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«A Critical Assessment of Microfinance Afghanistan Public Policy Research Organization Policy Paper March 2008 Acknowledgements Lead author: Saeed ...»

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In Afghanistan MFIs entered communities with the assumption that there is sizable unmet demand for microfinance. The analysis of the information from secondary sources and the from the field visits undertaken for this research suggests that MFIs entered an already sizable credit market as just another product. The establishment and sustainability of MFIs depends squarely on how MFIs as new challengers manage to find their niche and fit in with the key institutions that govern transactions in a pre-existing market dominated by traditional credit providers. To illustrate, reducing the influence of traditional credit sources as a means to capture a part of the market for microfinance requires introducing incentives to make MFI loans and other financial schemes more competitive and attractive to the prospective borrowers. In the longer term, institutionalization of MFIs is contingent on how effectively long-established social norms and values are changed in favour of borrowing from microfinance organizations. This is not a task to be left only to MFIs, but a challenge for reconstruction programs to provide other necessary elements, such as improved infrastructure and addressing the many-faceted water and land issues, conducive to increased economic activity.

Unchecked, microcredit from MFIs can become parasitic in combination with credit from traditional sources, with traditional credit being used to pay off MFI loans. There is also evidence to suggest that the reverse, with MFI loans being used to pay off loans from traditional sources, also takes place. Similar examples have been found in studies of microcredit loans provided in Bangladesh (Klijn and Pain 2007). Inter-reliance between microfinance from MFIs as a formal process and traditional systems also extends to the grass roots implementation of microfinance loans. Traditional community relations and trust networks are sometimes used to bend the rules in the implementation of microcredit, for example. Loan officers are sometimes from the same communities as borrowers, and are therefore part of the same community trust networks as the borrowers themselves. Working through these relations, some borrowers are able to take out more than one loan, or higher amounts and, through this process, reinforce the inequities evident in traditional power relations centered on gender, tribal connections, and wealth. Several loan officers interviewed in the four provinces reported that, based on trust and favouratism, they sometimes give borrowers more time to repay because of difficulties to meet repayment obligations.

Evaluations of the performance of microcredit loans appear to be preoccupied with the criteria of repayment. A recent publication (World Bank 2007) makes reference to a 95 per cent loan repayment rate, the fact that the microfinance sector as a whole is already covering 89 per cent of its costs from its own income earned from lending activities, and that some of the microfinance institutions have already reached operational self-sufficiency, suggesting that it is expected that most of the other MFIs will achieve financial sustainability by the end of 2008. Clearly, the financial sustainability of MFIs operating under MISFA is prioritized over measuring the sustainability of loans in terms of income generating gains to the borrowers. This preoccupation with repayment, coming from the highest donor and policymaking levels, is reflected in implementation by MFI staff in rural Afghanistan. All loan officers interviewed appeared to be under pressure to secure repayment, with reports in two locations that one MFI was docking loan officers’ wages when clients failed to repay.

22 Unless microfinance leaves households with more productive assets than they had before the loan, it is difficult to conclude that there has been an overall positive impact on rural livelihoods, despite instances of microfinance being productively used in some cases such as Herat. Due to acute poverty in many rural areas, compounded by external factors such as droughts and persistent civil and military strife, households often spend microcredit loans on consumption smoothing needs. In Herat, one borrower reported that she had taken out a microfinance loan to help pay for her son to get married, a story that was echoed in research from other provinces. Some borrowers spend all of their loans on consumption, while others divert portions of the loan for this purpose. If widespread, consumption smoothing based on credit from traditional sources and MFIs results in leaving the borrowers worse off than before. Desperate borrowers would borrow from anyone willing to lend, regardless of their future ability to repay. Those in debt and under pressure to repay may be forced to liquidate livestock and other assets or marry off, in some cases, their daughters to annul their debts, an outcome diametrically countered to the rationale of institutionalizing MFI credit as a means for increased income generating capacity and livelihood betterment. To be sure, MFI-originated loans alone cannot be expected to work around the pre-existing institutions that govern credit transactions in rural Afghanistan.

Microfinance is often presented as a way of fighting poverty, but it is not aimed at the very poorest groups, since ability to repay, and to successfully invest in productive assets are often beyond the reach of the very poorest. An implicit argument for microfinance programs including microcredit is that if they succeed in improving local economies as a whole, there are likely to be benefits for the poor through the trickle down effect. This research found, however, that it is possible that the strength of the local economy might have a decisive effect on the success of microfinance loans, rather than the other way around. Microfinance may be more successful in areas with a healthy existing market for a given crop or commodity, such as amongst potato farmers in Bamiyan, than in communities with a poorly functioning local economy. This suggests that, for microfinance schemes and programs to take root locally with tangible net benefits for the borrowers and the local economy in the longer term, pre-existing economic conditions would need to be better than poor and destitute – a relatively productive local economy is less conducive to consumption smoothing practices.

Credit and assistance from traditional sources, on the other hand, have been noted to have a positive impact on the livelihoods of the very poorest households in the community. The traditional sources of credit and assistance networks that support the poorest Afghan households are important features of the resilient livelihood strategies adopted by the Afghan poor under extreme conditions. Conclusive and comparable evidence does not yet exist to suggest an overall positive impact of microcredit on borrowers or the wider village economy. There is insufficient evidence to conclude that MFI-originated microfinance has resulted in making the rural poor, as a target group, more enterprising and economically more productive. This points to a need for more studies, spanning a longer period of time and covering larger samples of the population, to more accurately establish the benefits accrued to the rural poor through availability of loans from MFIs and in conjunction with credit from traditional sources. A longitudinal study is likely to capture the dynamics of loan cycles, drop out rates by borrowers and lenders from the system, and changes in the credit system as an outcome of learning, crucial in institutionalization processes, by both lenders and borrowers.

23 Where loans are tied to the building, expansion, or enhancement of an enterprise, it is vital that this should be linked to training and identification of business needs and viable markets for the end products of the enterprise. In the long run, external factors such as the strength of the local economy, irrigation issues in the case of agricultural enterprises, droughts, transport and energy infrastructure, and access to markets play quite instrumental roles in the success or failure of an MFI as far as making a lasting impact on livelihoods. Unless MFIs meet their declared aim of improving sustainable income generation in conjunction with improvements in all other facets of Afghan rural political economy, there is a risk that MFIoriginated loans might feed cycles of debt, instead of improving livelihoods in a sustainable fashion.

Future research and efforts to reform how MFI funds are disbursed will need to pay particular attention to the non-financial and longer term impact of credit provision and borrowing through MFIs. The design of microfinance organizations to prioritize repayment as a measure of success filters down to the loan officers and may be clouding a comprehensive view of exactly how far loans are helping livelihoods. The design of loans with very frequent and inflexible repayment schedules may also combine with small loans in initial cycles, making it hard for households to make a sufficient investment with their loan and make enough profit to both repay and end up with more assets than they started with.

Despite the many shortcomings in the introduction of microfinance in rural Afghanistan, it is too early to conclude that microfinance has been a failure. There have been, in Bamiyan and in some instances in Balkh and Herat, cases of increased participation of women in productive economic activity. There are also cases of livelihood improvements, more so in Bamiyan than in the other provinces. The introduction of microfinance in rural Afghanistan remains a work-in-progress. The future success or failure of this experiment depends on how well MISFA and its MFIs adapt to their operating environment by learning and how the many institutional gaps and obstacles highlighted in Figures 5-7 are understood and overcome.


Microfinance from traditional sources in Afghanistan is subject to a complex set of institutional arrangements. Numerous forms of credit transactions are governed by generations-old traditional institutions. Interventions through the introduction of MFIs to change the pre-existing lending and borrowing patterns and arrangements are thus difficult to institute in the short term and likely to be subjected to suspicion and mistrust, particularly if a given MFI fails to effectively “resonate” with the pre-existing institutions that govern credit transactions. There is clearly a perception amongst policymakers that microfinance is working in Afghanistan, although studies of microfinance have drawn mixed conclusions.

Evidence suggests that even the middle and higher income families targeted by microfinance do not always benefit fully, due to the small sizes of loans, short grace periods and frequent repayment cycles of some loans in the first cycles. Longer grace periods, and larger loans offered by microfinance organizations in the later cycles of lending are likely to 24 increase the potential for long term livelihoods benefits for borrowers. While some innovation has taken place, notably the implementation of the murhaba-based loans, there is clearly much more room for similar initiatives to make formal borrowing more acceptable to the potential borrowers. Future initiatives should focus on such issues as affordability to borrow (through flexible and/or reduced interest), longer grace periods, longer term loans, and larger loans.

There appears to be a desire by the Government and international donors to regulate and supervise the variety of people involved in hawala style activities including the hawaladars grocers, merchants and a host of other individuals. If identifying, licensing and regulating the well-established system of hawala transactions is difficult because of the number of actors and the complexity of their relationships, the task will be many folds more difficult, and perhaps not very useful, for the less common but equally complex traditional forms of transaction such as alms. This calls for increased attention to and innovativeness in the development of new lending and borrowing arrangements with a capacity to replace the less transparent and difficult-to-document traditional institutions. Policy innovation in this regard is only possible through engagement of the target population to continually define and re-define community needs. As Reich (1988) has eloquently put it, policymakers’ responsibility is not only to discover “objectively” what they think people want and then to devise solutions, but to provide the public with alternative visions through engaging with them so as to broaden the range of potential responses is being wanted.

Given the need for re-visioning and reexamination, the replacement and transformation of traditional institutions of credit with MFIs is at best a medium-term objective. As such, it would require on the part of MFIs competitiveness of lending terms, receptiveness to client needs and, most importantly, increased trust by the borrowers in MFIs. These requirements would only emerge over time through further adaptation by MFIs to better fit with local conditions (including what the public wants) and through positive livelihood impacts felt by the borrowers of MFI loans.



- The emphasis on the financial sustainability of MFIs must be supplemented with equal emphasis on assessments of the social sustainability of MFIs, if the introduction of microfinance is to lead to measurable, documented improvements in rural livelihoods.

- A change of thinking at policymaking levels is necessary regarding the moral framework in which traditional microfinance transactions are discussed. The discussion of “informal credit” or “moneylending” in a pejorative leads to an implicit assumption that all traditional sources of credit should wither away along with increased regulation of financial transfers and increased reach of formal financial services through, for example, MFIs.


- Policy options that recognize, respect, and work with and through the more equitable pre-existing lending and borrowing arrangements need to be more closely investigated to reduce the tension between the introduced and traditional forms of lending and borrowing. A starting point in this process is to engage the relevant community actors such as mullahs prior to introducing MFI-orginated loans in rural communities.

- Introducing records or paper trails for traditional financial transactions is perhaps overambitious. However, MFIs could be regulated to perform an additional function in monitoring the debt to traditional sources.

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