ToR: Integrated Study on Cost of Capital and Appropriate Lending Rates for Uncollateralized MSME Lending in Ethiopia

Key Definitions

To ensure clarity and consistency throughout this study, the following terms are defined:

Cost of Capital (for banks): The cost that a bank incurs to obtain funds available for lending. This includes: (i) the interest rate paid on customer deposits; (ii) the cost of wholesale borrowing (interbank lending, bonds); (iii) the implicit cost of equity capital; and (iv) the cost of maintaining regulatory capital buffers. Cost of capital is the INPUT cost for the lender and varies with macroeconomic conditions, monetary policy, liquidity conditions, and bank-specific factors[1]. In Ethiopia’s current environment (early 2026), the cost of capital for banks remains elevated due to high NBE policy rates[2], tight liquidity, and elevated sovereign risk premiums.

Lending Rate (Interest Rate charged to borrowers): The rate of interest a bank charges to MSME borrowers for credit. This is the OUTPUT price and must exceed the cost of capital by a sufficient spread (margin) to cover operational costs, credit risk, regulatory compliance costs, and the bank’s profit requirement. Publicly available information suggests that collateral-free digital MSME lending in Ethiopia is priced at monthly rates that can translate into roughly mid-20s to 30% annualized cost before fees, although pricing varies by lender and product.

Lending Spread: The difference between the lending rate charged to borrowers and the bank’s cost of capital. The spread must be sufficient to cover: (i) operational costs (staff, technology, processing); (ii) credit risk premium (expected losses from defaults); (iii) regulatory/liquidity costs (reserve requirements, capital adequacy, AML/KYC); and (iv) profit margin. A sustainable lending spread keeps the bank solvent and allows it to maintain prudent risk management.

Sustainability Threshold (Minimum Lending Rate): The minimum interest rate at which a bank can offer uncollateralized MSME lending while remaining financially sustainable, covering all costs and maintaining prudential standards. This threshold varies primarily by capital provider (the institution whose balance sheet carries the loan and bears the credit risk, i.e. commercial banks and microfinance institutions today, and potentially a distinct NBE-licensed digital credit provider category if the proposed licensing reform proceeds) and by delivery channel (traditional branch-based origination versus digital/telco-or-agent-network-based origination, which carries a materially different operational cost structure even within the same institution). The study will estimate this threshold for each capital-provider category, disaggregated by delivery channel where data allow, for example, comparing a commercial bank’s branch-based MSME lending against its digitally-delivered products.

Affordability Ceiling (Maximum Sustainable Rate for Borrowers): The maximum interest rate at which MSMEs can sustainably service debt without compromising business viability or falling into financial distress. This rate depends on MSME cash flows, profit margins, existing debt obligations, and repayment capacity. The study will estimate this threshold, recognizing it varies by firm size, sector, and geographic location.

Ecosystem Sustainability: A credit market is sustainable when (i) lenders can profitably offer credit while maintaining prudent risk management; (ii) borrowers can afford to repay loans while remaining economically viable; and (iii) the market expands access to finance without creating systemic risk or destabilizing borrower finances. The study seeks to identify the interest rate range and structural conditions that enable ecosystem sustainability.

1. Background and Rationale

Ethiopian micro, small, and medium enterprises (MSMEs) continue to face a structural and persistent financing gap estimated at the SME finance gap update in 2025 (https://www.smefinanceforum.org/page/data-sites-msme-finance-gap ) estimated finance gap of 7.5B for formal MSMEs in Ethiopia (9.55B demand – 2.03B supply) and an additional estimated 3.3B informal sector demand.

This gap forces the vast majority of firms into informal credit channels, constraining growth, employment, and productivity across the economy.

The NBE’s policy rate, initially set at 15% ± 3% under its interest-rate-based framework, was raised to 16% in July 2026 reflecting efforts to anchor inflation expectations. In a landmark structural shift, NBE Directive No. NBE/INT/13/2026 (January 2026) fully deregulated lending interest rates, ending years of administered caps and marking a decisive transition to market-determined pricing. Although headline inflation has moderated to approximately 9.7% (February 2026), the combination of high policy rates, tight liquidity, and a competitive market for domestic debt has resulted in commercial bank lending rates for  MSME loans ranging from 18 to 23 percent per annum.

These high lending rates are not arbitrary. They reflect the legitimate cost of capital for banks in Ethiopia’s current macroeconomic environment elevated NBE policy rates, limited interbank liquidity, high sovereign risk premiums, and the operational and credit risks inherent in uncollateralized MSME lending. Yet the critical question for policymakers, lenders, and development institutions is: Can MSMEs actually afford these rates, or have high lending rates simply priced out the poorest segments of the market?

In this environment, infrastructure providers such as Kifiya Financial Technology have invested in AI-driven credit scoring which reduces operational costs and lower credit risk premiums, two key components of the lending spread. Yet even with these innovations, the prevailing rate range raises urgent and largely unanswered questions:

What is the authentic cost of capital for commercial banks and microfinance institutions offering uncollateralized MSME credit, broken down by component (cost of funds, implicit cost of equity, and regulatory capital buffers), and how does this cost of capital differ when the same institution delivers a product through a digital/telco-partnered channel versus a traditional branch-based channel?”

• What is the minimum lending rate required for sustainable uncollateralized MSME lending given current costs and risks?
• What maximum lending rate can MSMEs realistically afford while remaining profitable and financially healthy?
• Is there a viable pricing zone where the minimum sustainable lending rate and the maximum affordable rate for borrowers overlap?
• What policy and market interventions could expand that zone and create a sustainable, inclusive financial ecosystem?

 

Answering these questions requires a rigorous, integrated analysis that examines both sides of the credit market simultaneously. The study must decompose and quantify the cost of capital for banks including funding costs, regulatory costs, operational costs, and risk premiums to establish the foundation upon which sustainable lending rates must be built. Equally, the study must analyze MSME affordability including cash flows, debt-service capacity, repayment behavior, and willingness to pay to establish what rates borrowers can sustain without distress.

The goal is not to defend the current rate, but rather to determine what lending rates should be based on rigorous evidence from both sides of the market grounded in explicit assumptions about costs, risks, and sustainability. The study will also explore what structural interventions (partial credit guarantees, digital infrastructure, regulatory reforms, concessional funding) could shift the viable pricing zone in favor of greater access while maintaining financial sustainability and prudent risk management.

The study will analyze both commercial loan products (offered at market rates reflecting full cost recovery and risk-appropriate pricing) and concessional loan products (offered at subsidized or blended rates reflecting policy objectives of financial inclusion). Understanding both product categories is essential because they serve different market segments, have different cost structures, and require different approaches to sustainability.

The ultimate output will be a policy-grounded, evidence-based recommendation on what lending rate range for non-collateral digital MSME credit would keep the ecosystem sustainable supporting financial access and inclusion for borrowers, maintaining commercial viability and prudent risk management for lenders, and advancing regulatory and development objectives for the financial sector.

2. Study Objectives

2.1 General Objective

The general objective of this study is to determine the appropriate lending rate range for non-collateral MSME credit by conducting an integrated analysis of bank cost of capital and MSME borrower affordability and service sustainability. The study will establish the minimum lending rates required for bank sustainability and the maximum lending rates supportable by MSME borrowers and will identify the zone of pricing feasibility that enables ecosystem sustainability. The study will produce evidence-based recommendations on appropriate lending rates, product design (commercial vs. concessional), and policy/market interventions necessary to support both financial inclusion and ecosystem viability.

2.2 Specific Objectives

The study will achieve the following specific objectives:

2.2.1 Supply-Side (Bank Cost of Capital and Lending Rate Sustainability)

• Decompose and quantify the two components of the lending rate for banks and digital lenders offering uncollateralized MSME credit, per the Key Definitions: (a) cost of capital, comprising interest on consumer deposits and wholesale borrowing, the implicit cost of equity capital, and regulatory capital buffers; and (b) lending spread, comprising operational costs (staffing, technology, processing), credit risk premiums (expected losses from defaults), liquidity and regulatory/compliance costs (reserve requirements, AML/KYC), and the lender’s profit margin. Establish the minimum lending rate at which uncollateralized MSME lending remains financially sustainable, maintains prudential standards, and allows banks to cover all costs plus a reasonable profit.
• Assess how cost of capital and lending rate requirements differs between commercial loan products (at full cost-recovery rates) and concessional loan products (at subsidized or blended rates) and clarify how concessional products should be financed to ensure sustainability.
• Quantify the contribution of macroeconomic variables (NBE policy rate, inflation, liquidity conditions), regulatory factors (reserve requirements, capital adequacy, compliance costs), and operational efficiency (digital vs. traditional delivery) to the cost of capital and required lending spreads.

2.2.2 Demand-Side (MSME Affordability and Repayment Capacity)

• Assess MSME affordability and debt-service capacity to establish the maximum sustainable lending rate from the borrower perspective, recognizing that MSMEs must remain profitable and viable after taking on debt service.
• Understand MSME willingness to pay and price sensitivity, including the lending rate threshold at which firms self-select out of formal credit markets and turn instead to informal sources.
• Analyze actual repayment performance to distinguish between inability to repay (affordability failure) and unwillingness to repay (behavioral or enforcement issues).
• Establish affordability profiles that vary by MSME size and formality (informal/unregistered vs formal) , sector, and geographic location.

2.2.3 Integrated Ecosystem and Policy Objectives

• Identify the gap, overlap, or convergence between minimum sustainable lending rates (supply side) and maximum affordable lending rates (demand side), and map the zone of pricing feasibility where both lenders and borrowers can operate viably.
• Quantify what structural interventions (credit guarantees, digital infrastructure improvements, regulatory reforms, concessional funding mechanisms, improved information systems) could shift the cost of capital downward and the affordability ceiling upward, thereby expanding the zone of viable pricing.
• Provide evidence-based policy recommendations on appropriate lending rates and rate ranges for commercial and concessional products that would support financial inclusion, maintain ecosystem sustainability, and meet prudential standards.
• Deliver actionable recommendations for Kifiya’s product strategy, lender partnerships, guarantee fund design, and evidence-based policy advocacy with the NBE and development finance institutions.

3. Key Research Questions

The study might be guided by (not limited to) the following integrated research questions spanning both the supply side (cost of capital and lending rate sustainability) and the demand side (affordability and willingness to pay):

 

 

4. Scope of Work

The study focuses exclusively on uncollateralized MSME lending in Ethiopia. It will examine both the supply side (bank cost of capital and minimum sustainable lending rates) and the demand side (MSME affordability and maximum sustainable rates) simultaneously and in an integrated manner. The scope is defined as follows:

 

The consultant will work under the supervision of Kifiya’s Research Lead and report to a Steering Committee comprising Kifiya’s MERL unit and senior management. Access to Kifiya’s internal loan portfolio data will be provided under a confidentiality agreement.

5. Methodology

5.1 Overall Analytical Framework

The consultant shall review the study objectives and propose an updated, appropriate, and methodologically sound approach for conducting the assignment. The proposed methodology should be clearly justified, including the rationale for selecting the approach, its suitability for the research questions, and how it will ensure credible and useful findings.

The suggested methodology should adopt an integrated mixed-methods framework that combines supply-side cost of capital decomposition with demand-side affordability analysis. The two analytical tracks should be designed to converge on a single, evidence-based policy output: a non-collateral digital MSME lending that is sustainable for lenders and affordable for borrowers.

Supply-side analysis establishes the foundation: what is the cost of capital for banks in Ethiopia’s current environment, and what minimum lending rates are required for sustainable uncollateralized MSME lending? Demand-side analysis establishes the ceiling: what rates disaggregated by product type (e.g., short-term working capital, asset-backed/device financing, invoice financing, digital micro-credit)? can MSMEs afford to pay? The synthesis identifies the zone of feasibility where lending rates can be both sustainable and affordable, and what structural changes could expand in that zone.

5.2 Integrated Gap Analysis and Ecosystem Sustainability

Following supply-side and demand-side analyses, the consultant will conduct integrated analysis:

5.2.1 Gap Mapping

• Compare the minimum sustainable lending rate (supply side) against the maximum affordable lending rate (demand side);
• Identify whether these rates overlap (zone of feasibility), diverge (no overlap), or partially overlap;
• If divergence exists, quantify the size of the gap and identify which segments (by size, sector, geography) are most affected.

5.2.2 Current Market Assessment

Evaluate whether the current prevailing lending rate range falls within, above, or below the zone of feasibility for different MSME segments.

5.2.3 Scenario Modeling

Model forward-looking scenarios assessing how targeted interventions could shift the cost of capital downward and the affordability ceiling upward:

• Partial credit guarantees (e.g., 50% LGD coverage) reducing risk spreads;
• Improved digital infrastructure (AI scoring, digital ID, credit bureau integration) reducing operating cost and risk spreads;
• Regulatory reforms (reduced reserve requirements, streamlined compliance) lowering regulatory cost spreads;
• Improved liquidity conditions;
• Concessional funding mechanisms for subsidizing rates for priority segments.

5.2.4 Recommendations

Based on the gap analysis and scenario modeling, produce recommendations on:

1. What can work commercially now? lending rate ranges where the sustainable threshold already meets MSME affordability, and which cost components (risk premium, operational cost) could compress further to expand this zone;
2. Where concessional or blended support is genuinely needed? Which segments show a persistent gap, which cost-of-capital component(s) drive it (cost of funds and/or risk premium), and how targeted concessional funding or guarantees close that specific gap without distorting commercial pricing elsewhere;
3. What it takes to graduate from concessional to commercial? How each relevant cost-of-capital component would need to fall over time (track record, scale, infrastructure) for currently concessional-dependent borrowers, products, or institutions to reach a commercially sustainable rate

5.3.  Data Sources and Collection

The study might triangulate multiple primary and secondary data sources:

Macroeconomic data: NBE policy rate, T-bill yields, inflation, exchange rates, GDP, sovereign ratings from NBE, Ministry of Finance, Ethiopian Statistics Service, IMF, World Bank;

Institution-level data: Bank financial statements, loan portfolio data, cost structures, risk data, funding source breakdown, obtained under confidentiality agreements from participating lenders;

MSME survey data: Secondary data from Kifiya database as well as from other relevant national and regional MSME behavioral data/reports/analysis/publication.

Repayment data: Loan-level repayment performance from lenders (dependent on data protection policy)

(Key informant interviews: Structured interviews with NBE officials, Ministry of Finance, bank executives, MSMEs and industry associations;

Secondary research: NBE directives, bank financial reports, academic research on MSME finance and credit markets.

5.4.  Validation and Policy Engagement

Interim findings will be presented for Kifiya management and Kifiya internal teams for validation. And the final findings will be presented at a workshop involving stakeholders, possibly including but not limited to, NBE, Ministry of Finance, participating lenders, fintech operators, guarantee funds, and development of finance partners. Dedicated separate briefing to Kifiya leadership will be presented.

6. Expected Outputs and Policy Contributions

The study is expected to produce the following substantive analytical and policy outputs:

A quantified decomposition of the cost of capital for banks offering uncollateralized MSME credit, showing WACC, operating costs, credit risk spreads, regulatory costs, and profit margins by lender type;

An estimate of the minimum sustainable lending rate for commercial and concessional products by lender type, grounded in rigorous cost analysis;

A demand-side affordability profile of Ethiopian MSMEs, showing maximum sustainable debt-service ratios and maximum affordable lending rates by size, formalization, gender, sector, and region;

A gap analysis identifying whether, and for which segments, sustainable lending rates and affordable borrowing rates overlap or diverge;

A recommended lending rate range for commercial and concessional non-collateral digital MSME credit that enables ecosystem sustainability;

Quantified scenarios showing how targeted interventions (guarantees, digital infrastructure, regulatory reforms) would affect the cost of capital, required lending spreads, and the zone of pricing feasibility;

Evidence-based policy recommendations addressing appropriate pricing, product design, structural interventions, and reforms needed to support sustainable inclusive lending;

Actionable recommendations for Kifiya’s product strategy, lender partnerships, guarantee fund design, and evidence-based policy engagement.

7. Deliverables

All deliverables must be in English, professionally formatted (1.5-line spacing, 12pt font, all charts included), and in specified formats. All deliverables must be approved by Kifiya Research Steering Committee.

 

8. Indicative Timeline

[1] https://publications.gc.ca/collections/collection_2010/banque-bank-canada/FB3-4-2010-16-eng.pdf

[2] https://nbe.gov.et/

. Qualifications of the Consultant or Team

Applications are invited from qualified research firms or multidisciplinary consultant teams. The following qualifications are required:

9.1 Technical Expertise

• Demonstrated expertise in cost-of-capital studies, financial sector analysis, credit market research, and MSME finance in Ethiopian or East African context;
• Proven capacity in econometric analysis including interest rate decomposition, panel regression, sensitivity analysis, and scenario modeling;
• Experience in demand-side enterprise surveys including instrument design, sampling, and statistical analysis;
• Familiarity with Ethiopian banking regulation, NBE directives, and the post-2026 deregulated lending environment;
• Understanding digital credit infrastructure (credit bureaus, digital ID, AI scoring).

9.2 Professional Experience

• Key personnel with 7-10+ years in financial sector research, development economics, or applied econometrics;
• Team including at least one MSME/inclusive finance specialist and one quantitative/econometric modeling specialist;
• Prior experience with cost-of-capital studies, interest rate analyses, or financial sustainability assessments strongly preferred.

9.3 Language and Operational Capacity

• Research design and conduct in English and relevant local languages;
• Capacity to manage multi-site data collection and institutional interviews within timeline;
• Familiarity with ethical research practices and data protection.

Risk and Mitigation

Risk Description Mitigation

Data Access Lenders reluctant to share proprietary data. Confidentiality agreements; aggregated/anonymized data; Kifiya facilitation.

Timeline Slippage Delays in approvals or review cycles. Buffer periods; regular check-ins; parallel workstreams.

Policy Volatility Further NBE regulatory changes to mid-study. Scenarios accommodate policy shifts; sensitivity testing.

Resource Risk Key personnel changes disrupting continuity. Documented work plan; team backfill provisions.

MSME KII Response Low response rates affect affordability analysis. Pilot testing; experienced enumerators; validation protocols.

Eligibility Criteria

Interested firms must demonstrate:

• Proven experience in conducting financial sector analyses and qualitative research in Ethiopia or East Africa. Key research personnel should have 7-10 years of experience in conducting similar studies.
• Ability to design and conduct a study in English and local languages (Amharic, Afan Oromo, Tigrinya)
• Expertise in livelihoods, economic research, and financial services.
• Capacity to manage data collection and analysis.
• Familiarity with ethical research practices, safeguarding and data protection

Submission Requirements

• Company profile and relevant assignments (one-page maximum);
• Technical proposal with integrated methodology, cost-of-capital approach, affordability assessment, sampling strategy (four pages maximum);
• CVs of key personnel;
• Two references with sample work product;
• Business license, TIN, VAT certificates;
• Financial proposal (separate from technical), covering all costs.

Evaluation Criteria

• Criterion Weight
• Technical expertise in cost-of-capital studies and MSME finance 50%
• Quality of integrated methodology addressing supply-side and demand-side 20%
• Financial proposal (all costs inclusive) 30%

Ethics, Safeguarding, and Data Protection

• The consultant must adhere to ethical research standards:
• Informed consent from all interview and KII participants;
• Anonymization of confidential or personally identifiable information;
• Disclosure and management of conflicts of interest;
• Do-no-harm principles in field interactions;
• Compliance with Ethiopia’s data protection regulations.
• All Kifiya internal data must remain strictly confidential.

Intellectual Property and Data Management

All intellectual property (reports, models, datasets) produced will be Kifiya’s property; consultant retains authorship credit. Any external publication requires Kifiya’s approval. Upon request by Kifiya team at any stage of the study and upon completion, the consultant must transfer all raw data (de-identified), code, and documentation to Kifiya securely