The Nepali microfinance sector appears to be entangled in controversies in recent months. But does this mean a beginning of a new chapter for the Nepali microfinance industry or a tougher environment in the upcoming years? Microfinance in Nepal has been like a river coursing through the landscape, ushering in change and possibilities for many individuals. Originating from the Grameen model in Bangladesh during the 1980s, the microfinance industry has been instrumental in offering financial services to low-income individuals through microfinance institutions, often known as MFIs. Here, we explore the current global microfinance landscape and ascertain potential strategies for further growth and development within the microfinance sector in Nepal.

Global Insights

As opposed to Nepal’s shrinking microfinance industry, the global microfinance industry is expanding. Market research company, Mordor Intelligence, reports that the global microfinance industry could grow from $232.2 billion in 2024 to $384 billion by 2029 - an 11% compounded annual growth rate. Growing financial literacy, improvements in digital technology and mobile banking, and encouraging legislative frameworks and governmental programs, are the main drivers of this rise.

In neighbouring India, Satin Credit Care is focusing on digital transformation initiatives to simplify payment and innovate its operations. Likewise, Indian microfinance associations recently called for the reinstatement of the 100% tax holiday to promote affordable homes. Similarly, Chaitanya India Fin Credit raised approximately $229 million investment from Advent International and Multiples to improve technology and financial accessibility. Consequently, FINCA partnered with CIRCLE to help enhance digital and financial literacy of low-income women. Meanwhile, Bangladesh appointed microfinance pioneer Muhammad Yunus as the interim head of the government in a significant political shift. A world away, the Irish government recently raised the microfinance loan cap to €50,000 (approx. $54,613). The pandemic-led operational interruptions led European MFIs to adopt digital technology and improve their business models, emphasising financial sustainability and efficiency.

Challenges in Global Microfinance

Although the microfinance sector is growing worldwide, it is not without its challenges. Though the European microfinance sector has not made significant changes to their business models, they have adopted digital technology to enhance operations and reduce face-to-face interactions. This represents a move from traditional "low-tech high-touch" models towards simpler digital strategies. Yet, experts in the industry are divided on the necessity of digitising customer interfaces and processes.

According to 360 Market, MFIs in other regions are battling to employ strategies like reducing loan amounts and expanding remote channels like call centres and digital transactions to reach more clients. They are also facing obstacles to growth due to high interest rates and distressing repayment terms which has deterred borrowing and limited market expansion (Mordor). The Asian Development Bank has highlighted the significant impact of high inflation caused by global geopolitical turmoil, on the income and debt repayment ability of microborrowers, particularly those reliant on agriculture. Challenges were also seen in attracting international private investments due to increasing global interest rates and a stronger US dollar, which are dampening investor risk appetite.

Despite facing obstacles, the microfinance industry worldwide has shown promising growth opportunities. So what lies ahead for Nepal amidst the global outlook?

Prospects for Nepalese MFIs

Nepal is working towards improving its economy, and microfinance has become a hopeful strategy for promoting financial access and diminishing poverty. Taking cue from global MFIs, Nepali MFIs have also started offering financial assistance to individuals with limited resources. These institutions have now transformed into entities regulated by Nepal Rastra Bank (NRB), serving as a vital instrument in reducing poverty by empowering women and rural dwellers to achieve economic independence and elevate their social standing within the nation. Microfinance has evolved into a powerful instrument for promoting economic growth, independence and financial accessibility, and social and economic empowerment.

The flexibility of microfinance models has been crucial to their evolution, enabling them to adapt creatively to contemporary needs. Nepal Investment Mega Bank has observed that Nepali MFIs are pioneering innovative business models, including the cooperative model, the small farmer cooperative limited model, the Grameen bank model, and the community-based organizations or self-help groups model, which also includes village banks. Each model presents a unique and tailored approach to implementing business strategies, highlighting the versatility and significance of microfinance in diverse settings. This adaptability not only meets the specific needs of various communities but also ensures the long-term viability and impact of microfinance as a transformative tool. The ongoing success of these strategies clearly demonstrates that microfinance is essential in promoting economic development and social progress. The Nepal Rastra Bank (NRB) is pioneering transformative policies to support Nepali MFIs by enforcing capital adequacy requirements.

The introduction of central KYC integration with National ID is expected to enhance customer verification processes, streamline operations for MFIs and reduce the risk of fraud. Additionally, in March 2024, the government formed a seven-member task force, led by the deputy governor of the NRB, to address issues faced by MFI customers in Nepal. The task force is expected to conduct inspections and engage in discussions to consider policy changes. These initiatives aim to improve financial stability, boost efficiency in MFI operations, and strengthen regulatory oversight within the industry. 

Similar to global trends, Nepal is also transitioning to digital financial services. Nepali MFIs are poised for growth, as evidenced by the impressive 24.4 million mobile banking users in June 2024 and a 52% internet penetration rate in 2023, further supported by 42.8 million cellular mobile users (NRB, Data Portal). Reflecting this evolution, National Microfinance, a Nepalese MFI, has begun offering mobile banking and SMS banking to its customers. This represents a shift towards digitising services to expand access, improve customer satisfaction, and increase operational efficiency for Nepali MFIs.

Challenges in Nepal

Nepal’s microfinance industry faces significant challenges despite its commendable contribution to economic upliftment. These include multiple borrowings, unhealthy competition, high interest rates, lack of financial literacy, and over-indebtedness—all of which threaten the sector’s sustainability .

The number of Nepali MFIs decreased from 65 in July 2022 to 55 in June 2024, while the number of borrowers also dropped by 20%, from 3.3 million to 2.7 million, indicating a challenging market for these institutions. Loan disbursements also declined by 12%, reaching Rs 46.6 billion in March 2024, compared to July 2023.

Moreover, Nepali MFIs are facing additional obstacles that cast a dark shadow on the industry’s growth prospects. These issues include accusations of prioritising profits over customer well-being, weak internal controls and governance, and burdening clients with excessive debt and multiple loans. The problem of duplicate loans among members and insufficient inspections of loan utilisation has exacerbated these issues, leading to increased opposition towards MFIs. Savings and credit cooperatives are experiencing even greater difficulties, with many shutting down due to a lack of trust from depositors.

Nepali MFIs are also dealing with intense competition which has led to aggressive lending practices. In some cases, loan officers are pressured to provide loans without properly assessing repayment capacity of borrowers to meet strict targets and safeguard their job security, trapping borrowers in a cycle of financial distress caused by unpaid obligations.

Adding to the concerns, the inaccessibility of key figures in MFIs has further aggravated distrust among Nepali consumers.

Despite these mounting challenges, one might wonder how Nepali MFIs can turn the tide. Exploring potential learning opportunities from the global context could illuminate pathways to resilience and innovation, guiding the sector towards a more stable future for these institutions.

Potential Learning Opportunities

We have all witnessed Nepali MFIs growing at an impressive rate, which may have contributed to the challenges they now face. While the NRB has implemented some positive policies, their success hinges on effective execution and the establishment of strong oversight mechanisms. MFIs may struggle until these systems are fully operational. Therefore, regulators need experts at the helm to identify potential issues early on. Encouraging MFIs to regularly disclose detailed financial information could also enhance transparency, deter fraud and improve customer protection.

Nepali MFIs largely rely on offline methods for their operations, primarily due to a lack of awareness. However, promising efforts are underway. Private sector players like eSewa are working to improve financial literacy and enhance MFI service offerings. Supporting this digitalisation trend are Nepal’s growing number of mobile banking customers, increasing internet penetration, and rising cellular connections which present substantial opportunities for MFIs to expand their digital presence. By adopting digital practices similar to those of Satin Credit Care, such as contactless repayment options and customer support apps, Nepali MFIs can improve efficiency and convenience. Additionally, the growing internet usage among families, driven by out-migration, provides further impetus for MFIs to embrace digital solutions, with financial literacy acting as a catalyst for growth—much like India's FINCA collaborating with CIRCLE.

Conclusion

Nepal's microfinance industry holds immense potential for positive change, especially if it learns from global examples. Nepal can create a robust microfinance environment by embracing technology, investing in financial education, and addressing existing challenges head-on. This requires collaboration, innovation and a commitment to empowering individuals and communities. The road ahead may be challenging, but with careful planning, the destination can be a thriving microfinance ecosystem.

(Baruwal and Gadtaula are analysts at Business Brainz, a global business research and insight firm operating from Nepal.)

(This opinion article was originally published in  September 2024  issue of New Business Age Magazine.)