Naseema, 36, fled to Kabul with her family in 1999 after the Taliban set fire to their village in northern Afghanistan. Like many residents of the mountainous country’s northern regions, Naseema’s family built a one-room shack in Kabul’s mountains, where thousands of the city’s poor live in illegal tenements.

With missiles flying and violence showing no signs of abating, Naseema, like many others, ran the risk of being turned into an impoverished refugee in her own country. That was until Sharifa Hashimi, a loan officer for the microfinance institution (MFI) Ariana Financial Services Group, lent her $150 to set up a small shop. Four years later, the canteen Naseema opened near her house with the loan helps supplement her husband’s construction job income.

Without Ariana, “there is no other way I would have been able to borrow money,” Naseema says. She is now part of a group of borrowers who provide important support for one another. “If one of us had sick relatives or other problems that impacted our loan repayment, we could always borrow money from someone within our group,” she says.

The four-year-old microfinance initiative in war-torn Afghanistan shows that such programs can work in conditions where the normal functioning of an economy is severely impaired, as it is in several developing countries. Still, the business of providing small loans in Afghanistan has major obstacles to overcome in order to thrive, including ever-present security concerns and the lack of a regulatory framework to ensure that the sector develops along healthy lines.

Because of the lack of safety of both property and person, MFIs in Afghanistan incur far more costs. “In Bangladesh, we don’t have to pay for armed guards like we do in some communities here,” says Gunendu Roy, a program coordinator for BRAC, the largest MFI in Afghanistan, with 175,000 clients. Clients of MFIs often pay annual interest rates of 30% to 35%, compared with the 25% that is more typical elsewhere in South Asia.

That’s why the Microfinance Investment Support Facility for Afghanistan (MISFA) — a multi-donor venture established in 2003 that provides incentives to MFIs that take on additional costs to operate in less-secure provinces — has become far more important. MISFA has now spawned nearly 400,000 clients serviced by a staff of 4,000, most of them local women. Access to microfinance helps communities, where villagers had previously borrowed money at rates of 40% to 100%.

Fifteen microfinance institutions (MFIs) are in place in 24 of Afghanistan’s 34 provinces. Their average loan size is $270, made to a clientele that is 70% composed of women. Nearly all loans — 97% — are being repaid. The initiative has grown by an average of 13,000 clients per month this year.  

Already, three of the MFIs — Child Fund Afghanistan, the Afghanistan Rural Microfinance Program and First Microfinance Bank — have reached operational sustainability. Two others are nearly there. How deeply embedded they have become in the local economy can be gleaned from the fact that five MFIs have Afghan chief executive officers and more than 95% of their field staff is local.

The Kabul branch of the United Arab Emirates-based Bank Alfalah recently started lending to MFIs. Whereas MISFA provides loans at a 5% annual interest rate, Bank Alfalah is negotiating to offer loans at 2% to 3% lower than its 8% to 9% commercial lending rate. This is possible because MISFA will guarantee these loans up to 25%.

“If all goes well, there are no limits to how much money could come from the commercial banking industry,” says Adnan Fraz, Bank Alfalah’s credit chief. “It would have been easy to walk into Afghanistan in 2002 and say nothing is here and little can be done,” says Stephen Rasmussen of the World Bank’s South Asia region’s private sector development unit. “But some of us saw a huge opportunity to shape microfinance the right way by building on more than 30 years of microfinance history.”

It was just more than 30 years ago that Muhammad Yunus started the microfinance movement, lending $27 out-of-pocket to a group of poor craftsmen in his native Bangladesh. Yunus won the 2006 Nobel Peace Prize for his microfinance efforts, and his Grameen Bank has made more than $5 billion in microfinance loans to seven million borrowers.

The success is quite an achievement in a country which few foreigners would consider a great place to do business. In the best of environments, where infrastructure is stable and the rules are clear, “five years for an institution to become even operationally sustainable is the minimum,” says Joyce Lehman, chief of party for ARIES, the United States Agency for International Development-funded rural finance project in Afghanistan, and a former MISFA chief operating officer.

MISFA got its start within Afghanistan’s Ministry of Rural Rehabilitation and Development through the World Bank-administered Afghanistan Reconstruction Fund. It has since become a limited liability company governed by an independent board of directors elected by its donors. These donors, led by Canada and the United Kingdom, have provided more than $100 million to the agency.

“We focused on fast outreach and sustainability from the very beginning,” says MISFA’s managing director, Amjad Arbab.

Strong Managers Needed

Recently, a BRAC employee in Badakhshan province was killed by gunfire and one in Logar province was kidnapped. “Over the last three months especially, the security situation has gotten worse,” says Arbab. The lack of security threatens the sector’s expansion, he adds. As a result, attracting adequate human resources to spread the program nationwide is a challenge.

“It’s still not quite at the point where there are enough people with experience and capacity to manage at the upper levels,” says Lehman. “Three or four of the smaller programs have Afghan managers and some of them are terrific, but there are not enough of them. It takes time to grow a manager. They can learn the tasks, but to be strategic and to think long-term takes something different.”

Just like managers, borrowers, too, need coaching. Setting up self-help groups requires a concerted effort. To make mircrofinance work requires “extensive training of the clients before they ever get their loans,” Lehman adds. Such training is costly, and not all MFIs are looking to invest in activities that provide positive outcomes.

Due to inadequate civil laws, the system is prone to abuses too. Erna Andersen, a researcher with the Afghanistan Research and Evaluation Unit (AREU), says that some MFIs function as much for their own benefit as for any sense of altruism. In more than one instance, she says, loan officers didn’t protest when rich villagers organized poor ones into groups to secure access to loans, and then profited at their expense.

One MFI forced borrowers to repay loans within a week. “The chicken has to start laying eggs really fast to make any surplus out of $100 if you have to pay the first instalment the week after you get the loan,” says Andersen, whose organization’s funders include the European Commission and the World Bank.

Getting to Sustainability

The biggest challenge before the Afghan industry, however, is to get microfinance on a sound and self sustaining commercial footing. To accelerate this process, MISFA is educating Afghanistan’s commercial banks while MFIs, including BRAC, are negotiating directly with banks.

Before this takes root however, the institutions will have to prove that they are less reliant on donor funds and are ready for the rigor of the market. “We hope to see a shift in the near future,” Rasmussen says. “MFIs are getting steady funds and can afford to pay commercial rates. They can also graduate to become regulated financial institutions that can mobilize deposits.” So far, MFIs have taken in $10 million in deposits.

Before that happens, however, there are some issues to overcome. Bank Alfalah’s Fraz says the lack of a legal framework poses problems. “In Pakistan, for example, there are specific laws that give protection to banks. Banks can recover money from defaulters.” Regulations are now being developed by foreign consultants for this. “[But] judges will need proper training and orientation to understand how to incorporate them,” Fraz says. “It takes time for this type of legal framework to develop.”

Conditions in Afghanistan still haven’t reached a point where international social investment funds or large international banks with microfinance investment programs are ready to sign on, Rasmussen says. But since some MFIs have strong balance sheets and solid portfolios, he expects that eventually, they will attract social investment funds working in other countries. “Once commercial banks have a relationship established, it will scale back dependency on donors,” says Amit Brar, technical advisor for MISFA. “It always starts out small. The two institutions need to test each other out. It was the same in India [which now has a $650 million microfinance industry].”

MISFA itself could find that it is becoming more like a commercial entity. Currently, it passes on donor funds to MFIs. Principal isn’t repaid. Instead, it only receives 5% interest, and that is sufficient to meet its operating costs, Arbab says. It plans to raise the interest rate it charges MFIs, as more are able to afford commercial rates, he adds.

Meanwhile, a trade association created two years ago through MISFA funding is in its early stages. Meant to provide a forum for MFIs to discuss such issues as products, security, information flow, fraud and training needs, the Afghanistan Microfinance Association could eventually play a regulatory role. That will truly signal that the nascent business has, indeed, grown beyond adolescence.