Towards a More Enabling Legal Framework for Microfinance in Iraq
How can development practitioners put forward relevant solutions amidst the ongoing conflict and fragility across the Arab world? CGAP has featured various options in a recent blog series on financial inclusion during crisis. They notably highlight that, while conflict and the associated violence and uncertainty can make it difficult to find practical ways forward, it is during these critical times that solid institutions and infrastructure are the most needed to maintain economic resilience.
In Iraq, this challenge is particularly pressing today, as authorities continue to battle ISIS while advancing important political reforms. And microfinance – in the broad sense of providing credit, savings, payments, and insurance to low-income households and small businesses – is one intervention poised to promote local economic activity and help manage economic shocks. The 2014 Findex survey found that only 11% of the adult population has an account at a formal financial institution, the second lowest among surveyed countries in the region, and significantly below the upper middle income group’s average of 70%. It also revealed a significant gap between Iraqi citizens who borrowed formally (4%) and those who did so informally (65%), hinting for a much higher demand than that currently served by the financial sector. This is notably because Iraq’s financial system remains seriously underdeveloped, as highlighted in the World Bank’s 2011 Financial Sector Review. According to latest estimates, total domestic credit to the private sector amounted to 6.2% of GDP – lower than every country in the region except Yemen.
Photo Credit: Sultan Hussein Ali
Prior to the ISIS conflict, the microfinance sector had emerged as a credible financing source for close to 100,000 low-income entrepreneurs, although representing a tiny share of the banking sector’s assets (0.25%) with US$ 150 million (IQD 175 billion) of outstanding portfolio. It included 12 credit-focused institutions (MFIs) operating across Iraq’s 18 provinces. In the recent past, four MFIs operating in ISIS-controlled territory have stopped their lending operations, which has eliminated an estimated 15% of the market – representing over 20,000 active clients, US$ 22 million in credit outstanding, and 42,000 lost job opportunities according to the World Bank’s Economic and Social Impact Assessment of the Syrian conflict and ISIS in Iraqi’s Kurdistan. Despite these difficult circumstances, Iraqi MFIs in operation continue to report high demand for credit and financial services, as clients seek tangible strategies to manage their financial needs, generate income, and smooth consumption in a general environment of declining economic activity and investor uncertainty. This has also been reinforced by liquidity issues and general weaknesses in banking sector lending activity.
While the microfinance sector has the potential to play a strong role in addressing the Iraqi financing gap, its growth and development is hindered through a combination of operational and regulatory challenges. A recent World Bank-CGAP report provides an analysis of the sector and outlines key challenges with regards to the legal and regulatory framework, currently the largest constraint to growth. Indeed, all MFIs have been established as NGOs and historically relied on grants, which have dried up since September 2012. NGOs being unable to raise equity or accept deposits, and given the difficulty of finding affordable local or international lenders, the result has been a decrease in credit activity and has threatened operational sustainability of certain MFIs. The crisis has also exacerbated institutional weaknesses of some MFIs, which reported increased cases of non-repayment and fraud, hereby revealing governance and risk management issues. Non-performing loans greater than 30 days (NPL 30) have increased to an estimated 6-7% for the sector, although they remain below 2% for the best performing MFIs – an impressive result when put in context of international press headlines.
To overcome this deadlock and resume growth, immediate technical assistance in the area of internal controls, credit lending methodology, and accessing clients in conflict zones would be helpful. But for microfinance to realize its true potential in Iraq, the regulatory and legal framework of the sector needs to become much more conducive to long-term growth and sustainability.
- MFIs are currently supervised by the NGO Directorate, which lacks specialized knowledge of microfinance to provide appropriate oversight. The Central Bank of Iraq, which has skills relating to financial services, does not currently play any role in monitoring and supervising the sector.
- There is also a lack of clarity on how an NGO can transfer its assets to a finance company, which would help it attract funding and offer more diverse products.
- Finally, there is no level playing field for small loans, notably between MFIs and SME finance companies – although none of the latter has been created since a dedicated ordinance was passed in 2010.
Ramping up support to Iraq’s microfinance sector is important now, more than ever. In this regard, the Central Bank’s recent interest in financial inclusion and in promoting small businesses is more than welcome. It could well represent the opportunity for a long-awaited change, not only for microfinance professionals, but for the countless financially under-served Iraqis.