Digital Credit and Borrowers’ Welfare and Resilience in Ethiopia

Context

Ethiopia lags behind Sub-Saharan countries in terms of key financial inclusion indicators. For example, roughly 81% of the rural adult population was unbanked as of the most recent World Bank Global Findex Survey. Micro and Small Enterprises (MSEs) have not fared much better. Around 70% of MSEs do not have access to credit and 60% had never ever applied for a loan owing to a lack of collateral. Nearly all (95.7%) reported using their savings to establish their businesses.

With small businesses so credit constrained, the Ethiopian government has taken steps to promote digitization of financial services and to introduce new players to the sector, such as the large Kenyan firm Safaricom. The introduction of mobile money and digital credit services offers promising potential to improve living standards by smoothing consumption for consumers and alleviating liquidity constraints for farmers and small businesses. . Cooperative Bank of Oromia (CooPBank) launched the first bank-based digital credit, called Michu, in Ethiopia in January 2022. Michu has offered uncollateralized digital credit to over 275,000 applications from MSEs as of December 2024. While this extension of capital may benefit MSEs, it may also have negative impacts due to loans’ high interest rates, short credit periods, and low financial literacy among lenders.

Study Design

Researchers aim to study the welfare effects of digital credit loans and financial skills training for MSEs. To do this, the team has partnered with CooPBank, who as of the start of the study period, had more demand for business loans than funds to provide them, which created a waiting list. Researchers randomly assigned qualified MSEs that applied for a digital loan with CooPBank into one of three groups. The control group whose applications for credit approval were delayed for four months; Treatment Group 1 received access to a digital loan (a short-term working capital loan); Treatment Group 2 received access to a digital loan plus a financial literacy training, which may help improve their ability to decide on whether to take the offered loan and repay loans. Majority (64.5%) of the Treatment groups were able to borrower multiple times during the study period. The research team followed up with participants four months after enrolment to evaluate how access to credit and the financial literacy training effect profitability for the borrowers’ businesses, as well as consumption, employment, and other outcome variables.

Results and Policy Lessons

Preliminary findings from this randomized control trial suggest that digital credit, both with and without financial literacy training, has limited impact on improving key outcomes for MSEs in Ethiopia, such as profit, employment, and household consumption. Financial literacy training reduced the likelihood of loan defaults and penalties. However, systemic issues, including short loan durations, high borrowing costs, and small loan amounts, limited borrowers’ ability to invest in substantial business growth using digital credit. Gender disparities were also notable, with women receiving lower loan amounts despite constituting a significant share of borrowers. These challenges, coupled with low financial literacy and frequent borrower dissatisfaction with credit terms, highlight the need for policymakers and financial institutions to redesign digital credit products to address structural barriers and better support financial inclusion and economic development.

These results highlight that digital credit has a high potential for financial inclusion. However, further research is needed to understand why, despite access to finance being the top challenge cited by MSEs, digital working capital loans do not translate into improved MSE performance in the short-term. Given the potential of MSEs to inclusive economic development and employment, policymakers and financial institutions should consider expanding the range of available digital credit products for MSEs, revising digital credit terms, addressing supply-side constraints and structural barriers. Finally, further study is needed to understand both supply and demand sides barriers and to identify sustainable win-win credit terms between borrowers and digital credit service providers, and to provide insights for policy interventions.