After a sharp contraction during the pandemic, the microfinance sector rebounded well in 2022. The initial concerns, which raised existential issues about the future of this financing activity, which relies on extensive physical interaction and group processes in small communities, have been put to rest.

Microfinancing has become stronger post-pandemic, and the ability of the sector to handle uncertainties has been amply demonstrated. All the ingredients for the sector’s robust performance in 2023 are on the table. However, its growth, access to capital and, most critically, the ability of micro borrowers to repay these small loans will depend on many factors, some from faraway shores and some closer to home. These include:

The Russian invasion of Ukraine: Though it is distant from microfinancing activities in Asia’s developing countries, the uncertainties related to the Russian invasion of Ukraine will shape the sector’s outlook.  Increased energy and food prices have triggered record-high inflation, which impacts the income and the repayment ability of micro borrowers. For example, a sharp increase in fertilizer prices, linked to energy prices, has burdened micro borrowers, nearly 80% of whom are dependent on farm-based income.

The global response to inflationary pressures: Central banks have raised interest rates across developing countries to counter inflationary pressures. This will increase borrowing costs for microfinance institutions, most of which would have difficulty passing these increased costs on to their borrowers. This will impact their profitability. The US dollar and other currencies have strengthened with the rising interest rates, which will limit the ability of microfinance institutions to seek overseas private investment, as foreign investors raise their perceived risk and return thresholds. This will also limit the borrowing options of microfinance institutions from overseas lenders. Rising prices, reduced spending and recessionary conditions in the US and Europe also hurt the ability of overseas migrants to remit their savings back to their families. This is essential cash inflow for low-income rural households, particularly in countries like Bangladesh, Indonesia, Nepal, and the Philippines.

Growth in urban employment: Before the pandemic, rural households benefited from the out-migration of (usually male) household members who were employed in the informal services sector in the cities. The remittances from these urban wage earners were critical for the micro-borrower, sometimes contributing nearly a third of household income. These urban employment opportunities, primarily wiped out during the pandemic and the associated lockdowns, have been slow to return.

The pace of micro-lending: As rural household incomes are more vulnerable and expenses on food and energy are rising, their need for and dependence on microloans is likely to increase. While microfinance institutions can respond aggressively to this opportunity, caution is expected to be exercised. Given the recent concerns over excessive borrowings among micro borrowers, there will likely be closer oversight by regulators, with microfinance institutions expected to reduce lending rates and fees by the former. While the regulators’ supervision can enhance stability, it will impose limitations on microfinance institutions. Overall, lower profitability in the short run may emerge.

This may be a year for the microfinance institutions and their clients to hold steady together, promising a better future for the sector.

This, combined with limited access to capital, could impact growth prospects. Also, microfinance institutions with a substantial portfolio of microloans that allowed more lenient repayment terms during the pandemic will see a drag on their finances and access to funding.

Smaller microfinance institutions will likely face steeper challenges, given their limited capital and access to new means of financing. While they do not usually cover a large proportion of the rural population, their overall well-being is critical for maintaining stability in the local microfinance ecosystem.

Governments in developing countries can help address some of these issues by strengthening and expanding the coverage of credit bureaus and launching national campaigns on financial literacy. Regulators will need to find the delicate balance between safeguarding the micro-borrowers from too much debt or high-interest rates and ensuring the long-term commercial viability of the sector. Steady progress in introducing related services like micro-insurance and small savings products will also enhance long-term viability. 

 The immediate future may be a time for microfinance institutions and their investors to defer ambitions and ‘stick to the knitting.’ Growth, for instance, can rely more on adding new borrowers rather than increasing loan sizes. For smaller microfinance institutions, the wait for new capital will likely be longer. They should explore other business models, such as being an agent for other larger commercial banks or institutions. This could help sustain their operations, even though growth opportunities may be limited.

There is no basis for a gloom and doom outlook for microfinance. This may be a year for the microfinance institutions and their clients to hold steady together, promising a better future for the sector.