Why is Microfinance Growing so Quickly in Georgia?

The FINANCIAL — Explore the Georgian market for micro-lending and look at how microfinance organizations fit into the overall structure of credit supply.

Microfinance is a major force in Georgia. Over sixty microfinance organizations operate in Georgia today, and they hold over 800 million GEL in assets. Three years ago there were only 49 with half that amount of money.

Why is microfinance growing so quickly in Georgia? To answer that question, one must first understand the sources of credit in Georgia. Businesses and individuals can access credit from three main groups: banks, microfinance organizations and private lenders. Each group serves a different type of client, but they all supply capital for both personal and business needs.

Microfinance companies attract clients who are not financially established or patient enough to access bank credit, but want lower rates and more flexible terms than those offered by unregulated private lenders. Microfinance companies provide a valuable service to a large portion of the country’s population by offering capital at a lower overall cost than other lenders would in similar situations.

Microfinance organizations also provide a path for individuals and small business customers to establish a financial track record. After about a year of on-time microfinance payments, many customers can meet the criteria required to secure a bank loan and “graduate” the lowest-cost tier of credit in Georgia.

Conversely, microfinance organizations provide a “safety net” for current bank customers. If someone falls into financial difficulty and cannot make loan payments on time, a microfinance organization could refinance his or her overdue loan. This refinancing gives a client valuable time to sort out financial issues while still retaining control of his or her house or pledged assets.

One of the first microfinance organization in Georgia, Constanta, was founded in 1997 with significant contributions from Save the Children USA. It used group loans to help refugees in Tbilisi. By 2001, there were five firms serving clients across Georgia. Now, there are twelve times as many firms.

In 2006, parliament even drafted special laws regulating microfinance and bringing these companies under the watchful eye of the National Bank of Georgia. Some firms, like CREDO, target agricultural loans in rural areas of Georgia. Others, like Kutaisi-based GeoCapital, provide credit for houses, cars, and new businesses.

Microfinance’s growth is not limited to Georgia. The World Bank estimates that, in the past few decades, over 160 million people have come to depend on micro-lending services. This is a huge number, but it’s just a small fraction of the available market.

Net loans from microfinance firms in Georgia have increased from 270 million GEL in 2011 to 605 million in 2013. USAID calculates an average loan size of $4700 for small businesses, but because microfinance lending extends beyond strict business loans, the average loan sizes of microfinance companies are typically smaller. Crystal Microfinance, another firm in Western Georgia, reports an average of $1500.

Critics of microfinance often accuse lenders of charging predatory interest rates, which often range annually from 20% – 60%. They point out that this differs substantially from the interest rates of traditional bank loans, which can run in the single digits. The primary reason for this rate difference is the flat costs associated with originating and servicing loans. Just like any other bank, microfinance firms have to maintain branches and hire employees.

A bank mortgage lender might only charge an interest rate of 1% per month on a $90k real estate loan. However, because of the size of this loan, the 1% interest generates income of $900 per month. The bank can easily carve out $50 per month from loan management activities and still be left with enough money to cover their cost of capital and make a small profit for their investors.

Because microfinance organizations give out smaller loans, their interest rates must be higher to cover cost the simple costs of loan management. A $2K real estate loan at 3% per month only generates $60 of income for the microfinance company (compared to the $900 generated for the bank above). Even though microfinance organizations typically operate more efficiently than banks, there is still direct, flat cost associated with loan management. $25 per month for loan servicing costs is not uncommon internal charge, leaving the company with only $35 from which to cover their cost of capital, just to break even.

Proponents of microfinance lending argue that low default rates indicate that the loans are largely successful and ultimately help increase borrower incomes. Another positive aspect is that microfinance capital tends to stay in the region where it’s borrowed. A woman opening a new hair salon buys her supplies and pay construction costs in her local economy. She will use her additional income to help send children to school or university, which raises lifetime earnings. A 2010 World Bank paper assessing poverty reduction in Bangladesh reported that in areas with growing access to microloans, poverty rates fell by 10%, while areas with a small proportion of borrowers only reduced poverty by 4%. The value of microfinance has a positive macro effect on community prosperity.

Loans to low-income clients provide more than just money. They offer hope for the future. Small loans can offer reliable returns for investors, but the true value of microfinance in Georgia is the way it opens up business to the poor and disenfranchised.