legal persons. The fundamental problem of small business – using the service of main high technological means of an enterprise is successfully solved by means of developing leasing relationships. Franchise advantages are also widely used while organizing small business. By now venture investment cases are relatively few unfortunately, although it’s worth noting, that while banking institutions and leasing companies easily cooperate with large and medium enterprises, non-bank financial institutions, state support programs and credit unions finance small and micro-enterprises. It is important to introduce solid mechanism of finance and credit risk guarantees to overcome this challenge. It is also important that National Bank implements a corresponding policy for further cheapening of small business credits that requires full application of resources related to banking products cost decreasing. Small and medium business development is difficult to imagine without the investors support participating in SME projects. The role of state finances in supporting microfinance sector is not well distinguished up to date. Besides, non-bank microfinance institutions closely cooperate with banking sector.
Banking micro credits have relatively few amounts (USD 1000 – 15 000) shorter terms (3-12 months for filling a cash flow, and 6-14 months for major means and repairs), more flexible covering scheme (every week, twice a month, once in a moth). Although interest rates are important, but loan maintenance is simpler – private property as well as enterprise and personal assets are used, the third part guarantee regime is also acceptable. The minimum requirement is to maintain 100% of credit amount. Micro credit line mechanisms also operate (with the maximum term of 36 months) that leads to customer’s and bank’s long-term relations and decreases expenditures related to repeated registration. Considering the fact that it is usually directed to small business, being certainly flexible but lacking stability; credits are issued only to defined levels and spheres of activities. Namely, irrelevance is related to a borrower having less than 6 months working experience, not having fixed place of activity and place of living; if his/her sphere of activity is agriculture (except for processing), production of tobacco and alcoholic beverages, gambling business, activity that makes negative influence on the environment etc,. Well, as we can see banking micro credit is an expensive pleasure for small enterprises. Besides, on the one hand lack of population’s trust towards banking system and state finances is shown; on the other hand banks’ trust crisis towards borrowers is noted. Micro credits received from microfinance institutions bear an utmost importance for entrepreneurs. For example, Constanta Foundation is directed to supporting small business. It offers micro credit services to small entrepreneurs – group and individual loans. In the first case a loan product is issued on the basis of group guarantee. Any small entrepreneur being a citizen of Georgia may apply for it. A group loan is issued without mortgaging and returning guarantee is a solid responsibility. Issue of interest rate need to be regulated, concentration of risks as well as safety maintenance limits require more precise determination. In addition, flexibility of operation policy should not be limited. Law on microfinance institutions was adapted only in July 2006, till then micro financing was regulated on the basis of enterprise legislation, civil code and law on non-bank deposit institutions – credit unions. Microfinance sector was functioning as non-governmental (non-profit) organizations, foundations and unions. According to a new legislation, microfinance organization is a legal person based with the form of Ltd or JSC, being registered by National Bank of Georgia and carries its activity under NBG supervision / financial supervisory agency will carry this function in the future/. The law determines that while creating a microfinance institution authorized capital should be no less than Gel 250 000 and maximum of total amount issued by these organizations per one borrower should not exceed Gel 50 000. Microcredit is defined as an amount issued by a microfinance organization to a borrower with a credit agreement in accordance with terms, returning, price and purpose conditions. Microfinance institution is not permitted to receive deposit from individuals as well as from legal persons. Microfinance organization is authorized to implement only the following activities:
· Issuing micro-loans – consumer, pawn, hypothec, non-guaranteed, group and other types of loans credits) to individuals and legal persons;
· Investment in state and public securities;
· Implementation of money transfers;
· Fulfilling functions of an insurance agent;
· Providing consulting related to micro-crediting;
· Receiving loans from resident and nonresident individuals and legal persons;
· Owning shares of individuals’ authorized capital ( their total amount should not exceed 15% of organization’s authorized capital);
· Other financial services and operations defined by Georgian legislation (micro leasing, factoring, currency exchange, issuing and realizing promissory notes and other related operations).
Loan issuing conditions as well as right and obligations of borrower and lender became the subject of legislative regulation. Issuing micro-loans is confirmed by written credit agreement; rules and conditions of issuing micro-loans are defined by microfinance organization. Interest rate, service fee etc., are worked out there as well. A loan may be either collective or individual, guaranteed or blank. Microfinance organization may carry out a monitoring on loan purpose and it is obliged to keep confidentiality of loan related issues. The law also defines the rule of creating microfinance organization’s leading bodies and their prerogatives as well as rights and obligations of the director. Public economy savings are insignificant in Georgia, vast majority of the population live in poverty. Supporting the formation of micro-enterprises while spread unemployment and poverty in the country carries utmost importance (there are lots of people losing their jobs, working force dismissed as a result of enterprise restructuring, limiting the activities of self-employed population living in poverty etc,). State as well as non-governmental organizations play an important role in developing these people’s business activities. Micro financing is viewed as a tool while fighting against poverty and unemployment.
Georgia’s economic growth has significantly hastened in recent years. In spite of imposed Russian trade and economic embargo (that significantly damaged certain spheres of economy) Georgia kept high growth rate. Yet, in spite of certain economic success reached by the country, Georgia still lacks behind neighboring states, as well as post soviet countries, with its development level. According to the final version of Law on Georgian state budget 2008, real GDP growth rate will decrease in 2008 in comparison with the previous year. It will equal to 6.0 %, and in nominal terms it will be Gel 19.4 billion. According to the same document, consumers price index growth with 8.0% is feasible by 2008. Although the first version of the draft implied only 5.0%. Medium term period (2009-2011), as aimed by the country’s monetary and credit policy, inflation should be kept at a single figure indicator. Prices on short term consumption goods were increasing in proportion with official inflation rate during the year of 2007. Prices relatively decreased on medium length consumption goods (with 3.6%) and long term consumption goods U 1%) in comparison with the previous year. At the same time rates on financial services have significantly increased (13.1%), especially due to city communal transport price rise (15.6%). National currency rate strengthened. Prices increased on significant part of consumption goods, being formed on the basis of import. For example: according to long term consumption prices in December 2007 decreased with 1.0% in comparison with the previous year, but in reality (in foreign currency) they increased with 5 %. Officially the country’s monetary policy priority is a decrease of Gel nominal exchange rate sharp competitive fluctuation. Gel exchange rate against USD in2007 had an increasing tendency. Fiscal order has formed in Georgia since the Rose Revolution, large scale privatization with the participation of foreign capital and great flow of foreign direct investments caused exceeded delivery of currency, that lead to internal currency market conjuncture, namely foreigners have to convert USD into national currency to implement these operations inside a country. A long term tendency of strengthening national currency – Gel was shaped . Although artificial and natural methods of strengthening Gel effected realization of the country’s export opportunities. As the investment put in Georgia show, investment inflow was fragmentary, and therefore less stable. Majority of them were related to international oil and gas pipelines in previous year. Since then service sphere dominates in investment field structure, investment flow following the privatization has a single character if they are not followed by capital investment. The country could not yet attract investment in high technology fields. It is also true that attracted investment in the field of real estate and infrastructure objects have improved general situation, but it is less affective from the production and export growth point of view. The capital investment in the spheres that will support the growth of Georgian export potential should be encouraged. Inflation risks influence the formation and structure of loan market. Inflation affects the country’s social and economic condition, therefore it is government’s obligation to confront inflation processes, work out anti inflation program and to strengthen the country’s financial and economic stability. Two approaches are defined: the first implies the implementation of adaptation policy during which economic activities are combined with inflation processes; the second is related to implementation of anti inflation policy – leading inflation to its minimum level. Adaptation policy against inflation consists of great risk; its operation is only temporary and it does not show desired affect within a long term period. Therefore, due to international financial institutions’ recommendation, Georgia considered the implementation of anti inflation events as a priority. As a result, monetary and Keynesian approaches based on the method of monetary aggregation and exchange rate maneuverability, gives a way to price – inflation regulation. It is called inflation targeting that implies directing inflation during a forecasting period to certain purposeful meaning. This forecasting was founded on the edge of neo classical and neo keynesian conception and is based on the following activities on the National Bank: forecasting the feasible inflation level, comparison of desired (purpose) inflation level with feasible (forecasted) size. Checking monetary policy with the purpose of neutralization the difference between purpose and forecasting. The most important principle of this regime is the independence of National Bank while choosing monetary and credit mechanisms. This background leads to discussion on changing National Banks role and awarding range of functions on new institutions / like financial Supervision Agency, being created under NBG and having its Board, National Bank Committee that will be conferred the part of Boards’ competence and so on / the legal status of which is, to put it mildly, confirmed under law in force. At first, so called Currency Board was discussed to substitute NBG. Introducing this mechanism is more or less advisable while high inflation level and as an international experience has shown, this mechanism have overcome the hyperinflation spread in Latin America in XX century and it lead to minimum in Baltian countries. The whole idea of it lies in a fact that national currency is attached to other foreign stable currency with a fixed rate, and its exchange on the above mentioned currency is implemented without limitation. This requires plenty of financial resources in foreign currency and budget surplus from the country. Accordingly National Bank reform announced by the government is quite clear, although forecasting its outcomes within new circumstances seems to be a hard work. There is no doubt that all the above mentioned will affect the development of microfinance sector. Micro-financing enables micro-enterprises to adapt environment factors and to solve necessary economic tasks for effective functioning: to fill circulating means, to form major funds, to create credit history for further attraction of investment resources etc., in addition, the above mentioned makes a social affect on economic environment as well – it is an affective tool for fighting against poverty and unemployment, decriminalization of business, material basis for entrepreneurial activity and self help for socially unprotected people. Banking micro- credit is quite expensive and hardly obtainable. Getting micro loans from microfinance organizations bears significant importance for entrepreneurs. They make a certain contribution in employing the social group living in poverty and having low income by issuing individual and group loans to them. State support and encouraging microfinance organizations supporting entrepreneurship, as well as active cooperation with donor organizations and international finance institutions is a necessity. Micro financing assists moving entrepreneurs from shadow economics to a legal business, increasing the country’s tax incomes and further movement of a small entrepreneur using micro-credit to a bank credit. Introducing programs related to bank credit interest subsidiaries and credit guarantees will hasten positive outcomes. Microfinance organizations in Georgia were founded since 1997, the first credit union was created in 2002. International organizations (like the United States International Development Agency, the World Bank, European Bank, Eurasia Foundation etc.,) play an immense role in developing microfinance services and foreign states governments (like the US, Canada, France, Holland etc.,) make a great contribution from the means and technical assistance point of view. International finance institutions provide microfinance organizations with guarantees or privileged, long term credits. Yet none of microfinance organizations, registered at the National Bank of Georgia have used this source, If not taking Rico Express into consideration, that has borrowed a long term credit from nonresident legal person. Since the day of entering Law on Microfinance Organizations into force up to date nine microfinance organizations registered at the National Bank of Georgia: three of them were registered during 2006, and the rest during 2007. Besides the microfinance organizations registered by National Bank of Georgia, there are others that have gone through the registration process earlier at the Ministry of Justice of Georgia and have been formed as noncommercial funds. They should have been formed with organizational and legal form of Ltd or JSC till the end of 2007 according to the amendments and changes to the ‘Law on Micro-Finance Organizations’ adopted in July 11, 2007. This process is in action nowadays / 50% of MFOs have completed corresponding procedures/. By the beginning of 2007 about 13 organizations officially carried out micro-financing activities, significant part of them have been founded with the financial support of foreign donor organizations. Their loan portfolio amounts to about Gel 51 million and about 43 borrowers, mainly self-employed, develop their business by means of received micro loans. Total assets of the MFO’s registered at the National Bank of Georgia amount to Gel 33 670 058 due to 9 months of 2007. They have given loans of Gel 22,2 million, that is 67% of their total assets. Credit portfolio of registered MFOs mainly contains consumption loans (53% of portfolio), but loans issued to small businesses increase little by little. According to statistical data, major field of micro-loans is financing trade and service sectors. 31% of issued micro-loans are directed to trade and service spheres. Share of means for financing agriculture have relatively increased, but still it is low – up to 5%. 11 % of issued micro-loans are directed to other fields. Major part of MFO clients are individuals. Only 6 % their loans are issued to legal entities. There are two main sources of obtaining MFO loan means: own capital from which 32% of total assets are formed and borrowed means that balance 55,5 % of total assets. In addition, issuing of own loan securities by a MFO Kartuli Krediti’ (Georgian Credit) is worth noting. Their share in liabilities is still small and makes only Gel 340 000.
Legislation that has been in force since 2002 on credit unions – non-bank deposit institutions, has not lost its importance when MFO regulation norms were imposed. Credit unions function as enterprises registered with cooperative’s organizational and legal form that receive deposits/accounts/ only from their members (individuals) give them loans, carry permitted banking activities. Getting profit is not their major goal. In spite of the title – law on ‘financial sector global competitiveness’ it serves the strategic solving of local challenges as well and enables to develop loan market clusterization. Number of state and international programs are implemented in regions of Georgia nowadays, they should naturally fill each other. Although due to absence of cluster principle the programs of employment, training cheap credit, technical assistance are carried out spontaneously. As a result, existing field and territorial development potential is not used. Credit units should be viewed as a form of local self government’s democratic development, encouraging initiative, citizens’ social activity as well as a flexible social and economic system. According to Porter M. clusterisation views organizational environment as an effective usage of competitiveness, local market conjuncture, production factors, related fields cooperation and major common infrastructure. It is a concentration of interrelated enterprises with geographical sign, that interact both in cooperation and competitiveness regime, besides they jointly use existing resources. Quite often their activity is interfiling (for instance: production, procession and sale of agricultural products) and directed to getting high incomes by means of creating chain of values into network of values. For loan market it implies cooperation of borrowers as well as lenders, getting synergic affect by joining resources and organizational potential. Each element of financial and credit field operates in local geographic space in the regime of cooperation and competitiveness. Business relations between banks and micro financial sector may serve as a good example here. To cluster development microfinancing is the basis of other fields’ progress. Clear, it is reached through development’s internal factors mobilization, civil monitoring and civilized methods of competitiveness. This is profitable for each organization of cluster (innovators as well as imitators) as competitiveness forces them to seek new signs and launch high standards. Advanced experience becomes equally available for MFOs as well as for entrepreneurs related to them. Providing them with free business consulting and auditing, organizing training programs, launching modern information technologies, joined researches as well as market risk forecasting and estimation becomes possible. Agricultural enterprises imply farmers (farming organizations) receiving MFO services and whole infrastructure. Although within the framework of state policy program of cheap credits is being implemented and banking sector has separated about Gel 40 millions to support 5 enterprises, yet according to experts’ evaluation, demand on resources was ten times more and 9% rate is not an easy task for an entrepreneur of an agrarian sector. While state applies clusterization mechanism for forming free industrial zones and financial centers, such complex approach can not be seen with agrarian territorial units. Any long term perspective initiative supporting agriculture (like creation of auto and Tractor Park etc.,) are limited without it. Developing credit unions is one of the progressive ways of financial maintenance agricultural production. Credit unions, as subjects of small industry, support monetary circulation and distribution of finances in villages and generally in regions. In addition, they create the basis for formation of credit relationships in regions that in its part maintains development of small business, functioning of small enterprises in villages and accordingly employment of local population. In case of surplus liquidity credit unions are authorized to invest in state securities with the form of short term deposits at commercial banks and issuing short term loans to other credit unions. Credit unions were formed in Georgia when majority of peasants did not have corresponding financial, material and technical resources for starting their activities, they could not afford banking loans. The unions from the beginning since 1995 were established with the help of foreign donors (World Bank, TASIS< Government of France) and gained farmers support from the very beginning: 11 thousand farmers joined 200 unions and their common capital amounted to Gel 3,5 millions. Issued credits were 100% returned from the first stage, but due to difficult natural and climate conditions in 1998, the process was hampered. Since 2003 the above mentioned projects were canceled due to massive non payment of loans, completed projects in 2004 did not renew. In case of more active state support provided to credit unions the story could have developed otherwise. Foreign experience may serve s a perfect example:in 2005 Lithuania state budget separated means that amounted to Euro 2 millions to get interest free loans by credit unions. The idea of creating Credit unions originated in Germany, in the middle of XIX century. It was viewed as a self-help financial institution to provide farmers with deposit and credit services. Cooperative banking systems of central European states have originated on the basis of credit unions. Cooperatives like credit unions successfully provide financial services to small entrepreneurs in the US, Canada, Australia etc., in Asian and Latin American states their major goal is to provide deposit and credit services to organizations having consumption and production character. Number of credit unions in Georgia by October 1, 2007 makes up 23 units / one more union was added to them by the end of the year/. Credit Unions cover almost whole territory of Georgia by now /their activities in Adjaria and Guria are worth noting/. Their consolidated total assets amount to Gel 1 539 551, 67% of them are related to pure credit investment amounting Gel 1 035 278. Total liabilities of current credit unions in Georgia equals to Gel 1 149 090 according to consolidated balance. 18% of total liabilities or Gel 201 403 are loans received from financial organizations. 81% of liabilities are deposits, 81% of which are related to term deposits that amount to Gel 741 981; as for the rest 19%, amounting to Gel 172 178, they are related to current deposits. Only 1,1% (Gel 12 582) of credit unions’ liabilities comprise interests and total sum of dividends. Total capital volume of 23 credit unions is Gel 390 461 according to 9 months of the previous year. Monetary sources of commercial banks are not invested in credit unions. Law on Credit Unions has formed major norms of their registration, licensing, financial parameters, organizational structure of management and rule of activity. The legislation changes intend to authorize financial supervising agency to carry out monitoring on it. The agency will periodically determine credit unions’ minimum amount of authorized capital. Recent decrease of the number of credit unions have been caused not only by the fact that their majority could not meet legislation requirement, but a credit union is required to have a guarantee property and interest on issued loans are quite high. Therefore, the following is required to raise the effectiveness of their activity: · Restructuring credit unions having financial problems and providing state support in long term low interest rate credit maintenance; · Creating special insurance system for serving credit unions’ property and loans; · Attracting and mobilizing free financial resources and highly affective application within insuring possible risks; · Providing relevant information as well as education and consulting activities on financial, accounting, taxation, new technologies and other issues in order to raise the qualification level of credit union’s members; · Forming regional service – cooperatives; · Launching convenient ways of financial payment for farming to credit unions (including production agreed prices ; · Using credit unions’ capacity for improving enterprises that process agricultural production as well as for developing relations with consumers. Putting highly affective integration mechanisms into motion.