This article was reposted from NextBillion Financial Innovation.
Microfinance isn’t the be-all, end-all cure for poverty. But in Kyrgyzstan, what microloans lack in immediate economic benefit, they make up for in stable, long-term job creation.
According to a recent report by the Department of Information Policy in Kyrgyzstan, almost 4,500 unemployed individuals were employed in 2012 as a direct result of microloans provided to individuals registered with unemployment agencies. This was nearly double the amount of jobs created in the previous year for Kyrgyzstan’s unemployed.
But in a country with little financial regulation and no sovereign credit rating, increasing government directives may soon have negative consequences for all of Kyrgyzstan’s microfinance institutions (MFIs) and their clients.
Kyrgyzstan President Almazbek Atambayev’s signing of a usury bill in August capping MFI interest rates is the most recent manifestation of this trend. The interest rate cap to be applied under the bill will be set monthly by the National Bank of the Kyrgyz Republic (NBKR) and will be based on the nominal average weighted interest rate for loans by banks plus 15 percent.
Though MFIs in Kyrgyzstan are already regulated by the NBKR , they now also fall under the jurisdiction of this new usury bill, along with credit unions, pawnshops and private lenders. In Kyrgyzstan’s immature microfinance market, this new bill is meant to protect consumers from predatory lenders.
The problem? Because making a large volume of very small loans is a costly activity, MFIs may be unable to make these loans at interest rates below the “cap,” meaning that MFIs face the risk of violating the law or making loans below their cost. Essentially, the cap will threaten the sustainability of Kyrgyzstan’s MFIs, and may cause lenders and investors to lose confidence in their investments. As a result, many MFIs may be forced to sharply curtail lending, especially in more remote rural areas where operational costs are higher, hurting the very people the law is intended to protect.
Microfinance experts, like the Association of Microfinance Institutions (AMFI), are increasingly concerned that the Kyrgyz government’s attempts to regulate the country’s financial markets through bills like this one are ill-formed and will have negative effects on Kyrgyzstan’s economy. Some believe that regulations like the usury bill will cause the formal MFIs to discontinue lending in these areas, forcing rural clients to borrow from informal lenders, or shadow loan markets, with even higher interest rates.
In other words, the intervention meant to benefit Kyrgyzstan’s poor, rural populations is projected to do exactly the opposite.
Microfinance in Kyrgyzstan
A little over a decade old, Kyrgyzstan’s microfinance sector is young compared to that of Bangladesh or India. But it has already provided thousands of Kyrgyz citizens with the chance to invest in their entrepreneurial skills and become financially independent.
Among the country’s 303 microfinance institutions, including five large microfinance companies, 225 microcredit companies and 73 microcredit agencies, annual interest rates usually hover around 36 percent. While this may seem high, six years ago, during Kyrgyzstan’s microfinance infancy, interest rates were much higher--averaging 44 percent.
The reason for the drop? Growth and competition within Kyrgyzstan’s MFI market.
And for reliable, long-term clients of Kyrgyzstan’s MFIs, interest rates steadily dropped following the borrower’s first successful repayment. To cite one example, Dilde Obozova, a client of Kompanion Financial Group (founded by Mercy Corps in 2004) started borrowing 10 years ago with an interest rate of 36 percent. Today, the interest rate for her most recent loan is 19 percent.
The reality is that higher microcredit interest rates are necessary for MFIs to mitigate the high cost of providing thousands of small loans to high-risk clients with no prior credit history. Microcredit borrowers are able and willing to accept high interest rates if it means they are given the chance to invest in their entrepreneurial skills and profit in the long run.
And in a country where 97 percent of microloans are repaid on time by borrowers, it’s safe to say that Kyrgyzstan’s microfinance sector has been relatively stable over the past decade. This stability has allowed the sector to grow quite dramatically, which is a credit to the hard work of Kyrgyzstan’s borrowers amidst periodic civil unrest and a general lack of financial options.
Why capping interest rates will hurt microfinance in Kyrgyzstan
"Microfinance institutions have their representations in all the regions. The share of loan non-repayment [in Kyrgyzstan] is only 2.6 percent. This means that in general all of the borrowers are normal, and they develop their businesses and are glad to have access to financial resources. But once a ceiling is introduced, MFIs will withdraw from [rural] regions where it is expensive to maintain branches,” said Erkinbek Jumabaev, Chairman of AMFI, at a press meeting in June 2013 after a draft of the usury law was passed by the Kyrgyz Parliament.
Other experts have provided numerous examples from countries in which interest rate caps have had overwhelmingly negative impacts on local economic systems.
In countries like India and Bangladesh, where fixed maximum interest rates were introduced, MFIs were forced to close, slowed their growth rates, and lost transparency in terms of the total cost of loans. They were also often forced to reduce their scope of transactions in remote areas - usually in poor communities where microloans typically represented the only form of financing available.
These factors directly contributed to the bankruptcy of multiple MFIs and forced low-income clients to apply for services in the more expensive informal market, where no formal protection is provided.
Under the new usury bill there is also a high risk that active loan clients (regardless of whether their loan agreement conditions fall under the new law or not) will take advantage of the opportunity to refer claims to court authorities and stop making scheduled repayments. Borrowers may fail to repay their loans and break their original contracts.
In Kyrgyzstan’s fickle economy, the microcredit market may be about to face more trouble. If all that is projected to go wrong with the usury bill does, it could have negative economic effects across all levels of Kyrgyzstan’s economy.
"Microfinance organizations are the only legal way to get money for the development of business without property collateral in remote regions," Executive Director of the International Business Council (IBC) Aktilek Tungatarov said in a March 2013 meeting on a draft of the usury bill. "Experts, members of IBC, reviewed the bill and concluded that it has the right to exist but it should apply to only the activity of usurers and owners of pawn shops."
Kyrgyzstan’s MFI business community is already beginning to witness the ill effects of August’s usury bill. In the beginning of October, a large group rallied together to encourage loan clients in the country’s eastern Issyk-Kul region to cease all loan repayments to MFIs. As one of the more open and democratic societies in Central Asia, Kyrgyzstan is also experiencing frequent protests and demonstrations, including those against banks and other institutions. These trends are only expected to continue.