Small went smart in finance after the train wreck financial crisis that shattered the core of the global financial system in 2008. Too big to fail becomes the new normal for apologetic statists that categorically count bailouts as crimes. Chopping the big investment banks of the developed world into new breeds of downsized financial institutions was their resultant advices for the recent financial crisis.

At the other end of the spectrum dwell microfinance institutions (MFIs) that have little to do with the global financial crisis. Extending small and tailored loans for small and micro enterprises, they are even seen as lifesavers of the lopsided and ill-managed global books of accounts.

There are 30 of them in Ethiopia with 2.5 million active beneficiaries, a total capital of 2.5 billion Br and an outstanding loan size of 6.1 billion Br. Unlike their global stature, MFIs in Ethiopia are less popular. They are criticized for poor credit management system, undeveloped research and development activities, directed credit provision and high politicization. These are not good blames for financial institutions.

So much as holidays witness a credit spree, debates on effective microloans stir in social circles. It would be complemented with individuals that have taken loans for their immediate needs: a new trend in most towns and urban centers of the country. As the new trend is growingly getting worrisome, the debate has even haunted policy makers.

On the one hand, the existing policy framework considers microloans as financial tools to promote small enterprise creation and poverty reduction. Linked with small and medium enterprises (SMEs), they are reckoned by the Revolutionary Democrats as the vehicles of empowerment under the developmental state model. They are also taken as fixers of the holes of the elitist, neo-liberal financial model that caters service for the privileged few.

Skeptics, however, claim that the Ethiopian model of microfinance, as it appears, is a politicized version of the traditional approach. Structures defined along administrative regimes, institutions too dependent on government financing and directed loan provision are symbolic of the systemic parochialism. Instead of instigating small business creation, they argue, they are serving as platforms of consolidating politically defined simulative enterprise breeding.

Much is at stake, though. It even goes beyond the services of the institutions. Total savings of 2.7 billion Br and liabilities close to six billion Br mean a lot for the fiscal and monetary policy of the country. Hence, the debate transcends microeconomics.

As it stands, government policy protects microfinance institutions. Their close linkage with regional governments provides them with unrestrained supply of finance. It also shelters them from competition as they are delimited in regions. In so doing, it has put them beyond the radar of the central bank.

To the credit of the policy, outstanding loans by the institutions continue to increase with the largest MFI witnessing a loan size of 1.7 billion Br, in 2011. Five of the 30 operational institutions serve 84.7pc of the beneficiaries with a capital ranging from 360 million Br to 760 million Br, each. They have also individually mobilized savings ranging from 130 million Br to 1.1 billion Br, in 2011.

Yet, their books witness huge liability. Much of it is owed to regional governments depriving the institutions of operational autonomy. An increasing default rate that is hovering at a rate of 39pc, annually, according to some studies, is no less worrisome for the institutions.

Protectionist approach is harmful for the monetary policy of the nation. Since much of the inflationary pressure in the economy is monetarily driven, unregulated institutional holes such as MFIs will exacerbate the problem. So far as the monetary buildup will happen at the bottom, it might further structuralize inflation.

Coupled with increasing default rate and relatively high non-performing loans, this could grow too big to challenge vthe ery objectives of the monetary policy. At the helm of it, however, lies the unrestrained and unconditional fiscal support that regional governments provide for MFIs.

Good as it may be to support financial institutions, sheltering them from the realities of the market will make them vulnerable. It will also deprive them the comparative advantage they could have built through genuine, market-based competition. That is exactly what has happened in the Ethiopian MFI system with even the largest institutions unable to poise their balance sheet.

Poor research and development capacity of the institutions also contributes its fair share for their sub-par operations. In absence of vibrant research wings, most MFIs allocate resources abruptly. The most active ones follow the policy line, which is not always lucrative from business point of view. Rampant institutional passivity underlies the system in the country that only systemic overhauling could reverse the trend.

Much of the outstanding loans of the institutions are spent on duplicative and unviable portfolios. It is even worse in urban areas, wherein microfinance institutions are turning into sources of unwarranted finance with no strings attached. Cash demands for household activities dominate the scene.

Comparatively, the policy intent was to promote small business creation that could support upward mobility. But the results deviate from the intent. At it appears, access to finance is not adequately serving its purpose and right beneficiaries.

At the heart of it all lays the undeveloped capacity of the institutions to assess the creditworthiness of an individual or a business establishment. In absence of the needed human resource, research information, credibility, societal linkage and reputation, the institutions have little to do than taking client information at its face value. Project and individual appraisal are given less of an attention and hence, a rising default rate.

It is pitiful that such a large amount of money is locked in a rather uncoordinated sector that is allowed to grow with all its malfunctions. Neither would it be comprehensible that the government allowed its crucial development tool to spoil at the face of it. So long as MFIs are vital sources of finance for the poor and important vehicles to derive small business creation, they must be given attention by the government.

As a regulator of the financial sector, the central bank has to embrace the institution under its newly established credit information system. Doing so would help to regulate them properly, avoid inflationary externalities and institute consolidated monetary policy. Regulatory excuses will no more be excusable as they will allow inflationary monetary buildup at the bottom.

Fiscal support for MFIs by regional governments has to be linked to performance. It must be conditional upon proofs of business and job creation. Measures of performance have to relate operations of the institutions with policy targets, aside customary accounting indices. Similarly, linkage effects with SMEs development ought to be embraced within the performance measures.

Building the research and development capacity of the MFIs will also be essential as that will guarantee their sustained operation, solvency and relevance. Regional government must relate their fiscal support for MFIs with research, so that they provide it with sufficient attention. Putting a compulsory research budget could help in these terms.

Above all, though, exposing the institutions for the vagaries of the market will be the lasting solution. The era of protectionism must end as it only incubated parochial, financially reckless, and unregulated microfinance system in the country. Sustainable microfinance system could only be built through the very forces of demand and supply defined in a transparent system with self-regulation.

That needs to be the road for the Ethiopian microfinance system if it is meant to play its role of serving the poor, empowering them and pushing them up the income ladder. A lot of that, however, will depend on the political willingness of the Revolutionary Democrats.