MSD Hub editor's note (Michael Field, Senior Systems Specialist, Vikāra Institute):
This blog highlights an important aspect of risk management/MSR in relation to SME debt during shocks and stresses, as well as limiting potential contagion that could spread throughout the financial services market system. While it is a common public-goods service in many countries to support banks/SMEs to manage their financial well-being during a shock or stress, it is also important to minimize the effects on the commercial side (i.e., shift the pricing of loans without considering the underlying risk factors) of the financial services market systems. Maintaining a context specific balance can be tricky and a potential area of learning as MS4G continues to provide support to banks to limit their down side risk on loans to agricultural SMEs during shocks and stresses.
The average person often thinks of food, water, shelter, and fuel as the most important response to a shock or crisis. While these are valid responses to many types of shocks, we overlook more complicated system-based solutions that keep enterprises and financial institutions afloat to survive past the crisis period. The right solution can sustain those very enterprises who are the engines of agriculture-led economic growth to ensure they can continue to provide critical products and services to the market and to the people that depend on them. Most importantly, these types of approaches can sustain livelihoods and jobs in times of uncertainty and instability.
A systems-based solution in Ethiopia
In Ethiopia, in 2022, there were thousands of agriculture SMEs and farmers that were suddenly unable to pay their loans. This was largely due to spike in fertilizer and other input prices that impacted supply due to the war between Russia and Ukraine. Their economic troubles did not end there -- they were forced to lay off employees, sell assets, and many were on the verge of collapse. Additionally, the inability to pay their loans was dragging down the financial sector. Thirty percent of MS4G’s partner banks indicated that while the average rate of non-performing loans (NPL) was 5%, their agricultural portfolio was at a higher risk of default with a 12% NPL. This was a precarious situation that was set to get worse with time. Also, it would only make future loans and financial services for the agricultural sector more expensive.
It cannot be overstated that SMEs are the backbone of the agriculture sector in Ethiopia, making up nearly 75% of jobs. Many of these SMEs have been 100% reliant on imported fertilizers for their business operations to function, as traditionally there has been no domestic fertilizer manufacturing sector. The inflation and supply challenges were a major shock to these enterprises.
With the USAID Ukraine Supplemental funding, MS4G initially designed and launched a USD $3.2 million initiative to help four banks restructure the loans that were at risk of default. This initial tranche was expected to restructure $15 million in debt and help more than 1,991 SME borrowers who support a network of up to 25,000 farmers. The mechanism works as follows: through a grant to the bank, MS4G pays the borrower’s fees to restructure and renegotiate the loan with improved terms, allowing the SME to be able to pay the loan over a longer period or with a lower interest rate. The banks pay internal costs of restructuring (i.e., labor, legal, processing fees). The borrowers’ restructuring fees are established and mandated by the Central Bank of Ethiopia.
MS4G has found that this mechanism is a win-win for all parties involved. The financial institutions win because they earn forex, improve liquidity, and decrease their portfolio-at-risk. The borrowers win because they get back into financial good standing, save their business, get more realistic repayment terms, and can retain their hard-earned assets and employees. The system wins because both financial institutions and SMEs continue operations, maintaining the foundation of the agricultural sector.
Because of how successful this initiative has been, MS4G is in the process of adding another tranche of $900,000 to restructure an additional $4.5 million in loans to reach an additional 130 SMEs and 2,500 farmers. Under this tranche, MS4G will be working with the two most successful banks, who reached their target number of loans restructured and demonstrated there was still a demand for additional clients to benefit from this activity.
As of October 31, 2023, MS4G has spent $1.56 million in grant funds on this intervention, effectively restructuring $8.5 million in loans for 180 borrowers. On average, each SME borrower needed approximately $7,300 to complete the restructuring, several of SMEs were able to include improved payment terms with lower monthly payment rates, and refinancing opportunities.
One such SME-borrower, Mr. Gebisa Bejiga is a dairy farmer in Oromia. In 2019, he secured working capital loan of approximately ETB 2 million ($36,000) to expand his dairy farm to 40 cows and hire 5 new employees. However, following the Ukraine conflict and the consequent shortage of inputs such as feed in early 2022, productivity declined; the business faced a severe working capital shortage and was unable to service its debts. As a result, he had to reduce his workforce. The loan status was labelled as substandard, forcing an additional penalty payment of interest charge causing a more strained cash flow. With MS4G’s debt restructuring partnership with Cooperative Bank of Oromia, the loan was restructured in a way that is based on the timing of his typical cash flow, which makes repayment possible, and allows Mr. Bejiga to remain in good standing with the lender, re-hire staff, and maintain his business which provides a critical food for the Ethiopian population.
By the end of the program, MS4G will have spent $4.1 million total and estimates this will restructure over $20 million in debt and reach over 2,000 SMEs and approximately 30,000 smallholders.
Please see MS4G’s Agrilinks blog from July 2023 for more information on this initiative.
Continuing the conversation:
Do you think this approach would work in another country?
Have you overseen a debt restructuring approach somewhere? If so, was it successful? Why or why not?
What other shocks may be appropriate to use this type of response?
What do you think the gender implications are for this type of activity?
Elizabeth Adams, Technical Director, Palladium
Sehul Truesaw, Deputy Country Director, MS4G, Ethiopia