Box 7: Insurance

5. Findings I: Barriers to Agricultural Finance for SMEs in Ethiopia (cont.)

5.3 Supply-side barriers (cont.)

5.3.4 Technical (staff) capacity (cont.)

 Lack of technical capacity, incl. lack of agricultural knowledge, to carry out

SME loan appraisal is seen as a major reason for banks and SMEs to stick to physically collateralised lending, as it is much simpler to manage and monitor.

 MFIs are exposed to financial and operational risks:  There has been hardly any attempt by Ethiopian MFIs to identify, measure and manage risks.  Drought, seasonality of rural activities and local market failures negatively affect the performance of MFIs.  Insurance and derivative product that helps MFIs and clients to manage production and price risk are virtually absent.

Box 7: Insurance

According to the “Study On Crop and Seed Insurance In Ethiopia” by GIZ (2019) the insurance sector in Ethiopia is relatively young. Insurance can improve farmers’ access to credit and access to inputs. Financial institutions should analyse the benefits of integrating crop insurance with crop loans and other financial products, such as savings. Commercial banks have not played an active role as aggregators yet. The business case for aggregators may include reduction of credit risk exposure, increased loyalty among contracted farmers and pre-financing the premium on behalf of the farmers.

5. Findings I: Barriers to Agricultural Finance for SMEs in Ethiopia (cont.)

5.3 Supply-side barriers (cont.)

5.3.4 Technical (staff) capacity (cont.)

 So far, Ethiopia’s M/FIs have not introduced credit scoring systems. These are an important building bloc to reduce costs of small-loan-delivery in other markets. In Ethiopia, a World Bank pilot of psychometric credit scoring found that those borrowers who scored higher on the test were seven times more likely to repay their loans than lower scoring customers.

 Low computerisation/ digitalisation. Hence the credit cycle is managed through paper-based trial.

For example, the World Bank 2020 highlights the lack of robust core banking systems and ITintegration of branches.

 Additionally, the banking system lacks interoperability where the same infrastructure can be used to support multiple payment mechanisms. This affects adversely the possibility of achieving economies of scale.

 Missing (agricultural) product development skills. Particularly MFIs still largely rely on highly standardised group lending (with cash-collateral, see 6.3.1), though individual lending has emerged.

5. Findings I: Barriers to Agricultural Finance for SMEs in Ethiopia (cont.)

5.3 Supply-side barriers (cont.)

5.3.5 Strategic outlook

 (M)FIs have not developed SME-finance strategies or policies.

 Mismatch of loan products that Ethiopia’s (M)FIs have to offer:  Lack of inventory financing for traders.  Lack of export financing for exporters.  (M)FIs only offer short-term finance, while SMEs are looking for medium and long-term finance.  Lack of innovation drive. SMEs are interested in other financial services such as attractive deposit products, and reliable payment products.

 The liberalisation of the telecommunications sector will likely lead to a surge of new payment and, in perspective, other m-banking services and M/FIs require a clear strategy if they want to remain relevant with the IT-driven change of the financial service market.

5. Findings I: Barriers to Agricultural Finance for SMEs in Ethiopia (cont.)

5.3 Supply-side barriers (cont.)

5.3.5 Interlinkages between barriers

Prohibition of foreign direct investment in the financial sector

This is the major barrier which causes shortage of loanable funds and lack of competition. Supply side barrier This dis-incentivises (M)FIs from engaging in new (or adapted) financial products for agricultural SMEs.

Internet connectivity is poor and ITcompetency costly

‚Traditional‘ collateral is the most conveni-

ent security for (M)FIs Investing in improved ITsystems requires new skills and new management systems (e.g. data security). Supply side barrier Without such systems, an expanded range of financial products is very difficult to manage (if at all profitable).

SME-operators pledging land or housing, risk losing it in case of market challenges– not so when borrowing from friends and family. Demand side barrier No Incentive to acquire skills/ build systems for financial record keeping & biz planning.

Demand side barrier

SMEs manage and document their finances poorly

(M)FIs demand a lot of upfront documentation to be presented at their branches. Supply side barrier With demand exceeding loanable funds, (M)FIs pick the loan applicants with convenient appraisal, i.e. high traditional collateral.

6. Country Comparisons on Barriers to Agricultural Finance