Engraving on copper. From the 2018 IFC report, Transforming Microfinance Institutions in the Arab World.
Transformations in the microfinance industry, primarily from NGOs to regulated for-profit financial institutions, have been quite common globally since the late 1990s. In fact, today’s transformed MFIs transact the bulk of all microfinance operations when we measure it by number of clients and portfolio size. MFIs who have pursued transformation have done so for many reasons including improving governance and gaining legitimacy, diversifying product offering and increasing access to capital, which in turn results in greater leverage and thus increased potential outreach.
Despite the many benefits, there have been very few incidents of transformations in the Arab World and the ones we have seen have mostly involved transforming international microcredit programs into registered institutions, with many of them remaining unregulated.
So why have MFIs in the Arab World been reluctant to transform? Simply put, for many, there is little incentive to transform at this point.
We have recently seen a wave of regulatory changes that opened the door for the entry of new for-profit players, beginning in Syria (2008), Yemen (2009), and Sudan (2011), and followed by Tunisia (2011), Palestine (2011), Egypt (2014), and Jordan (2015). These new regulations brought the sector under the supervision of the central bank (Syria, Yemen, Sudan, Jordan, Palestine) or other entities (in Tunisia L’Autorité de Contrôle de la Microfinance, and in Egypt the Financial Regulatory Authority).
In some countries such as Syria, Yemen, and Sudan, the new regulations have allowed transformed MFIs to mobilize savings, a primary incentive for MFIs to consider transformation. In the rest of the region, however, regulations have only allowed institutions to continue providing credit, keeping savings mobilization off-limits. Some of these countries, such as Tunisia, Palestine, and Jordan, have tried to encourage MFIs to transform with other incentives such as increasing the ceiling on microfinance loan sizes for transformed institutions compared to NGOs. However, in other countries, new regulations did not provide any clear benefits to for-profit companies compared to NGOs, but rather – most likely unintentionally – created disincentives through higher income taxes, a doubling of supervision fees and so on, making operations costlier and placing greater limitations on the product offering.
Regulations aside, some of the larger MFIs in the region are reluctant to transform for other reasons.
Many fear the risk of mission drift; that by transforming into a for-profit company, they will be forced to behave like commercial lenders - the same lenders that ignored low-income populations and made it necessary for microfinance NGOs to serve the underserved in the first place.
Others are dissuaded by the costs associated with transformation. These include the cost of valuation, legal fees both for the incorporation into a for-profit company and for shareholders agreement negotiations, taxes on the sale of the NGO’s portfolio to the for-profit company and ongoing income taxes levied on the for-profit company.
And many have staff-related concerns. Institutions transforming into for-profit companies will likely require a different skill-set within their pool of staff and must identify ways to compensate staff for having built up the institution to the point of success where it can become a for-profit entity, and to align staff incentives with the future of the institution.
While these concerns are all of course valid, we must not forget that they can be overcome. There have been many successful cases of transformation in other parts of the world. MFIs who have been able to manage the transformation process effectively have expanded their outreach to more of the un- and under-banked - the essence of the microfinance industry - while also gaining access to capital in the forms of both debt and equity to allow for continued growth. These institutions have also been able to enjoy the benefits of improved governance and ownership structures.
We would love to hear your thoughts as well on why transformations in the Arab region have been fewer than in other parts of the world. What changes would you like to see happen for you to consider transformation of your own institution? Please provide your comments below.