Microfinance at Risk as Palestine Faces Economic Downturn

By : Motaz Abu-Mweis - Palestine - 04/10/2024

Foreword:

As humanitarian aid and diplomatic efforts dominate global headlines, the economic disaster impacting the Palestinian economy takes a back seat. Despite the small size of the Palestinian economy , Palestine holds strategic significance for the world’s most powerful observers, particularly in how it illustrates the fragility of conflict-ridden economies.

In September 2024, the World Bank issued a stark warning: Palestine is nearing economic freefall. This term describes an uncontrollable downward spiral of an economy, where disruptions across sectors converge to create a deep crisis .Consider that in the first quarter of 2024 alone, the Palestinian territories saw a staggering 35% contraction in real GDP. This level of contraction is often a precursor to full economic collapse, bringing with it widespread poverty, political instability, breakdowns in public services, and the disintegration of key financial systems. Among the sectors most affected by this downturn is the Palestinian microfinance sector, which was once viewed as a lifeline for financial inclusion and resilience.

The State of the Palestinian Microfinance Sector:

The Palestinian microfinance sector is a crucial part of the country’s economy, serving marginalized and financially excluded communities. Comprised of nine microfinance institutions (MFIs), these institutions have been regulated by the Palestine Monetary Authority (PMA) for over a decade. The MFIs operate through 95 branches and offices across the West Bank and Gaza.

However, the microfinance sector has not been immune to the broader economic crisis. As of June 30, 2024, the total outstanding loan portfolio of Palestinian MFIs stood at $343 million, a significant drop from $367 million just nine months earlier. Equally concerning is the demographic shift in lending: while 50% of microloans in 2021 went to women, this figure had plummeted to 30% by mid-2024. This indicates a shrinking focus on empowering vulnerable groups, particularly women. https://palmfi.ps/

The penetration of microfinance in Palestine remains low, reaching just 1.3% of the total population of 5.5 million. To achieve a more robust penetration rate of 7.5% to 10%, Palestinian MFIs would need to serve between 412,500 and 550,000 borrowers. With an average loan size of $4,750, this expansion would need an additional $1.6 billion to $2.2 billion in funding.

Rather than closing this gap, the ongoing economic downturn threatens to exacerbate it. The equity of MFIs is depleting rapidly. Their average debt-to-equity ratio stands at 2:1, which is in line with global standards, but in Palestine's context, marked by political instability and conflict, this creates a far more precarious situation.

Liquidity Crisis: The Core Threat to Survival:

The most pressing threat to the microfinance sector is liquidity . In 2019, PMA introduced an ambitious financial inclusion strategy aimed at increasing access from 36.4% to at least 50% by 2025. However, the economic and political upheavals of October 2023 have derailed these objectives. Rather than focusing on service expansion and innovation, the microfinance sector has shifted its priorities to survival, as the ongoing instability threatens its viability and long-term goals.

A particularly devastating blow to the microfinance sector came with the near-total collapse of operations in Gaza. As of 2024, MFIs in Gaza lost their entire $54 million portfolio, which constituted 14.7% of the sector’s total lending. The situation in the West Bank, while slightly better, remains dire. Borrowers there are also struggling to repay loans due to widespread financial instability and income loss, especially among families reliant on employment in Israel. Restrictions on movement and the downturn in commercial activity have crippled small businesses, leaving many unable to generate the revenue needed to meet loan obligations.

MFIs have been forced to reschedule 50-60% of their loan portfolios, deferring payments originally due in 2024 to the end of the year. While this rescheduling offers short-term relief for borrowers, it has pushed MFIs into severe cash deficits. With operational expenses such as salaries still due, the sector is now facing monthly losses ranging from $1million to $1.5 million, rapidly depleting its already fragile capital reserves. Without immediate intervention, the liquidity crisis could escalate into a full-scale institutional collapse, threatening the entire microfinance infrastructure.

In Palestine, labor costs are high, representing one of the largest operational expenses. Yet, unlike MFIs in more stable regions, Palestinian MFIs are severely limited in their ability to cut costs. Even with a drastic reduction in loan disbursements (82% drop by 2024), the MFIs still bear the dual burden of maintaining operations in the West Bank and continuing to pay Gaza-based staff, despite their inability to work due to ongoing conflict.

Opportunities and Strategic Shifts:

While the outlook for 2025 remains bleak, there are still potential opportunities for the microfinance sector if it can weather the current storm. The sector could explore new lending programs and diversify its product offerings to meet specific market needs. Notably, there is growing demand for Islamic Sharia-compliant financial products, which have not yet been fully developed within the Palestinian microfinance landscape.

Additionally, there are untapped opportunities in sectors such as women’s economic participation, household finance, and informal sector projects. If MFIs can successfully expand their lending to these areas, they may not only survive but play a critical role in driving financial inclusion. The agricultural sector and fintech investments also represent promising avenues for growth. Furthermore, MFIs could expand their reach into more marginalized areas, where there is significant unmet demand for financial services.

However, capitalizing on these opportunities requires more than just strategic vision, it requires liquidity. MFIs cannot develop new products or expand into underserved areas if they are operating at a loss and unable to cover basic operational costs.

Conclusion and Recommendations:

The challenges faced by the Palestinian MFIs are unprecedented, and they will not be solved through traditional recovery mechanisms. Unlike global counterparts, MFIs in Palestine do not experience economic growth cycles that can balance out downturns. Instead, they are trapped in a long-term contraction, exacerbated by political instability and conflict. Compounding the issue is the lack of government support or international aid, which leaves these institutions vulnerable to collapse.

The path to survival begins with liquidity. Immediate capital infusion is the only way to stave off institutional collapse. This capital should come in the form of cash grants, equity investments, guarantee schemes, blended finance, subordinated long-term debt, and concessional loans. The Palestinian government, in partnership with international donors and bodies, must advocate for targeted financial aid, particularly for Gaza. This would allow MFIs to cover operational costs, restore lending capacity, and build reserves for future shocks.

In the longer term, MFIs need to focus on cost efficiency. One potential solution is the adoption of digital infrastructure to reduce operational expenses. Digital payment systems, client tracking, and mobile banking platforms can streamline operations, reduce personnel costs, and increase resilience in times of crisis. The relatively supporting infrastructure in the West Bank provides a foundation for such digital solutions, which could lead to long-term savings and improved service delivery.

With appropriate support, Palestinian MFIs have the potential to remain a pillar of financial inclusion in a challenging environment. However, without swift and decisive intervention, the sector faces the risk of collapse, which would not only exacerbate the fragility of the Palestinian economy but also deprive its most vulnerable populations of essential financial services.