an inclusive financial sector for all

Transcription

1 an inclusive financial sector for all

2 MICROFINANCE IN KAZAKHSTAN: AN INCLUSIVE FINANCIAL SECTOR FOR ALL Àlmaty 2005

3 Report materials could be reproduced in other publications, without prior permission of UNDP, provided proper reference is made to this publication. The views expressed in this report are those of the authors and do not necessarily represent the views of UNDP.

4 FOREWORD BY YURIKO SHOJI UN RESIDENT COORDINATOR/ UNDP RESIDENT REPRESENTATIVE IN KAZAKHSTAN The UN General Assembly has declared this year, 2005, as the International Year of Microcredit and called for governments, UN agencies, non-governmental organisations, private sector and mass media to make their contributions in building capacity in the microfinance sector. At the same time, all parties involved in poverty reduction have been called to take additional steps to strengthen existing and start-up microfinance institutions, so that they can effectively provide services for self-employment and income generation to the poor. In this framework UNDP Kazakhstan has decided to contribute by reviewing the development of microfinance in Kazakhstan and the challenges it faces. Until 1976 there was a latent perception that poor people were not able to receive and manage loans. It was believed that providing credit to the poor was too costly, laborious and unreliable. In 1976, however, professor Mohammed Yunus and his counterparts from Bangladesh began handing out small loans to poor people, and in few years they created one of the icons of microfinance, the Grameen Bank. With this experience and the ones of equally successful microfinance institutions around the globe, microfinance has been shown to be an essential tool for poverty reduction. In 1997 the Microcredit Summit launched a campaign targeting the year 2005 for achieving microcredit coverage of 100 million poor. This first objective is almost achieved, considering a Microcredit Summit Campaign report claiming that over 80 million poor households received microcredit in However, microfinance is yet to be implemented in full, with an estimated 1 billion poor people without basic access to financial services. Based on the past success, at the recent Microcredit Summit in Santiago it was announced that the campaign would be extended to The new goal of the campaign is to ensure that 175 million of the world's poorest families are receiving credit and related services for self-employment by the end of In Kazakhstan the first microcredit project emerged as early as the mid-1990s. Since then, microcredit agencies have significantly expanded the scope of services and now provide a broad range of financial products to the poor. Their operations are spread throughout the whole country, but they are not able to meet the increasing demand for basic financial services. Moreover the microfinance sector demands continued attention from the Government and support from international organizations. The Government of Kazakhstan already considers microfinance as an effective tool for poverty reduction. Reference to microcredit is included in the national development strategy "Kazakhstan 2030" and the Poverty Reduction Programme for elaborated with assistance of the UN Development Programme and the Asian Development bank - identifies the "number of microcredit given to poor households" as a poverty reduction indicator. This report presents an updated outline of international and national microfinance practices, and identifies challenges and provides recommendations for the development of an efficient and effective microfinance industry in Kazakhstan. The report analyzes the major strengths and weaknesses of existing micro-lending models in the context of the current policy and legal environment in Kazakhstan and provides recommendations for policy-makers. It is my hope that the report will promote better understanding of microfinance as an economic tool for improving the lives of the people of Kazakhstan. UNDP is looking forward to work with the Government and other partners to make this possible. Yuriko Shoji 3

5 Microfinance in Kazakhstan: an inclusive financial sector for all FOREWORD BY SAUAT MYNBAEV MINISTER OF INDUSTRY AND TRADE OF THE REPUBLIC OF KAZAKHSTAN Today, the reforms being conducted in Kazakhstan give their first significant results. The financial sector is developing rapidly, living standards of population are getting better, and several measures aimed at development of stable economy are being undertaken in Kazakhstan. The financial sector of Kazakhstan includes commercial banks, credit partnerships, microcredit organizations and other financial institutions. The legislative foundation of Kazakhstan's financial market was established, the Concept on Finance Sector Development was adopted. Adoption of the new laws considerably increased the effectiveness of the financial system of Kazakhstan. Support to small and medium enterprises is considered to be a priority of the Government's economic development strategy. High emphasis is placed on introduction of innovative information technologies and establishment of legal framework favourable for entrepreneurs. However, despite the rapid economic growth and continuous government support to SMEs, unemployment is still an acute problem in Kazakhstan. In this situation, microcredit becomes an effective tool to support the economically active population and to stimulate the entrepreneurship incentives and, as a result, to attract the private capital into the financial sector. Microcredit organizations provide access to loan funds for SMEs, contribute to the establishment of the credit culture of population and, thus, to their exclusion from the informal financial sector, which is still considered to be the main source of funding for microenterprises. A set of measures aimed at development of microfinance in Kazakhstan has been undertaken. Its major objective is creation of the enabling environment for independent and effective microcredit organizations, which will ensure continuous funding for entrepreneurs, promote competitiveness on the finance market as well as increase the entrepreneurship potential of the population. All of these will help to overcome social challenges by creating new jobs, increased self-employment and incomes of the population. The report "Microfinance in Kazakhstan: an inclusive financial sector for all" is one of the first attempts to analyze the microfinance sector in Kazakhstan. The report gives an overview of the existing microfinance sector in the country, analyzes the demand for microfinance as well as assesses the potential for further development and improvement of the sector. International best practices and recommendations, presented in the report, are of the special interest. I believe that the report would be a valuable source for government officials, international organizations and other microfinance players in Kazakhstan. I would like to take this opportunity and to extend my gratitude to the United Nations Development Programme in Kazakhstan. I hope for our future fruitful cooperation on microfinance issues in Kazakhstan. Sauat Mynbaev 4

6 Contents Foreword by Yuriko Shoji, UN Resident Coordinator/ UNDP Resident Representative in Kazakhstan... 3 Foreword by Sauat Mynbaev Minister of Industry and Trade of the Republic of Kazakhstan... 4 Executive summary... 7 Acknowledgements Acronyms CHAPTER 1 Conceptual framework An inclusive financial sector for all Microfinance services and institutions Financing microcredit and sustainability Microfinance social and economic impact Challenges, findings and conclusions CHAPTER 2 Microfinance global development International initiatives in support of microfinance Microfinance best practices Microfinance in transitional economies and in Central Asia Major findings and conclusions CHAPTER 3 Microfinance in Kazakhstan Background Microfinance sector outlook Microfinance in Kazakhstan: institutional outline Assessing microcredit demand and supply Microfinance strategies and methodologies Barriers for developing microfinance Institutional actors: the state, international organizations and donors Principal findings and conclusions

7 Microfinance in Kazakhstan: an inclusive financial sector for all CHAPTER 4 Opportunities and challenges Legal and policy improvements to enhance microfinance Alternatives to foster microfinance development Enhancing the impact of microfinance on social and economic development Major findings and conclusions Conclusions and recommendations Bibliography ANNEX 1 Glossary of terms and indicators ANNEX 2 General review of microfinance literature FIGURES 1.1 The poor use financial services to? Main components of microfinance services Microfinance environment Microfinance service providers Number of microcredit organizations in Kazakhstan TABLES 2.1 Microfinance in Central Eastern Europe and in the Newly Independent States Top 10 MFIs in CEE and NIS (number of clients) MFIs in Central Asia Outreach indicators for Central Asia Microfinance institutions in Kazakhstan Microfinance law framework Poverty in Kazakhstan Microcredit demand - standard of living approach Microcredit demand - private sector approach Commercial banks' microcredit portfolio Geographical distribution of microcredit organizations in Kazakhstan UNDP/AMFOK survey results: largest MFIs in Kazakhstan ACCION CAMEL quantitative and qualitative indicators International microfinance investor funds in Kazakhstan Comparison of SME contributions to the national economy in selected states Moldir Women's Association activities

8 EXECUTIVE SUMMARY The International Year of Microcredit is a remarkable opportunity to highlight microfinance as an important instrument for economic and social development. As well it provides a perfect chance to evaluate the remarkable results of twenty years of microfinance development. International consensus now considers microfinance to be one of the main tools to achieve poverty reduction goals and to improve the daily lives and well being of people. This report provides an overview on why and how microfinance has emerged and evolved in the past twenty years. It describes microfinance services and microfinance institutions and reviews challenges facing the microfinance sector. This sectoral information is intended to offer the essential tools for understanding the latest developments in microfinance in the world and specifically in Kazakhstan. The report analyzes the state of the microfinance sector in Kazakhstan, its challenges and opportunities, and explains its impact on society and the economy. The report then reviews several options for the development of the sector and suggests a number of specific recommendations for the main stakeholders. The main conclusions and recommendations of this report are based on a number of important studies that were recently conducted on the microfinance sector in Kazakhstan. Most significant among these was a survey sponsored by the United Nations Development Programme (UNDP) and conducted by the Institute for Social Survey in February and March UNDP and the Association of Microfinance Organizations in Kazakhstan organized another survey in August and September 2005 to assess the supply of microfinance in Kazakhstan. The definition and breadth of microfinance have evolved over time. The term now refers to financial services that are targeted at low-income clients including credit, savings, insurance and money transfer services. Microfinance has catalyzed opportunities for millions of poor people. While many have already had the chance to become economically productive members of society as cash income earners and entrepreneurs, the number that have not had this opportunity is even larger. It is in fact for many of these most vulnerable individuals that the impact of microfinance is most significant and convincing. The challenge is to create a financial sector that serves these groups -- an inclusive financial sector for all. Microfinance has already proven to be an effective tool to fight poverty and a useful means to achieve the MDGs in a sustainable way. Yet the impact of microfinance is not limited to the creation of new and diversified incomes -- the positive personal and social outcomes are often even more striking. The enhancement of selfesteem, the expansion of people's choices and the empowerment of women are among the best assets produced by micro loans. Over the years microfinance evolved as a viable industry with great client outreach and social and economic impact in many countries. Today the microfinance sector has expanded to include globally between 10,000 and 15,000 institutions that consistently reach more than 80 million poor people. Microfinance arrived in Central Asia only in the early to mid-1990s, leaving countries in the region far behind the world's average for development in the sector. Despite this late start, one of the highest growth rates in the world has quickly begun to reduce this gap. Indeed, the financial and operational efficiency levels of Central Asian microfinance institutions (MFIs) show good results, but access to microfinance services remains limited. Microfinance has shown positive impact on poverty alleviation among the countries of Central and Eastern Europe and the Newly Independent States, with successful examples in Russia, Poland and other parts of Eastern Europe. Of all the best practices gathered through research into the wide variety of existing microcredit methodologies and practices, it is acknowledged that one remains paramount: any scheme should be tailored to the specific needs of poor clients, taking into account local traditions, customs, legislation and economic structures. Microfinance in Kazakhstan is still a relatively young concept that was only introduced in the mid-nineties. Despite the diversity and number of existing microfinance institutions, there is still a high demand for financial services that remains unfulfilled. Moreover, most of the necessary legal reforms have already been undertaken. Three main laws regulate Kazakhstan's financial sector. An overall framework is provided by the "Law on Banks and Banking Activity," while two other laws on microcredit organizations and credit partnerships -- enacted in provide specific regulations for MFIs. The "Concept of Finance Sector Develop- 7

9 Microfinance in Kazakhstan: an inclusive financial sector for all ment in Kazakhstan" was adopted by the Government in mid-2003 to further streamline the development of Kazakhstan's financial sector. This concept presented a three-tier model: Level 1: commercial banks Level 2: non-banking financial institutions, credit partnerships, pawnshops Level 3: microcredit organizations Prudent financial supervision in Kazakhstan only allows banks to collect savings. However, the requirements for becoming a bank are restrictive and therefore prevent MFIs from accessing the public savings that they need. Consequently, unregulated microcredit organizations will not be able to attract the investors needed to diversify and expand their services. Many larger MFIs are using licenses as non-banking financial institutions to operate, while others are planning to become commercial banks. The main stakeholders in the microfinance sector in Kazakhstan are: the state; international organizations; commercial banks; NGOs and credit partnerships; and the Association of Microfinance Organizations in Kazakhstan. The Government of Kazakhstan has established all the basic preconditions necessary to develop the microfinance sector: a stable macroeconomic environment, an enabling legal framework for MFIs, and an explicit recognition of microfinance as a tool to fight poverty. However, state intervention in the microfinance sector will not be effective if there are no reliable mechanisms to ensure effective implementation. The Government made a commitment to provide funds to MFIs. However, rather than being a direct provider of financial services it is recommended that the Government create a conducive environment for microfinance institutions. Increased transparency and accountability could make a difference in the results of Government sponsored projects/strategies. The role played by donors in Kazakhstan in developing the microfinance sector was significant in the recent past. They contributed by introducing international best practices and state of the art technologies as well as providing startup capital. Several projects can be considered successful and some can even be viewed as world best practices. Most of the MFIs that were originally founded with the help of international organizations are now self-sustainable non-profit organizations. Remarkable results were also achieved through downscaling programmes funded by international development banks and implemented by commercial banks. However, the volumes of donor funding are now shrinking in Kazakhstan. It is therefore necessary to carry out an in-depth analysis on how to maintain established relations with Kazakhstani MFIs, and to transfer their unique experience to young organizations in the years to come. Although more than seven banks have active microcredit downscaling programs, non-banking financial institutions, credit partnerships, pawnshops, and microcredit organizations constitute the vast majority of entities serving microfinance clients. NGOs and public funds have in fact been the main providers of microfinance services on the ground. Indeed, in their work with sociallyvulnerable groups, NGOs were among the first organizations in Kazakhstan to develop and implement effective methods for delivering financial services to the poor. Microfinance institutions themselves are the main driver in fostering development in this field. The main challenge for them is to expand their outreach, while maintaining outstanding financial records in order to build confidence in the sector and become established as credible institutions. Although MFIs in Kazakhstan are young relative to other similar institutions around the world, they have already achieved good self-sustainability and efficiency records. However, many MFIs in Kazakhstan are still dependent on donor support to finance their expansion strategies and there are only few MFIs that are able to attract external commercial funding. A part of the reason is that, since MFIs are not allowed to collect public deposits, donor and government support will remain their major source of funding. The transition to a market economy caused uneasy transformations in the labor market and disruptions to the social benefit system in Kazakhstan. This process increased social vulnerability for a significant part of the population. Only in recent years has this trend reversed. In 2003 and 2004, the economy continued to grow at a fast pace: the growth of real GDP equaled 9.5 percent and 9.2 percent respectively. By 2004, only 16.1 percent of the population lived below the subsistence minimum of KZT 5,427 per month (or about USD 3.5 per day at purchasing power parity), compared to 39 percent in In light of the poverty situation outlined above, many people turned to microcredit during the transition period as a way to overcome the economic challenges they faced and the demand keeps on increasing. In 2004, according to the Agency of Statistics, 50,600 people received microcredit loans, a 57 percent increase over the 8

10 Executive summary 32,300 people who received microcredit in Preliminary estimates for 2005 indicate that there are 60,000-70,000 active microfinance clients in Kazakhstan. Formal and informal sector enterprises (both in urban and rural areas), the unemployed, and households are the actual and potential MFI clients. The potential demand for microfinance can be studied by understanding the characteristics of micro enterprises that look for financial resources to grow, and by understanding poor households that seek loans for a wider set of needs. Based on these considerations, two different models have been formulated: the standard of living approach and the private sector approach. Based on these two approaches, the demand for microfinance services has been estimated to include between 140,000 and 220,000 clients, and the total value of the microfinance market could exceed USD 800 million. However the real demand could easily expand beyond these numbers as more than two million vulnerable people could benefit from increased access to microfinance as well. Putting considerations of microfinance supply and demand together, it becomes obvious that the demand far outstrips the supply in Kazakhstan. According to the latest official figures, there are over 400 registered microfinance institutions in all three levels of the financial system. However, these figures should be taken with some caution since not all of the listed organizations are in operation, and many have only a small number of clients and/or limited turnover. There are very few MFIs with a significant number of clients, resulting in a major population segment without access to modern financial services. Rapid growth in the sector during the past few years indicates a prompt market response to the demand for microfinance services. However, even if the supply grows at a high rate, the supply of microfinance will not be adequate. Surveys have indicated that with few exceptions MFIs are small in Kazakhstan. Only one microfinance organization has more than 10,000 clients and only eight MFIs have an active portfolio that exceeds USD 500,000. While NGO-MFIs have a lower average loan size, the highest loan sizes were found among credit partnerships. Two kinds of borrowers emerge: small traders, farmers and entrepreneurs on one side, and SMEs on the other. The average size of loans varies greatly from USD 300 to more than USD 200,000. The MFIs that widely employ group loans have the lowest average loan size. Kazakhstan MFIs offer only microcredit services but have developed different products, such us solidarity group loans, individual loans, agriculture loans, and housing loans. Almost all of the MFIs that responded to the survey are nearly or fully self-sustainable. This validates the fact that MFIs in Kazakhstan have relatively good financial records. It is difficult to draw a map of funding sources. However it seems that very few MFIs received money from the government. Otherwise there are good indicators of private sector involvement. MFIs that received donor grants tend to have better performance overall. There are several environmental obstacles that restrain the development of the microfinance sector as a whole: legal barriers; low population density; high transportation and security costs; underdeveloped collaboration between MFIs, state administrations and national development institutions and funds; poor interaction with commercial banks; lack of service providers for MFIs. Moreover the challenges faced by MFIs in their everyday activities include the following: high cost of funding; shrinking of grant commitments; shortage of qualified personnel; lack of methodology and training programs for MFIs' staff; poor methodological and accounting know how and low level of computer skills; unequal competition terms with commercial banks. On the basis of the surveys' findings, various development options were analyzed to identify possible drivers to speed up the expansion of the microfinance sector in Kazakhstan: Attracting financial resources from various actors such as the private sector, commercial banks, international private funds, and pension funds; Designing an effective state funding strategy with the establishment of an independent institution and a transparent and effective disbursing mechanism; Expanding beyond microcredit to microsavings, microinsurance and leasing. In order to overcome the bottlenecks that prevent the expansion of microfinance services and to promote sustainable development, the government, donor community, and microfinance institutions themselves are encouraged to consider the following recommendations. 9

11 Microfinance in Kazakhstan: an inclusive financial sector for all On the basis of these considerations the government is advised to: Facilitate an open and inclusive dialogue on microfinance in Kazakhstan and create a conducive environment for microfinance institutions. Promote amendments to laws that are in line with international best practices to foster microfinance growth in Kazakhstan as discussed in this report. Under the current law MCOs have several disadvantages relative to commercial banks in terms of savings mobilization, product diversification, and expansion opportunities. The loan size limits could be redefined, as could the narrow definition of microcredit borr owers. Create a state coordinating body for microfinance, such as a National Committee, to coordinate the activities and initiatives that address the challenges that the poor face in accessing financial services. Members should not be limited to government bodies but should also include representatives from multilateral organizations, donors, MFIs, sector associations, academia, and civil society. Prevent interventions that could distort the microfinance sector. Subsidized lending programs should be avoided as selfsustainable microfinance institutions may be excluded from unfair competition from subsidized state institutions. Promote the development of transparent and effective mechanisms to transfer state funds to MFIs. The independence of the disbursing institutions would be the major factor in achieving good results. International experience in implementing apex funds should be looked at with special attention. The involvement of international organizations and experts in the process can help to assure credibility and transparency. Strengthen microfinance expertise among the staff in key ministries that work with microfinance projects. Sponsor an independent evaluation of ongoing state microfinance projects. Encourage Government funds and programmes to follow international practices and encourage transparency in decisionmaking processes. The donor community should continue to support MFIs to grow in recognition of the important role played by microfinance, especially for the rural poor and small-scale borrowers. Donors should continue to: Provide inputs to the government to improve the design of pro-poor policies and the microfinance strategy; Participate in government microfinance projects to assure transparency and effectiveness; Support MFI associations and networks; Sponsor the creation of a market for MFI services, such as training, international and local audits, and rating services; Finance MFI capacity building and expansion; Disseminate information about best practices and sector standards; Conduct new surveys to better assess the impact of microfinance in Kazakhstan and to study the introduction of innovative microfinance products; Develop suitable donor exit strategies for existing projects; Support the introduction of microfinance services other than microcredit; Strengthen donor coordination. MFIs are thus encouraged to: Expand their outreach, especially in rural areas, where the poor are concentrated; Gain ownership of the microfinance strategy in Kazakhstan by researching and proposing specific solutions to current challenges; Multiply networking and enhance national associations; Promote investment in human resources and adopt modern international microfinance management techniques; Comply with international standards in accounting and reporting; Seek international ratings; Facilitate knowledge sharing of best practices among MFIs in Kazakhstan and within the region; Become proactive in their strategies by developing creative and innovative methodologies for reaching clients and attracting resources; Approach national and international commercial banks, as well as international private investors, to increase financial resources; Exploit available opportunities offered by the government budget. 10

12 ACKNOWLEDGEMENTS The report would not have been possible without support and contributions of many organisations and individuals. The authors and UNDP Kazakhstan extend their thanks to the following organisations for their contributions to the preparation of the report: the Association of Microfinance Organizations of Kazakhstan (AMFOK), the Institute for Social Research, the Small Entrepreneurship Development Fund and the Microfinance Centre for CEE and the NIS. Special acknowledgements should be extended to the Ministry of Economy and Budget Planning of the Republic of Kazakhstan, the Committee for Small Enterprise Development under the Ministry of Industry and Trade of Kazakhstan, the Kazakhstan Agency for Management and Supervision of Financial Market and Financial Organizations, the National Insurance Corporation for Export Credit and Investment Insurance, the TuranAlem Bank, the Temir Bank, the World Bank, the European Bank for Reconstruction and Development, the Asian Development Bank, the Embassy of Germany, the Embassy of Hungary, the Embassy of the Czech Republic, the Embassy of Poland and the Embassy of the Republic of Lithuania. In the course of the report writing the following professionals offered their constructive remarks and comments: Olga Tamilova and Rakhat Uraimova, Microfinance Centre for CIS and the NIS experts, Shalkar Zhussupov, AMFOK President and Ainur Arenova, AMFOK Director, Maurizio Guadagni, World Bank Senior Rural Development Specialist, Sophia Nazmetdinova, CAMFA Project Coordinator and Kishori Kedlaya, Online UN Volunteer. Special thanks go to the Institute of Social Research and personally to Gulnar Ismukhanova, Director, for their initial research on microfinance in Kazakhstan. Finally, the authors would like to extend their sincere thanks to all members of the Advisory Board and personal thanks to Yuriko Shoji, the UN Resident Coordinator/UNDP Resident Representative in Kazakhstan and Gordon Johnson, Deputy Resident Representative, UNDP Kazakhstan. Special thanks goes to Malin Herwig, Chief of Poverty Reduction Team, UNDP Kazakhstan; Irina Buchinskaya, Programme Assistant, Poverty Reduction Team, UNDP Kazakhstan; Alma Buirakulova, Research Assistant, UNDP Kazakhstan; Aliya Ilyassova and Maral Sheshembekova, Project Experts, UNDP Kazakhstan. Special thanks go to Christopher Herwig, who kindly provided photos for the report. 11

13 Microfinance in Kazakhstan: an inclusive financial sector for all ACRONYMS ACC - Agrarian Credit Corporation ACF - Asian Credit Fund ADB - Asian Development Bank AFI - Alternative Finance Institution AMFOK - Association of Microfinance Organizations in Kazakhstan CA - Central Asia CAMFA - Central Asia Micro Finance Alliance CAMFC - Central Asian Microfinance Center CEE - Central and Eastern Europe CGAP - Consultative Group to Assist the Poor CIS - Commonwealth of Independent States DCD - Disbursement and Cash Departments EBRD - European Bank for Reconstruction and Development EU - European Union FAO - Food and Agriculture Organization FFSA - Foundation for Financial Support to Agriculture GDP - Gross Domestic Product GTZ - Gesellschaft fur Technische Zusammenarbeit IFAD - International Fund for Agricultural Development IE - Individual Entrepreneurs ILO - International Labour Organization IMF - International Monetary Fund ISS - Institute for Social Survey IYM - International Year of Microcredit KFW - Kreditanstalt fur Wiederaufbau KLF - Kazakhstan Loan Fund KZT - Kazakhstan Tenge MCO - Microcredit Organization MDG - Millennium Development Goals MFB - Microfinance Bank MFC - Microfinance Centre (for Central and Eastern Europe and New Independent States) MFI - Microfinance Institution MIS - Management Information System MTI - Ministry of Industry and Trade NBFI - Non-banking financial institution NGO - Non-governmental organisation NIS - Newly Independent States OSS - Operational Self-Sufficiency PAEF - Polish American Enterprise Fund PPP - Purchasing Power Parity RCP - Rural credit partnerships RK - Republic of Kazakhstan ROA - Return on Assets ROE - Return on Equity SE - Small Enterprises SEDF - Small Entrepreneurship Development Fund SLB - Second Level Bank SM - Subsistence Minimum SME - Small Medium Enterprises SUM - Special Unit for Microfinance S&P - Standard & Poor's TA - Technical Assistance TACIS - Technical Assistance to the Commonwealth of Independent States UK - United Kingdom UN - United Nations UNCDF - United Nations Capital Development Fund UNDP - United Nations Development Programme USAID - United States Agency for International Development USD - United States Dollar WB - World Bank 12

14 CHAPTER 1 CONCEPTUAL FRAMEWORK 1.1 An inclusive financial sector for all "The stark reality is that most poor people in the world lack access to sustainable financial services, whether it is savings, credit or insurance. The great challenge before us is to address the constraints that exclude people from full participation in the financial sector. " Kofi Annan (UN Secretary General) Financial services are available only to a small percentage of the world's population, meaning that the poor are usually excluded. A more inclusive financial sector would require that everyone in need of financial services could access them under sustainable and cost-effective conditions, regardless of location, income, or assets. Microfinance is one concrete attempt to build an inclusive financial sector in a manner that could alleviate poverty and help the poorest to help themselves. The term microfinance institutions (MFIs) refers to the broad range of organizations that provide such financial services to the poor. The aim of microfinance is to help the poor and alleviate poverty both by enlarging access to services and by providing financial and social intermediation to low-income clients. Microfinance, however, is not merely finance; it is an essential development tool to fight poverty and social exclusion. Success stories have offered evidence that microcredit and savings services can be powerful tools to expand people's choices and to reduce their vulnerability. Low-income groups have been shown to use financial services to respond to economic opportunities, to reduce their vulnerability to risk, and to invest their profits in their future and in the future of their children. In an environment rich with economic opportunities, micro loans can raise family incomes and improve the borrower's quality of life through increased expenditures on health, nutrition, education and shelter. Loans can also be used to manage a crisis and maintain a business in operation. Figure 1.1 Invest in their future The poor use financial services to? Poor use financial services Respond quickly to economic opportunities Reduce vulnerability to external shocks A brief overview of the history of microfinance provides important context for better understanding the latest developments in the sector. During the 1970s and early 1980s, direct loans were provided to poor people under subsidized terms. These first programs, though innovative in their nature, were limited in their scope, duration and vision. The facilities built were small, isolated, and project-based. After the initial period of funding from donors, many of these MFIs went bankrupt, leaving them unable to provide capital for new loans. In addition to the lack of sustainability, the outreach of these initial experiments was also insufficient. Typically only the richest among the poor benefited from the services offered and distortions in the local private market were common. Eventually, successes such as the Grameen Bank in Bangladesh and the Bank Rakyat Indonesia provided the first concrete evidence that the 13

15 Microfinance in Kazakhstan: an inclusive financial sector for all provision of financial access to the poor could be effective in bringing people out of poverty. Central to these original models was a commitment to self-sufficiency from the outset. These models proved to be successful because their founders were first able to understand people's needs, second capable of delivering appropriate and high quality financial services, and third able to develop the right methodologies. The birth of group lending methodologies, for example, is considered a milestone in microfinance history. The history, methodology, and organizational structures of these successful programs were quickly studied, and their best practices showed up in both newer microcredit organizations and donor programs. Soon after, more and more good and innovative examples of MFIs emerged all over the world, adapting the new findings to the local context. Today the microfinance industry has expanded globally to include between 10,000 and 15,000 1 institutions that consistently reach an estimated 80 million 2 poor people. Indeed, the annual average market growth rate for the industry remains in the double digits. The Consultative Group to Assist the Poor (CGAP) 3 reports even bigger numbers: they calculate that an estimated 750 million accounts (savings and credit) are open in alternative finance institutions (AFIs). While these figures may be overly generous as they incorporate the whole microfinance market below the level of commercial banks (including state-owned agricultural banks, development banks and postal banks), CGAP argues that that some substantial fraction of the clientele of these non-microfinance institutions are poor or near poor. Nevertheless, outreach has deepened throughout the past twenty years with an increasing number of the poorest being MFI clients. The future of microfinance continues to look bright: its full potential is still far from being reached due mainly to limited supply. Most poor people already pay informal moneylenders for high-cost, low-quality financial products; the experience of existing MFIs indicates that clients are willing to pay for a variety of improved services. The market potential also remains vast: an estimated 1-2 billion people are demanding access to basic financial services. Moreover, successful methodologies have been developed that allow financial sustainability without compromising the outreach of microfinance services. The importance of sustainability should not be under valued. As CGAP states in its latest strategy document: "The promise of sustainability meant that microfinance could leverage relatively scarce donor funding by attracting much larger pools of private capital, thus expanding outreach to massive numbers of the poor." 4 The definition and breadth of microfinance have evolved over time. The term now refers to financial services that are targeted at low-income clients, including credit, savings, insurance and money transfer services. Indeed microcredit, the flagship product, has become one service among many. The role of savings and insurance services has proven to be especially effective because not everyone needs loans, but the majority of people need to save money and insure against risks. Figure 1.2 summarizes the basic components of microfinance. Figure 1.2 MICROCREDIT MICROSAVINGS MICROINSURANCE MONEY TRANSFERS Main components of microfinance services A credit methodology that employs effective collateral substitutes to deliver shortterm micro loans to lowincome clients. Deposit services that allow to store small amounts of money in secure and readily accessible places. Insurance services that allow to mitigate and share risks to reduce people s vulnerability to external shocks. Financial services that allow to safely transfer funds from different places. Even with all its promise, microfinance is not a panacea. MFIs can translate potential economic opportunities into tangible realities, but they cannot create business opportunities if the environment is not conducive. The poorest of the poor require other kinds of assistance to be able to use loans and set up new businesses. Microfinance remains only one of many powerful approaches to social and economic development. 1 UNDP staff estimates, Daley-Harris Sam, State of Microcredit Summit Campaign Report 2004, 2005; data refers to clients from about 3,000 institutions in CGAP, Occasional Paper n 8, 2004 for details on statistics. 4 CGAP, Phase III Strategy ,

16 CHAPTER 1 Conceptual framework Microfinance does not exist in a vacuum. Microfinance is a tool to enlarge access to financial services, but not everyone should or needs to apply for loans. The lessons learned from the first experiments gave crucial inputs to MFIs and policymakers for developing sound management and policy tools. Today best practices for MFIs are available for many of the pressing issues concerning microfinance. However, these practical tools are not always widely adopted or implemented. To be the most effective, microfinance requires integrated, focused strategies and effective actions by several different actors other than lenders (MFIs) and borrowers. Specifically, microfinance would benefit from coordination between three different levels: the macro level where the government defines the legislative framework; the meso level that includes the whole financial infrastructure, such as the services that MFIs can exploit to expand their networks; and the micro level intended as the level of microfinance service distribution. As shown in Figure 1.3 the poor stand at the center of this model. The poor are both beneficiaries (according to donors) and clients (according to the business structure), and understanding their needs must be a priority for all parties involved. Donors are included in this model to stress the important role they continue to play in the development of microfinance, but are set apart to underline that the donors' role is one of support. Donors should act as investors who help the MFIs to achieve their objectives. National governments need to set the policy framework to sustain financial services targeted at the poor. Governments must maintain macroeconomic stability, avoid interest rate caps, and refrain from distorting markets. In special cases, public funding may be a useful means to develop the microfinance sector, but best practices indicate that the government should refrain from participating directly in microfinance activities in order to avoid market distortions and inefficiencies. Figure 1.3 Microfinance environment MACRO LEVEL POLICY, LEGISLATION REGULATION, SUPERVISION Government MESO LEVEL FINANCIAL INFRASTRUCTURE Insurers Poor MICRO LEVEL SERVICES TO THE POOR DONORS FUNDS AND TECHNICAL ASSISTENCE 15

17 Microfinance in Kazakhstan: an inclusive financial sector for all 1.2 Microfinance services and institutions Targeting microfinance to the customer MFIs seek to maximize the service value for the customer and minimize the financial provider's risks and costs. To meet clients' requirements and be accepted within the culture and environment, all aspects of microfinance services -- loan duration, size, interest rate, and repayment schedules -- have to be tailored to the customer. Since there is no "one size fits all" methodology, MFIs may also look at the informal sector to assess the local demand for financial services. Customer satisfaction and low MFI operation costs are the best tests to assess the effectiveness of microfinance. Potential users of microfinance services are individuals with entrepreneurship potential, including the unemployed, but without means to access bank services. The majority of entrepreneurs indicate the lack of required financial resources as the main barrier to setting up a business. Even when microfinance services are provided only in urban areas, traders and farmers still benefit. The most successful MFI experiences also indicate that women are among the best potential clients. The gender development of microfinance is a vital topic explored later in this chapter. In order to deliver high quality services to the poor, MFIs should concentrate on operating processes, institutional capacity and staff development. Along with the previous measures, a detailed market assessment should be developed and the MFI's mission should be clearly stated. Such an analysis would cover the political and economic background of the country; government and social policies (in particular microfinance sector policies and laws); and the level of the country's economic development (and that of the financial sector). In order to create new businesses, the existence of some basic requirements must be assessed: some level of economic stability -- such as the existence of markets (cash economy), a manageable level of economic volatility, and potential to grow -- is essential to implementing microfinance activities. Finally, the analysis must then identify current financial providers and the target clients' characteristics, such as the level and the depth of poverty, population density, education level, and cultural background (religion, customs and ethnicity). The targeting should also take in account the potential role of women and the different needs of the urban and rural poor Microfinance services At present, microfinance includes micro lending, savings, insurance and payment transfers. Such services, labeled financial intermediation by the World Bank 5, are sometimes accompanied by business development services in order to help clients develop business plans or better manage their activities. MFIs can also provide another range of services, called social intermediation, that focus on the process of building human and social capital through group formation, leadership training and cooperative learning. Although a brief overview of the main characteristics and purposes of all these services are provided in this chapter, the report will subsequently focus exclusively on microcredit activities. Microcredit Standing at the core of microfinance, microcredit is directed towards funding both existing and startup enterprises. Microcredit activities seek to enhance the access to credit of those small business owners who are excluded from traditional bank-provided loans, allowing them to expand their existing enterprises. As well, microcredit is used to finance disadvantaged entrepreneurs who are willing to start their own businesses, but who cannot afford traditional funding. In short, microcredit means granting small credits to poor individuals in order to develop their own businesses with the purpose of income generation. The main characteristics of micro loans (size, maturity, interest and repayment rates) can vary widely. Although there is no common standard for the size of microcredit loans, MFIs have shown that even small amounts of money can have a dramatic impact on the life of a poor individual. Loans can start from USD 5 to USD 500 in the least developed countries and reach to USD 10,000 in middle-income countries; the Micro Banking Bulletin calculates the average loan size as USD Micro loan maturity is usually very short (under 3 months and rarely beyond 12 months) with weekly or even daily repayment schedules. As with commercial banks, most MFIs offer different and better conditions, such as longer repayment schedules or bigger amounts, to conscientious borrowers. To cover the cost of micro lending and thereby ensure the financial sustainability of microcredit services, interest rates are usually well above those of commercial loans, but fall far below the usurious terms of moneylenders. 5 World Bank, Microfinance Handbook, The loan average size is calculated upon data from 124 major MFIs for which data are available. 16

18 CHAPTER 1 Conceptual framework The last 20 years have seen the rapid development of sustainable micro loan methodologies that offer practical tools for MFIs to design better and more innovative services. The best and most effective of these is group financing. In this form of lending, self-selected groups of 3-10 people join together in so-called "solidarity groups." Each member fulfills his or her own credit liabilities but also shares some degree of responsibility for other members' repayments, varying from legal guarantees to the loss of further access to credit. Trust within the crediting group is central to group lending and serves as a substitute to standard banking collateral and allows MFIs to test for reliability before members apply for bigger individual loans. Loan services can be made most effective and affordable to the poor if they meet the following requirements: Loan use should be flexible. The poor use loan money to meet needs as diverse as starting business activities, sending children to school or paying their monthly rent. As a result, the flexibility of money use is very important for these clients. A light control of money utilization and a detailed knowledge of the borrower and of his or her repayment capacity should be sufficient; at this stage the person is more important than the business project. Tied loans produce costs for both lenders and borrowers alike and unnecessary requirements are seen as obstacles that limit access. Transaction costs should be minimized. The poor ask for simple procedures and quick access to money in order to exploit economic opportunities as they come. Unnecessary restrictions, administrative requirements and long loan processes increase transaction costs. A concern for transaction costs is essential to understanding poor people's needs and allowing them to benefit from microfinance. Indeed, transaction costs that represent a burden for both MFIs and clients should be minimized. Quick access to loans and easy administrative requirements should characterize credit services. Collateral substitutes, such as group guarantees, should be accepted as an alternative security for credit repayment. Because the poor often do not own the property or have the viable credit records required by standard banking sector collateral practices, MFIs need to rely on collateral substitutes. The previously given example of group lending illustrates many of the alternatives to collateral that can be used to prevent delinquency and assure due repayment: ñommunity relationships; social sanctions; group or shared responsibility; reputation; informal or personal properties (personal value more than commercial value); continued access to MFI services. Loans should be tailored and designed to meet client's needs. MFIs should provide appropriate products that are adequate to the environment and meet local demand. Only stable and viable institutions should provide loans. Only stable and viable institutions can guarantee the long-term prospects for microfinance services. To achieve sustainability MFIs should not depend only on donors' assistance, but rather are encouraged to apply market prices to their costumers. Doing so allows MFIs to maintain services in the face of competition. Successful micro loans have been shown to improve the borrower's economic security by: increasing the borrower's liquidity in the short and long term; increasing the borrower's economic power; reducing risks of economic shocks through diversifying incomes and creating opportunities to pursue viable economic opportunities. Microsavings Saving can be more important than borrowing for the poorest of the poor. While in the past microfinance institutions and experts have focused more on loans than savings, a consensus has recently developed acknowledging that most poor people save, even if their savings are not financial assets. Savings typically take the form of very illiquid assets such as cattle, crops, and jewelry. The CGAP recognizes that the demand for savings is even higher than the demand for loans among poor families, and it is often the lack of financial services that impedes their access to safer and more liquid forms of savings. Microsavings are intended as micro deposits that allow the poor to store small amounts of money in a safe place. Easy accessibility and high liquidity are the conditions most demanded. Microsavings enable low-income households to accumulate resources for future purchases and investments, or to have reserve funds in case of limited income due to crop failure. Access to savings services protects these households by making them 17

19 Microfinance in Kazakhstan: an inclusive financial sector for all less vulnerable in relation to external factors. Savings undertaken for these purposes (referred to as voluntary savings) are distinct from the loan practice that requires keeping a specified amount of money in the lending institutions as collateral (referred to as compulsory savings). To minimize the risks associated with savings, all individuals seek to place their deposits in a reliable and stable institution. MFIs, following the regulations that govern private savings, are rarely allowed to collect voluntary savings. Savings services to the poor are now often provided by postal banks or state agricultural banks that have the widest coverage in the poorest areas and are under government supervision. However, MFIs are often in the position to offer better targeted savings services and ad hoc regulation should in certain situations exempt these organizations from strict central bank regulations. Microinsurance Microinsurance is the latest experiment in microfinance. Microinsurance is an effective tool for reducing vulnerability by enabling people to cover unexpected expenses in cases of emergency such as illness, death, or injury. Access to microinsurance can also help the poor to achieve an improved standard of living, mitigate the effects of potential adverse external factors and facilitate poverty alleviation. The demand for coverage is high among the poor and nearly poor, who seek health and life insurance services. Rural farmers are particularly attracted to insurance that would protect against a bad harvest. Despite this widespread interest, few institutions, even among MFIs, provide such products. Some group lending programs currently provide compulsory insurance schemes in order to mitigate shocks like the death of one of the group members. It is likely that these financial services will continue to develop and eventually reach a wide enough audience to include the poor. Money transfers The importance of the delivery and security of money transfers is sometimes underestimated. Because remittances from developed countries alone represent one of the biggest income transfers to the poor in many developing countries, financial services that allow for the safe transfer of money can be valuable tools. Money transfer services usually develop alongside other microfinance services such as credit and savings. Non-financial services The provision of financial services can be accompanied by other, non-financial services that aim to maximize the client's business development, such as training in entrepreneurial skills, marketing, quality assurance and institution building. While these types of services are often demanded by clients, making them compulsory for borrowers would increase transaction costs and thus should be avoided. Training can also be used to target women and other particularly vulnerable groups to raise their self-esteem and cultivate appropriate business conduct Microfinance institutions A microfinance institution (MFI) is an organization that provides financial services to the poor. Given that microfinance intermediaries range from highly formalized institutions to shopkeepers, many organizations potentially can be described as MFIs. However, the term MFI is traditionally limited to the level of services below commercial banks and the market (stocks and securities). Figure 1.4 classifies the spectrum of microfinance providers by sector. Figure 1.4 Microfinance service providers Formal Sector Semi - formal Sector Informal Sector International development banks Banks ( commercial banks, state banks, rural banks, postal banks, etc) Other financial companies Microfinance banks Savings and credit cooperatives Credit unions Village banks Specialized and multipurpose NGOs Registered self-help groups Development projects Saving and credit associations Rotating saving groups Non registered selfhelp groups Individual moneylenders Traders and shopkeepers 18

20 CHAPTER 1 Conceptual framework Institutions that belong to the formal sector, such as state banks and private companies, fall under banking regulations and oversight. While the branch networks of formal sector agricultural and postal banks play a key role in enlarging access of the poor to financial services, it is the semi-informal sector that serves as the incubator for most microfinance institutions. Examples of institutions in this sector include credit unions, specialized NGOs, village banks and cooperatives. In the informal sector moneylenders, traders and informal credit and saving associations provide some basic -- though often expensive -- financial products. Depending on the country's environment and financial development it is possible to find many combinations of formal, semi-informal, and informal sector financial providers. Despite the broad sectoral range of these organizations and their obvious differences in mission (making profits vs. providing social services to the poorest), all MFIs share common elements due to the products they offer: governance systems; ownership frameworks (shareholders and stakeholders); human resources; products and processes; management information systems and financial management systems. Key indicators of good governance include a strong, long-lasting and committed leadership, a clear identification of an MFI's mission, a skilled board, and the shared values of loyalty, transparency and accountability among the staff. A capable and motivated staff with the right economic incentives is the principal resource for MFIs. Governance also has a strong relationship with ownership: MFIs have to respond to shareholders and stakeholders and to meet their different priorities. Products, information management systems, reporting systems and financial prospects are often similar for different kind of MFIs that operate in the same market. The management of loans, clients and branches is also common to all MFIs. While the goal of being effective and efficient is shared by informal community savings associations and big commercial banks alike, different types of institutions face unique challenges in delivering microfinance services. For example, NGOs can benefit from donors' funds during their start up while commercial banks have to reform their business culture to promote microfinance activities. 1.3 Financing microcredit and sustainability Source of funding for microcredit activities Money is an essential component of financial services and all MFIs face the challenge of raising funds. Sources of funding for MFIs can be either internal (retained earnings) or external (any kind of money transfer to the MFI). The following list includes major external funding sources for microfinance activities: grants and donations; soft loans; commercial loans; other market-based products (securities, etc.); shareholder capital; deposits. The above list can be loosely grouped into three categories: donors, commercial sources and savings accounts. MFIs usually benefit from multiple source financing but each MFI has to carefully plan its financial needs, check availability of funds and calculate the financial costs that can be covered by operations. The possibility of accessing funds varies on the basis of an MFI's BOX 1.1 Average characteristics of self-sustainable MFIs* Total Assets: USD 19.9 million (Banks: USD 60 million, NGOs: USD 10 million) Total number of borrowers: 81,510 Average outstanding loan size as GNP per capita: 83% Average outstanding loan: USD 752 Adjusted return on assets: 5.5% Adjusted return on equity: 14.1% Portfolio at risk > 90 days: 2.3% Number of active borrowers per loan officer: 408 Yield on gross portfolio (approximately equal to interest rate): 40.6% Note: * the average was calculated with data from 62 financial self-sustainable MFIs around the world. Significant differences emerged among the surveyed MFIs. Source: The MicroBanking Bulletin, Issue No. 8, November 2002, MIX 19

21 Microfinance in Kazakhstan: an inclusive financial sector for all financial characteristics and ownership structure. Not all organizations can benefit from donor grants. Similarly, financial market products are available only to MFIs that have achieved financial sustainability and voluntary savings are often excluded from use due to national prudential requirements. An MFI's funding structure is also correlated to the MFI's stage of development; indeed the most successful NGOs sooner or later move up from donor financing to the market in order to achieve their business development objectives Sustainability and effectiveness of microfinance operations Outreach and viability are the two macro variables that must be considered in evaluating MFIs. Outreach is an indicator of poor people's access to financial services and commercial funding. Viability, the key factor to sustain the delivery of quality financial services over a long period, is a necessary condition to cover the largest number of the poor. Outreach measures the achievements of the MFI in targeting financial services to the poor. It is evaluated by identifying: outreach scale (number of people served); outreach depth (degree of poverty targeted); quality of services (liquidity, convenience, availability, and flexibility). Some of the most common outreach ratios include: number of clients; number of poorest as a percent of total borrowers; number of women as a percent of total borrowers; average loan size; average disbursed loan size as percent of per capita GDP. Both the number of people and the number of the poorest are used to qualify the outreach of an MFI. Such measures notwithstanding, the quality of services as perceived by clients must always remain at the top of the list of factors used to evaluate microfinance activities. The term viability theoretically encompasses two aspects of sustainability: financial sustainability and institutional sustainability. Financial sustainability refers to the MFI's capacity to reach the break-even point without donor grants or subsidies. History has shown that the most successful MFIs became self-sustaining. The Micro Banking Bulletin counts 66 financially self-sufficient MFIs, reporting an average return on assets (ROA) of 5.7 percent. Several MFIs have experienced even higher financial performance than traditional commercial banks due to very good repayment records and high interest rates. While sustainability is a precondition for reaching a high number of clients, the concern that the depth of outreach would be damaged by microfinance sector "marketization" should always be taken in consideration. Box 1.1 lists some financial sustainability indicators. Institutional viability is a broad term assess the MFI's overall governance structure and its capacity to face internal and external challenges. Indicators of productivity and efficiency (Box 1.2) are used to judge the institution's health and to evaluate an MFI's mission and business plan prospects 7. BOX 1.2 Indicators of financial and institutional sustainability FINANCIAL SUSTAINABILITY Financial Ratios Portfolio Yield Adjusted Returns on Assets Adjusted Returns on Equity Performance Ratios Operational Self Sufficiency Financial Self Sufficiency INSTITUTIONAL VIABILITY Productivity ratios Active loan clients per loan officer Portfolio outstanding per loan officer Efficiency ratios Administrative efficiency Operational efficiency Delinquency Arrears Rate Portfolio at Risk Loan Loss Rate 7 Definitions of financial sustainability and institutional viability indicators can be found in the glossary. 20

22 CHAPTER 1 Conceptual framework 1.4 Microfinance social and economic impact Microfinance as a tool for economic growth and poverty reduction Underlying all microfinance activities is the belief that financial services are useful tools to reduce the vulnerability of the poor. Microfinance can have a direct impact on local economies and can play a significant role in alleviating poverty. By creating jobs through self-employment and new businesses, it promotes a better use of productive capital. The availability of microcredit also enlarges the supply of goods and services to low-income populations, thereby expanding the choices available to them. International data indicates that the new income obtained through microfinance is often invested into activities that can improve family living standards, such as sending children to school or upgrading household facilities 8. Extensive qualitative surveys conducted around the world have confirmed this positive impact. For example, impact studies conducted in more than 24 countries found dramatic improvements in household income levels 9. However, it is difficult to assess the direct correlation between improved living standards and specific services like micro loans. Not all the studies conducted prove a clear and strong relationship between microfinance and increased standards of living. The enlarging of people's choice and the creation of physical and human capital are more often seen as direct consequences of microfinance. Through income creation opportunities, microfinance can help fight social exclusion by integrating traditionally marginalized groups into the mainstream. Indeed, empowerment and increased self-esteem, particularly among women, are considered to be among the most beneficial outcomes of microfinance activities. Several actions can be implemented in order to enhance positive, long-term social outcomes for clients and the local society 10 : assure outreach to poor people; ensure MFI focus and clarity of purpose; build management and board commitment to serving the poor; emphasize vision and mission in staff recruiting and training; shape organizational culture and staff incentives to support clients' well-being; identify clear indicators for measuring social and financial performance; train management and non-management staff to influence social performance; provide regular, transparent reporting on social performance Microfinance contribution to the Millennium Development Goals Microfinance is much more than simply an income generation tool. By directly empowering poor people, particularly women, it has become one of the key driving mechanisms towards meeting the Millennium Development Goals, specifically the overreaching target of halving extreme poverty and hunger by Mark Malloch Brown (former Administrator of the United Nations Development Programme) The Millennium Declaration, outlining a set of eight development goals, was signed by world leaders at the UN Millennium Summit in September 2000 to address global development challenges (see Box 1.3). The multiple roles of financial services for the poor parallel the multiple dimensions of poverty captured in the Millennium Development Goals (MDGs); therefore it is not surprising that microfinance is contributing significantly to the achievement of many of the development goals. BOX 1.3 The 8 Millenium Development Goals Eradicate extreme poverty and hunger Achieve universal primary education Promote gender equality and empower woman Reduce child mortality Improve maternal health Combat HIV-AIDS, malaria and other diseases Ensure environmental sustainability Develop a global partnership for development 8 International Year of Microcredit Fact Sheet, , and Elizabeth Littlefield, Jonathan Murduch, and Syed Hashemi, Is Microfinance an Effective Strategy to Reach the Millennium Development Goals?, UNCDF and Unitus, 10 Sean Kline, Freedom from Hunger - Measuring and managing social performance ( 21

23 Microfinance in Kazakhstan: an inclusive financial sector for all Specifically, improved access to financial services enhances the capacity of the poor to help themselves to reach the MDGs in a sustainable framework. Financial services enable the poor to increase and diversify incomes and improve their lives, enabling vulnerable individuals to actively participate within the local economy. Evidence shows that poor people choose to invest in a wide range of assets: better nutrition, improved health, access to schooling, and better housing facilities. Microfinance has already contributed to several MDGs 11 : Eradicate extreme poverty and hunger. Microfinance increases and diversifies incomes, allowing the poor to increase consumption and investments. A study on Bank Rakyat Indonesia borrowers on the island of Lombok in Indonesia reports that the average income of clients had increased by 112 percent and that 90 percent of households had moved out of poverty 12. Achieve universal education. Households that have access to microfinance services spend more on their children's education. Promote gender equality and women's empowerment. A high percent of microfinance clients are women. Microfinance has empowered women by increasing their self-esteem and their control over household budgets due to their increased income contribution. The Tulay Sa Pag-Unlad Inc. in the Philippines reported that program participation increased the percentage of women who were the principal managers of household funds from 33 percent to 51 percent 13. Reduce child mortality, improve maternal health and combat disease. Poor people that have access to microfinance services are able to invest more in nutrition, housing and health. Ensure environmental sustainability. Increased incomes stemming from access to financial services bring new investments in housing, water, and sanitation. Many microfinance programs provide loans specifically to finance tube-wells and toilets. Programs, such as the Self-employed Women's Association in India, provide loans to upgrade community infrastructure (including tap water, toilets, drainage, and paved roads) Gender aspects of microfinance Women are the most targeted group among microfinance programs for two main reasons: women have proven to be among the best clients and they tend to spend increased income in development-related activities. Although women often form the majority of the economically active population, they face numerous economic barriers. Women working in the informal sector often have fewer assets, jobs and opportunities than their male counterparts. Moreover, women generally lack access to start-up capital or working assets, they face severe obstacles in accessing services and securing property rights, and they are regularly subject to unequal wage distribution. Within the context of these challenges, microfinance can play an important role in enlarging women's access to services and jobs. Studies have shown that women are not only capable of individual enterprise development, but that they also tend to be more careful in business administration and decision-making, more responsible in compliance with assumed obligations, and more cautious in avoiding unnecessary risks. Finally, existing microcredit experiences show that the majority of individuals borrowing money for the short term are women. Development theories argue that women are more likely than men to invest income in household well-being and on their children's future, a prediction that has been shown correct in numerous microfinance programs. Microfinance records also report that women have some of the best repayment rates among microfinance clients. Perhaps even more important than improvements in family income and well-being is the impact of financial services on women's empowerment. Those women who can access services become more self-confident, more assertive, more willing to participate in family decisions, and better able to face gender challenges. Effective microfinance programs have had a strong positive impact on women's self-esteem and have resulted in women owning more assets and having a more active role in budget decisions. However, women's empowerment does not invariably follow from the implementation of microfi- 11 CGAP, Phase III Strategy , Panjaitan-Drioadisuryo, D.M. Rositan, and Kathleen Cloud, "Gender, Self-Employment, and Microcredit Programs: An Indonesian Case Study", Quarterly Review of Economics and Finance 39 (1999). 13 CGAP, Focus Notes. 24, Syed Hashemi, Consultative Group to Assist the Poor in id21 insights, issue #5. 22

24 CHAPTER 1 Conceptual framework nance programs. Given the complexity of gender issues, services must be specially designed with gender-specific requirements. For example, any assets purchased with loans to women should be registered in their names to both increase their control over assets and decrease the risk that other family members will misappropriate or otherwise misuse the women's increased income. Some MFIs, including the Grameen Bank, include this and other conditions in their operations to maximize women's empowerment. 1.5 Challenges, findings and conclusions Microfinance has catalyzed opportunities for millions of poor people. While many have already had the chance to become economically productive members of society as cash income earners and entrepreneurs, the number that have not had this opportunity is even larger. It is in fact for many of these most vulnerable individuals that the impact of microfinance is most significant and convincing. The challenge is to create a financial sector that serves these groups -- an inclusive financial sector for all. Microfinance has already proven to be an effective tool to fight poverty and a useful means to achieve the MDGs in a sustainable way. Yet the impact of microfinance is not limited to the creation of new and diversified incomes -- the positive personal and social outcomes are often even more striking. The enhancement of selfesteem, the expansion of people's choices and the empowerment of women are among the best assets produced by micro loans. In summary, some of the main findings of CGAP experts regarding microfinance are included in the Box 1.4 below. BOX 1.4 Key messages for the Year of Microcredit The poor need a variety of financial services, not just loans. Microfinance is a powerful instrument against poverty. Microfinance means building financial systems that serve the poor. Financial sustainability is necessary to reach significant numbers of poor people. Microfinance is about building permanent local financial institutions. Microcredit is not always the answer. Interest ceilings can damage poor people s access to financial services. The government s role is as an enabler, not as a direct provider. Donor subsidies should complement, not compete with private sector capital. The lack of institutional and human capacity is the key constraint. The importance of financial and outreach transparency. Source: CGAP, Key Messages for the Year of Microcredit 2005, 23

25 Microfinance in Kazakhstan: an inclusive financial sector for all CHAPTER 2 MICROFINANCE GLOBAL DEVELOPMENT 2.1 International initiatives in support of microfinance The Microcredit Summit Campaign and beyond Our purpose as an assembly is to launch a global campaign to reach 100 million of the world s poorest families, especially the women of those families, with credit for self-employment and other financial and business services by the year We commit to the development of sustainable institutions, which assist very poor women and their families to work their way out of poverty. Microcredit Summit Declaration 1997 Considered the first major international effort to address and support microfinance activities, the International Microcredit Summit took place in Washington DC in February As part of its efforts to launch a global anti-poverty movement with the development of microcredit at its core, the summit committed itself to achieving an important goal: ensuring that 100 million of the world's poorest families were receiving microcredit by the year The summit, and the valuable resources on microfinance practices it generated, created an impetus that a year later led the United Nations General Assembly to declare 2005 as the International Year of Microcredit. As it approached the international community to push the implementation of microcredit programs around the world, the General Assembly suggested that all parties engaged in poverty reduction take additional measures to make available loans and related services for the poor to facilitate opportunities for self-employment and other profit-making activities. Specifically, the UN proposed that governments, NGOs, the private sector and the mass media include microcredit in their poverty reduction strategies, underlining its contribution to social development and its positive influence on the lives of people living in poverty. Many countries took up this challenge during the 2002 World Summit on Sustainable Development in Johannesburg, South Africa. There governments tried to negotiate a common plan of action for microfinance development, setting the following objectives: to build and strengthen microcredit and microsavings networks to provide services and share experiences; to introduce training programs for MFI staff and clients; to promote adequate policies and legislative frameworks for the development of microcredit. The latest State of the Microcredit Summit Campaign Report (2004) reveals that progress has been made towards the goal set back in As of December 2003, approximately 2,936 microcredit institutions reported an outreach of about 81 million clients, 55 million of whom are considered among the poorest. When counting family members, this outreach is estimated at 274 million people. Moreover, the annual client growth rate averaged just under 39 percent between 1997 and Based on this success, at the recent Latin America/Caribbean Microcredit Summit in Santiago, Chile, it was announced that the campaign would be extended to 2015 to better contribute to achieving the MDGs. The new goal of the campaign is twofold: to ensure that 175 million of the world's poorest families are receiving credit and related services for self-employment by the end of 2015, and to ensure that 100 million of the world's poorest families move from below USD 1 a day to above USD 1 a day by the end of

26 CHAPTER 2 Microfinance global development The International Year of Microcredit 2005 "The great challenge before us is to address the constraints that exclude people from full participation in the financial sector. The International Year of Microcredit offers a pivotal opportunity for the international community to engage in a shared commitment to meet this challenge. Together, we can and must build inclusive financial sectors that help people improve their lives." Kofi Annan (UN Secretary General) The 2005 International Year of Microcredit (IYM) aims at building an inclusive financial sector and strengthening the entrepreneurial spirit existing within impoverished communities. To this end, the IYM has among its goals: to increase public awareness and understanding of microfinance, particularly its contribution to poverty alleviation; to develop strategies to include and consider microfinance as a part of every country's financial system; to enable MFIs to become more effective in servicing the poor; to strengthen donor and government capacities to support MFIs; to expand MFI outreach by encouraging partnership among governments, the United Nations, the private and public sectors, and non-governmental organizations. 1 Within this large IYM framework, three major initiatives have been undertaken: the Global Microentrepreneurship Awards: Celebrating Entrepreneurship Around the World; the Data Project: What Type of Access Do Poor and Low Income People Have to Financial Services?; and the Blue Book Project: Why Are So Many Bankable Clients Unbanked? The last of these initiatives, the Blue Book Project, is a particularly innovative global project designed to address the challenges of microfinance by identifying key constraints and opportunities. Led by the United Nations Capital Development Fund (UNCDF) in collaboration with the World Bank, International Monetary Fund (IMF), International Labor Organization (ILO) and International Fund for Agricultural Development (IFAD), this project is based on the commitment of Secretary General Kofi Annan to the goal of "addressing the constraints that exclude people from full participation in the financial sector" and the global commitment to collective action established during the 2002 International Conference on Financing for Development in Monterrey, Mexico. The conclusion of the project will be marked by the publication and dissemination of the Blue Book on Building an Inclusive Financial Sector CGAP, UNCDF and other international organizations The Consultative Group to Assist the Poor (CGAP), a consortium of 28 public and private development agencies, is considered one of the world's leading microfinance think tanks. In its efforts to realize a world where all poor people have permanent access to affordable and client-responsive financial services, CGAP has become an effective platform to generate global consensus on microfinance standards and norms. In its five focus areas -- financial transparency, enabling policy frameworks, poverty outreach, institution building, and donor effectiveness -- CGAP serves a variety of roles. First and foremost, CGAP is a resource center for the entire microfinance industry, where it incubates and supports innovative products, ideas, and cuttingedge technology for MFIs. As well, CGAP provides microfinance stakeholders (development agencies, MFIs, government authorities, auditors and rating agencies, etc.) with advisory services, training, and research services. Finally, CGAP is also active in consensus building and information sharing, with its concept dissemination and best practices analysis among its most successful activities. The United Nations Capital Development Fund (UNCDF) also has developed a special expertise in microfinance. UNCDF supports the development of reliable and sustainable MFIs through several different means. Its Special Unit for Microfinance (SUM) uses experienced practitioners to help develop a range of financial services for the poor. SUM supports the MicroStart program, which seeks to innovate in the development of new microfinance ventures by supporting young and promising financial operators in a sustainable manner. SUM also supports the MicroSave program, which promotes savings systems in Africa. Services are tailored to support countries with emerging microfinance sectors and include grants International Year of Microcredit brochure,

27 Microfinance in Kazakhstan: an inclusive financial sector for all and soft loans, technical and policy guidance, training and information dissemination. In addition to these two leaders, the United Nations Development Organization, World Bank, UN Food and Agricultural Organization (FAO), ILO, IFAD and other international organizations have committed to developing microfinance by contributing their knowledge and resources. Perhaps even more important are the international NGOs, which are sharing and disseminating their successful experiences to sister organizations all over the world. 2.2 Microfinance best practices International experiences and lessons learned Over the last few decades a large collection of resources, tools, guidelines, training courses and best practices for NGO, MFIs and donors have been produced and disseminated in the area of microfinance. From this vast collective experience, one fact soon emerged: while the economic and poverty alleviation goals of microfinance are the same around the world, microfinance solutions must be tailored to the different needs of each individual country. Microfinance is a flexible tool that has been adapted to the most varied conditions around the world. Indeed, many successful examples exist and can be chosen as best practices for adaptation on the basis of local needs assessments. There is now global consensus that any player involved in microfinance activities, including MFIs, the government, the financial sector, or donors, should conform with international practice standards. Below are some of the most important lessons learned. Poor clients are willing to pay for a variety of financial services. Even the poorest save. Financial sustainability is the key to offer durable and valuable microfinance services to the poor and to expand outreach. Financial services should be tailored to client needs and not be supply driven. MFIs, and not donors, should design services for the poor. The time needed to reach financial sustainability can vary from 5 to 10 years depending on the country environment. MFIs should invest in efficiency to reduce costs and provide high-quality services. National level microfinance associations can support capacity building of MFIs and influence the political agenda. Accurate and comparable financial statements are essential for all stakeholders. A government's primary role is as a facilitator, not as a direct provider of financial services. Interest rates should be market-oriented. Replication and expansion are necessary. NGOs need specific training. National coordination and strategy ownership are needed. Impact upon the poor should be measured. Many official microfinance poverty alleviation programs have not been effective in the past. Several obstacles to the development of microfinance exist in many developing countries. These typically include: political interference in program implementation and in the selection of eligible borrowers; little knowledge and understanding amongst policy makers and regulators on microfinance; lack of a sound legislative framework for microfinance activities, and in particular lack of regulations that allow MFIs to collect savings and impose collateral requirements; distorted interest structures and interest rate caps; weak institutional and human capacities; an underdeveloped and unreliable financial sector; non-availability of well-planned and wellstructured support services (e.g., rating services, training centers, etc.); presence of government or donor-subsidized loan programs; lack of retail capacity that bottlenecks microfinance development. Addressing these barriers is necessary for creating a healthy environment for microfinance activities International best practices Two highly successful MFIs -- the Grameen Bank in Bangladesh and Fundusz Micro in Poland -- give some sense of the variety of microfinance experiences across different regions. Bangladesh's Grameen Bank is arguably the world's best-known MFI. From its founding in 1976 within a research program, Grameen has grown through its exceptional success in reducing poverty to become an independent bank with special status: the Central Bank of Bangladesh, which owns a relevant share in Grameen Bank, regulates only its network extension. At present, the Grameen 26

28 CHAPTER 2 Microfinance global development Bank covers practically all rural areas in Bangladesh and extends its services mainly among poor women. Every month, the Grameen Bank grants loans totaling USD 25 million and serves more than 2 million borrowers in 36,000 Bangladeshi villages. The Grameen Bank applies operational models based on a credit-saving scheme. After genderbased loan groups are formed according to income levels, the microcredit process begins with small weekly contributions by group members to a savings pool. Obligatory savings deposits are made 3-4 weeks before the loan extension, and during the first stage only group members can apply for loans. Once loans are disbursed, repayment takes place in equal installments over 50 weeks and the borrower must contribute 5 percent of the loan amount into the group savings fund. Because the Grameen Bank grants loans to people who have no education, property, or expertise, group relationships form an alternative collateral; the group is responsible for loan repayment in case an individual fails to do it. Five to eight groups then join together to form a "development center" run by a chairman and secretary. To promote discipline, timely repayment, reporting, and credit recovery, participation in weekly group meetings is obligatory for all members. Transparency is maintained throughout, with all operations made openly at the meetings and in the center. If a group successfully fulfills all its obligations, loan terms can be expanded. These loans can range from USD with a 20 percent annual interest rate. During the entire process, loan groups are supervised and supported by a Grameen Bank officer who manages loan provisions and monitoring for an average of clients a month. While the Grameen Bank has achieved success in Asia, the Polish Fundusz Micro Fund has proven to be one of the most notable microfinance institutions in Eastern Europe. Fundusz Micro, an NGO MFI, was established in 1994 by the Polish American Enterprise Fund (PAEF) to promote the development of micro enterprises in Poland. It now has 32 branches operating in all regions of the country. The fund has served 33,800 micro enterprises throughout Poland, with a total loan disbursement of about USD 170 million. The fund combines lending services with savings collection, training and consulting. Using individual, group and rotational models, the fund employees a set of standardized terms that typically include an average loan size of USD 1,500, a threemonth repayment period, and an effective interest rate of 35 percent. Forty-two percent of Fundusz Micro's borrowers are women and the delinquency rate is under 3 percent New challenges MFIs constantly encounter new challenges in their efforts to provide financial services to the world's poorest. Expansion is a central challenge -- MFIs must expand their outreach to rural and remote areas to meet the huge untapped market and expand their services with savings and insurance products to meet demand, all while maintaining financial sustainability. Creating a sound policy environment is also a constant concern. When MFIs reach a high level of development and a relevant number of clients, the management faces a different set of challenges involving transformation and the problem of finding new money through access to financial markets, savings collection and loans from commercial banks. In 1992, Banco Sol in Bolivia became one of the first NGO MFIs to become a commercial bank. Not long after, Banco Sol financially outperformed Bolivian commercial banks and gained access to international capital markets. Following this successful example, several other well-known NGOs in other regions transformed themselves into commercial banks between 1992 and This new option raised concerns over whether the poverty reduction goal of the NGOs might be damaged by the transformation. Yet while NGOs entered the commercial sector, commercial banks have begun downscaling programs in an attempt to reach the poor. 2.3 Microfinance in transitional economies and in Central Asia Overview of the social and economic aspects of microfinance in Central Eastern Europe and in the Newly Independent States Countries labeled as transition economies share one major historical commonality, namely a movement away from socialism and a centrally-planned economy towards democracy and a market economy. While many state-run companies were dismantled, growth of the private sector has been uneven. Self-employment and small businesses have been the main replacement for state-owned enterprises, but high taxation, excessive regula- 2 ADB, Great Expectations: Microfinance and Poverty Reduction in Asia and Latin America, ADB Institute Discussion Paper No.15,

29 Microfinance in Kazakhstan: an inclusive financial sector for all Table 2.1 Microfinance in Central Eastern Europe and in the Newly Independent States Institutions Number Portfolio outstanding (Mln. USD) Active borrowers ('000) Total deposit (Mln. USD) Active depositors ('000) Average loan size (USD) Credit unions 5, , , NGO MFIs , Commercial banks N.A. N.A. 7, Microfinance banks Total 5, , ,356 Source: MFC for CIS and NIS 2001 Depth Ratio (%) tions and corruption have hindered the formal sector. Even a decade after the fall of the Soviet Union, the old and the new systems continue to co-exist in many of these countries. This economic transition has had high social costs that include increased poverty, inequality, and unemployment. Many well-educated individuals formerly employed in state companies lost their jobs and have been unable to maintain their standard of living. The existence of these "new poor" distinguishes poverty in transitional economies from that in developing countries. Since the early 1990s, the countries of Central and Eastern Europe (CEE) and Newly Independent States (NIS) reformed their financial sector along the western model. Although private banking developed from privatization policies and foreign investment, many banks, particularly public ones, face challenges like weak governance, bad debts and undercapitalization. Even taking into account variations between countries, few of these financial institutions are focusing on small- or medium-size enterprises. MFIs have developed to serve the huge untapped market, but compared to other regions the outreach is poor: it is estimated that only 5 percent of the market is served. Nevertheless, the sector growth rate reported by the Microfinance Center (MFC) for CEE and NIS is remarkable: the number of clients grew by 30 percent a year over ten years. By 2001, MFIs had reached 1.7 million borrowers and 2.3 million depositors in the CEE and NIS 3. The contribution of MIFs to poverty reduction and business development has been significant, even if the outreach is far from optimal. Table 2.2 Top 10 MFIs in CEE and NIS (number of clients) MFIs Country Type Year of operation Number of borrowers Notes: 1 OSS = Operational Self Sufficiency 2 ROA = Return On Assets 3 Depth ratio = average loan balance as percentage of GDP per capita Source: MFC for CEE and NIS 31/12/2002 Loan portfolio (Mln USD Profitability (OSS1 or ROA2) Microfinance Bank Georgia MFB , KMB Bank Russia MFB , Kyrgyz Agricultural Finance Corporation Kyrgyzstan Public Company Depth Ratio3 (%) , FINCA Kyrgyzstan NGO ,789 4, Constanta Foundation Georgia NGO , Mercy Corps Women's MicroCredit Program Kyrgyzstan NGO , UMCOR/AREGAK Armenia NGO , XAC Bank Mongolia MFB , FORA Russia NGO , Microfinance Bank of Serbia Serbia MFB , Microfinance Centre for CEE and NIS, The State of Microfinance,

30 CHAPTER 2 Microfinance global development Transitional economies share certain features in common: risks associated with inflation and devaluation; high tax rates on public sector enterprises; prevalence of cash in the payment system; exposure of creditors and clients operating outside the banking system; lack of a reliable system of communications and information on the microfinance services market. Within this context, regional differences between Eastern Europe and Central Asian states can be substantial, particularly in regard to levels of economic development and the prevalence of certain kinds of organizations. For example, the development of credit unions was remarkable in Eastern Europe, while in Central Asia they scarcely exist. Despite the equal availability of donor funds (mainly from European Bank for Reconstruction and Development and European Union/Tacis), the most developed MFIs can be found in Eastern Europe and in the Caucasus while the lowest levels of activities are in Central Asia and Russia. Due to the fact that the development of microfinance varies considerably between sub regions, the following pages will focus on Central Asia exclusively Microfinance in Central Asia Microfinance is relatively new to Central Asia, first arriving in the region only during the mid-1990s. As a result of this late start and lack of systematic data, it is hard to draw a comprehensive picture of the sector. Nevertheless, in 2001 and 2002 the MFC for CEE an NIS and the World Bank conducted two surveys of microfinance developments in the region that showed promising initial results: microfinance institutions have been established and actively operate with the support of governments and international organizations. The World Bank, as of December 2002, estimated outstanding loans for MFIs operating in Central Asia at USD 200 million, with a yearly growth rate of nearly 40 percent. These loans are going to an estimated 200,000 microfinance clients, a client base that is itself growing at percent per year 4. These numbers indicate both that microfinance sector development is at an early stage and that the potential of microfinance outreach is wide. Table 2.3 Institutions MFIs in Central Asia Number Portfolio outstanding (Mln. USD) Active borrowers ('000) Credit unions NGO MFIs Commercial banks Microfinance banks 1 n.a. n.a. Total Source: WB 2003 survey While credit unions rank first in terms of the sheer number of institutions in Central Asia, they are comparatively small in terms of number of clients and portfolio size. Rather, MFIs operated by NGOs achieve the greatest outreach, while commercial banks own, as expected, the largest outstanding portfolios. Indeed, NGO MFIs and commercial bank downscaling programs dominate the microfinance market in Central Asia. Good performance was achieved by only small number of NGO MFIs, such as the Foundation for International Community Assistance (FINCA) and Mercy Corps in Kyrgyzstan and the Kazakhstan Loan Fund (KLF) in Kazakhstan. The majority remain small, young and with limited financial sustainability. Among commercial banks, those in Kazakhstan attained the widest outreach, but they serve only the richest among the poor 5. Only one microfinance bank has so far been established and is located in Tajikistan. In their most recent survey, the Microfinance Center found that half of the MFIs interviewed have less than 500 clients. On the other side there are on average 3,300 active borrowers per MFI, indicating that there are several institutions serving more than 10,000 clients 6. Considering that MFIs in the region are the youngest in world, their financial and operational efficiency levels are good, if varied. The Microfinance Bulletin estimates that Central Asian MFIs have operated on average for four years compared to the global average of eight years 7. The Microfinance Bulletin sets the average operational selfsufficiency ratio at 135 percent in Central Asia (compared with 117 percent in CEE and NIS), the highest among the sub regional groups. Regarding MFI productivity (measured here as active borrowers per loan officer), figures indicate that Central Asia stands behind the best performers in CEE and NIS: there are 123 active borrowers per loan 4 World Bank, Microfinance and the Poor in Central Asia, Microfinance Centre for CEE and NIS, The State of Microfinance, Microfinance Centre for CEE and NIS, MFC Spotlight Note 12, Microfinance Bulletin, Benchmarking Microfinance in Eastern Europe and Central Asia,

31 Microfinance in Kazakhstan: an inclusive financial sector for all officer in Central Asia compared with 219 in the Caucasus and 206 in the Balkans 8. Three Kyrgyz MFIs figure among the Microfinance Center's top ten list, and successful examples can also be found in Kazakhstan. However, local MFIs serve their clients mainly through working capital loans, while insurance and savings (except compulsory savings) services are not provided. Central Asia MFIs also offer a smaller number of loan products in comparison with CEE and NIS due manly to limited outreach. The table below shows that microfinance services in Central Asia target the poor. The depth of outreach compares GDP per capita with average loan size. Generally a ratio under 250 percent indicates that the poor are the main clients; in all four states considered (Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan) the level is far below this line. However, it is clear that only a tiny percentage of the poor benefit from the access to financial services. The best performer, Kyrgyzstan, still has an outreach ratio of 3 percent, a level far below that of Eastern Europe. The untapped market is even bigger for the other three countries, which do not go beyond the 1 percent threshold. Table 2.4 Outreach indicators Microfinance clients as % of total poor Microfinance clients as % of rural poor Depth of outreach (%) Source: WB 2003 survey Outreach indicators for Central Asia Kyrgyz Republic Kazakhstan Tajikistan Uzbekistan The degree of poverty in Central Asia ranges from Kazakhstan, the wealthiest country in the region, to Tajikistan, the poorest. Unemployment and low salaries are among the main causes of poverty, which is concentrated in rural areas. Microfinance has shown it can alleviate poverty in the region, but the rural outreach is still minimal. Part of this problem stems from the fact that MFIs are often based only in the main cities or in oblast capitals, even though about half of the population lives in the countryside. As well, MFIs usually serve the unfulfilled financial needs of the self-employed and small and micro entrepreneurs in urban areas, rather than targeting the poor in less accessible areas. Given their differences in levels of social and economic development, financial sector development and the number and characteristics of the poor, Central Asian countries not surprisingly have varying microfinance environments. The strongest MFIs are found in Kyrgyzstan and Tajikistan, while in Kazakhstan and Uzbekistan microfinance outreach is very limited in relation to total population. A brief summary of the current microfinance situation in each country is provided below: Kazakhstan is the wealthiest and most developed country in the region. It is equipped with an advanced and liquid financial system, but the microfinance sector is underdeveloped. Because MFI activities are concentrated mainly in urban areas, outreach is below 1 percent of the poor with about two million rural people lacking access to financial services. MFIs' operation sustainability varies, but the cost of activities is among the highest in the area. Several commercial banks are engaged in microlending and the government has drafted a large state support program for small and medium enterprises. Kyrgyzstan is a poor country with a low level of economic development and a relatively underdeveloped financial sector. Despite these factors, microfinance outreach is the best in the region, even in rural areas. Of the significant MFIs operating in the country, three are among the top ten in the CEE and NIS region -- the Kyrgyz Agriculture Finance Corporation, FINCA and Mercy Corps women's microcredit program. The country offers one of the best legislative environments to support microfinance sector development. Success has even allowed some MFIs to access commercial funds. The portfolio growth of credit union MFIs in particular must be noted. This development should be studied in more detail to share good practices and experiences in regions where these MFIs are underdeveloped. Tajikistan was seriously weakened by civil war during the 1990s and remains the country with the lowest per capita GDP within the NIS. The economy is highly dependent on agriculture and remittances, and the financial system is weak and undercapitalized. Microfinance is developing quickly in the country, but outreach remains below 1 percent. Specialized NGO MFIs provide the most financial assistance to the poor. New microfinance 8 Microfinance Centre for CEE and NIS, MFC Spotlight Note 12,

32 CHAPTER 2 Microfinance global development legislation was enacted in 2003 and the region's only microfinance bank initiated its activities in the country. Uzbekistan's microfinance sector is only at a very early stage of development. MFIs, often started as NGOs launched by international donor programs, suffer from a weak and government-controlled financial sector. Commercial banks are not currently involved in microfinance. Despite having the fastest microfinance demand-driven growth in the region, the legal and regulatory environment is inadequate due to detrimental state policies such as interest rate caps. The new law on credit unions helped establish some institutions, but their scale of operations is still minimal. 2.4 Major findings and conclusions The International Year of Microcredit 2005 concludes a period of strong development for microfinance theory and practice. Since the International Microcredit Summit, international microfinance awareness campaigns have been able to reach both donors and the wider public. International consensus now considers microfinance as one of the main tools for reducing poverty and improving people's well being. Yet while many international organizations and numerous NGOs have raised funds and developed strategies in support of microfinance activities, the global outreach of microfinance is far from optimal. Microfinance arrived in Central Asia only in the early to mid 1990s, leaving countries in the region far behind the world's average for development in the sector. Despite this late start, one of the highest growth rates in the world has quickly begun to reduce this gap. Indeed, the financial and operational efficiency levels of Central Asian MFIs show good results, but access to microfinance services remains limited. Microfinance has shown positive impact on poverty alleviation among the CEE and NIS countries, with successful examples in Russia, Poland and other parts of Eastern Europe. Of all the best practices gathered through research into the wide variety of existing microcredit methodologies and practices, it is acknowledged that one remains paramount: any scheme should be tailored to the specific needs of poor clients, taking into account local traditions, customs, legislation and economic structures. For example, while a wide range of microfinance programs from around the world could be adapted to Kazakhstan, their success will depend on how well they account for Kazakhstan's unique characteristics in terms of its people, culture, history and current level of socioeconomic development. 31

33 Microfinance in Kazakhstan: an inclusive financial sector for all CHAPTER 3 MICROFINANCE IN KAZAKHSTAN 3.1 Background The main conclusions and recommendations of this report are based on a number of important studies that were recently conducted on the microfinance sector in Kazakhstan. Chief among these was a UNDP-sponsored survey conducted by the Institute for Social Survey in February and March The survey included focus groups and in-depth interviews in 6 of Kazakhstan's oblasts. UNDP and the Association of Microfinance Organizations in Kazakhstan organized another survey in August and September 2005 to assess the supply of microfinance in Kazakhstan. Other resources contribute to this analysis of the microfinance sector in Kazakhstan as well, including the following: A study entitled "Justifying Areas of UNDP Technical Assistance to Support Microcredit Development in Kazakhstan" conducted in This study included interviews with 17 experts, whose answers provided an overall picture of microcredit in Kazakhstan at that time. A study entitled "Financial and Credit Support of Small Enterprises in Kazakhstan" conducted in 2003 by the NGO Kazakhstan Business Service. A survey of microfinance in Central Asia conducted in the winter of 2003 by the World Bank. This report provides an overview of the major types of -- and detailed financial information about -- existing MFIs in Central Asia. A report entitled "Reviewing Microcredit Agency Operation and Developing the Concept of Microcredit Agencies to Enhance Access to Financial Resources: Analyzing and Developing Monitoring Indicators" published in 2003 by the TENIR-Project Company. This report includes a brief narrative based on research conducted by the Center for Marketing and Analytical Research. These analytical works include a number of common conclusions: Although there are several successful MFIs with 6-7 years of experience in Kazakhstan, microfinance remains a relatively new concept here. Many MFIs remain at the stage of experimentation in their development. Microfinance reduces the activities of moneylenders and promotes the entry of entrepreneurs into the formal economy as well as increasing the attractiveness of such entrepreneurs as creditworthy clients for the formal financial sector. The Government should continue strengthening the environment for MFIs, including removing administrative barriers, further developing the economic infrastructure, and facilitating the development of services for MFIs. Overall, systemic actions on the part of the Government, donor community and NGOs are helping to create a network of experienced microfinance organizations. Such organizations in turn will help ensure increased access to financial resources in the future for enterprises and individuals who are currently excluded from the formal financial system. 3.2 Microfinance sector outlook Often the terms microfinance and microcredit are considered to be synonymous. In Kazakhstan, there appears to be some confusion between these terms as well. In fact microfinance refers to a full range of financial services, whereas microcredit refers only to a specific type of financial service. Unfortunately, Kazakhstani legislation recognizes only the concept of microcredit even though microcredit services are being provided not only by microcredit organizations (MCOs), which operate under the "Law on Microcredit Organizations," but also by other non-banking financial institutions (NBFI) that specialize in providing micro loans. This report includes all such organizations in the term "microfinance institutions" (MFIs). During the second half of the 20th century, microfinance developed quickly around the globe. In recent years the trend has been to diversify financial services based on market demands. Microfi- 32

34 CHAPTER 3 Microfinance in Kazakhstan nance is considered to be especially attractive for transitional economies, as shown by the experiences of Eastern Europe and the Balkans. Present circumstances suggest that dramatic growth in microfinance services could take place in Kazakhstan as well. Indeed, since Kazakhstan's independence, supporting low-income groups has been a priority of the Government's social and economic development strategy. As in many other transitional economies, the promotion of small and micro enterprises is considered to be one of the most effective methods to address poverty. Microfinance is a central component of such growth. In fact, since the initial development of its own market economy, Kazakhstani consumers and entrepreneurs have been demanding more and more access to financial services. The distinctive features of microfinance in Kazakhstan derive from its unique socio-economic context and the characteristics of its financial system. Important factors include good performance in the banking sector, positive trends in the industrial and agricultural sectors, and a low population density. According to Standard & Poor's, Kazakhstan's banking system is more developed than in many other CIS countries 1. Tougher banking regulations in the 1990s, recalls of licenses and mergers resulted in the consolidation of banks, the number of which fell from 44 in 2000 to 36 in Further consolidation and concentration presumably will take place in the future as a result of continued high growth in this sector. Other distinctive features of Kazakhstan include its unique geography and demographic profile. The most successful examples of microfinance are found in Bolivia and Bangladesh, both of which have rather high population densities. In contrast, Kazakhstan has only 15 million people in a vast territory of 2,725,000 square kilometers. Thus, further development of the microfinance sector in Kazakhstan faces a paradox. On the one hand, high economic growth, a revival in domestic demand, progress in the regulatory framework, and improvements in banking credit and management systems are all positive signs for future development. On the other hand, Kazakhstan's limited market size, low population density, uneven distribution of human resources, and patterns of internal migration and livelihoods could constrain such development. In any case, bank credit remains inaccessible to many small enterprises and individual entrepreneurs. This situation in itself creates an incentive to further develop microfinance as an integral part of the country's financial system and poverty reduction strategy. The advent of microcredit in Kazakhstan is associated with the establishment of a legislative framework in the mid-1990s with adoption the "Law on Banks and Banking Activity." This resulted in the emergence of banks along with new participants who later became the main promoters of microfinance: non-banking financial institutions, credit partnerships, and pawnshops. Initially, the Government concentrated its efforts primarily on strengthening the banking sector and credit partnerships (e.g., the Agrarian Credit Corporation), while international organizations focused on microfinance projects to provide financial services to the poor (e.g., the Kazakhstan Loan Fund, Asian Credit Fund, etc.). The development of pawnshops was solely the result of private sector activity. Finally, the adoption of a 3-tier credit system and related laws on credit partnerships and microcredit organizations became the foundations in promoting microfinance in Kazakhstan. The organizations listed in the following chart make up today's microfinance sector in Kazakhstan. Table 3.1 Microfinance institutions in Kazakhstan Level Actors Number I Second-tier banks (including EBRD Downscaling Programme) 7 II Non-banking financial institutions 32 Credit partnerships 89 Pawnshops 78 III Microcredit organizations 208 TOTAL Microfinance institutions 414 Source: National Bank of Kazakhstan, 1 March Standard and Poor's, Bank Industry Risk Analysis: Kazakhstan (Republic of), National Bank of Kazakhstan, 1 January

35 Microfinance in Kazakhstan: an inclusive financial sector for all According to the latest official figures, there are over 400 registered microfinance institutions in all three levels of the financial system. However, these figures should be taken with some caution since not all of the listed organizations are in operation, and many have only a small number of clients and/or limited turnover. Although the seven banks listed above have active microcredit downscaling programs, non-banking financial institutions, credit partnerships, pawnshops, and microcredit organizations constitute the vast majority of entities serving this sector. As well, although not listed in this table, informal lending activities have not disappeared based on the continuing high level of demand for microcredit. Further development of the microfinance sector could positively affect the social and economic development of the country. The following outcomes are of particular relevance for Kazakhstan: Increased living standards and poverty reduction as additional income is used to improve quality of life, increase economic security and alleviate poverty; Employment creation as new and expanded businesses help create jobs; Personal empowerment as microfinance helps increase choice and expand opportunities; Gender equality as microfinance borrowers are often women; Entrepreneurial development as the incentives grow to set up and expand small businesses; Business promotion as improved financial skills and credit histories facilitate the access of small entrepreneurs to formal sector bank loans. Thus, in addition to being an important part of the financial system, microfinance could very well help address many of the economic and social challenges currently faced in Kazakhstan. Thus it will be vitally important to promote and monitor the impact of microfinance on social and economic development in the years to come. 3.3 Microfinance in Kazakhstan: institutional outline Microfinance stakeholders The main stakeholders in the microfinance sector in Kazakhstan are: the state; international organizations; commercial banks; NGOs and credit partnerships; and the Association of Microfinance Organizations in Kazakhstan. On the macro-level, the main function of the state is to develop a conceptual approach, establish a legislative basis, set up the institutional infrastructure, and create appropriate opportunities. On the meso-level, state support is effected through developing specialized sectoral programs and allocating resources from national and local budgets. In Kazakhstan, the state is involved in supervising commercial banks and non-banking financial institutions, while microcredit organizations are exempted. Although the state budget financed several microfinance projects during the past ten years, these achieved only limited results due to the lack of experience and a clear strategy. New measures to promote microfinance are currently being supported. International organizations, such as UNDP and the World Bank, contributed to the formation of the microfinance sector in Kazakhstan. Bilateral donors, such us the US Agency for International Development (USAID), also participated actively by funding several projects. Major international NGOs operating in Kazakhstan, such as the Soros Foundation, Eurasia Foundation and Mercy Corps, also contributed. The role of development banks was notable in promoting downscaling programs in commercial banks. Through advocacy, grants, concessional loans and technical assistance, international organizations promoted reforms and helped MFIs to grow. Although Kazakhstan's financial sector is well developed compared with other countries in the region and many reforms have already been undertaken, commercial banks have only had a limited impact on microfinance. The most notable results have been achieved through downscaling programs supported by international development banks. The recent emergence of loan agreements between leading MFIs and banks is opening new doors for future development of the sector. Although the state, international organizations and commercial banks have all supported the development of microfinance in Kazakhstan, NGOs and public funds have in fact been the main providers of microfinance services on the ground. Indeed, in their work with socially-vulnerable groups, NGOs were among the first organizations in Kazakhstan to develop and implement effective methods for delivering financial services to the poor. Such NGO-MFIs were often established with the support of international donors through grants and technical assistance. However, given the economic development of Kazakhstan and the decline in donor funding, many leading MFIs 34

36 CHAPTER 3 Microfinance in Kazakhstan have now become non-profit organizations, often in the legal form of public funds. As of 1 March 2004, there were 36 NGO-MFIs providing microcredit services in Kazakhstan. Credit partnerships officially emerged in Kazakhstan in 1997 when the first regulations on credit partnerships were adopted. Currently the "Law on Credit Partnerships" 3 regulates their activities. Credit partnerships are defined as legal entities established to provide financial services to members by accumulating internal and external financial resources. Credit partnerships have been most effective in rural areas. However, rather than providing traditional agricultural loans, many such credits partnerships focus on more short-term loans with higher interest rates (up to 30 percent a year). The lack of reliable data on credit partnerships in Kazakhstan requires additional research to understand their effectiveness, usefulness and outreach. In the beginning of 2004, based on the initiative of leading MFIs, the Association of Microfinance Organizations of Kazakhstan (AMFOK) was created to help coordinate and promote microfinance. The main goals of the association are to further develop and strengthen the microfinance sector in Kazakhstan, to lobby government and legislators, to address social issues and economic problems by providing low-income people with access to financial services, and to provide technical assistance to its members. As of 31 August 2005, 31 MFIs had joined AMFOK. Such an umbrella organization is vital for further development of the microfinance sector Financial sector developments: the three-tier model The "Concept of Finance Sector Development in Kazakhstan" was adopted by the Government in mid-2003 to further streamline the development of Kazakhstan's financial sector by identifying main targets and priority areas for the period This concept presented a three-tier model for the sector: 4 Level 1: commercial banks Level 2: non-banking financial institutions, credit partnerships, pawnshops Level 3: microcredit organizations This framework suggests that institutions in the second and third tiers will deliver microfinance services. Credit partnerships, pawnshops, mortgage companies and other organizations providing licensed banking services comprise the second tier. The target clients of such organizations include small and medium enterprises (SMEs) and individuals. The third tier is comprised of organizations engaged only in microcredit. The "Law on Microcredit Organizations," adopted in March 2003, allows MCOs to work with less regulation, for example, without formal licensing. Kazakhstan MCOs only have to register with the Agency of Statistics and local juridical bodies. There are no additional requirements from the National Bank for licensing and monitoring. This approach is driven by the desire to promote the development of a network of MCOs. Equally important is the desire to significantly reduce the expensive forms of informal lending, which are currently the main source of financing for micro entrepreneurs. MFIs generally deliver services that are complementary to commercial banks. Commercial banks are often not interested in micro loans because of their relatively high transaction costs, and micro enterprises are often not able to meet the conditions required for commercial loans, especially with regard to collateral. MFIs on the other hand are more willing to conduct relatively small financial operations because they have developed effective technologies to ensure profits and lower risks even with relatively small loans. MFIs also have a comparative advantage in rural areas, especially through the use of membership organizations such as credit unions or cooperatives. Thus MFIs fill a gap in providing services that are normally beyond the interests of commercial banks. At the same time, MFIs contribute to strengthening commercial banks by actively mobilizing savings, encouraging successful entrepreneurs to set up SMEs, and preparing clients for entry into the formal financial system. This three-tier concept of financial services underlies the overall structure of the financial system in Kazakhstan. Such a structure is intended to promote a range of actions to: improve the banking system; promote fair competition among banks; upgrade the normative and regulatory framework of credit partnerships and pawnshops; develop state support mechanisms for MFIs; provide preferential taxation for MFIs; and approve and implement a public microcredit program that includes training and technical assistance 5. Relationships between financial institutions in each of the three levels should move further towards building partnerships and expanding outreach and services. 3 Law on Credit Partnerships as of 28 March Government's Decree #753 as of 28 July Kazakhstanskaya Pravda Newspaper, 19 December

37 Microfinance in Kazakhstan: an inclusive financial sector for all Evolution of microfinance legislation Three main laws regulate Kazakhstan's financial sector. An overall framework is provided by the "Law on Banks and Banking Activity," while two other laws on microcredit organizations and credit partnerships -- enacted in provide specific regulations for MFIs. The legislative foundation of Kazakhstan's financial market is the "Law on Banks and Banking Activity" adopted in the mid-1990s. Thus, in the beginning, microfinance licenses were distributed among different institutions unified by the framework of a single law. It was necessary at that time for the organizations involved in microfinance to be under National Bank's supervision, encouraging the establishment of clear and transparent activities. As the microfinance sector developed, two new laws were approved: the "Law on Credit Partnerships" and "Law on Microcredit Organizations." Later, the three-tier credit system acquired more weight with the Government decision to approve this conception of the financial sector. The "Law on Microcredit Organizations" places MCOs under market principles and establishes the basis for simplified procedures to establish new MCOs. MCO activity does not require licensing and is not under central bank surveillance. The "Law on Credit Partnerships" considerably increases the effectiveness of the credit system through setting rules for credit unions. Along with pawnshops, mortgage companies, and other non-banking financial institutions, credit partnerships have become an important component of the second tier of the credit system. The law provides simplified tools for joining and leaving credit partnerships, equal rights for members, and simplified rules for creating, licensing and regulating credit partnerships. 3.4 Assessing microcredit demand and supply With the growth of microfinance activities in Kazakhstan and the establishment of a firm legal foundation as discussed above, this sections provides an assessment of the actual demand for microfinance in Kazakhstan and a description of the supply of microfinance services. Two different approaches are used to estimate microfinance demand: the standard of living approach and the private sector approach. Microfinance supply is assessed on the basis of existing legal categories of MFIs: commercial banks, non-banking financial institutions, credit partnerships and microcredit organizations Assessing microcredit demand Traditionally, microfinance was intended to support low-income people and stimulate entrepreneurship. The transition to a market economy caused uneasy transformations in the labor market and disruptions to the social benefit system in Kazakhstan. This process increased social vulnerability for a significant part of the population. Indeed, in the early years of the transition period, poverty became a serious problem as a result of the widespread closure of enterprises, forced vacations, unemployment, and high inflation. In 1998, almost 40 percent of the population (about 5,923,000 people 5 ) had incomes below the subsis- Table 3.2 Microfinance law framework # Law Date Summary 1. Banks and Banking 2. Microcredit Organizations 3. Credit Partnerships 31 August March March 2003 This law provides the legal framework for banking activities both for banks and organizations carrying out banking operations. It establishes registration procedures, organizational and legal structures, amounts of chartered capital, and operations and reporting requirements. It also defines the responsibilities of banks in: (a) disclosing their terms of operations, (b) granting special terms for individuals with whom banks have special relations, (c) regulating bank operations and (d) protecting the interests of depositors. The law also specifies the supervision authority under which banks and non-banking financial institutions operate. This law governs the relations in the provision of microcredit and provides specifics regarding the establishment, legal status, operations, and re-organization and liquidation of microcredit organizations. This law establishes a special regime for mutual credit, which allows access to credit for small enterprises. In addition, the law provides simplified procedures for private individuals and legal entities to set up and withdraw funds from credit partnerships, specifies the terms of participation in credit partnerships, and defines simplified procedures for their licensing and supervision. 36

38 CHAPTER 3 Microfinance in Kazakhstan Standard of living approach In the standard of living approach, the demand for microfinance is estimated conservatively by counting 20 percent of vulnerable households in the country. This value defines the percentage of households that most likely would want to access microfinance services. It is common practice to use the household as unit of analysis, since total household income is often used to verify repayment capacity 10. The number of vulnerable housetence minimum (i.e., the value of a basket of goods and services necessary to meet human basic requirements for living). In recent years this trend has reversed: between 1999 and 2002 aggregate GDP growth exceeded 40 percent. In 2003 and 2004, the economy continued to grow at a fast pace: the growth of real GDP equaled 9.5 percent and 9.2 percent respectively 6. By 2004, only 16.1 percent of the population lived below the subsistence minimum of KZT 5,427 per month (or about USD 3.5 per day at purchasing power parity), compared to 39 percent in Other indicators, such as poverty depth and severity, which characterize the income shortfall of the poor and the degree of inequality, clearly show improvements in the recent years as well. Yet, in spite of these remarkable improvements, many people continue to live in poverty today. In Kazakhstan, about 58 percent of the poor are people of working age, unemployed or with salaries so inadequate that they cannot provide for themselves 7. Proposed changes to the subsistence minimum value would change the percentage of people that are considered poor or near poor. Table 3.3 Poverty in Kazakhstan Proportion of population with income below Subsistence minimum Food basket Poverty depth Poverty severity % 16.2% 12.8% 3.8% % 4.3% 3.3% 1.0% Source: Agency of Statistics of Kazakhstan and UNDP, 2005 As in many other countries, the incidence of poverty in Kazakhstan is higher for the rural population than the urban population. In 2004, the poverty level was almost three times as high in rural areas as it was in urban areas 8. Higher levels of education and greater economic opportunities for urban residents are two of the main factors contributing to such differences. There are also important regional disparities: the ratio between the highest and lowest poverty rates in oblasts increased to 26.5 in Kostanay, Atyrau, Mangystau, Zhabul, South Kazakhstan and Kyzylorda oblasts are the poorest regions in the country with poverty rates higher than 18 percent. In addition, Kazakhstan suffered a crisis in its small towns (defined as towns with less than 50,000 inhabitants). The economy and social infrastructure of many such towns were dependent on state enterprises. Many of these enterprises failed during the transition process to a market economy, leaving a sizeable population without work. The Agency of Statistics in 2000 reported that unemployment levels in some small towns reached as high as 47 percent. In many such towns unemployment is chronic. Nearly 87 percent of the unemployed may be without employment for over 12 months, and even highly qualified workers often experience difficulties in finding employment. In light of the poverty situation outlined above, many people turned to microcredit during the transition period as a way to overcome the economic challenges they faced. By 2004, according to the Agency of Statistics, 50,600 people received microcredit loans, a 57 percent increase over the 32,300 people that received microcredit in Preliminary estimates for 2005 indicate that there are 60,000-70,000 active microfinance clients in Kazakhstan. Formal and informal sector enterprises (both in urban and rural areas), unemployed, and households are potential MFI clients. The potential demand for microfinance can be studied by understanding the type of perspectives of micro enterprises that look for financial resources to grow, and by understanding poor households that seek loans for a wider set of needs. Based on these considerations, two different models can be formulated to asses microfinance demand: Standard of living approach Private sector approach While these are not intended to provide precise figures, both models aim at building credible scenarios to indicate the magnitude of potential microfinance demand. Potential demand provides an indication of development and market opportunities. 5 Agency of Statistics of Kazakhstan, ADB, Development Prospects for Asian Countries, UNDP, Poverty in Kazakhstan: Causes and Cures, Agency of Statistics of Kazakhstan and UN Theme Group on Poverty Alleviation, Living Standards and Poverty in Kazakhstan, Agency of Statistics of Kazakhstan, Living Standards and Poverty in Kazakhstan. Preliminary data for

39 Microfinance in Kazakhstan: an inclusive financial sector for all holds is estimated using the concept of subsistence minimum defined by Kazakhstan authorities (i.e., people with incomes less than KZT 5,427 per month). Therefore, based on an estimated 687,755 poor households in the country, the demand for microfinance in Kazakhstan could include about 140,000 clients. Table 3.4 Microcredit demand - standard of living approach Average size of households Total population Vulnerable population* Vulnerable households* Microfinance demand 14,951,200 2,407, , ,551 *The vulnerable population is calculated using the 2004 subsistence minimum ratio of 16.1 % Source: Agency of Statistics of Kazakhstan, data for 2004 Private sector approach A more accurate picture is provided by looking at the private sector and the unemployed. However, it must be noted that these approaches are used only for rough estimates. Following this procedure, the potential demand for microfinance is estimated by looking first at the characteristics of the unemployed, and second at the number of SMEs in the country. The following refers mainly to data from the Agency of Statistics from The unemployment rate in Kazakhstan was 8.4 percent totaling 658,800 people, 42.7 percent men and 57.3 percent women respectively 11. The age distribution of the unemployed shows that almost half are in age brackets favorable to entrepreneurial activity. People with higher education and incomplete higher and special vocational education comprise 18 percent of unemployed men and 29 percent of unemployed women 12. A survey conducted by the Asian Development Bank shows that the unemployed in Kazakhstan are involved in different kinds of informal economic activities, such as farming small plots and small trade related activities. Unemployed earnings consist of income from household plots (26 percent), small trade (24 percent), temporary work (22 percent), grants from relatives (16 percent), sale of personal property (6 percent), rent revenues (3 percent), and begging and illegal operations (2 percent) 13. The social picture of managers/heads of SMEs helps identify the potential of the unemployed as entrepreneurs. Men and women aged comprise 40 percent of the managers/heads of SMEs, followed by people aged at 30 percent. While 65 percent of the managers/heads of SMEs have higher education, 25 percent have incomplete higher and secondary education. Differences in the education levels between men and women as managers/heads of SMEs are insignificant. The professional status of entrepreneurs was quite high before they entered the market. Almost half (45.5 percent) were previously employed as managers/ leaders, and 22.5 percent were specialists. In other words, the ranks of entrepreneurs are filled mostly by managers/leaders of all levels. These figures also indicate that a high percent of entrepreneurs are highly educated people 14. It is possible to estimate that about 20 percent of the unemployed have the required personal characteristics (age, education, professional experience) to launch entrepreneurial activities. Because they have to start their own businesses with little or no resources, however, it is likely that they would need the help of MFIs. Factors such as the lack of entrepreneurship skills and business knowledge (management, marketing, planning, etc.) may reduce the number of potential microfinance clients. The negative effects of these factors could be compensated through developing a network of educational, infor- BOX 3.1 Small and medium enterprises in Kazakhstan Individual enterprises are private individuals engaged in business activities without a legal identity and with no characteristics of a legal entity. Micro enterprises are private individuals or legal entities employing up to 10 people. Micro enterprises fall under the category of small enterprise entities. Small enterprises are private individuals and legal entities employing up to 50 people and owning assets valued up to 60,000 times the monthly calculation index (over USD 430,000). Medium enterprises are private individuals and legal entities employing up to 250 staff and owning assets valued up to 325,000 times the monthly calculation index (approximately USD 2,340,000). Source: Law of the Republic of Kazakhstan #1543-XII On protection and support to private enterprise of 4 July 1992, Art Agency of Statistics of Kazakhstan, Living Standards and Poverty in Kazakhstan. Preliminary data for Agency of Statistics of Kazakhstan, Living Standards and Poverty in Kazakhstan. Preliminary data for ADB, Agency of Statistics of Kazakhstan, Women and Men of Kazakhstan: Gender Statistics,

40 CHAPTER 3 Microfinance in Kazakhstan mation, and consultation services to help entrepreneurs, as well as through establishing financial organizations that promote start-up businesses. Individual entrepreneurs are another category of target clients for microcredit. As of April 2004, there were about 428,000 individual entrepreneurs (IE) in Kazakhstan, including 350,000 in operation. About 40 percent of all IEs (136,000) are involved in trade and with the remainder in agriculture (134,000) and other services (30,000). From a regional standpoint, there are 73,000 IEs in the South Kazakhstan oblast (21 percent), 47,000 in the Almaty oblast (14 percent) and 39,000 and 24,000, respectively in the East Kazakhstan and Karaganda oblasts (or 11 percent and 7 percent). As a conservative estimate, the potential microfinance demand is calculated using a 20 percent threshold for operational IE. This results in 70,000 potential clients 15. According to the "Law on Protection and Promotion of Private Entrepreneurship," micro enterprises are individual entrepreneurs and legal entities with less than 10 employees. As of 1 April 2004, the total number of enterprises employing less than 10 people was about 82,400, or 84 percent of the total number of operational SMEs. Micro enterprises engaged in trade and construction constitute about 61 percent of the total number of micro enterprises 16. Micro enterprises have limited starting capital/equity and face market conditions, such as high inflation, in which working with borrowed money brings potential benefits. This is especially true in the trade and construction sectors, where enterprises have high capital turnover and/or high demands for working capital. Thus, based on business size, sector affiliation, and external financing needs, the demand generated by micro enterprises is not insignificant. By applying a conservative line of 20 percent, micro enterprises would include at least 16,500 potential clients for microfinance. The above analysis shows that more than 200,000 people need access to basic financial services in Kazakhstan. In monetary terms, it is estimated that the market for microfinance services could be as much as USD 810 million. Clearly Kazakhstan has a high potential for development of the domestic microfinance sector. Finally, credit demand from enterprises, including short-term loans, can be also assessed by looking at the accounting reports of SMEs. Though these data apply to all SMEs, the results of the analysis are similar for micro enterprises. The need for external funding for working capital is even higher in micro enterprises, and they have fewer opportunities to access financial services. In general, according to accounting reports from SMEs, 18 percent of working capital originates from social capital and 72 percent from credits 17. Working capital for SMEs comes mainly through loan instruments available in the formal financial market (i.e., banks, credit unions and cooperatives) and from moneylenders. The latter financial flows are not reflected in formal reporting. The market does not meet the external funding needs of SMEs. About 40 percent of SMEs define the shortage of working capital as the main challenge to business. The size of this problem has not decreased over time. To address this problem legally and help entrepreneurs avoid the informal markets, a network of financial institutions should exist to provide micro and short-term loans to finance working capital: in other words, a network of MFIs. It is possible to conclude on the basis of official statistics and "informal" reporting that only percent of SMEs operate without loans. The priority for the remaining entrepreneurs is to attract external funding. This issue is more acute for micro enterprises in comparison with larger businesses Assessing microcredit supply Assessing the supply of microfinance is a complex task. Although official figures indicate that over 400 MFIs exist, this offers only an insight into the real level of supply. Not all registered MFIs are Table 3.5 Microcredit demand - private sector approach Microfinance clients Demand for microfinance services (potential clients) Average loan size Demand for microfinance services (USD) Unemployed 131,760 people 1, ,000,000 Individual entrepreneurs 70,000 entrepreneurs 2, ,000,000 Micro-enterprises 16,500 enterprises 25, ,000,000 TOTAL 218,260 clients 812,000, Agency of Statistics of Kazakhstan, April Law of the Republic of Kazakhstan on Protection and Support to Private Enterprise as of 4 July Small Entrepreneurship Development Fund,

41 Microfinance in Kazakhstan: an inclusive financial sector for all BOX 3.2 Starting a micro-enterprise in Kazakhstan 1. Registration USD Licensing USD Rent of premises USD Purchase of equipment USD 1, Salaries (2 workers - $150 each) USD 300 TOTAL USD 1,700 Source: UNDP staff estimates based on data from the Agency of Statistics of Kazakhstan operational and most of them are small family businesses with an insignificant number of clients. The following sections provide a brief overview of MFIs in Kazakhstan with field survey data on a selected sample of MFIs. As part of the three-tier model, four legal institutions are allowed to provide microfinance services in Kazakhstan: Commercial banks Non-banking financial institutions Credit partnership Microcredit organizations Commercial banks As of 31 January 2005, about 28,450 active microcredit accounts with a total value of USD 52.4 million were registered with commercial banks. The average credit size ranges from USD 1,650 to USD 2,400 with a good depth of outreach, with average loan sizes between 61 percent and 88 percent of per capita GDP respectively 18. Seven commercial banks (as listed in the table below) are using credit lines from the European Bank for reconstruction and Development (EBRD). Kazkommertzbank and Narodny Bank also benefit from the German Kreditanstalt fur Wiederaufbau (KFW) credit line for supporting SMEs. Some NGO-MFIs have conducted feasibility studies to analyze the benefits of becoming banks. However, very strict capital requirements have restricted this opportunity, even for the most successful MFIs. Non-banking financial institutions Non-banking financial institutions are legal entities that obtained a credit license from the National Bank. As of 1 March 2005, there were 48 non-banking financial institutions in Kazakhstan. The biggest MFIs, such as Kazakhstan Loan Fund (KLF) and Asian Credit Fund (ACF), have obtained licenses for their credit operations. However, the benefits of the transformation from MCO to NBFI are still unclear, leaving several MFIs without clear strategies. Table 3.6 Commercial banks' microcredit portfolio Active credits accounts Credit amount (USD) Average credit size (USD) ATF Bank 3, ,3245 2,058 Bank TsentrKredit 3, ,366 1,655 Kazkommertzbank 5,448 10,102,944 1,854 Narodny Bank 7,226 13,709,060 1,896 TemirBank 1,809 3,486,194 1,927 Bank TuranAlem 7,188 12,465,034 1,734 Tsesnabank ,804 2,396 TOTAL 28,442 52,397,647 1,842 Source: International Partner Search, 31 January Agency of Statistics of Kazakhstan, per capita GDP in 2004 was USD 2,713. Depth of outreach is considered good if under 250%. 40

42 CHAPTER 3 Microfinance in Kazakhstan BOX 3.3 MFI best practices in Kazakhstan: Kazakhstan Loan Fund Kazakhstan Loan Fund (KLF) is a non-profit organisation carrying out banking operations under a credit license from the National Bank credit license. The Fund was created by ACDI/VOCA and supported financially with USAID grants. KLF started its operations in Taldykorgan in Now the fund has offices in Taldykorgan, Shymkent, Almaty, Taraz and Turkestan. KLF is one of the most developed Central Asian microfinance institutions that delivers financial services to group and individuals. Key to KLF s success are well-developed financial management tools, continued relations with clients, and feedback and monitoring of financial and administrative indicators. In a few years KLF reached remarkable financial and outreach goals: more than 11,000 clients are served with a total loan portfolio of USD 6 million. The MFI is both financially (105 percent ) and operationally (122 percent ) self sustainable. Achievements as of 30 June 2005 Active borrowers 11,858 clients Credit portfolio USD 6,961,675 Branches 5 Loan Officers 60 Credit partnerships Credit partnerships (CP), recognized around the world as credit unions, are legal entities established by physical persons and/or legal entities to provide credit and other financial services to its members. As of 1 March 2005, there were 89 registered credit partnerships in Kazakhstan. Microcredit organizations Microcredit organizations are legal entities that provide microcredit under USD 7, MCOs can be profit and non-profit organizations. As of 1 March 2005, there were 208 registered MCOs in Kazakhstan, of which 84 (40 percent) were operational. Among the operational MCOs, only 6 had more than 10 employees, while the vast majority had less than five. The growth of registered microcredit organizations after the implementation of the new law is impressive: from 85 MCOs in January 2004 to 177 in December 2004 to 208 in March Operational MCOs are concentrated mostly in the South Kazakhstan oblast (32 percent) and Almaty city (18 percent). The table below shows the number of MCOs at the oblast level. Cultural, economic and geographic explanations lie behind the distribution. South Kazakhstan is one of the most densely populated areas in the country and also one of the poorest oblasts. On the other hand, Almaty is Kazakhstan's financial center, where the some of the first MFIs were established and where the entrepreneurial spirit is high. Figure 3.7 Number of microcredit organizations in Kazakhstan _ _ _ _ _ _ _ _ _ _ _ _2004 Source: Agency of Statistics of Kazakhstan, One thousand monthly calculation indicator, about USD 7,

43 Microfinance in Kazakhstan: an inclusive financial sector for all Table 3.8 Geographical distribution of microcredit organizations in Kazakhstan Oblast Number of MCOs % of total Almaty City % Astana City 4 4.8% Aktobinsk Oblast 2 2.4% Almaty Oblast 2 2.4% Atyrau Oblast 2 2.4% East Kazakhstan Oblast 6 7.1% Zhambyl Oblast 2 2.4% West Kazakhstan Oblast 4 4.8% Karaganda Oblast 7 8.3% Kostanai Oblast 5 6.0% Kyzylorda Oblast 4 4.8% Pavladar Oblast 2 2.4% North Kazakhstan Oblast 2 2.4% South Kazakhstan Oblast % Total % Source: Agency of Statistics of Kazakhstan, UNDP/AMFOK survey on microfinance institutions in Kazakhstan The United Nations Development Programme and the Association of Microfinance Organizations of Kazakhstan conducted a survey to assess the characteristics of MFIs in Kazakhstan. Data was collected between August and September 2005, from among AMFOK members and 22 non-member MFIs. Considering limitations in the data collection, lack of reliable information, scarce utilization of international financial reporting practices, and a general culture that does not offer incentives to disclose information, figures from only major MFIs are presented in detail. Sixteen MFIs completed the questionnaire prepared by UNDP, while basic information is available on most AMFOK members. AMFOK aggregate data as of 30 July 2005 indicates that its members have an active portfolio USD 29,585,850 with a total of 16,833 clients served. Although AMFOK members do not represent the entire spectrum of microfinance services in Kazakhstan, they offer an indicative picture of the microfinance sector. Name Table 3.9 UNDP/AMFOK survey results: largest MFIs in Kazakhstan Type of MFI Active clients Active portfolio (USD) % of women clients Average loan size (USD) Loan products Loan officers Clients per loan officer Operation self-sufficiency Portfolio at risk (30 days) Kazakhstan Loan Fund NBFI 12,209 7,268,624 81% % 0.0% Valut Transit Microcredit MCO 9,266 7,713,605 NA NA NA 138% 9.0% MCO Bereke MCO 2, ,751 98% % 1.3% Association of Societies Baspana NBFI ,876 48% 1,097 NA % 2.4% Asian Credit fund NBFI 420 2,331,604 66% 5, % 0.3% Credit Union Orda Credit CP 93 3,658,424 19% 39,338 NA NA NA NA NA Credit Union Ak Bulak CP 34 10,499,374 30% 308, NA NA Credit Union Almaty Credit CP 10 2,695,805 0% 269,581 NA 2 5 NA 0.3% Notes: MFIs with a loan portfolio larger than USD 500,000 Active clients and active portfolio as of 30 July 2005 Percentage of women clients as of 31 December 2004 Other columns as of September 2005 NA = Not Available Source: AMFOK/UNDP survey, September

44 CHAPTER 3 Microfinance in Kazakhstan MFIs with a loan portfolio larger than USD 500,000 are listed in table 3.9. An analysis of the survey data provides some useful insights on the supply of microfinance services in Kazakhstan: Outreach. Only one MFI has more than 10,000 clients and only two have more than 1,000. Among the 18 AMFOK members for which data is available, 10 have less than 100 clients. NGO-MFIs have the biggest outreach, while credit partnerships have the smallest. The MCO Valut Transit is an interesting case since the organization was founded by a commercial bank. Loan portfolio. Only eight MFIs have an active portfolio that exceeds USD 500,000. The average size of loans varies greatly from USD 275 to USD 212,000. While NGO-MFIs have a lower average loan size, the highest loan sizes were found among credit partnership. Size. With few exceptions MFIs are small in Kazakhstan: they often have only one office/ branch and cover only one oblast. The number of loan officers employed confirms the relative small size of Kazakhstan MFIs. As noted before, outreach is limited but the size of the portfolio is not always linked with the number of clients due to the existence of different kinds of borrowers. Therefore, MFIs that show better results in terms of clients are not necessarily the ones with the biggest loan portfolios. Kazakhstan MFIs are decidedly smaller, both in terms of portfolio and number of client, than the international average. Clients. Two kinds of borrowers emerge: small traders, farmers and entrepreneurs on one side, and SMEs on the other. The size of loans varies greatly from USD 300 to more than USD 200,000. The MFIs that widely employ group loans have the lowest average loan size. Loan products. Kazakhstan MFIs offer only microcredit services but have developed different products, such us solidarity group loans, individual loans, agriculture loans, and housing loans. Some of them require collateral. Self-sustainability. Almost all of the MFIs that responded to the survey are nearly or fully self-sustainable. This validates the fact that MFIs in Kazakhstan have relatively good financial records. Source of funding. It is difficult to draw a map of funding sources. However it seems that very few MFIs received money from the government. Otherwise there are good indicators of private sector involvement. MFIs that received donor grants tend to have better performance overall Matching demand and supply Putting the above considerations of microfinance supply and demand together, it becomes obvious that the demand far outstrips the supply in Kazakhstan. The demand for microfinance services has been estimated to include between 140,000 and 220,000 clients, and the total value of the microfinance market could exceed USD 800 million. However the real demand could easily expand beyond these numbers as more than two million vulnerable people could benefit from increased access to microfinance as well. Up to now the existing supply has not been able to fulfill this demand. Members of the Association of Microfinance Organizations of Kazakhstan claim about 17,000 clients. Commercial banks serve an additional 30,000 microcredit clients. Although comprehensive data is not available from NBFIs, MCOs and credit partnerships, the Agency of Statistics indicates that about 50,600 people received microcredit loans in All told there could be between 60,000 and 70,000 active microfinance clients in Kazakhstan today. Despite the fact that there are a variety of organizations providing microcredit, the weight of microcredit in the aggregate credit portfolio of the country is still marginal. As well, the consideration of only microcredit services is a limit in itself. Microsavings, microinsurance, and leasing services are needed among the poor or nearly poor households as well. For these cases there is no supply. The main reasons for sector underdevelopment are the institutional immaturity of MFIs and financial bottlenecks. These limitations call for improved strategies and methodologies to promote in Kazakhstan. 3.5 Microfinance strategies and methodologies In this section current MFI strategies and methodologies in Kazakhstan are reviewed in order to enrich the description of the microfinance sector in Kazakhstan with qualitative data. The following objectives should be taken into account when analyzing the effectiveness of MFI management strategies: To develop efficient information systems that connect microcredit service units and management to improve decision making; To develop products that meet client needs and streamline credit procedures; 43

45 Microfinance in Kazakhstan: an inclusive financial sector for all To implement reliable indicators to assess borrower solvency and business capacity. Microcredit methodologies employed by MFIs in Kazakhstan derive from international practices. However, even at this stage there are methodologies that are clearly local in nature. In Kazakhstan the majority of MFIs provide collateral individual loans and mortgages. Such credit schemes lower risks for the MFIs, but result in very low outreach. Thus, AMFOK reported that, as of 1 January 2005, only 2 of its members used group-lending schemes. That being said, these organizations alone -- the Kazakhstan Loan Fund and MCO Bereke -- serve nearly 90 percent of the total clients of AMFOK members. Summarized below are the findings from the survey conducted by the Institute of Sociological Survey (ISS) in 2003/2004 on a selected sample of MFIs: Entrepreneurs with low income constitute the target client group of microcredit projects. The lack of assets and collateral among entrepreneurs is a major obstacle for obtaining loans. Farmers use MFI services as they fail to access banks. Banks and some MFIs tend to rate assets and loan guarantees provided by rural borrowers -- such as second-hand equipment, rural real estates and livestock -- as non-liquid. Collateral recovery involves considerable costs, which most MFIs cannot afford. The business of the borrower is the most common guarantee for loan repayments. In-depth analysis of the business, financial flows, and borrower reputation, as well as estimates of future cash flows, are fairly good indicators of the repayment capacity of he borrower. Non-liquid items can be accepted as the above-mentioned indicators are satisfactory. Loan disbursement strategies are based on the fast delivery of financial services to borrowers: 3-4 days are required to obtain the initial loan; further loans may be obtained within 1-3 days. In-depth interviews identified the following credit practices in MFIs: Many MFIs disseminate information about services through free awareness raising seminars, outreach activities, information leaflets, etc. As part of their microcredit activities, many MFIs provide consultations and training services such as preparing mini-business plans. However, they do not deliver on a regular and continuous basis comprehensive training programs on how to handle loans, how to effectively run a business, or how to choose an appropriate market strategy. Only some MFIs, such as Bereke (Semipalatinsk), conduct group workshops on a regular basis. The Association of Women, Moldir (Almaty), delivers a training course where participants can proceed to apply for a loan. A great many MFIs do not apply updated approaches to the analysis of client businesses. This analysis is usually based on a review of mini-business plans with a projected income and expense statement and loan repayment schedule. When making a decision on individual loan, MFIs usually appraise loan guarantees without any external assistance. However, appraisals are most often undertaken in partnership with real estate centers, which are in place in all oblasts. While low, the cost of such an appraisal is the responsibility of credit recipients. Credit committees usually include MFI directors, chief accountants, and credit specialists. Applications are considered on a "first come, first served" basis. Many MFIs make agreements with bank disbursement and cash departments (DCD) for the issuance of loans to reduce costs. Working with banks is beneficial and convenient for both clients and MFIs, since setting up their own DCD would involve high maintenance costs and security risks. Agreements with banks often entail some other benefits as well such as discounts on bank commissions. Findings from the focus group interviews show that credit recipients see monitoring visits as friendly visits, even if the main purpose is to assess a client's loan repayments. In addition, borrowers would like to make such monitoring visits more frequent to receive business advice from credit experts. The common practice among Kazakhstan MFIs is to provide individual loans at an average monthly interest rate of 3-7 percent with monthly repayments for up to 3 months. Twice-per-month repayments are also used. Interest is charged on fixed schedules. Depending on the borrower's credit history, type of business and actual turnover cycle, reduced interest rates may be considered. A credit committee decides whether the loan should be issued. All loans must be secured by personal property, which as a rule is the borrower's business. Guarantees provided by a third party may be accepted as collateral as well. Loans are only issued to registered enterprises. Below are the principal strengths of individual loan products offered by MFIs in comparison with bank products: Flexible interest rates Less strict requirements for loan guarantees Access to further loans under simplified procedures and preferential conditions Fast access to credit. In international practice, group loans are the basis for most microfinance projects. Today there are only few MFIs practicing extensive group 44

46 CHAPTER 3 Microfinance in Kazakhstan lending schemes in Kazakhstan. KLF and MCO Bereke experiences have shown that a well-developed approach to group lending brings both good financial performance and satisfactory outreach. Group lending in Kazakhstan is channeled through loan groups consisting of 5-7 members, usually business partners or market neighbors. Groups are self-built, with members free to choose partners and elect leaders to perform monetary management, screening of new applicants, loan approvals, and monitoring of loan repayments. Each group member gets an individual loan based on his/her needs. Subsidiary liability of the group for each member's liability is a common version of this model. In some MFIs, in order to reduce risks, groups are encouraged to set up a reserve to be used in cases of member repayment failure or during emergencies. Personal interaction between loan officers and group members is essential to build trust. Loan officers work with groups rather than individual borrowers. A gradual increase in credit lines and better credit terms are based on group credit records. Kazakhstan MFIs often employ a step-by-step principle for loan issuance. The amount of the initial loan to be issued to the group is based on the total amount of all individual loan applications, provided each of them is no more than KZT 20,000-70,000. The average loan period is 2-10 months. When moving up to the next stage, the group can obtain an increase in the loan size or preferential interest rates. In summary, out of all lending models, individual guaranteed credit schemes are most common in Kazakhstan. Kazakhstan MFIs generally believe that group credit schemes have high initial costs such as staff training, borrower training, monitoring, etc. There is also a cultural argument against group lending. At the same time, it will be difficult to expand client groups in the future if group lending schemes are not employed. The successes of KLF and MFO Bereke demonstrate that investing in methodology, staff training and monitoring eventually proves to be a justified and financially sustainable strategy. At the initial phase of development, MFIs often require external sources of funding to invest in management and technical upgrading. Donors and the government could play a leading role in facilitating the training of staff and adoption of state of the art microfinance technologies. However, as MFIs become mature, technical assistance should be reduced as the management itself should be ready to invest money in productivity growth and innovation. A good management information system (MIS) is a key element for MFI development. The common threshold in the industry for moving to a professional microfinance MIS seems to be approximately 2,000 clients. However, some MFIs managing their information manually have grown to more than 30,000 clients. If an MFI has a limited number clients, and limited plans for growth, then a system that relies on spreadsheets for managing its loan portfolio is sufficient, affordable and preferable considering the costs of MIS software packages and hardware. Some software firms offer microfinance MIS products that work in a stand-alone mode, which could be an inexpensive means to automate small microfinance operations. Typically, it is much easier for an organization to step from a manual system to a partially automated system, and then to specialized software applications, rather than leaping directly from a manual system to sophisticated information systems. Furthermore, given the time it takes to select and implement an MIS software application, it is also recommended that an organization implement the software before pursuing aggressive growth, rather than as a reaction to such growth. As the sector develops, the introduction of international microfinance standards and up-to-date management techniques assumes greater importance. Management and accounting improvements will help MFIs to: be transparent; improve strategic planning; determine industry standard models; analyze and improve output and management skills; introduce international auditing and rating. BOX 3.4 Best world practices in microfinance sector accounting system Today CGAP-MIX (microfinance sector information exchange) is a modern method of information collection, accounting system and global dissemination mechanism. MIX provides: MFIs detailed reports in a chronological order (demand) MFIs global comparison within their own (groups of homogeneous structure) Reports on subsidization organization and opportunities (supply) More details can be found on 45

47 Microfinance in Kazakhstan: an inclusive financial sector for all International practice includes several well-known rating systems that share internationally-recognized rating principles, such as ACCION CAMEL (Capital Adequacy, Asset Quality, Management, Earnings, and Liquidity Management), PlaNet Finance GIRAFE (Governance, Information, Risk Management, Activities and Services, Financing and Liquidity and Efficiency and Profitability) and others. The CAMEL-based rating is offered as an example below. The ACCION CAMEL is a diagnostic and management tool designed to help MFI managers assess the organization's financial health and overall performance. The original CAMEL model was developed in 1978 by the US Federal Reserve to evaluate the solvency of US banks. In 1993, ACCION, a leading international microfinance NGO, adapted the CAMEL to MFIs. International private funds, and among them international venture funds, often require international ratings prior to investing in an MFI. MFIs with good results should consider international ratings as a precondition to apply for international capital. International ratings are an expensive tool for MFIs, but many donors are keen to provide ad hoc resources. CGAP in Washington and international donors active in Kazakhstan are helping NGO-MFIs to obtain these valuable international certifications. In July 2005, the Microfinance Center for Central and Eastern Europe and New Independent States and CGAP opened the Central Asian Microfinance Center (CAMFC) in Almaty. CAMFC is ideally positioned to make a significant and timely impact on the emerging microfinance industry in Kazakhstan in the areas of policy dialogue, donor coordination, training and capacity building, transparency, and dissemination of industry standards and best practices. The establishment of a Credit Bureau is considered to be a means to lower MFI risks and costs. By accessing a common database of credit histories, MFIs can reduce time and effort in rating borrowers' credentials. A Credit Bureau has been recently established in Kazakhstan. MFIs should work closely with the newborn Credit Bureau to participate in the creation its database and benefit from the information made available. 3.6 Barriers for developing microfinance The development of the microfinance sector in Kazakhstan is necessary for several reasons: Traditional credit sources are not accessible to small and micro businesses; The requirements for collateral property are too high; Information about microcredit policies are not easily available; There is lack of management experience among MFIs; Borrowers are uneasy in managing credit resources; and Table 3.10 ACCION CAMEL quantitative and qualitative indicators QUANTITATIVE INDICATORS QUALITATIVE INDICATORS CAPITAL ADEQUACY Capital Adequacy Ability to Raise Equity Adequacy of Reserves ASSET QUALITY Portfolio at Risk Write-offs/ Portfolio Classification System Write-off Policy Productivity of Long-Term Assets MANAGEMENT Governance Management Human Resources Processes, Controls and Audit Information System Strategic Planning and Budgeting EARNINGS Return on Equity Interest Rate Policy Operational Efficiency Return on Assets LIQUIDITY MANAGEMENT Liability Structure Cash Flow Projections Productivity of Liquid Assets Source: ACCION International,

48 CHAPTER 3 Microfinance in Kazakhstan Microcredit schemes and methodologies still exhibit a number of weaknesses. In general, barriers affecting microfinance can be divided into two big blocks. The first block concerns the whole set of microfinance stakeholders, while the second directly concerns the ongoing activities of MFIs. There are several environmental obstacles that restrain the development of the microfinance sector as a whole: Legal barriers; Low population density; High transportation and security costs; Underdeveloped collaboration between MFIs, state administrations and national development institutions and funds; Poor interaction between domestic banks and non-banking organizations and MFIs; Lack of advanced managements and monitoring systems, internal control procedures, impact assessment tools and appropriate management software; Lack of agreements with postal services and banks with branch networks; Lack of services providers for MFIs. No doubt the above-mentioned factors affect MFI activities as well, and efforts to overcome these problems will have a positive impact on both the microfinance system and its participants. The challenges faced by MFIs in their everyday activities include the following: Operational deficits; High costs of funds; Shrinking grant commitments; Shortages of qualified personnel; Lack of methodologies and training programs for staff; Poor methodological and accounting know-how Low levels of computer skills; Unequal competition terms with commercial banks 21. In the initial stage of development, most MFIs received grants from donors who also contributed by defining MFI strategies and long-term priorities. Today most of MFIs work on market-based criteria. Therefore it is especially important to develop mechanisms to attract capital flows from the market. It is necessary to design a systematic and comprehensive approach to microfinance, which takes into consideration the complexity of state support and the adaptation of international best practices of microfinance to local conditions. Different measures should also be directed toward increasing the attractiveness of MFIs to potential investors. A set of measures to be promoted to overcome existing barriers has been developed: Legal barriers: it is necessary to remove legal obstacles that prevent the development of the microfinance sector, such as limits on microcredit size. Legal improvements and suggested law amendments are analyzed in detail in chapter four. Technological barriers: it is necessary to provide more opportunities to MFIs to operate with state of the art technology, enabling them to be more flexible and effective in making decisions. It has been suggested to develop and promote specific software packages for MFIs, which would maximize information, risk analysis, and portfolio quality management and monitoring. The introduction of updated MIS could be a priority. Donors and state funds could play a crucial role in promoting new technologies and thus reducing the costs for MFIs. Planning and ownership barriers: the development of a state microfinance strategy and a more coordinated approach to microfinance could be beneficial considering the different government programs and funds that are currently operational. Better coordination is also needed among donors to channel money into priority areas. On the other side, MFIs should take the leadership in defining priorities and solutions. Financial bottlenecks: the creation of specialized wholesale-credit institutes is being considered as a mechanism to increase MFI activities and opportunities through the delivery of technical assistance and credit lines. The same institutions would also function as a magnet to introduce international standards, thus enabling MFIs to develop effectively in the long-term. The above-mentioned measures are intended to support more effectively the microfinance sector through developing a competitive market for MFIs that could possibly play a greater role in social stabilization. 3.7 Institutional actors: the state, international organizations and donors The state In Kazakhstan, microcredit is considered to be an effective mechanism for supporting entrepreneurship and is becoming an integral component of the country's economic and social strategy through (a) developing the economic capacity of private entrepreneurship, (b) providing new job opportuni- 21 Government of Kazakhstan, Program of the rapid measures for the development of the small and medium entrepreneurship in the Republic of Kazakhstan for the years of

49 Microfinance in Kazakhstan: an inclusive financial sector for all ties for low- and medium-income people, and (c) stimulating the creation of new SMEs. The development of different state credit programs, aimed at ensuring a broader coverage and better targeting of microfinance services, is necessary. The Ministry of Industry and Trade (MIT) is the agency responsible for developing the microfinance sector in Kazakhstan. In mid-2004, MIT in cooperation with AMFOK drafted a national microcredit program for , which, unfortunately, was not adopted. Currently several state programs with microfinance components are in operation. Different state authorities and ministries (especially the Ministry of Agriculture) are involved besides the MIT. The government has created several funds in support of small business and agriculture that are engaged in microfinance activities. Therefore, relevant government projects are briefly reviewed below. Under the Microcredit Program to the Poorest Citizens of Kazakhstan ( ), pilot microcredit projects were initiated in five oblasts (South Kazakhstan, Zhambyl, Kyzylorda, Almaty, and the East Kazakhstan). A special fund was established to allocate KZT 40 million. The loan size (USD 400) and annual interest rate (5 percent) were fixed. Credit duration varied from 3 to 12 months depending on the type of activity. A network of affiliated NGOs "Microcredit" was established in seven oblasts to implement the program. Loans were disbursed directly from state funds to borrowers. Relevant problems rose in relation to high non-repayment rates (and several cases were brought to court). Lack of experience was evident. Very low interest rates are often a guarantee of failure in microfinance, and that was true in this situation. Moreover, there was not enough interest and involvement among organizations involved in the program. The program ended in 2000, but few "Microcredit" NGOs are still operating 22. The Agrarian Credit Corporation (ACC) was set up by the Ministry of Agriculture to provide financial resources to rural enterprises. ACC was a pilot project implemented according to a Government resolution dated A 100 percent state corporation was created and a network of rural credit partnerships (RCP) was established. The main goal of the RCPs is to ensure agricultural producers have access to credit. The mechanism is based on the RCP network, established by the ACC jointly with agricultural organizations as cofounders holding not less than a 35 percent share. ACC also provides financial support to RCPs at preferential terms. Profitable RCPs may decide to attract financial resources from external sources. Today 84 RCPs operate in 12 oblasts with the involvement of 2,733 agricultural organizations owning 5.5 million hectares of land. The RCPs issued loans for KZT 4.6 billion to 1,036 agricultural organizations, and the RCPs managed to ensure full return of credit resources to the corporation. An association of RCPs was established to coordinate members' activities, analyze development trends, facilitate external financing, and represent members' interests 23. The Fund for Financial Support to Agriculture (FFSA) was established by the Ministry of Agriculture to support small rural farmers and provide microcredit in rural areas. FFSA provides microcredit services to the rural population. FFSA works directly both through its branches as well as through contracting MCOs on a competitive basis. Bids require MCOs to have the following qualifications: two years of previous experience, a focus on rural residents, 100 percent return on credit, repayment terms of 3-5 years, and interest rates not higher than 12 percent. Thus, KZT billion was allocated as follows: KZT billion (5 percent) through MCOs at 12 percent interest KZT billion (95 percent) through FFSA affiliates at 8 percent interest This mechanism proved to be far from optimal as the interest rates (8 percent and 12 percent) were too low to cover expenses. It is estimated that interest rates had to be at least 25 percent to cover all operational costs. An interest cap of 12 percent for MCOs causes management problems that prevent a healthy development in client NGOs and in the entire system 24. The Small Entrepreneurship Development Fund (SEDF) was established to stimulate and promote economic growth and entrepreneurship in Kazakhstan and to increase the efficiency of state funds in support of small businesses. The fund provides loans to small business projects as well as competitive distribution of funds through second-level banks. SEDF aims to: Participate in developing and implementing state financial support to small entrepreneurship and contribute to the development of business centers and SMEs incubators; Create new jobs through helping SMEs, small entrepreneurs and the self-employed to grow; Provide guarantees to small entrepreneurs in order to access credit from banks; 22 Kurasova A.M., Justifying Areas of UNDP Technical Assistance to Support Microcredit Development in Kazakhstan, Kazakhstanskaya Pravda Newspaper for 14 December Ministry of Agriculture of Kazakhstan,

50 CHAPTER 3 Microfinance in Kazakhstan Provide financial resources to MFIs; Provide technical assistance to MFIs (software implementation, consulting, training); Participate in credit programs as established by the Government of Kazakhstan. In 2002, to ensure greater accessibility, SEDF formed its own network of branches in 14 oblasts and maintained its head office in Almaty, a branch in Astana and special representatives in Zhezkazgan and Semipalatinsk. SEDF recently developed a strategy for the development of the microfinance sector 25. SEDF intends to support MFIs with direct participation in social capital programs. This approach has been chosen to sponsor a step-by-step growth path for the microfinance sector and to facilitate MFI creation and development. Besides helping the formation of a MFI network, SEDF provides financial support through soft credit lines (6 percent interest rate up to 5 years) 26. State intervention in microfinance should be aimed at the creation of a favorable environment for an independent and effective system of MFIs. Previous attempts of the Government to directly deliver microfinance services to the final borrower were not successful in Kazakhstan. The fourth chapter analyzes the new government strategy based on a willingness to establish a wholesale credit institution International organizations and donors By analyzing the origin and development of the Kazakhstan microfinance sector, the role played by international organizations becomes important. They helped to introduce international best practices and state of the art microfinance technologies, adjusted methodologies, and developed software and other management tools. All of these were significant contributions as local managers had very little or no experience on how to organize MFIs. Also, international organizations and donors provided the starting capital for most MFIs. In this context, international donors provided technical assistance, which was necessary for the development of microfinance institutions. Technical assistance projects are intended to provide methodological tools, information, know-how, and non-financial resources to support recipient organizations in developing their activities and strategies. Good examples come from UNDP, the US- AID/PRAGMA program on the development of entrepreneurship, CAMFA, the EBRD Central Asia Business Advisory Services Programme, and the TACIS program. Several development banks have worked in the microfinance sector in Kazakhstan, among them: BOX 3.5 Best practices in Kazakhstan: European Bank for Reconstruction and Development Downscaling Programme In 1997 the European Bank for Reconstruction and Development (EBRD) introduced a Kazakhstan Small Business Programme (KSBP) to provide small businesses with a sustainable long-term source of funding by ensuring access to credit resources of Kazakhstan commercial banks. The KSBP was made possible through a credit line of USD175 million provided by the EBRD and technical assistance to give the partner banks skills and necessary know how. The overall aim of the KSBP is to build a bridge between Kazakhstan banks and entrepreneurs. The Programme was originally aimed at introducing effective credit procedures and training competent personnel in servicing micro and small business. Now as the credit portfolio grows and the institutional structure develops, the KSBP focuses on ensuring access to financial resources for the smallest businesses and creating competition for working with such. Not only did the KSBP help many entrepreneurs to expand their business and increase their capital but to develop new areas of work, which resulted in creating new jobs and maintaining existing ones. Over 298,000 new jobs have been created over the period the Programme has been operational. Achievements as of 30 June 2005 Current Portfolio Total loans Regional network Number of officers 47,700 credit, USD 328 mill. 152,000 credits, USD 944 mill. 206 offices in 45 towns and cities 629 officers 25 Small entrepreneurship development fund "Concept on development of system of microcredit in Kazakhstan", Small entrepreneurship development fund,

51 Microfinance in Kazakhstan: an inclusive financial sector for all European Bank of Reconstruction and Development World Bank Asian Development Bank Kreditanstalt fur Wiederaufbau Islamic Development Bank These financial institutions provide funds for entrepreneurs generally through soft credit lines. In order to realize these programs, development banks collaborate closely with financial organizations, such as banks, and state organizations. EBRD has the most extensive microcredit downscaling program (see the box below). Three banks -- Kazkommertzbank, Narodny Bank and Almatinsky Torgovo-Finansovy Bank -- are implementing a KFW credit line supporting SMEs. In 2001, the credit line policy was that the final borrower gets credit at a 12 percent annual interest rate in hard currency. The loan size varies from EURO 500 to 750,000 and lasts up to 4 years. The World Bank's new "Second Agricultural Post- Privatization Assistance Project" will have an important microfinance component. The rural microfinance development component (USD 5.4 million) aims to enhance the rural portfolio of selected MFIs in view of the increased importance of microfinance in the country and the potential contribution of microfinance to rural areas. The project will provide to selected MFIs both technical assistance and capital. The Government will lend credit facility proceeds to MFIs in tenge at the National Bank of Kazakhstan's discount rate. The maturity of these loans will be 3 years, with a one-year grace period. MFIs will be able to set their own interest rates 27. The outline below offers a brief summary of all international donors active in Kazakhstan with interest and experience in microfinance. The US Agency for International Development (USAID) conducted its microfinance projects through the CF "Kazakhstan Loan Fund" which is one of the leading MFIs in Central Asia. KLF delivers financial services to small entrepreneurs in the form of non-collateral group lending. USAID promotes institutional development of Kazakhstan small business through a number of other projects as well. CAMFA is a USAID-funded four-year project ( ) administered to support and expand microfinance agencies operating in rural and urban areas of Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan. CAMFA has a wide range of tools and services and provides grants to credit organizations in order to develop their credit operations, internal systems, and human resources. Organizations willing and taking the responsibility to carry out credit operations and achieve self-sustainability are eligible for the program. CAMFA assesses MFI credit operations, strengths and weaknesses, international control systems, and management and financial performance. An expert team in cooperation with the microfinance organization develops a plan of action to support the program. CAMFA provides trainings, technical assistance and grant packages for MFIs, which must submit financial reports quarterly over the next year. The United Nations Development Program (UNDP) supports the development of SMEs by promoting a supportive environment, creating business advisory services and building national capacities in related fields. UNDP implemented microfinance projects in Semipalatinsk, Kyzylorda and Atyrau. Currently UNDP is assisting in developing the network of microfinance organization in Kazakhstan. BOX 3.6 MFI best practices in Kazakhstan: MCO Bereke KMLO Bereke has emerged as an independent non-profit organization from the UNDP microcredit for women project in Semipalatinsk. The project started in 1997 as the initiative of UNDP, Mercy Corps and Government of Kazakhstan. In 2001 the Government of Japan and Japan Women in Development Fund disbursed funds to the UNDP Semipalatinsk Programme. Public fund MCO Bereke was founded in May Bereke pursues the economic and social development of Semipalatinsk region, contributing to foster entrepreneurial activity and increase people s welfare. Women make up 98 percent of the actual 3,200 clients. Bereke plans to increase the number of borrowers involving both man and women and expanding further to rural areas. Bereke, with a loan portfolio of about USD 1 million, achieved both financial and operational self-sufficiency. Bereke has successfully implemented individual and group loans with mainly monthly repayments. An external evaluation conducted under the umbrella of UNDP Semipalatinsk programme recognized Bereke effectiveness in alleviating poverty indicating that economic position of clients has improved as a result of borrowing from Bereke. 27 World Bank, Second Agricultural Post-Privatization Project, Project Appraisal Document,

52 CHAPTER 3 Microfinance in Kazakhstan Gesellshaft fur Technische Zusammenarbeit (GTZ), in the framework of the Houston Initiative, has launched a program for the development of SMEs called PROSME. The main goal is to provide a complete package of business consultation services to SMEs. In the framework of PROSME new support has been provided to existing business associations to promote the use of modern technologies. Starting in the early 1990s, donors have conducted considerable activities directed towards the development of microfinance. Currently the volumes of donor funding are shrinking in Kazakhstan. It is necessary to analyze in-depth how to maintain established relations with Kazakhstan MFIs, and to transfer their unique experience to young organizations in the years to come. The new framework opens new challenges for MFIs. MFIs need to find alternative resources from the market and to persuade investors to put money in the microfinance sector, which, to date, has received support from international donors for over ten years. 3.8 Principal findings and conclusions Despite the diversity and multiplicity of operating MFIs, there is still a high unmet demand for credit. Further growth of the microfinance sector would positively affect the social and economic development of the country and contribute to the formation of a strong group of small entrepreneurs. Despite all efforts and a relatively good legal framework, microfinance legislation still needs to become effective in supporting MFIs. While much work has already been done to improve and strengthen the legislative framework, several amendments to the current law are needed to empower MFIs. Microfinance is a relatively new concept in Kazakhstan. The Agency of Statistics indicates that 50,600 people received microcredit loans in 2004, a 57 percent increase over the 32,300 people that received microcredit in Preliminary estimates for 2005 indicate that there are 60,000-70,000 active microfinance clients in Kazakhstan. The potential demand indicates an immediate market of 140, ,000 clients, but the ideal objective would be to provide financial services to all of Kazakhstan's 700,000 poor households. Even if the supply grows at an incredible rate, the supply of microfinance will not be adequate. There are very few MFIs with a significant number of clients, resulting in a major population segment without access to modern financial services. Starting from the best practice in the country, a more concrete effort to expand services and outreach is needed. MFIs are at the stage of experimentation in their development. Microfinance methodologies should be updated in order to expand the outreach and the quality of services provided. The demand for training and MIS is high among MFIs. International rating of MFIs is only at the very initial stages of development in Kazakhstan. Financial institutions belonging to all three levels of the credit system (commercial banks, nonfinancial banking institutions, credit partnerships and microcredit organizations) should work to strengthen partnerships to offer a wider range of services to poorer borrowers and SMEs. In addition to being an important segment of the financial market of the country, the microfinance sector can be an adequate economic tool to address the social problems by promoting long-term sustainable development. Microcredit is also closely associated with entrepreneurship development and the creation of a middle class. All these premises, such as the existence of numerous MFIs, state funds, and projects, demonstrate the positive attitude of the Government and international donors towards microfinance, showing good prospects for improvements. Despite this support the microfinance sector is still considered underdeveloped and young in Kazakhstan. Support and attention from both the state and international organizations are required to assure microfinance expansion. A too rapid withdrawal of donors from the sector could stop the high growth rate and hinder the development of new MFIs. The weight of microcredit in the total credit portfolio of the country is still insignificant. This is a consequence of inadequate development of MFIs, institutional immaturity and scarce financial resources to expand microfinance activities. 51

53 Microfinance in Kazakhstan: an inclusive financial sector for all CHAPTER 4 OPPORTUNITIES AND CHALLENGES 4.1 Legal and policy improvements to enhance microfinance The legal framework for microfinance in Kazakhstan needs further improvement. Leading MFIs and the Association of Microfinance Organizations of Kazakhstan proposed amending the law on microcredit organizations. In April 2005, AM- FOK with the Kazakhstan Association of Financiers and National Union of Entrepreneurs and Employers Atamekent organized a roundtable on improving the legal framework for credit partnerships and microcredit organizations in Kazakhstan. The Agency for Supervising Financial Markets and Organizations and the Kazakhstan Association of Financiers suggested the following amendments to the law: 1. Liberalizing operations for non-banking organizations, for example by eliminating requirements for the licensing and supervision of credit partnerships, pawnshops, and NFBIs. 2. Distributing net profits of credit partnership based on additional contributions. This would facilitate market implementation of rules and make additional contributions more attractive. 3. Revising taxation schemes for credit partnerships since they are no longer licensed or monitored by the Agency for Supervising Financial Markets and Organizations. 4. Expanding the definition of the term "borrower of a microcredit agency" since it now only includes small enterprise entities. 5. Increasing the maximum loan size for MCO clients from 1,000 times the monthly calculation index (around USD 7,000) up to 4,000 times the monthly calculation index (around USD 28,000) and removing the 25percent limit for own capital. 6. Improving taxation schemes for MFIs. Such changes would expand outreach, especially in rural areas, promote the involvement of small entrepreneurs in this sector, contribute to legalizing informal moneylender activities, and foster greater competition in the market 1. Other voices are calling for enabling MFIs to collect capital by offering savings accounts. Theoretically, savings collection is an appropriate and secure source of funding for MFIs, but it requires some form of control from supervising bodies. Considering the strict requirements for institutions to become banks, which are the only institutions legally able to collect savings, and the need of funding to expand activities, a cautious policy that allow MFIs to raise capital by collecting savings from the public could achieve good results. Institutions that collect savings should always be supervised depending on their specific situation and requirements. Specific amendments could tailor accountability requirements to the scale of the deposit institution. In any case, it needs to be kept in mind that most NGO-MFIs lack the governance and institutional capacities to manage savings accounts. A good side strategy to expand microfinance outreach would be to develop savings products in commercial banks specifically targeted at the poor. Finally, concerns remain regarding the advantages and privileges banks have over MFIs, such as different definitions of pre-tax expenses. The proposal to simplify the structure of the microfinance sector by eliminating the licensing system for non-banking financial institutions should be carefully considered due to the possible negative impact on the microfinance sector. If NBFIs are excluded from the "Law on Banks and Banking Activity," several MFIs could be damaged by losing their VAT and tax benefits and would be obliged to respect loan ceilings established for MCOs. If this change is introduced without adequately reforming the provisions for MCOs, the microfinance sector could be negatively affected. 1 Finance and Credit, Monthly informational and analytical publication. Issue 5,

54 CHAPTER 4 Opportunities and challenges Most of the MFIs that are now licensed as NBFIs do not have the bases to transform themselves into banks and would be obliged to become MCOs instead. Analyses of documents and interviews with experts indicate that in Kazakhstan the management of microcredit policies by the government is still relatively weak, which has often resulted in weak management of government programs, and nontransparency in many MCOs. The government has not clearly determined what role microfinance should play in socio-economic development even though the term microcredit is included in various government strategy documents. Indeed the Kazakhstan Strategy 2030, which is the key document guiding long-term government policies, defines microcredit as a tool for poverty reduction. The "Concept on the Development of the Financial Sector in Kazakhstan" clearly regards microcredit as a practical tool to support SMEs and micro enterprises by including microfinance in the country's financial infrastructure. Finally the Poverty Reduction Program for considers microcredit as a tool to fight poverty. 4.2 Alternatives to foster microfinance development New resources to expand microfinance activities There are several widely acknowledged funding sources for MFIs. Equity contributions and loans offered at concessional or market rates represent the main options. Many MFIs operate as nonprofit organizations that implement microcredit programs with financial support from international donors in their initial stages of operation. In some cases funding from the state budget is provided on a reimbursable basis with low interest rates to provided loans to SMEs; however, state grants have to be "paid out" by extra administrative costs charged to borrowers and there are additional restrictions on their utilization. It must be noted that MFIs can attract funds by collecting savings and from commercial banks or investors. Despite the financial problems and obstacles confronting MFIs in Kazakhstan as described above, opportunities have increased and access to new financial resources has become easier: Donors: The second phase of the World Bank Agricultural Post-Privatization Assistance Project (APPAP-2), which has a large microfinance component, is to begin in The European Bank for Reconstruction and Development (EBRD), alongside their cooperation with commercial banks, is expected also to fund individual MFIs that meet EBRD requirements. Government: In 2005 the Government allocated about KZT 3 billion for development of the microfinance sector, and in 2006 and 2007 an additional KZT 4 billion per year are expected. Thus the sector is to obtain government investments totaling KZT 11 billion (roughly USD 8 million) over three years. The management of these funds is under the responsibility of the "Small Entrepreneurship Development Fund" (SEDF). Private capital: Private capital largely accounts for the recent sector development. Many MFIs use private funds and include those which are set up by private individuals who regard microfinance activity as their own family business. Commercial banks: Local banks are only slowly coming to recognize the advantages of funding and investing in MFIs. In some cases, MFIs work on the ground for banks by training potential bank clients and teaching them the credit culture. One large Kazakhstani bank has decided to use a fast-track procedure for the issuance of loans to borrowers with credit histories at KLF. This means there is no need for the bank to fully screen entrepreneurs who have a record of at least two loans from the MFI. On the other hand, as long as Kazakhstani MFIs are not well developed, self-sustainable, and technically capable, banks do not seem to be particularly interested in working with them. However several MFIs that have reached self-sustainability have also successfully approached commercial banks, although the cost of commercial funds is high. ACF was provided with a USD 1 million revolving credit line from Demir Kazakhstan Bank. Another good example of MFI-commercial bank cooperation is the use of bank infrastructure for client account management and loan repayment, which reduces risks and operational costs for MFIs. Both Bereke and ACF have developed special agreements with bank branches and also obtained preferential commission rates from them. Transnational companies and large national companies have also developed social responsibility programs in cooperation with MFIs. ChevronTexaco, Citibank and ExxonMobile have funded MFIs to develop microfinance programs in different regions of Kazakhstan. 53

55 Microfinance in Kazakhstan: an inclusive financial sector for all Table 4.1 International microfinance investor funds in Kazakhstan Name Country Fund global Assets allo Active MF assets (USD) cated to MFIs (%) investments (#) DBMDF United States 3,027, % 27 (30/06/04) (30/06/04) (30/06/04) Dexia Microcredit Fund Luxembourg 51,669, % 49 (31/12/04) (31/12/04) (31/12/04) ECLOF Switzerland n/a n/a n/a HTF Netherlands 22,713, % 36 (31/12/04) (31/12/04) (31/12/04) I&P Development France 10,000, % 5 (31/03/04) (31/03/04) (31/03/04) KFW Germany 85,400, % 31 (01/01/02) (01/01/02) (01/01/02) MicroVest United States 15,000, % 7 (29/11/04) (29/11/04) (29/11/04) Oikocredit Netherlands 275,899, % 159 (31/12/03) (31/12/03) (31/12/03) ResponsAbility Fund Luxembourg 7,051, % 22 (30/09/04) (30/09/04) (30/09/04) Source: MIXmarket website ( accessed July 2005 MixMarket indicates that nine international funds invested resources in the Kazakhstani microfinance market. In the table below, the general characteristics of these investor funds are summarized. There are an increasing number of international private investors interested in lending money to MFIs with good credentials. In dealing with international investors, some type of intermediation or brokering may be required for small MFIs. Pension funds: After the latest pension reforms in Kazakhstan, several pension funds were created. These institutions have surplus liquidity that can be channeled to finance MFIs through advanced financial products (e.g., credit securitization). Even if the financial market is not ready for such kinds of products, feasibility studies should further explore this opportunity Introduction to apex funds Apex organizations are wholesale institutions that provide funds (grants, loans, guarantees) and services to MFIs on a geographical basis. Funding can be provided with or without technical assistance. Apex organizations attract donors and investors to supply funding and technical assistance to MFIs. As reliable local institutions, apex organizations are attractive because they provide foreign investors -- such as donors, private investment funds and even governments -- with increased confidence in supporting microfinance activities. In spite of these facts, only a limited number of successful apex experiences can be found around the world due to several challenges that these organizations face. CGAP suggests some practical factors to be addressed in order to design a successful and effective apex system. BOX 4.1 Mission Success factors for apex Long-term commitment to developing of sustainable microfinance providers Governance Management Political independence and decision - making autonomy High quality management: microfinance expertise, managerial and financial skills, integrity Operations Source: CGAP Use of clear selection criteria to fund MFIs Loans tailored to MFI cash flows and needs MFIs monitored via a few well - defined, enforced performance targets 54

56 CHAPTER 4 Opportunities and challenges Designing successful apex systems is a complex challenge. These are problems that apex institutions usually face: Apex planners often face the situation where very few MFIs can apply for funds due to strict selection criteria. Even in Bangladesh, where the microfinance sector is highly developed, the Palli Karma Sahayak Foundation apex fund found that only 10percent of MFIs that submitted applications satisfied funding requirements. Apex funds in Kenya, Dominican Republic (FondoMicro), Columbia and Pakistan had more money than qualified MFIs. Apex funds that conscientiously select organizations based on strict criteria cannot allocate funds rapidly. Political pressures often influence MFI financing decisions. Apex funds rarely become a bridge between MFIs and commercial banks and funds. Global microfinance experiences shows that microcredit should be combined with technical assistance, but apex funds are not always equipped to provide TA. Kazakhstan differs in some respects from other transitional economies due to its relatively well developed banking and insurance markets, enabling microfinance laws, and number of successfully established MFIs. In addition, the Government has so far given positive appraisal to microfinance and appears prepared to provide financial support to the sector. However, the lack of a coherent sector strategy could hamper the further development of the sector. An apex institution planned by the Government in Kazakhstan could possibly play a positive role in the development of the sector, provided that the problems mentioned above are faced transparently. The apex fund might act as a wholesale credit institution for MFIs, initially in Kazakhstan, possibly to be replicated within the Central Asian region. However, plans for developing an apex institution seems somewhat ambitious for Kazakhstan, even if the strategy would be well defined and designed. Considering the poor experience in bridging government funds to MFIs collected in previous microcredit programs, it would not be simple to establish an apex institution and to guarantee its independence of action. Further involvement of international organizations, international experts, and the Association of Microfinance Organizations in the process could be an instrument to build up credibility and assure effectiveness Beyond microcredit Another option to foster MFI expansion is the introduction of a set of new, tested, and highly effective financial services. These options and other considerations are analyzed below. International experience shows that a population with low incomes can benefit from additional financial services besides loans. Microsavings, microinsurance and micro leasing services are most needed in Kazakhstan. MFIs are encouraged to introduce a client focus - - and particularly a pro-poor focus -- and to develop innovative products in order to meet and adapt to clients' needs. However, the development of new product requires accurate analysis. Before moving from core products like microcredit into new areas, an organization should test its governance system and carefully look at the market. The organization Microsave developed several useful tools to help MFIs in the decision to expand their services. BOX 4.2 Wholesale lending institutions in Central Asia: Frontiers Kyrgyzstan Frontiers is probably the only wholesale lending intuitions that serves MFIs in Central Asia. Frontiers began its operation in 2004 with the support from CAMFA/USAID. In numbers ( ): Outstanding portfolio: USD 1,987,453 Active Clients: 18 Loan size: from USD 5,000 to USD 200,000 Tailored repayment terms up to 2 years Interest rates (12%-15%) Main requirements for loan applications: - Legal registered entity - Reached or approaching operational self sufficiency - 3 years financial statements - Cash Flows projections 55

57 Microfinance in Kazakhstan: an inclusive financial sector for all BOX 4.3 Developing new products Microsave developed a set of tools to help MFIs to develop, design and launch new products. The product development process is complex and needs to be faced through systematic steps. These are the 5 phases in which the product development process is usually divided: Evaluation and Preparation Market Research Concept/Prototype Design Pilot Testing Product Launch and Roll out Source: Microsave, Expansion to savings services is one option, even if often such financial activity is strictly regulated. One of the main tasks in the development of an effective savings program is the adaptation of MFI corporate culture to provide deposit services. As important is the need to have regulating bodies supervising the institutions that collect savings, including MFIs. Well-developed deposit services could lead to a successful integration of financial services, reduce MFI dependence on external financing, and create a stable cash flow to cover operational costs. With savings services, MFIs obtain one important advantage: a stable and relatively cheap source of funds to expand loan operations. MFIs can also lower liquidity risks and become less vulnerable to external shocks. However, MFIs must be aware of other elements -- most of which are beyond the control of MFIs -- that are vitally important for the successful provision of savings products: a healthy macroeconomic environment and healthy financial sector; an efficient management structure; proper liquidity risk management; a legislative and supervisory framework that ensures the safety of savings; effective products and mechanisms that cover expenses of savings collection. The current legislation in Kazakhstan allows only commercial banks to collect savings. To become a bank, MFIs have to meet strict requirements for capital stock and guaranteed funds. Kazakhstani MFIs seem to frequently consider the possibility of collecting savings to mobilize financial means in the credit portfolio and direct them as a component of their further development. International practice shows that managing savings increases the responsibility and accountability of MFIs in comparison with managing state grants or subsidies. At this stage, when efforts of the Agency for Supervising Financial Markets and Organizations are focused on enhancing control of commercial bank activities, Kazakhstan MFIs could not hope to begin collecting savings due to the fact that savings restrictions are not likely to be amended soon. Micro leasing, according to the International Financial Corporation (IFC), is a very attractive financial service for small and medium businesses and an option which might be easier for MFIs in Kazakhstan that are planning to diversify their services. Entrepreneurs can acquire, with the help of leasing service providers, equipment on the basis of business cash flows and not on their credit history or collateral. Some advantages of leasing include 2 : Supply and demand. In most developing countries leasing is one of the main forms of medium- and long-term financing of fixed assets. Leasing provides MFIs with an opportunity to reach new borrowers and expand existing markets. Effective capital use. Leasing ensures efficient and effective use of the capital available. In some cases leasing offers also the opportunity to set lower costs and fees due to highvolume purchases. Collateral financing. The leasing company keeps the ownership of the leased asset, which is used as collateral. As the rightful asset owner, the leasing company has a stronger position in case of default. Low cost of operations. Leasing operations can be fast and simple. Known characteristics of cash flows peculiar to leasing makes planning easier and reduces risks. Financing at a fixed rate. Leasing as a rule offers medium- and long-term financing at a fixed rate. Leasing also has some disadvantages that MFIs should be aware of, including: Asset ownership. The lessor is in responsible for maintenance expenses related to obsolescence. In most cases the leasing period is shorter than the period of equipment use. MFIs must take into consideration the work- 2 Daley-Harris, Pathways Out of Poverty: Innovations in Microfinance for the Poorest Families,

58 CHAPTER 4 Opportunities and challenges ing life of property and its resale potential. Fixed rates. Most payment rates are fixed and do not depend on characteristics of the client, leasing company or equipment. Therefore, the cost of operations for leasing cheap equipment will be higher. Asset value and liquidity. Derived income must exceed the leaser's asset value to be profitable. MFI assets tend to have costs that are higher than the prevailing market rates. Given the characteristics of leasing and the significant advance expenses, there is a risk of negative influence on MFI liquidity and reduction of profitability. Depreciation analysis. The leasing company devalues leased assets during the leasing period. Measuring future asset value includes both potential profits and possible losses, which is vitally important to measure the profitability of leasing operations. In Kazakhstan, no microfinance products have been provided except for microcredit. Other microfinance products such as microsavings, microinsurance and micro leasing are not commonly used, since only specialized legal entities such as leasing and insurance companies may deliver them. There are strict requirements for obtaining such licenses, including capital requirements, reserves, adherence to prudential norms, asset placement, etc. Kazakhstani MFIs have carried out a preliminary survey on leasing. It was found that micro entrepreneurs are very interested into purchasing miniequipment and second-hand equipment. As a rule, leasing companies provide new expensive equipment, which is not affordable for the microfinance target group. Therefore, there is enough space for MFIs to establish pilot leasing projects to assess the viability of micro leasing operations. Insurance services are regulated following prudential requirements. For this reason banks and other financial institutions need to create affiliated companies to provide insurance. Requirements for setting up new insurance companies discourage MFIs from entering the market directly. In general, the insurance market in Kazakhstan is considered to be relatively young and still underdeveloped. An agreement between insurance companies and MFIs to market innovative microinsurance products is probably the best option at this stage of development. On this there have been no pilot projects or plans among MFIs to develop microinsurance programs and there is a lack of market research on the needs. Feasibility studies to assess the actual demand in Kazakhstan and opportunities to expand insurance services to the poor, and in particular to the rural poor, should be sponsored by donors or the government. An interesting study was conducted in 2005 in Georgia to assess the demand for microinsurance service 3. The Microinsurance Center provides easily accessible documents focusing on all aspects of providing microinsurance 4. Money transfer services and remittance management are considered to be highly profitable services, but only banks and international companies provide these services in Kazakhstan. However, pilot studies could be launched to assess the feasibility for larger MFIs to develop adequate capacities to offer these valuable services to their clients. The delivery of microfinance services may be part of the cooperation between specialized financial institutions and MFIs. For example, under agency agreements with banks and insurance companies, MFIs could promote a spectrum of financial services including microinsurance products specifically designed for the poor. 4.3 Enhancing the impact of microfinance on social and economic development Development of entrepreneurial initiatives in remote areas Business infrastructure development is not balanced throughout Kazakhstan. For example, in Kyzylorda, Manghistau and Atyrau oblasts, low entrepreneurial activity is registered with a corresponding lack of infrastructure such as transportation and communication facilities. On the other hand, in South Kazakhstan and Karaganda oblasts and in Almaty city, there is no need to go beyond facilitating the SME environment since these regions already have a well-developed business climate. A regional needs-based approach and analysis should therefore be applied to policies aimed at developing the business infrastructure in an integrated manner. For example, enterprise development in the northwestern regions of Kazakhstan, which suffers from relative poverty, also has a social dimension and could improve the level of employment, while the business attitudes 3 The Microfinance Center for CEE and NIS, Demand for Microinsurance in Georgia, Quantitative Study Results Microinsurance Center, 57

59 Microfinance in Kazakhstan: an inclusive financial sector for all are already prevalent in the relatively well-developed areas of southeastern Kazakhstan. SME distribution is highly imbalanced in Kazakhstan. In particular, SMEs are mostly located in only 3 regions: Almaty city and Karaganda and South Kazakhstan oblasts. Seventy-five percent of SMEs are individual entrepreneurs and only 7percent of all SMEs are engaged in manufacturing activities 5. Such an environment highlights the need for an effective microfinance sector. In general, the proportion of SMEs to GDP remains low in Kazakhstan compared to western economies. The business environment is only slowly improving for SMEs. The Agency for Statistics reports that as of 1 October 2004, the contribution of small enterprises to GDP was as high as 24.6percent with 611,522 registered small enterprises, versus 23.7 percent and 494,297 small enterprises as of 1 October On 1 October 2004, the number of workers employed in small enterprises reached 1,384,500. However, heavy disproportions in access to financial services are faced by SMEs compared with medium- and large-scale enterprises. A systemic approach to the development of SMEs and the promotion of microcredit as a tool for encouraging entrepreneurial initiatives could be beneficial. Infrastructure problems do not have to prevent the activity of MFIs in rural areas. All over the world it has been proven that even people living in remote areas are in need of financial services and that MFI operations in these areas can be profitable. Until now, however, microfinance outreach has been minimal in the rural areas of Kazakhstan, where most of the poverty is concentrated A functioning and inclusive financial system Microfinance is an effective instrument for encouraging entrepreneurship and reducing poverty. The microfinance sector is an important component of the financial system and can cooperate with different players (banks, insurance, leasing and mortgage companies) to expand the range of services and the access to financial services. The concept of financial system development of the Republic of Kazakhstan has been developed below to take better account of microfinance players and to highlight the potential role of an apex institution Role of women in microcredit Women often face the same challenges as men in running businesses but with increased severity due to gender discrimination. Moreover, many women who are willing to start or expand their businesses not only maintain their responsibilities at home and earn money for their families, but also have to overcome numerous social and cultural obstacles. MFI experiences show us that women are often better borrowers than men and that microcredit projects targeted at women in Kazakhstan are achieving remarkable results. In many microfinance projects around the world it has been found that women demonstrate better repayment rates than men. The transition process resulted in higher unemployed among women than men in Kazakhstan. In 2004, women accounted for 57.3 percent of all unemployed people. The specific profile of Kazakhstan is that unemployed women are comparatively well educated (both higher and vocational education). In Kazakhstan, 42.3 percent of those self-employed in small businesses are women 6. The self-employment of women, especially in rural areas, largely accounts for the high level of women's participation in the economic activity of Kazakhstan. The traditional sectors of female selfemployment are trade with clothes and foods, crafts, agricultural production, personal services, catering, advice-giving and teaching, folk medicine, cosmetology, etc. Such activities are good candidates to be financed by MFIs. The development of networks and associations of Table 4.2 Comparison of SME contributions to the national economy in selected states USA Canada Japan UK Italy Kazakhstan SME contribution to national GDP 52.0% 43.0% 51.6% 52.0% 55.0% 20.0% Proportion of SME employees out of total employees 50.1% 47.0% 69.5% 55.5% 71.0% 18.0% Proportion of SMEs out of all enterprises 97.6% 99.8% 99.2% 99.1% 99.2% - Proportion of national budget expenditures on support to SMEs 0.04% 0.23% 0.21% 0.25% 0.4% - Source: Turjanov S.A., Turjanov S.A., The small and middle business: problems of development, ways of solution,

60 CHAPTER 4 Opportunities and challenges BOX 4.4 Financial sector concept for Kazakhstan Clients Borrowers (individuals, corporate clients, etc.) SMEs, individuals Financial Service Providers LEVEL I: Banks Services : all types of bank services ( credit, deposit, etc.) Supervision : high LEVEL II: credit associations, pawnshops, and non banking financial institutions; Services : credit, leasing Supervision : partial Source of funding Equity capital, savings, syndicated loans, external loans, etc. International organizations, state, private investors Microfinance Institutions APEX Mainly state budget, private investors, banks Small and micro entrepreneurs and individuals without access to bank services LEVEL III: microcredit institutions Services: credit Supervision : registration only International organizations, state, private investors self-employed women and small businesses would help businesswomen to set up or expand their economic activities. The experiences of many countries show that services and assistance targeted at women have a positive impact on society as a whole. Microfinance is usually promoted along with training and business advisory services. The Association of Businesswomen in Kazakhstan and the national branch of the Environmental Association of Oriental Women are the largest women's NGOs in this area. Projects focused on women in Kazakhstan include the following: The Association of Businesswomen in Kazakhstan is implementing a project, called "The Status and Economic Advancement of Women in Kazakhstan," which supports women in rural areas. The project covers Kyzylorda city, and the Aral and Kazalinsky Rayon. Women can receive microcredit, varying between USD 100 and USD 600, for a period of three months. Microcredit is disbursed individually, by loan groups and to families. In total, micro loans now total USD 255,500. The Environmental Association of Oriental Women is working very actively in implementing a UNDP project on economic training for women. The Golda Meir Mount Carmel International Training Center (Israel) has carried out a short training course titled "Women in Business." The participants of the workshop included heads of divisions, directors of companies, entrepreneurs, and leaders of women's NGOs. Annually, to stimulate woman entrepreneurship, the National Commission on Family and Women Affairs carries out a republican competition -- Best Business Headed by a Woman -- in seven categories. There is also a special annual campaign, Ak Niet, carried out by the National Commission for rural women. Under this campaign, more than a thousand women have been trained in business; the best among them received access to extra loans. Several MFIs specialize in providing microfinance services for women. MCO Bereke gives loans to women's groups and provides consultative and other services. About 98 percent of the 4,000 Bereke clients were women. An independent survey conducted under the umbrella of UNDP Semipalatinsk Programme showed real improvements in the lives of Bereke borrowers. In 2000, a study by Yasushi Tairo concluded that clients on average increased their profit KZT 4,215 over the credit 6 UNDP Kazakhstan, Gender equality and the status of women,

61 Microfinance in Kazakhstan: an inclusive financial sector for all period and saw an increase in wages by, on average, KZT 39 per hour. A Bereke survey conducted in 2004 found that 87 percent of the clients interviewed reported an increase in the profitability of their business 7. Moldir Women's Association (an NGO) started its activities in December 1993, operating on the idea to develop self-help groups. The association helps people to adapt to the market economy, fight unemployment, and collect resources to meet their financial needs. Moldir activities are related to the national program aimed at poverty reduction, employment of poor people, development of the strategy for the small business sector, and advocacy for sound nutrition and healthy lifestyle. Self-help groups are actively in operation following the principles of mutual help and assistance. In sum, as a result of the programs of a number of microfinance associations, many women have improved their living standards. 4.4 Major findings and conclusions The microfinance legal framework of Kazakhstan needs to be further refined. Some amendments were considered, such as relaxing licensing requirements for NFBIs and credit partnerships, revising taxation schemes, expanding the definition of the term borrower of a MCO, and increasing the maximum loan size for MCOs. Various development options for the microfinance sector were analyzed: Attracting financial resources from various actors such as the private sector, commercial banks, international private funds, and pension funds. New government-financed microfinance projects could also become an alternative to donor grants. Introducing apex funds. The idea of creating an apex institution was reviewed by outlining the advantages and disadvantages. The SEDF apex Activities Social services Employment services Information service Legal advice Psychological services Other activities Table 4.3 Moldir Women's Association activities Description of activities Organization of women into self-help groups by mobilizing members and external resources; provision of training to women in how to articulate their own interests, protect their rights, and achieve independence. Provision of help to vulnerable groups such as single mothers to obtain employment through training and income generation activities. Research and lobbying in the interests of unemployed. Promotion of organizational activities among target groups, government agencies, the private sector and NGOs. Publication of newsletter "Moldir" and other leaflets. Provision of professional legal advice; representation of interest of single mothers in court and other institutions; assessment of the status of vulnerable families to feed into draft laws. Promotion of active life styles, positive self-esteem, mutual understanding, trust building, psychological health and supporting environment, as well as delivering psychological advice. Provision of training workshops, conferences, and roundtables on socio-economic advancement of low-income families, single women, disabled people, and children and providing targeted social assistance. Source: Moldir Women's Association, The Information Bulletin of Moldir 7 UNDP Kazakhstan, Final evaluation of UNDP Semipalatinsk Programme outcomes,

62 CHAPTER 4 Opportunities and challenges strategy proved to be well designed, but the risks associated with such funds remain high when implemented by government bodies. Expanding beyond microcredit. The opportunity to expand microfinance services like microsavings, microinsurance and leasing was examined. MFIs have been excluded from collecting savings. Further research is needed to assess the actual demand for leasing and insurance products. When MFIs do not have their own capacity, agreements with commercial banks and insurance companies could overcome barriers and are being used to introduce innovative microfinance products in the country. Since there is no consolidated data, assessing the influence of microfinance on poverty and unemployment in Kazakhstan is a difficult task. Available information is sometimes contradictory in measuring the degree of outputs/outcomes and can be difficult to verify. However, independent project-based surveys indicate that borrower life has improved after being introduced to microfinance services. New statistics on the number of households who have and who do not have access to financial services should be included in the next statistical handbook. The Agency of Statistics is only at the planning stage of tracing microfinance activities in the country. In the report, infrastructure gaps and regional differences between oblasts are highlighted. The report also suggests that the role of woman in microfinance is central for the development of the sector in Kazakhstan. 61

63 Microfinance in Kazakhstan: an inclusive financial sector for all CONCLUSIONS AND RECOMMENDATIONS Microfinance in Kazakhstan is still a relatively young concept that was only introduced in the mid-nineties. Despite the diversity and number of existing microfinance institutions, there is still a high demand for financial services that remains unfulfilled. Microfinance has the ability to create enormous opportunities for people and in particular the poor. Therefore, a strong and positive impact on the social and economic development of the country is expected from the formation of a network of small and micro enterprises. The findings of this report confirm that microfinance outreach is still very low in Kazakhstan: it is estimated that there were 50,600 microcredit clients in 2004, only 2 percent of the poor living in Kazakhstan. Conservative estimates indicate that the potential microfinance demand is between 140,000 and 220,000 clients, although the ideal objective would be to expand microfinance access to all of the 700,000 poor households in Kazakhstan. Only one microfinance institution surpasses the threshold of 10,000 active clients, while the vast majority has less than 500 clients. Rapid growth in the sector during the past few years indicates a prompt market response to the demand of microfinance services. However, several bottlenecks hinder further development of the microfinance sector in Kazakhstan. All of the options mentioned in this report to expand microfinance services require a joint effort from all stakeholders. In order to overcome the bottlenecks that prevent the expansion of microfinance services and to promote sustainable development, the government, donor community, and microfinance institutions themselves are encouraged to consider the following recommendations. GOVERNMENT OF KAZAKHSTAN A sound policy and legal framework for the microfinance sector is an essential precondition for further development and should include provisions to: Secure savings of the poor; Promote competition in the microfinance sector; Develop the microfinance expertise of supervisory and regulatory bodies. Prudent financial supervision in Kazakhstan only allows banks to collect savings. However, the requirements for becoming a bank are restrictive and therefore prevent MFIs from accessing the public savings that they need. Consequently, unregulated MCOs will not be able to attract the investors needed to diversify and expand their services. Many larger MFIs are using licenses as non-banking financial institutions to operate, while others are planning to become commercial banks. A more balanced relationship between supervision and flexibility in MFI operations is desirable. A cautious policy allowing certain MFIs to offer savings services could also be designed to expand microfinance outreach. In this report some development alternatives for the microfinance sector have been reviewed, including the following that directly involve the government: An effective state funding strategy with the creation of an independent institution and a transparent and effective disbursement mechanism; The expansion of microfinance activities to include leasing, microinsurance and microsavings; Effective utilization of existing opportunities. On the basis of these considerations the government is advised to: Facilitate an open and inclusive dialogue on microfinance in Kazakhstan and create a conducive environment for microfinance institutions. Promote amendments to laws that are in line with international best practices to foster microfinance growth in Kazakhstan as discussed in this report. Under the current law MCOs have several disadvantages relative to commercial banks in terms of savings mobilization, product diversification, and expansion opportunities. The loan size limits could be redefined, as could the narrow definition of microcredit borrowers. Create a state coordinating body for microfinance, such as a National Committee, to 62

64 Conclusions and recommendations coordinate the activities and initiatives that address the challenges that the poor face in accessing financial services. Members should not be limited to government bodies but should also include representatives from multilateral organizations, donors, MFIs, sector associations, academia, and civil society. Prevent interventions that could distort the microfinance sector. Subsidized lending programs should be avoided as self-sustainable microfinance institutions may be excluded from subsidized competition. Promote the development of transparent and effective mechanisms to transfer state funds to MFIs. The independence of the disbursing institutions would be the major factor in achieving good results. International experience in implementing apex funds should be looked at with special attention. The involvement of international organizations and experts in the process can help to assure credibility and transparency. Strengthen microfinance expertise among the staff in key ministries that work with microfinance projects. Sponsor an independent evaluation of ongoing state microfinance projects. Encourage Government funds and programmes to follow international practices and encourage transparency in decision-making processes. The Government of Kazakhstan has established all the basic preconditions necessary to develop the microfinance sector: a stable macroeconomic environment, an enabling legal framework for MFIs, and an explicit recognition of microfinance as a tool to fight poverty. However, the State intervention in the microfinance sector will not be effective if there are no reliable mechanisms to ensure an effective implementation. The Government made a commitment to provide funds to MFIs. However, rather than being a direct provider of financial services it is recommended that the Government create a conducive environment for microfinance institutions. Increased transparency and accountability could make a difference in the results of Government sponsored projects/strategies. DONOR COMMUNITY The role played by donors in Kazakhstan in developing the microfinance sector was significant in the recent past. They contributed by introducing international best practices and state of the art technologies as well as providing startup capital. Several projects can be considered successful and some can even be viewed as world best practices. Partnerships with the private sector, such as corporate social responsibility departments, particularly from oil sector companies, should be encouraged by donors. As donor commitments continue to decline, these partners may become potential sources of funding. The donor community should continue to support MFIs to grow in recognition of the important role played by microfinance, especially for the rural poor and small-scale borrowers. It can be noted that: A significant portion of the poor are unable to access even basic financial services; There has not been enough time to create stable, reliable and self-sustainable microfinance institutions in the country; Many MFIs still need technical assistance and capital to disburse loans; A rapid withdrawal of donor assistance could damage sector prospects for growth in view of the continued dependence of many MFIs in Kazakhstan on donor support to grow; Qualitative studies and surveys demonstrate that the lack of financial resources is a common bottleneck that hampers sector growth. Based on these considerations, donors should continue to: Provide inputs to the government to improve the design of pro-poor policies and the microfinance strategy; Participate in government microfinance projects to assure transparency and effectiveness; Support MFI associations and networks; Sponsor the creation of a market for MFI services, such as training, international and local audits, and rating services; Finance MFI capacity building and expansion; Disseminate information about best practices and sector standards; Conduct new surveys to better assess the impact of microfinance in Kazakhstan and to study the introduction of innovative microfinance products; Develop suitable donor exit strategies for existing projects; Support the introduction of microfinance services other than microcredit; Strengthen donor coordination. MICROFINANCE INSTITUTIONS Microfinance institutions themselves are the main driver in fostering development in this field. The main challenge for them is to expand their outreach, while maintaining outstanding financial 63

65 Microfinance in Kazakhstan: an inclusive financial sector for all records in order to build confidence in the sector and become established as credible institutions. Although MFIs in Kazakhstan are young relative to other similar institutions around the world, they have already achieved good self-sustainability and efficiency records. However, many MFIs in Kazakhstan are still dependent on donor support to finance their expansion strategies and there are only few MFIs that are able to attract external commercial funding. A part of the reason is that since MFIs are not allowed to collect public deposits, donor and government support will remain their major source of funding. In the coming years the growth of the sector is at risk since shrinking donor involvement and uncertain government funding could possibly worsen financial bottlenecks. A high sector growth rate is much needed as an additional driver to reduce the gap between the supply and the demand for financial services in the country and, in particular, in rural areas. At the same time, it is observed in this report that the advanced and liquid financial system in Kazakhstan offers many opportunities for the development of the sector, which may be unique in this country. MFIs are thus encouraged to: Expand their outreach, especially in rural areas, where the poor are concentrated; Gain ownership of the microfinance strategy in Kazakhstan by researching and proposing specific solutions to current challenges; Multiply networking and enhance national associations; Promote investment in human resources and adopt modern international microfinance management techniques; Comply with international standards in accounting and reporting; Seek international ratings; Facilitate knowledge sharing of best practices among MFIs in Kazakhstan and within the region; Become proactive in their strategies by developing creative and innovative methodologies for reaching clients and attracting resources; Approach national and international commercial banks, as well as international private investors, to increase financial resources; Exploit available opportunities offered by the government budget. 64

66 BIBLIOGRAPHY ACCION International, Technical Handbook, ADB, Development Prospects for Asian Countries, ADB, Great Expectations: Microfinance and Poverty Reduction in Asia and Latin America. ADB Institute Discussion Paper No.15, September ADB, Finance for the Poor: Microfinance Development Strategy, May ADB, Mibanco, Peru: Profitable Microfinance Outreach, with Lessons for Asia, July Agency of Statistics of Kazakhstan, Kazakhstan: Almaty, Agency of Statistics of Kazakhstan, Statistical Methodologies. Almaty, Agency of Statistics of Kazakhstan, Socio-Economic Development in Kazakhstan. Monthly Information and Analytical Magazine, Nr. 1-12, Agency of Statistics of Kazakhstan, Finance of Kazakhstan Almaty, Agency of Statistics of Kazakhstan, Finance of Kazakhstan Almaty, Agency of Statistics of Kazakhstan, Regions of Kazakhstan. Almaty, Agency of Statistics of Kazakhstan, Regions of Kazakhstan. Almaty, Agency of Statistics of Kazakhstan, Living Standards of Population in Kazakhstan. Almaty, Agency of Statistics of Kazakhstan, Living Standards of Population in Kazakhstan. Almaty, Agency of Statistics of Kazakhstan, Living Standards of Population of Kazakhstan: Monitoring. Almaty, Agency of Statistics of Kazakhstan and UN Theme Group on Poverty Alleviation, Living Standards and Poverty in Kazakhstan, Almaty Agency of Statistics of Kazakhstan/UNDP Kazakhstan, Poverty Monitoring in Kazakhstan. Almaty, Agency of Statistics of Kazakhstan, Women and Men of Kazakhstan: Gender Statistics, Authers John, "Major Victories for Microfinance". Published May , Financial Times. Bean Ñlaire S., Building Multi-Sector or Specialized MFIs, NGOs/NBFIs: Experiences from Mercy Corps in Central Asia. April CGAP, Microfinance by numbers. CGAP website ( CGAP, Key Principles of Microfinance. CGAP website ( CGAP, Microfinance Consensus Guidelines. 2003, CGAP/World Bank Washington DC, USA. CGAP, Building Inclusive Financial Systems - Donor Guidelines on Good Practice in Microfinance. 2004, CGAP/World Bank. CGAP, Occasional Paper N 8 - Financial Institutions with a "Double Bottom Line": Implications for the Future of Microfinance. CGAP, July CGAP / World Bank, Scaling up Poverty Reduction: Case Studies in Microfinance CGAP / The World Bank Group Washington DC, USA. CGAP, Phase III Strategy CGAP Washington DC, USA, Cheston Susy and Kuhn Lisa, Empowering Women through Microfinance. Research sponsored by the Women's Opportunity Fund and UNIFEM. DRAFT 7/8/02. Constitution of the Republic of Kazakhstan. Comments. Eds. Sapargaliev. Almaty, Daley-Harris Sam, State of Microcredit Summit Campaign Report 2003, Daley-Harris Sam, State of Microcredit Summit Campaign Report 2004, Daley-Harris Sam, Pathways Out of Poverty: Innovations in Microfinance for the Poorest Families. Bloomfield, CT: Kumarian Press Inc, Finance and Credit, Monthly informational and analytical publication. Issue 5, Fischer Stanley, Microfinance. Note prepared for the Asia Society and Women's World Banking Annual Microfinance Conference, May Government of Kazakhstan, Government Decree on Concept of Financial Sector Development as of 28 July

67 Microfinance in Kazakhstan: an inclusive financial sector for all Government of Kazakhstan, Program of the rapid measures for the development of the small and medium entrepreneurship in the Republic of Kazakhstan for the years of Henry Carla, Manohar Sharma, Lapenu Cecile, Zeller Manfred, Microfinance Poverty Assessment Tool. CGAP/ World Bank, IFAD, Rural Finance. Policy Paper Series. Rome, January IFAD, Rural Enterprise. Policy Paper Series. Rome, January Imboden Kathryn, "Meeting the Challenge: the Inclusive Financial Sector as Development Paradigm". Article published on Jacob Tom, Microfinance in Central Asia: Varied, Growing, Reforming. Policy Monitor Nr5 - May 2004, Microfinance Centre for CEE and the NIS, Khandker Shahidur R. Fighting Poverty with Microcredit: Experience in Bangladesh. published for the World Bank, Oxford University Press, p.227. Kurassova Anastasia. Main Directions for UNDP Technical Assistance to Develop Microcrediting in Kazakhstan. Astana, Law of the Republic of Kazakhstan on State Support to Small Entrepreneurship as of 19 June Law on of the Republic of Kazakhstan Credit Unions as of 28 March 2003 Law on of the Republic of Kazakhstan Microcredit Organizations as of 6 March 2003 Law on of the Republic of Kazakhstan Republican Budget for 2003 as of 12 December Law of the Republic of Kazakhstan on Protection and Support to Private Enterprise as of 4 July Legal Culture Foundation, Comments on the Part 2 of the Civil Code of Russia. Legal Culture Foundation, Littlefield Elizabeth, Murduch Jonathan, and Hashemi Syed, Is Microfinance an Effective Strategy to Reach the Millennium Development Goals?, January Microfinance Centre for CEE and the NIS, The State of Microfinance in CEE and the NIS CGAP/ World Bank Washington DC, USA Microfinance Centre for CEE and the NIS, Overview of the Microfinance Industry in the ECA Region in Spotlight Note 12, August Microfinance Centre for CEE and the NIS, Demand for Microinsurance in Georgia, Quantitative Study Results, April Microfinance Information Exchange, Benchmarking Microfinance in Easter Europe and Central Asia. A report from Microfinance Information Exchange, May 2004 Moldir Women's Association, The information Bulletin of Moldir. Almaty Muzaparova Leyla, Challenges of Sustainable Development in Kazakhstan. Report prepared for World Sustainable Development Summit. Mukhtarova Karlygash, Poverty and Economics in Kazakhstan. Sayasat Magazine, Nr. 3-4, Nautilson K., Handbook for Managers of Microfinance Organizations. Monitoring Financial Results. The SEEP Network, National Bank of Kazakhstan, Statistical Bulletin of the National Bank of Kazakhstan, Almaty, September National Bank of Kazakhstan, Statistical Bulletin of the National Bank of Kazakhstan, Almaty, November National Bank of Kazakhstan, Statistical Bulletin of the National Bank of Kazakhstan, Almaty, December OECD, Microcredit in Transitional Economies General Distribution, OCDE/GD, Paris Patrick Honohan, Measuring microfinance access: building on existing cross-country data. Report prepared for the UNDP, World Bank and IMF Workshop Data on the Access of Poor and Low Income People to Financial Services Washington, DC, October Pearce Doug, Sustainability, Capacity and Outreach in Microfinance: Bank - MFI Linkages. Report prepared for the conference Expanding Access to Microfinance in Central Asia, Almaty, April Presidential Administration, Ministry of Economy and Budget Planning, Agency of Statistics, of Kazakhstan, 12 Years of Kazakhstan's Independence. Analytical Report. Almaty, January

68 Bibliography Robinson Marguerite S., The Microfinance Revolution: Sustainable Finance for the Poor, The World Bank, Washington D.C. Open Society Institute, New York, Robinson Marguerite S., The Microfinance Revolution: Lessons from Indonesia, The World Bank, Washington D.C. Open Society Institute, New York, Russian Bank Encyclopedia. Eds. Lavrushin O., Moscow, Salehuddin Ahmed, M.A. Hakim, Attacking Poverty with Microcredit. The University Press Limited, Dhaka Bangladesh Schreiner Mark, Aspects of Outreach: A Framework for the Discussion of the Social Benefits of Microfinance, June Srinivas Hari, Micro-Facts: Data Snapshots on Microfinance. Virtual Library on Microcredit. Stallard Janice K., Kazakhstan's Microfinance Law. Opportunities and future challenges. Essays on Regulation and Supervision. ACDI/VOCA, Central Asia Microfinance Alliance, June Sean Kline, Freedom from Hunger - Measuring and managing social performance ( Standard and Poor's, Bank Industry Risk Analysis: Kazakhstan (Republic of), TACIS, Microfinance in Russia. Small Business Support. Programme Document prepared for TACIS SMERUS, April TENIR Project, Analysis of microcredit organizations' activities and development of the concept to expand access of MCOs to financial resources. Analysis and development of microcredit monitoring indicators in Kazakhstan. Interim report, Turjanov S.A, The small and middle business: problems of development, ways of solution, 2005 UN, We, the Peoples. The Role of the United Nations in the 21st Century. Report of the Secretary- General of the United Nations, UNCDF, Increasing Access and Benefits for Women: Practices and Innovations among Microfinance Institutions, UNCDF, Microfinance Distance Learning Course. UNDCF New York USA, UNCDF, Microfinance in Turkey, UNDP Evaluation Office, Microfinance. Essentials No. 3, December UNDP, Microfinance and Anti-Poverty Strategies. A Donor Perspective. Programme Document, UNDP/UNCDF, Financing the Development of Poor Household and Women. Presentation for the Launch of the International Year of Microcredit 2005 & Rural Savings Program of BDFC April 5, UNDP Kazakhstan, Poverty in Kazakhstan: Causes and Cures. Almaty UNDP Kazakhstan, Non-Governmental Organizations of Kazakhstan: Past, Present, Future. Almaty, UNDP Kazakhstan, Final evaluation of UNDP Semipalatinsk Programme outcomes. Almaty UNDP Kazakhstan, Gender equality and the status of women, Almaty Vasilieva E. and others, Comparative Review of Legal Base and Practice of Microcrediting in Other Countries. Smolensk, World Bank, Microfinance Handbook - An institutional and financial perspective World Bank Washington DC, USA. World Bank, Microfinance and the Poor in Central Asia - Challenges and Opportunities. World Bank Washington DC, USA, May World Bank, Making Transition Work for Everyone: Poverty and Inequality in Europe and Central Asia, World Bank, Second Agricultural Post-Privatization Project. Project Appraisal Document,

69 Microfinance in Kazakhstan: an inclusive financial sector for all GLOSSARY OF TERMS AND INDICATORS ANNEX 1 General terms Consumer Price Index (CPI) Gross Domestic Product (GDP) GDP per Ñapita Gini Coefficient Gross National Product (GNP) Inequality Inflation Rate Poverty The consumer price index measures changes over time in the general level of prices and services that a reference population acquires, uses or pays for. A consumer price index is estimated as a series of summary measures of the period-to -period proportional change in the prices of a fixed set of consumer goods and services of constant quantity and characteristics, acquired, used or paid for by the reference population. Each summary measure is constructed as a weighted average of a large number of elementary aggregate indices. Each of the elementary aggregate indices is estimated using a sample of prices for a defined set of goods and services obtained in, or by residents of, a specific region from a given set of outlets or other sources of consumption goods and services 1. Macroeconomic indicator representing the total output of goods and services for final use produced by an economy, by both residents and non-residents, during a given period of time, regardless of the allocation to domestic and foreign claims and is calculated without making deductions for depreciation. There are three methods of GDP calculation: Refers to the GDP value divided by the average annual population of the country. Gini coefficient, which is one of the income differentiation indexes, measures the extent to which the distribution of income (or consumption) among individuals or households within a country deviates from a perfectly equal distribution. A value of 0 represents perfect equality, a value of 1 perfect inequality. Gini coefficient is expressed by the following formula: n = 1 Gini 1 n ( a + i 1 a i ) i= 1 where n - total population; a i - cumulative proportion on quintile (20% of total population) or decile (10% of total population) population groups. If the proportion of population is given in deciles, then in the main formula, n will be equal to 10. A macroeconomic indicator reflecting the final product produced by an economy during a given period of time, calculated at market prices. GNP includes both cost of the products produced in the country and outside the country using industries belonging to the country. This is the difference in income and living standards between the different groups of population, which are caused by a number of reasons of economic, regional, social, cultural and political nature. Refers to the rate of increase of the level of prices (measured by the consumer price index) during a given period. A human condition characterized by sustained or chronic deprivation of the resources, capabilities, choices, security and power necessary for the enjoyment of an adequate standard of living and other civil, cultural, economic, political and social rights 2. According to the absolute approach, poor people are those who have less than a certain absolute minimum. In other words, the concept of absolute poverty is based on establishing a list of a person s minimum basic needs (for example, the minimum consumer basket or the subsistence minimum), and the amount of resources needed to satisfy these needs. In particular, to determine needs 1 OECD Glossary of Statistical Terms. 2 The definition is made by Office of High Commissioner on Human Rights. 68

70 ANNEX 1 Glossary of terms and indicators Purchasing Power Parities Subsistence Minimum for grocery items, physiological norms for calorie, protein, fat and carbohydrate intake are used. According to the relative approach, wealth indicators for defining poverty are related to the predominant level of material wealth in a given country, rather than to minimum needs. In other words, people who have less than others are considered to be poor. In practice, according to this concept the relative poverty line is established as relative percentage of household s average or median income. The subjective approach is based on the people s subjective assessment of their living standards, it gives a possibility to the people themselves to judge if they are poor and if their income is enough to live a normal life. In this regard, this concept is closely connected with the principles of freedom and dignity of the human being and its rights to decent living standards, standard nutrition, access to health care services, education and other social and economic achievements of society. The subjective approach is widely used for qualitative analysis along with quantitative analysis. 3. The number of units of a country s currency required to purchase the same representative basket of goods and services (or similar basket of goods and services) that a US dollar (the reference currency) would buy in the United States. 4 Subsistence level is the value of goods and services at prevailing prices necessary to meet the basic requirements of a human being for supporting life. The subsistence minimum in Kazakhstan is an objectively determined level of income (expenditure) proportionate to the value of goods and services included in the consumer basket. Microfinance basic definitions Microcredit Microcredit Organizations Microfinance Microfinance Institutions Microinsurance Microsaving Money transfer A credit methodology that employs effective collateral substitutes to deliver shortterm micro loans to low-income clients. Legal definition used by the Government of Kazakhstan. It indicates microfinance institutions that provide microcredit, but that are not licensed or supervised by finance authorities. Financial services that are targeted at low-income clients, including credit, savings, insurance and money transfer services. General term that refers to organizations that provide microfinance services to lowincome people. Insurance services that allow to mitigate and share risks to reduce people vulnerability to external shocks. Deposit services that allow storing small amounts of money in secure and fast reaching places. Financial services that allow to transfer safely funds from different places. Additional financial terms 5 Adjustments Financial analysts often calculate a number of adjustments, most of which comprise analytical additions to the reported expenses of the MFI. Four groups of adjustments are common: * Subsidy adjustments * Inflation adjustments * Adjustments for non-performing loans 3 Human Development in Kazakhstan. A Textbook. UNDP Kazakhstan/Kazakh Economic University, Human Development Report UNDP, All definitions are taken from CGAP, Microfinance Consensus Guidelines 2003 and UNCDF Microfinance Distance Learning Course

71 Microfinance in Kazakhstan: an inclusive financial sector for all The value of savings that an MFI s clients are required to maintain as a conditi- on of an existing or future loan. Obligatory savings may be either a deposit held by an MFI or a facilitated savings account maintained outside of the MFI. The total value of funds placed in an account with an MFI that are payable on demand to a depositor. This item includes any current, checking, or savings accounts that are payable on demand. It also includes time deposits, which have a fixed maturity date. The outstanding principal balance of all of an MFI s outstanding loans, including current, delinquent, and restructured loans, but not loans that have been written off. It does not include interest receivable. Although some regulated MFIs may be required to include the balance of interest accrued and receivable, the MFI should provide a note that provides a breakdown between the sum of all principal payments outstanding and the sum of all interest accrued. Some MFIs choose to break down the components of the gross loan portfolio. The total number of individuals who currently have an outstanding loan balance with the MFI or are primarily responsible for repaying any portion of the gross loan portfolio. This number should be based on the number of individual borrowers rather than the number of groups. The total number of individuals who currently have funds on deposit with an MFI whom the MFI is liable to repay. This number applies only to deposits that are held by an MFI, not to those deposits held in other institutions by the MFI s clients. The number should be based on individuals rather than the number of groups. It is possible that a single deposit account may represent multiple depositors. The value of all loans outstanding that have one or more installments of principal past due more than a certain number of days. This item includes the entire unpaid principal balance, including both past-due and future installments, but not accrued interest. It also does not include loans that have been restructured or rescheduled. Includes all asset accounts net of all contra-asset accounts, such as the loan-loss allowance and accumulated depreciation. Total assets less total liabilities. It is also the sum of all equity accounts net of equity distributions such as dividends, stock repurchases, or other cash any payments made to shareholders. The value of loans that have been recognized for accounting purposes as uncollectible. The process of recognizing an uncollectible loan is called a write off or a charge off. The value of savings maintained by MFI clients that is not required as a condition of an existing or future loan. Voluntary savings may be deposits held by an MFI or facilitated savings maintained outside the MFI as part of the MFI s overall financial services. Compulsory or obligatory savings Deposits Gross loan portfolio Number of active borrowers Number of depositors or savers Portfolio at risk Total assets Total equity Value of loans written off Voluntary savings Microfinance Ratios 6 Active loan clients per loan officer Measures the operational productivity by indicating the average caseload of each loan officer. Number of active borrowers Number of loan officers 6 All definitions are taken from CGAP, Microfinance Consensus Guidelines 2003 and UNCDF Microfinance Distance Learning Course

72 ANNEX 1 Glossary of terms and indicators Average total equity Measures the portfolio risk. It compares the amount of loan installments past due to the gross loan portfolio. Total loan installments past due Gross portfolio outstanding Measures how well an MFI can cover its costs, taking into account a number of adjustments to operating revenues and expenses. The purpose of most of these adjustments is to model how well the MFI could cover its costs if its operations were unsubsidized and it were funding its expansion with commercial-cost liabilities. Adjusted operating revenue (Financial expense + Loan-loss provision expense + Operating expense + Expense adjustments) It is a historical measure of loss from unrecoverable loans. It is calculated by using loan write offs from a given period of time. Total amount of written off (over a given period) Average outstanding portfolio (for the same period) Measures the cost of lending a single unit of currency including both the costs of funds and loan loss provision expenses. Total operating expense + In-kind donations Average outstanding portfolio Measures how well an MFI covers its costs through operating revenues. In addition to operating expense, it is recommended that financial expense and loan-loss provision expense be included in this calculation, as they are a normal (and significant) cost of operating. Operating revenue (Financial expense + Loan-loss provision expense + Operating expense) The most accepted measure of portfolio quality. Portfolio at risk is the outstanding amount of all loans that have one or more installments of principal past due by a certain number of days. Portfolio at risk (X days) Gross portfolio outstanding Measures the financial productivity. It compares the gross loan portfolio outstan- ding to the number of loan officers. Gross portfolio outstanding Administrative efficiency Adjusted return on assets Adjusted return on equity Arrears rate Financial self-sufficiency Loan loss rate Operational efficiency Operational self-sufficiency Portfolio at risk (PAR) Portfolio outstanding per loan officer Portfolio yield Measures the cost of lending a single unit of currency. Total operating expense - Cost of funds - Loan loss provision exp. + In-kind donations Average outstanding portfolio Measures how well an MFI has used its asset base to generate income. Adjusted operating profits Average total assets Measures return earned on equity used to finance the institution s assets. Adjusted operating profits Number of loan officers Measures how much an MFI has earned through its lending operations. Income used to calculate yields includes all cash interests and fee payments, but does not include interest accruals. Income from lending Average outstanding portfolio 71

73 Microfinance in Kazakhstan: an inclusive financial sector for all GENERAL REVIEW OF MICROFINANCE LITERATURE Microfinance web sites: * Microfinance Gateway * CGAP * MIX MARKET * UNCDF * International Year of Microcredit * MicroSave * Micro Insurance Center * Virtual Library on Microcredit * Microfinance center for CIS and NIS * Banking with the Poor Network * Grameen Bank * Accion International * Russian Small Business Research Institute * Russian Microfinance Centre ANNEX 2 Resources on technical tools for microfinance institutions (Recommended by CGAP, Disclosure Guidelines for Financial Reporting by Microfinance Institutions (Microfinance Consensus Guidelines, 2001). The Disclosure Guidelines represent the CGAP s member consensus on MFI financial reporting requirements. The guidelines do not prescribe accounting policies or any particular format for financial reporting. Rather, they indicate the minimum information that should be included in MFI financial reports, regardless of how that information is presented. Definitions of Selected Financial Terms, Ratios, and Adjustments for Microfinance (Microfinance Consensus Guidelines, 2003) This guideline puts forward standard definitions for selected financial terms, commonly used, and suggests a standard method of calculating financial ratios. Scoring: The Next Breakthrough in Microcredit? (Occasional Paper No. 7, 2003) Scoring is a new way to judge the risk of whether the self-employed poor will repay their microcredit debts as promised. Financial Transparency: A Glossary of Terms (Donor Brief No. 7, 2002) Definition of terms that are often inconsistently used in collection, analysis, and disclosure of MFIs financial information. Microfinance Transparency and Reporting to Donors (Donor Brief No. 6, 2002) Knowing and understanding the components that contribute to transparency in microfinance is half of the battle. It is also particularly useful to know, with just a few strategic changes, how donor reports can enhance transparency for the whole microfinance sector. Making Sense of Microcredit Interest Rates (Donor Brief No. 6, 2002) Why do MFIs charge such high interest rates to the poor? This brief gives donors a quick reference to use when answering questions about the seemingly high microcredit interest rates. It also explains how donors can tell if an MFI s rates are too high and suggests what to do. Resource Guide to Microfinance Assessments (Focus Note No. 22, 2001) Five of the better-known rating methodologies for MFIs are compared here: CAMEL of Accion Inter- 72

74 ANNEX 2 General review of microfinance literature national, PEARLS of the World Council of Credit Unions (WOCCU), GIRAFE of PlaNet Rating, and the rating methodologies of MicroRate of Washington, D.C., and Micro-Credit Ratings and Guarantees India, Ltd. (M-CRIL). Focus on Financial Transparency: Building the Infrastructure of a Microfinance Industry (CGAP brochure) This update outlines the activities of CGAP and other industry players in the area of financial transparency. This document is part of a trilogy of special reports on financial transparency in microfinance. Helping to Build a Microfinance Industry (CGAP brochure) This identifies the CGAP mission and its services to the microfinance industry as a whole. Measuring Microcredit Delinquency: Ratios Can Be Harmful to Your Health (Occasional Paper No. 2, 1998) The paper reviews the experience of national microfinance apexes-wholesale mechanisms that channel funds, with or without supporting technical services, to retail microfinance institutions in a single country or integrated market. Cost Allocation For Multi-service Microfinance Institutions (Occasional Paper No. 2, 1998) The paper reviews the experience of national microfinance wholesale mechanisms that channel funds, with or without supporting technical services, to retail microfinance institutions in a single country or integrated market. Product Costing Tool (Technical Tool No. 6, 2002) CGAP has developed a tool that helps MFI managers understand and analyze individual product costs. The tool outlines two methods for determining the administrative cost structure of individual microfinance products. Once product costs are determined, the paper suggests methods for understanding how and why costs are incurred for that product, and how the product contributes (or not) to the overall financial viability of the MFI. This tool is currently being tested in the field. Poverty Assessment Tool (Technical Tool No. 5, 2003) The Poverty Assessment Tool (PAT) was developed for CGAP by the International Food Policy Research Institute. The multi-dimensional Poverty Index constructed by the tool is targeted at donors and investors who require a standardized, globally applicable set of poverty indicators to make poverty-focused funding decisions and to compare MFIs across regions and countries. Although it is more complex and costly than the simpler clienttargeting tools used by MFIs (such as means testing, the Housing Index, Participatory Wealth Ranking, Rapid Appraisals, and Participatory Appraisals), and less comprehensive (and therefore less costly) than the World Bank s Household Expenditure Survey, the PAT nonetheless yields rigorous data that can also be used to rank large populations, determine the poorest inhabitants of large geographical regions, and make valid comparisons across regions and countries. Format for Appraisal of Microfinance Institutions: A Handbook (Technical Tool No. 4, 1999) The Appraisal Format consists of detailed instructions and Excel spreadsheets to guide an experienced microfinance analyst through a qualitative, institutional evaluation of a relatively mature MFI. The Appraisal Format evaluation process covers the core components of a final evaluation report. The executive summary has quantitative and qualitative reviews of key -conclusions and recommendations. Individual sections are devoted to institutional factors, MFI services/clientele/market, strategic objectives, and financial performance, respectively. The handbook s annex provides additional information on how to calculate theoretical interest yields. CGAP Poverty Audit (Technical Tool No. 4-Companion, draft 2001) Designed to complement financial sustainability outlined in the Appraisal Format, the Poverty Audit provides instructions for conducting a qualitative review of the poverty focus of an MFI. The audit concentrates on five sets of issues: the vision of the MFI, its client-targeting strategy, staff-client interactions, the alignment between poverty focus and product design, and poverty impact. External Audits of Microfinance Institutions: A Handbook (Technical Tool No. 3, 1998) Volume 1 is geared towards the clients of MFI external audits: boards of directors and managers of MFIs, donors, creditors, and investors. It reviews the difference between internal and external audits, details specific audit issues associated with MFI loan portfolios, and provides concrete suggestions on how to commission an external audit, including writing the terms of reference and selecting the auditor. Volume 2 is geared towards external auditors, furnishing an overview of the microfinance industry for auditors unfamiliar with these financial institutions, and guidance on a range of audit issues specific to MFIs. to refer their auditors to the External Audit handbook. Using Microfin 3 A Handbook for Operational 73

75 Microfinance in Kazakhstan: an inclusive financial sector for all Planning and Financial Modeling (Technical Tool No. 2, 2001) Using Microfin 3.0 replaces the 1998 handbook, Business Planning and Financial Modeling for Microfinance Institutions. This new handbook provides detailed guidance on using version 3 of Microfin, the latest version of the Excel-based financial modeling tool specifically designed for microfinance institutions. Microfinance Glossaries (2003) Searchable glossaries in pdf format that cover basic and more advanced terms used in microfinance. They were developed and reviewed by microfinance experts to ensure consistent translation of CGAP documents. Resources on legal and policy studies for microfinance: Increasing Access to Financial Services While Balancing Supervisory Interests, Ricki Tigert, Federal Deposit Insurance Corporation of the US Microfinance Regulation in Developing Countries - a comparative review of current practice, Patrick Meagher CGAP Guiding Principles on Regulation and Supervision of Microfinance, Robert Peck Christen, Timothy R. Lyman and Richard Rosenberg Microfinance Institutions and Public Policy, Daniel C. Hardy, Paul Holden and Vassili Prokopenko. A Framework for Regulating Microfinance Institutions, Greuning, Hennie van Gallardo, J.S. Randhawa, Bikki K. / Washington, DC, USA: World Bank, 1999 Regulating Microfinance - The Options, Christen, Robert and Richard Rosenberg. Journal of Small Business and Enterprise Development. University of Manchester, U.K. Spring 2001 How to Regulate and Supervise Microfinance? - Key Issues in an International Perspective, Alfred Hannig & Edward Katimbo-Mugwanya (Eds.), FSD Series No. 1, Financial Systems Development (FSD) Project 2000 Regulation and Supervision of Microfinance Institutions: State of Knowledge, Stefan Staschen, Deutsche Gesellschaft fur Technische Zusammenarbeit (GTZ) GmbH Eschborn, August Regulation and Supervision of Microfinance: A Conceptual Framework. Draft for discussion only; Robert C. Vogel, Arelis Gomez, Thomas Fitzgerald, IMCC, February A Framework for Regulating Microfinance Institutions: The Experience in Ghana and the Philippines, Joselito Gallardo, Washington, DC: The World Bank, 2001 Regulatory Requirements for Microfinance. A Comparasion of Legal Frameworks in 11 Countries Worldwide, Stefan Staschen, Eschborn: GTZ, 2003 Bosnia & Herzegovina - The Region s First Specialized Microlending Law Set to Undergo Changes, Timothy R. Lyman, Berry & Howard Foundation Mihret Dizdar, Foundation for Sustainable Development Microlending Organizations in Kazakhstan. Regulation and Supervision Issues, Bryan D. Stirewalt Taking Care of The Mission Means Taking Care of The Client, Ximena Arteaga, Regulation and Policy Specialist, FINCA International Overview of the New Basel Capital Accord, Bank of International Settlements, Basel, 2003 Microfinance Banks and Policy Dialogue, Charlotte Grey, EBRD Planning for Taxes, Craig Gibian, Shearman & Sterling and Deborah Burand, FINCA International UNCDF Strategy for Policy Impact and Replication in Local Governance and Microfinance A Diagnostic Kit for Analyzing the Legal and Regulatory Environment for Microfinance Institutions in Countries and Regions in Central and Eastern Europe, Kathryn Funk and Timothy R. Lyman, The World Bank, Washington D.C. Innovations in Microfinance: Technical Notes, Series 1-7; This series highlights innovative practices and services from the Mali February 2000 conference Advancing Microfinance in Rural West Africa that Weidemann Associates implemented. The technical notes are a collaborative effort between Weidemann Associates, Inc./MicroServe and DAI, Inc/Microenterprise Best Practices Project, USAIDfunded contracts. Resources on microfinance impact studies: Barnes, Caroline, Gary Gaile, and Richard Kimbombo. Impact of Three Microfinance Programs in Uganda. USAID-AIMS Paper. Washington, D.C.: Management of Systems International, Barnes, Carolyn. Microfinance Program Clients and Impact: An Assessment of Zambuko Trust, Zimbabwe. USAID-AIMS Paper. Washington, D.C.: Chen, Martha A., and Donald Snodgrass. Managing Resources, Activities, and Risk in Urban India: The Impact of SEWA Bank. Washington, D.C.: AIMS, Cheston, Susy, and Lisa Kuhn. Empowering Women through Microfinance. New York: UNIFEM, Chowdhury, A.M.R., and A. Bhuiya. Do Poverty Alleviation Programmes Reduce Inequity in Health: Lessons from Bangladesh. In Poverty Inequity 74

76 ANNEX 2 General review of microfinance literature and Health, ed. D. Leon and G. Walt. Oxford: Oxford University Press, Hashemi, Syed, Sidney Schuler, and Ann Riley. Rural Credit Programs and Women s Empowerment in Bangladesh. World Development 24, no. 4 (1996): Hossain, M. Credit for the Alleviation of Rural Poverty: The Grameen Bank in Bangladesh. Research Report No. 55. Washington, D.C.: IFPRI, Kabeer, Naila. Money Can t Buy Me Love : Reevaluating Gender, Credit, and Empowerment in Rural Bangladesh. IDS Discussion Paper No Brighton, UK: Institute of Development Studies, University of Sussex, Khandker, Shahidur. Fighting Poverty with Microcredit: Experience in Bangladesh. New York: Oxford University Press, Inc., Lal, Abhishek. An Overview of Microfinance and Environmen tal Management. Green Microfinance Working Paper, July Marcus, R. Porter, B. and Harler, C. Money Matters: Understanding Microfinance. UK: Save the Children 1999 MkNelly, Barbara, and Christopher Dunford. Impact of Credit with Education on Mothers and Their Young Children s Nutrition: Lower Pra Rural Bank Credit with Education in Ghana. Freedom from Hunger Research Paper No. 4. Davis: Calif. Freedom from Hunger, As reported in Morduch, Jonathan, and Barbara Haley. Analysis of the Effects of Microfinance on Poverty Reduction. Prepared by RESULTS Canada for the Canadian International Development Agency, November MkNelly, Barbara, and Christopher Dunford. Impact of Credit with Education on Mothers and Their Young Children s Nutrition: CRECER Credit with Education Program in Bolivia. Freedom from Hunger Research Paper No. 5. Davis, Calif.: Freedom from Hunger, Morduch, Johnathan. Analysis of the effects of Microfinance on Poverty Reduction. NYU Wagner Working Paper No Series. New York: New York Univeristy, Mustafa, S.I. Ara, et al. Beacon of Hope: An Impact Assessment of BRAC s Rural Development Programme. Dhaka, Bangladesh: BRAC, Pallen, Dean. Environmental Sourcebook for Micro-Finance Insitutions. Canadian Internatoinal Development Agency, 1997 Panjaitan-Drioadisuryo, D.M. Rositan, and Kathleen Cloud. Gender, Self-Employment, and Microcredit Programs: An Indonesian Case Study Quarterly Review of Economics and Finance 39 (1999). Pitt, Mark M., Shahidur R. Khandker, Omar Haider Chowdhury, and Daniel Millimet. Credit Programs for the Poor and the Health Status of Children in Rural Bangladesh, International Economic Review. Forthcoming. Remenyi, Joe, and Benjamin Quinones Jr., eds. Microfinance and Poverty Alleviation: Case Studies from Asia and the Pacific. New York: Pinter Publishers, Ltd., June 2000: 79, ; Simonwitz, Anton. Appraising the Poverty Outreach of Microfinance: A Review of the CGAP Poverty Assessment Tool (PAT). Brighton, UK: Imp- Act, Institute of Development Studies, Varley, Robert C.G. Financial Services and Environmental Health: Household Credit for Water and Sanitation. Environmental Health Protection Agency Applied Study. Zaman, Hassan. Assessing the Poverty and Vulnerability Impact of Micro-Credit in Bangladesh: A Case Study of BRAC. Washington, D.C.: World Bank, Resources and tools for microfinance Management Information Systems Grameen Bank, Bangladesh softdep.htm Accounting software selection/evaluation tools (Commercial site) Comprehensive listing of hardware drivers available for free download Overview of Current Micro-Finance Software Programs Research engine for commercial accounting packages Information about ISO 9000 and international standards for software development Computer Society, a professional organization advocating standards in software design and development MIS Quarterly website, a peer reviewed scholarly journal, MIS Quarterly publishes research concerning both the management of information technology and the use of information technology for managerial and organizational purposes. 75

77

78 Authors Group Raushan M. Aymanbetova Madina Baynietova Massimiliano Riva Microcrediting Center Director, JSC "Small Entrepreneurship Development Fund" Microcrediting Center Chief Specialist, JSC "Small Entrepreneurship Development Fund" Programme Associate, UNDP Kazakhstan UNDP Consultative Board including the Coordination Group Yuriko Shoji Gordon Johnson Malin Herwig Zhanar Sagimbayeva Irina Buchinskaya Selima Salamova Gaukhar Mukhatzhanova Alma Buirakulova Aliya Ilyassova Maral Sheshembekova UN Resident Coordinator/UNDP Resident Representative Deputy Resident Representative, UNDP Kazakhstan Chief of Poverty Reduction Team Chief, UNDP Kazakhstan Chief of Good Governance and Sustainable Development Team, UNDP Kazakhstan Programme Assistant, UNDP Kazakhstan former Programme Assistant, UNDP Kazakhstan former Media and Outreach Specialist, UNDP Kazakhstan Research Assistant, UNDP Kazakhstan Project Expert, UNDP Kazakhstan Project Expert, UNDP Kazakhstan Technical Support Translation into English English Proof-reading Translation into Russian Translation into Kazakh Cover design Layout Photographs Alla Kalinina Kishori Kedlaya Chamith Fernando Botagoz Katenova Farida Isakova Adil Bekishev Gulmira Nurakhimova Christopher Herwig With financial assistance from JSC Citibank Kazakhstan