29 Aug Exploring Micro-finance in East Africa
Written by Suthen Sivanesarajah, 2014 East Africa: Youth in Action.
I chose to join the Youth in Action program in East Africa in part to understand the impact and challenges of micro-finance in sub-Saharan Africa. For the uninitiated, Micro-finance is an alternative way of providing financial services to people who don’t have access to the traditional banking system that many of us in North America use on a daily basis. I believe that Kenya and Tanzania, like other developing regions, can realize their potential if they are given the necessary resources and training to serve the “underbanked” segment of their respective populations.
While the need for capital exists in developed countries, a greater proportion of people are underbanked in Kenya and Tanzania. At a quick glance, one can point to a number of micro-finance organizations in the private, government, and non-government sectors and believe that the needs of the underbanked in Kenya and Tanzania are being met. However, my interactions with representatives from the local government, NGOs, and private institutions have led me to conclude that there are a number of challenges that limit the effectiveness of micro-finance in Kenya and Tanzania.
The governments in Kenya and Tanzania can be considered to be one of the biggest proponents of micro-finance simply because they provide access to a large amount of low-cost capital. As their main focus is to increase economic growth, the loans given out by the local governments are interest-free. The Owezo Fund, which is run by the Kenyan government, is a key example of a government that is trying to use micro-finance to spur local development. Based on reports, the fund has a mandate of issuing 6 billion Kenyan shillings ($68.7 million). Through our meeting with a local MP in the Kisumu County, I learned that these funds were earmarked for a second election that was avoided.
To ensure a local approach, the Uwezo Fund was divided up and given to county governments. The candidates are selected through the quality of their application, which is only available at the local level. Theoretically, a public institution that offers interest free loans to aspiring entrepreneurs should be immensely successful in terms of enabling local development. To my surprise, the local MP we met was opposed to the Uwezo Fund – he believed that most people would not pay back the government’s loans.
While his assertion may be true in some cases, it is important to recognize a critical flaw in the management of the Uwezo Fund in the Kisumu County. There is a lack of training and personal interaction between the lender (the county) and borrower. Many recipients of the Uwezo Fund have a great idea but lack the business education to manage the responsibilities that come with the loan itself. This includes basic concepts such as the difference between financial and cash profit.
Another flaw of the Uwezo Fund lies within the application process. The fund is not accessible to people who live in areas that are far from the county office and cannot afford to travel to receive and submit an application. Moreover, the current selection process eliminates a subset of the county’s population who may have a legitimate business idea but do not have the necessary education to complete an application. Despite the headlines made by the Uwezo Fund, it is important to recognize that the Kenyan government (in the Kisumu county) does not have the necessary structure and processes to properly administer the fund.
As with governmental projects in Kenya and Tanzania, a number of non-governmental organizations use micro-finaning to spur local development. These organizations receive donations which they lend to eligible candidates without charging interest.
I was able to see how an NGO can take part in micro-lending first hand through our partner organization Jifundishe, which has its own micro-lending program called UKUWAJI. This program has been growing every year, giving out 50 loans (out of 200 applications) with a grand total of 6.25 million shillings this year. The loans are given out based on the results of a selection process that includes the submission of an application, a reference check with the local village leader, and a home visit.
Like the governments of Kenya and Tanzania, UKUWAJI faces the challenge of having applicants who do not have the requisite business education to represent themselves in a credible manner during the application process. To help solve this challenge, UKUWAJI holds business-planning workshops (free of charge) for its applicants so that they can incorporate critical practices such as record keeping in their business processes. To ensure the organization maintains a 0% default rate, UKUWAJI holds monthly meetings where borrowers pay back their loans and also meet with each other to exchange ideas to improve their profitability.
Despite some of the success stories of UKUWAJI, the organization is troubled by borrowers who are not using the money to grow their respective businesses but rather simply sustain them. This is a key challenge, as I believe the purpose of micro-finance is to ensure the growth of a business.
Another issue faced by larger NGOs that practice micro-lending is that many people in Kenya and Tanzania believe that they should not be obligated to pay back the money given to them since the money received by NGOs is donated by well-off foreigners (“mzungus”). This challenge is mitigated in the case of UKUWAJI as the opinion of local community members is highly valued during the selection process. Although UKUWAJI has been more successful than other micro finance institutions, I believe that the structure of the organization is not scalable as it is heavily reliant on the strength of the community it works with.
Over the years, there has been tremendous growth in the number of private micro-finance institutions in Kenya and Tanzania. Within the private sector, I was able to meet people from two types of organizations; a niche financial services organization and a savings and credit cooperative society (SACCOS).
The niche financial services organization in Tanzania started with the vision of entering the field of micro-finance by lending to groups of people who aimed to start their own business. Each group was required to have 3-5 people, a designated group leader with a permanent address, and a form of collateral for the entire group loan. When the organization started a pilot program in-group lending, nearly half the groups defaulted on their loans because borrowers believed the organization was funded through donations. This perception may have been a result of the fact that the organization was founded and led by “mzungus”.
Their failure in group lending forced a transition toward emergency loans through which the company lent money to people who were dependent on their bi-weekly paycheque and needed access to funds quickly. The loans given out are based on the borrower’s regular salary, collateral, and the reputation of the borrower’s employer. It is important to note that the organization compensates itself at an above market interest rate for the risk it takes – loans can have an interest rate of 5% to 6.5% per month with a principal amount of anywhere between 100 thousand to 1 million Tanzanian shillings.
Although this product has been successful, the company faces the challenge of borrowers quitting their jobs and running away with the money after receiving a loan. The worst performing loans have a principal amount of over 1.5 million Tanzanian shillings; a barrier that the organization now refuses to lend above unless the client has an extremely good (and well-proven) relationship with their employer. Another challenge faced by organizations who operate in the area of group lending and emergency loans is that people can simultaneously be part of different groups which borrow money from different organizations. The central bank of Tanzania has recently implemented its own credit reference system, but the system is largely accessed and maintained by the larger banks in Tanzania. As more organizations enter the micro-finance market, this challenge will become more prevalent. According to an employee leading the implementation of the credit reference system for the Kenya Commercial Bank, the information being put into the system by the bank is only 70% accurate as the bank does not have key information such as home address for several of its clients. The process of establishing a credit reference system for all lenders will play a large role in success of private and public organizations in the area of micro-finance.
The second type of organization that I met with is a savings and credit cooperative society. Unlike other private micro-finance organizations, SACCOS are able to manage both savings and loans. This gives them an inherent advantage as they have a greater access to low cost funds whereas other private institutions may need to borrow from larger banks. It also allows SACCOS to build a stronger relationship (financially) with their clients. A SACCOS is a membership-based organization run by board members who are elected on an annual basis. The members themselves meet twice a year to discuss and vote for changes that the organization must make.
In the SACCOS structure, a typical borrower would first need to pay 20,000 Tanzanian shillings as a membership fee and 2,000 Tanzanian shillings as an application fee. Afterwards, the applicant would have to deposit money (a minimum of 5,000 shillings) over the course of three months. Once the three-month period is completed, the borrower is eligible to take out twice the amount he/she deposited. The borrower must pay back the loan within 12-24 months and is charged an interest rate between 2.25-2.5%. The borrower can also arrange a 60-day grace period if needed.
To help the SACCOS raise funds, the organization also sells shares to its members with each share priced at 5,000 shillings. The funds from the sale of shares are pooled together and lent to its members. At the end of the year, the profit earned by the organization is distributed back to the SACCOS’ shareholders. It is important to note that the organization has its own penalty system for situations such as late payments, where borrowers are given a 10-day grace period and are then required to pay a 2% fee on the outstanding amount.
A challenge that is faced by this organization is the fact that potential borrowers are often unable to show sufficient collateral. Thus, this organization mainly lends to agriculture businesses that are able to use land and/or farming equipment as collateral. When compared to other types of private institutions in micro finance, it is important to note that the division of profit and power is highly decentralized under the SACCOS. This corresponds to the communal aspect that I have seen within the culture of Kenya and Tanzania. However, a flaw within the SACCOS structure is that its selection process eliminates a sub-group of potential borrowers who may not be able to pay the membership fee and make monthly contributions. The organization I met with is also limited in terms of reach as it only has one office to serve all of its members.
SACCOS may not be as prevalent within the micro finance industry as they could be because the incentive for a founding group to establish a SACCOS in their local region is lacking. On the other hand, I found it interesting that a common characteristic of most private institutions in micro-finance is the fact that borrowers are required to use a portion of their loan (approximately 1%) to purchase insurance to protect the lender against the risk of default due to disability and/or death. Given the laborious nature of most of the businesses that seek funding, I think that this is a practice that the government and NGOs should adapt.
In summary, there are various forms of micro-finance in Kenya and Tanzania that fall under these categories:
1) Private institutions (I.e. banks and SACCOS)
3) Non-Government Organizations
1) Lack of accessibility in certain areas due to distance, cost of application, unawareness of programs
2) Lack of training in entrepreneurism (tendency to study professional services in Kenya, poor education system in Tanzania)
3) Reliance on loans to sustain business
4) Lack of continuous contact between lender and payee (no support for businesses) (increases default rate)
5) Cultural belief that funds from “mzungus” and the government do not have to be repaid
6) Lack of regulations that enable people to receive loans from multiple institutions
Based on my research, the need for micro-finance in developing countries such as Kenya and Tanzania is clear. According to an employee at the Kenya Commercial Bank, the banks in Tanzania only have a 28% penetration of its population. Although there have been many success stories that were only responsible through the emergence of micro finance, my experience in Kenya and Tanzania has taught me that there is a lot of room for improvement. To ensure sustainable growth in the micro finance industry, it is critical for the public and private sector to work in cohesion to create a supportive structure that enables borrowers to succeed and lenders to be compensated fairly for the risk they take.