the impact of microfinance institutions in local financial markets: a case study from kenya
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Journal of International Development
J. Int. Dev. 16, 501–517 (2004)
Published online in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/jid.1088
THE IMPACT OF MICROFINANCEINSTITUTIONS IN LOCAL FINANCIAL
MARKETS: A CASE STUDY FROM KENYA
SUSAN JOHNSON*
Centre for Development Studies, University of Bath, UK
Abstract: This paper looks beyond the direct impact of microcredit provision on users to
examine whether microfinance institutions (MFIs) have had wider impacts within the local
financial markets in which they are operating. It considers the potential for both competition
and demonstration effects on other financial providers. In the context of local financial
markets in and around the small town of Karatina in Central Kenya, supply side information is
used to investigate the key changes in provision between 1999 and 2003. The paper concludes
that changing macroeconomic conditions have been the main driver increasing competition
for middle and lower income clients and that few competition or demonstration effects
resulting from the MFIs are in evidence. Copyright # 2004 John Wiley & Sons, Ltd.
1 INTRODUCTION
The main emphasis in impact assessments of microfinance programmes has been to
examine the direct effects that the provision of small loans has had on the livelihoods and
wellbeing of poor clients. However, when supporting the entry of microfinance institu-
tions1 (MFIs) into financial markets, donors and academics have also considered the
potential impact on the financial market more broadly. Specifically on the behaviour of
other financial service providers, with the expectation that their entry might precipitate
innovation and hence further expand the supply of services to poor clients. However,
studies attempting to investigate such impacts are virtually non-existent. This research
under the ImpAct programme therefore set out to examine whether MFIs have had such
effects within financial markets.
This paper starts by reviewing the types of impact on financial markets that have been
discussed in the literature. The second section then sets out an approach to examining
Copyright # 2004 John Wiley & Sons, Ltd.
*Correspondence to: S. Johnson, Centre for Development Studies, University of Bath, Claverton Down, BathBA2 7AY, UK. E-mail: s.z.Johnson@bath.ac.uk1Microfinance refers to the provision of small scale savings and loan services. Many types of organization areoften referred to as MFIs including, for example, BRI in Indonesia and various Credit Unions. Here I use the termto refer to organizations providing microfinance services—usually microcredit—whose origins lie in NGOs, asthese represent a very specific form of intermediation where credit funds are—at least initially—externallysourced from donor grants.
these impacts. The third section reports results from a study of financial markets in and
around the small town of Karatina in Central Kenya to examine these impacts empirically.
The fourth section concludes.
2 MICROFINANCE INSTITUTIONS IN FINANCIAL MARKETS
The 1990s saw a paradigm shift in approaches to microfinance that moved the rationale for
interventions in credit provision from one of subsidized delivery to the need to build
healthy financial systems (Otero and Rhyne, 1994). This was the result of an increasingly
rich body of detailed research into informal financial arrangements converging with
insights from the new institutional economics and practical experience of lending to poor
people (McGregor, 1988). This resulted in a number of key departures from earlier
thinking. First, poor people can and will pay relatively high interest rates for loans and
their concern is for repeated and reliable access rather than cost. Second, poor people can
and do save, and practical experience suggested that ‘compulsory’ savings requirements
linked to loan access could provide funds for on-lending.2 Third, group-based methods
(regularly found in informal arrangements) could reduce transactions costs and had the
potential to ensure that large numbers of people could be reached with the services. These
developments gave rise to hopes that microfinance institutions could expand their out-
reach, reduce their costs as they grew in size, mobilize funds for on-lending independently
of donors, and hence become independently self-sustaining so providing services in the
long term (Johnson and Rogaly, 1997).
The idea of building sustainable microfinance institutions also converged with policy
debates regarding ‘financial repression’ and its implications for financial sector reform.
The financial repression thesis suggests that measures such as interest rate controls, high
reserve requirements and directed credit policies imposed distortions on financial inter-
mediation. Hence that the removal of interest rate ceilings, for example, improves the
quality and quantity of saving and investment in the economy. On the supply side higher
deposit interest rates mobilise savings since higher interest rates produce less of a bias for
present over future consumption. On the demand side, raising the interest rate improves
the efficiency of investment through deterring low-yielding investments that would
previously have qualified (and especially in the case where investments may have been
selected by administrative systems rather than price selection). With improved allocative
efficiency of the funds invested, output growth is generated that further stimulates savings
as incomes rise (Fry, 1997).
Along with the proponents of financial repression, subsidized lending both through the
state in the form of agricultural credit schemes and NGOs, had been criticized by the ‘Ohio
School’ who took the view that this was ‘undermining’ the market with cheap credit
(Adams et al., 1984). They argued that subsidized credit led to allocative inefficiency and
could erode the in-built mechanisms of indigenous lending practices (Nagarajan et al.,
1995). By contrast, the Ohio School supported building financial organizations that could
cover their costs and be financially self-sustaining thereby widening the market for
financial services in a sustainable way (Von Pischke, 1991).
2Although the capacity of poor people to save was recognized in this way, this did not lead to the availability offlexible savings services by MFIs. This is an area of current and ongoing debate, although the need for poorpeople to have access to savings services is increasingly recognized. See Rutherford (1998; 1999); Sharif andWood (2001).
502 S. Johnson
Copyright # 2004 John Wiley & Sons, Ltd. J. Int. Dev. 16, 501–517 (2004)
However, while subsidized credit to users is seen as distorting the market and no longer
good practice, cheap capital for the establishment of MFIs has been the norm. Using neo-
classically based infant industry arguments, Hulme and Mosley (1996—also Meyer et al.
(in this volume))—argue that subsidies are valid because the benefits of developing the
technology of lending to poor people involves externalities of knowledge which cannot be
internalised by the organization itself (Hulme and Mosley, 1996). However, the case made
is a general theoretical one and has not been applied to specific financial markets to
demonstrate the legitimacy of subsidies in a particular context. To do so would require the
development of criteria to be used in assessing what a ‘correct’ level of subsidy might be
which would avoid undermining already existing financial service providers (Johnson,
1998). Thus support to MFIs has been rationalised alongside thinking around liberalization
and in this sense moves towards removing the ‘distortion’ of subsidized credit to users
(Copestake, 1996). Yet their presence and promotion remains ‘distorting’.
The Ohio School has been a key player in the application of New Institutional
approaches to financial markets and has also considered the role of MFIs in developing
the rural financial market (RFM) however, they suggest that ‘the route to better RFM
performance is not well marked’ (Von Pischke, 1983, p. 12) but a well-functioning rural
financial market should have the following characteristics. It should:
* mobilize rural savings as well as disburse credit
* grow to meet expanding opportunities without the need for subsidies
* expand the array of vehicles for attracting savings
* offer varied and flexible lending terms and conditions
* have institutions which are healthy and expanding
* have active competition among formal and informal borrowers and lenders
* the costs of financial services should fall as a result of innovation
* the economically active population should have expanding access
* the capability of the RFM to take part in larger financial markets should grow.
The shifting of the financial ‘frontier’ (Von Pischke, 1991) is defined as the limit of the
activities of formal financial institutions or alternatively that it is a ‘limit that is pierced by
any financial innovation’ and in particular is expanded when poor people have their first
direct and sustainable interactions with the formal financial system. Von Pischke proposes
a four-level framework for review which looks at impact on borrowers; the intermediary
itself; financial market development and macroeconomy and macrofinancial situation. The
first level is the most familiar: impact on borrowers and their enterprises has been the main
focus of impact assessment work. The second level has been heavily emphasized by the
‘intermediary’ school (Hulme, 2000) which focuses on the building of sustainable
financial intermediaries.
Here we are concerned to examine the third level of impact on financial market
development. Von Pischke suggests that this can be established by asking the following
questions (Von Pischke, 1991, pp. 264–376) both at the level of the project or intermediary
and at the level of financial market structure:
* At the level of the project or intermediary:
� are project instruments innovative?
� did project instruments promote competition; have they proved catalytic, novel or
trivial?
MFIs: A Case Study from Kenya 503
Copyright # 2004 John Wiley & Sons, Ltd. J. Int. Dev. 16, 501–517 (2004)
* At the level of the structure of the financial market:
� What is the relationship of the project to the structure of the financial market and
changes in its structure?
� How did the project fare relative to other institutions in terms of market share?
� Have project interventions influenced other players and their pricing?
� What evidence is there that financial instruments have competed with non-
financial forms of savings and credit?
At the level of the financial market, von Pischke concentrates on the question of whether
projects have successfully lengthened the term structure of the market, i.e. whether they
have overcome the risks of borrowing short to lend long. Since, the role of a financial
intermediary is to overcome the risk of using funds taken in on relatively short-term
deposits and turn them into loans for much longer periods of time, the ability to
successfully manage liquidity and price risks is crucial. He proposes means of analysing
the MFI’s assets and liabilities to establish whether this is being achieved but also suggests
that where such refinements in valuation techniques have occurred they may be expected
to create demonstration effects that would further stimulate competition.
Additionally, he poses two further questions:
* whether injecting liquidity into tight financial markets has a greater impact on these
markets than where liquidity is not a problem?
* whether the intervention has successfully developed banking habits in terms of long
term relationships involving continuous deposits and repeated borrowing.
Von Pischke does not indicate the exact means of answering many of these questions.
However this approach to impact assessment in financial markets concentrates on improv-
ing their functioning as efficient allocators of resources for investment consistent with the
financial repression case. In line with the operationalising of New Institutional Economics
approaches, reducing transaction costs and managing risk are seen as the main indicators of
whether or not this has been achieved despite the inherent difficulties in their measurement.
It is clear therefore that interventions in the financial market through credit projects
established with subsidy have anticipated wider impacts on the structure and functioning
of those markets that go beyond the direct impact on users. While the ‘intermediary’
school has focused on evaluating the goal of sustainable provision, few studies have
attempted to investigate the wider impacts on financial market development. The
contributions reviewed here suggest two types of impact on market development. Mosley
and Hulme suggest that there are externalities of knowledge that will be of wider benefit to
the market as a whole, and this is reinforced by Von Pischke in suggesting that there may
be demonstration effects to other players of successful innovations. However, Von Pischke
particularly emphasizes the role of competition in creating incentives for innovation and
the creation of value through new financial instruments which breach the frontier. High
returns to innovation produce incentives to invest and in turn erode those returns—
fuelling Schumpeter’s cycle of ‘creative destruction’ which carries economic development
forward (Von Pischke, 1991, p. 201).
3 CONCEPTUAL APPROACH AND METHODOLOGY
Figure 1 presents the supply side of financial markets with respect to different categories
of financial service providers and helps to conceptualise the impact when NGO-originated
504 S. Johnson
Copyright # 2004 John Wiley & Sons, Ltd. J. Int. Dev. 16, 501–517 (2004)
MFIs enter these markets. First, is the direct impact that the provision of services has on
the livelihoods of the users of those services which is the main focus of most impact
assessment studies. Beyond these we can suggest that there are two domains of impact.
First, is the impact that the entry of MFIs has on other financial intermediaries. MFI
services might compete away business from other suppliers on the basis of price or service
quality and hence affect the volume of business and profitability of other intermediaries in
the market—a competition effect. Hence, this may affect the array of financial services
available in the market indirectly, for example (and as is often hoped) competing local
moneylenders out of business. Alternatively or additionally, other intermediaries may
change their own products and services to copy or mimic aspects of the MFI’s services—a
demonstration effect.
At the level of users, the competition effect is in operation when users of MFI services
change their use of other financial services, and hence we can consider changes in service use
from the perspective of clients also. This competition effect at the level of users might have
indirect impacts on non-clients also. For example, members who withdraw from a ROSCA
because they now have access to an MFI, may cause the collapse of the ROSCA and hence the
reduced availability of services for those who, for whatever reason, may not want or be eligible
to join the MFI programme. Also at the level of users, it is possible that MFI clients may
provide a demonstration effect to non-clients in terms of banking habits, for example, through
learning savings behaviour and credit discipline. This may, in turn, encourage non-members to
enter into financial transactions with other financial intermediaries.
This paper draws on supply-side data collected in Kenya to investigate whether there is
evidence for competition or demonstration effects operating at the level of financial
intermediaries as a result of MFI engagement in the market. It reviews information on
market shares and changing product mixes along with evidence from interviews with
managers and officials who were interviewed in-depth about the dynamics at work in the
market. Hence it uses respondents own reports to explain attribution. A first period of
Figure 1. Conceptualising impact in local financial markets
MFIs: A Case Study from Kenya 505
Copyright # 2004 John Wiley & Sons, Ltd. J. Int. Dev. 16, 501–517 (2004)
research was carried out in Karatina between 1999 and 2001 and supplemented by a period
of three weeks of fieldwork in February 2003 (see Johnson, 2003).
Karatina is a small town in Mathira Division of Nyeri District in Kenya’s Central
Province. Its location on the slopes of Mt Kenya means that it has fertile volcanic soils and
good rainfall, with no absolute poverty in Nyeri District when the rains are good
(Government of Kenya, 1998). However, along with the rest of Kenya, economic
conditions have deteriorated. National GDP growth rates fell from 4.6 per cent in 1996
to 1.4 per cent in 1999, and turned to negative 0.2 per cent in 2000 before recovering to
1.1 per cent in 2001.
The area’s strong agricultural potential has meant that Karatina is a small but vibrant
town and this is one of the reasons that four NGO-originated MFI programmes now
operate there, with Kenya Women Finance Trust being the most established, having started
its operations there in 1991. It also possesses a wide range of intermediaries including
banks and non-bank financial intermediaries3 (NBFIs), parastatals, savings and credit co-
operatives (SACCOs), and microfinance institutions. It was not possible to capture the
informal financial sector on the supply side in the same way. Karatina abounds with group
based financial arrangements, ROSCA and ASCAs operating in various ways—with
women in particular making extensive use of them (see Johnson, 2003). However,
moneylending as a commercial operation (i.e. not including friends and relatives) operates
on a very limited scale. What follows therefore attempts to assess the key changes and
dynamics among the financial service providers more formally defined.
4 FINANCIAL SERVICE PROVISION IN KARATINA, 1999–2003
4.1 Formal Financial Sector Intermediaries
Formal sector banks and non-bank financial institutions (NBFIs): four of the five main
banks with a national presence operate in Karatina and in addition there is a building
society4—Equity. In 1999 the commercial banks offered the usual range of current and
deposit accounts, along with loans usually secured against land, shares or cash. In 1999,
these accounted for 73 per cent of deposits by value, 55 per cent of outstanding loans and
49 per cent of the number of savings accounts (see Table 1).
By 2003, the number of accounts had fallen by 24 per cent although their proportion of
the total remained almost the same. Deposits remained stable in nominal terms signalling a
fall in real terms as prices rose 17 per cent over this period. The primary cause of the
falling number of savings accounts was increasing minimum deposit levels over the period
1999–2001 when banks decided to raise their minimum deposits and move their business
towards a high net worth customer base—primarily the business market and salaried
individuals. Customers heavily resented this and it distanced the commercial banks from
the mass market since even low-level salaried government employees could no longer
afford to leave the minimum balance in their accounts untouched. In their search for
3During the 1990s the Central Bank of Kenya brought the regulatory requirements for NBFIs into line with thoseof the commercial banks after a series of banking crises.4Building Society registration originally required lending for long-term housing purposes but during the 1990sthe Central Bank has treated this registration as little different from that under the Banking Act. However, itcannot operate cheque accounts.
506 S. Johnson
Copyright # 2004 John Wiley & Sons, Ltd. J. Int. Dev. 16, 501–517 (2004)
Tab
le1
.S
avin
gs
and
loan
sp
erfo
rman
ceo
ffi
nan
cial
inst
itu
tio
ns
inK
arat
ina,
Ken
ya
19
99
and
20
03
(Ksh
s’000s)
Note
Dep
osi
tsM
ember
s/sa
vin
gs
acco
unts
Loan
sL
oan
/dep
osi
tra
tio
19
99
%o
f2
00
3%
of
19
99
%o
f2
00
3%
of
19
99
%o
f2
00
3%
of
tota
lto
tal
tota
lto
tal
tota
lto
tal
19
99
20
03
Fo
rmal
sect
or:
Ban
ks
11
14
85
93
73
10
93
70
36
52
45
43
24
17
37
42
34
29
99
55
55
37
09
95
53
74
9
NB
FIs
21
13
97
37
16
00
00
10
25
66
32
52
10
00
28
70
99
59
82
00
08
62
51
Par
asta
tals
30
00
00
00
29
961
42
9961
3
Su
b-t
ota
l1
26
25
66
80
12
53
70
37
55
02
06
49
38
37
45
15
30
95
16
86
49
06
06
74
25
2
MF
Ise
cto
r:
Mai
nst
ream
MF
Is4
18
629
12
4947
11958
22911
42
8411
45
0500
5153
202
Man
agem
ent
543
184
32
6628
21
0329
10
5790
88
2050
10
29
919
3190
112
serv
ice
MF
Is
Su
b-t
ota
l6
18
13
45
15
75
31
22
87
12
87
01
12
11
04
61
14
80
41
98
17
91
56
SA
CC
Os:
Cas
h-c
rop
SA
CC
Os
61
68
44
91
12
35
10
21
43
72
83
36
25
25
03
45
34
95
71
12
66
21
23
24
8
Em
plo
yee
SA
CC
Os
79
01
50
61
47
34
39
22
77
22
04
83
80
11
71
01
14
25
71
28
97
8
Tra
nsp
ort
/bu
sin
ess
SA
CC
Os
81
25
60
11
33
73
13
96
03
96
11
14
48
11
21
70
19
19
1
Su
b-t
ota
l2
71
15
91
73
95
81
82
43
99
56
39
27
69
43
71
45
06
01
82
39
08
82
55
36
0
To
tal
15
76
90
91
01
16
76
14
91
01
10
24
49
10
07
47
68
10
07
86
47
11
00
96
85
67
10
0
Notes:
1.
Dat
afo
ro
ne
ban
kin
20
03
was
no
tav
aila
ble
soit
sn
um
ber
so
fac
cou
nts
and
vo
lum
esh
ave
bee
nas
sum
edto
hav
ech
ang
edco
mp
arab
lyto
the
oth
erb
ank
s.2
.D
ata
for
thes
ein
stit
uti
on
sis
inco
mp
lete
.3
.D
ata
for
Po
stO
ffice
Sav
ing
sw
asn
ot
avai
lab
leas
bal
ance
sar
en
ot
hel
dat
ab
ran
chle
vel
.4
.M
ainst
ream
MF
I’s
dep
osi
tsar
ein
the
mai
nm
ob
lise
db
yth
eM
FI
bu
td
epo
site
din
the
ban
kso
are
excl
ud
edfr
om
tota
ld
epo
sits
.5
.T
hes
eto
tals
hav
eb
een
esti
mat
edb
ased
on
aver
ages
from
asa
mp
leo
fg
rou
ps
of
on
eo
fth
eo
rgan
izat
ion
s.6
.D
ata
for
som
eo
fth
ese
inst
itu
tio
ns
was
esti
mat
edin
19
99.
7.F
or
20
03
dat
ao
nsm
all
SA
CC
Os
for
wh
ich
up
dat
edin
form
atio
nw
asn
ot
coll
ecte
d,
dep
osi
tg
row
thh
asb
een
assu
med
atap
pro
x1
0p
erce
nt
per
yea
r;w
ith
mem
ber
ship
un
chan
ged
.8
.F
or
20
03
dat
ao
ntr
ansp
ort
/bu
sin
ess
SA
CC
Os
was
no
tco
llec
ted
—d
epo
sit
gro
wth
at5
per
cen
tp
ery
ear
and
stat
icm
emb
ersh
iph
asb
een
assu
med
.
MFIs: A Case Study from Kenya 507
Copyright # 2004 John Wiley & Sons, Ltd. J. Int. Dev. 16, 501–517 (2004)
affordable places to save, clients moved to the Equity Building Society and to front office
services (FOSAs) opened by the SACCOs (see below).
By early 2003, this had started to change. All the main banks had lowered their
minimum deposits significantly, precipitated by the fact that all of them had been
chasing high net-worth individual customers who were increasingly scarce given recession
and retrenchment in both public and private sectors. Their revised products have been
accompanied by aggressive marketing campaigns with the previously rare event of bank
officials visiting businesses and individuals around the town on a door-to-door basis.
On the lending side, in 1999, collateral based lending—especially against land—was
very limited in Karatina (Johnson, 2004). Land registration and titling was initiated in
Kenya in the 1950s and aimed at creating a land market that would support the financial
market. This finding echoed those of other research that suggested there was little evidence
to show that formal land titling has increased the use of credit (Pinckney and Kimuyu,
1994; Place and Migot-Adholla, 1998). The reasons for this can be explained by the
political nature of the land question in Kenya alongside social and cultural constraints.5
Social constraints include the safety-net role of land and the fact that the agreement of
wives and other family members is required via Land Boards before men can formally use
land as collateral which brings a complex myriad of family and lineage relationships into
the transaction. These relationships also complicate bankers’ ability to repossess land in
the case of default (see also Shipton, 1992) to the extent that by 1999 one banker explained
that it was a ‘silent norm’ to avoid taking agricultural properties as collateral because
foreclosure was a ‘nightmare of a process’.
By 2003, one notable change was the emergence of unsecured personal loans offered by
the banks based on an assessment of cash flow through the newly revised current or
savings accounts, with many of the banks deliberately marketing these loans linked to
savings accounts. This has been assisted by the development of credit-scoring techniques
that enable decisions to be made quickly. However, these decisions are not usually made
locally but sent to Nairobi despite the fact that most of these banks are now online. This is
probably to protect the integrity of the credit-scoring process so that local staff cannot bias
the system. Earlier attempts to introduce such systems on-line at branch level failed for
this reason.
Overall these developments have raised the nominal value of lending by approx-
imately 22 per cent, at a time when there has been a 17 per cent increase in the price index
suggesting an increase of 5 per cent in real terms. This appears to have raised the loan to
deposit ratio from 37 per cent in 1999 to 49 per cent in 2003, which, while not substantial,
is perhaps significant given the state of the economy. The interest of the main commercial
banks in lending to the middle- to lower-income market has been largely precipitated by
the changing macroeconomic situation. With falling Treasury Bill rates they have no
longer been able to undertake riskless lending to the government and at the same time, this
has precipitated a new move to cash-flow rather than collateral based lending.
Among the commercial banks, it is the Co-operative Bank that has particularly focused
on developing microfinance products, as a result of liberalisation of the sector and the need
for product diversification (Bell et al., 2002). It developed a small business individual loan
product using stock and household assets as collateral but based on an assessment of cash
flows. It was aimed at clients at the upper end of the microfinance product range at the time
(1999). However, in the Karatina branch outreach of this product has remained quite low
5See Johnson (2004) for a more detailed explanation.
508 S. Johnson
Copyright # 2004 John Wiley & Sons, Ltd. J. Int. Dev. 16, 501–517 (2004)
although performance in other branches has been stronger. In addition, the Co-operative
Bank introduced a savings account for small savers with an (at the time) low minimum
balance, unlimited withdrawals and no fees. The account was initially marketed in a very
limited way since its profitability was uncertain. Moreover, its heavy promotion risked
undermining the normal savings account product whose minimum balances were being
raised during 1999 and 2000 alongside those in other banks. Subsequently, it has benefited
from the presence of the product in gaining customers from other banks during the ‘race to
the top’.
Compared to the commercial banks, however, Equity Building Society is aiming more
directly at the middle and lower end of the market and making unsecured loans up to a
ceiling of Kshs50 000 (approx. US$666) without the assistance of credit-scoring methods.
Collateral needed for loans above this amount is negotiated pragmatically and may, for
example, include the deposit of a title deed without it being formally charged. In this range
they have introduced a range of products including medical, education, salary advances,
farm input and business loans. This wide range of products means that they are also the
only formal sector organization that is really competing at the bottom end of the market for
both poor personal customers and those with small businesses who are MFI clients.
Lenders with parastatal and government origins have been in decline in the late 1990s.
In particular the Agriculture Finance Corporation (AFC) has a huge bad debt portfolio
which it has been unable to restructure and closed its office in Karatina in 1999 and no new
lending had taken place over the previous two years. Other parastatals such as The
Industrial and Commercial Development Corporation (ICDC) and Kenya Industrial
Estates (KIE) have a very small presence in the area. This sector was estimated to account
for 4 per cent of the value of outstanding loans. Apart from the Post Office for which
deposit data was not available,6 none of these organizations mobilized deposits.
4.2 NGO-originated Microfinance Institutions
The NGO based microfinance sector can be split into two sub-categories. First are what I
call the ‘mainstream’ MFIs which had donor or other external support. Kenya Women
Finance Trust was the biggest of these programmes and has its Mt Kenya Region Branch
in Karatina. FAULU, and the Small and Micro Enterprise Programme (SMEP—whose
origins lie in the National Council of Churches of Kenya) are the next largest programmes.
Finally, K-REP whose origins are an NGO based MFI became registered as a bank in
1999, but is treated here as part of the MFI sector. Since it suffered difficulties in Karatina
when it first went to work there it has expanded only cautiously.
A further microfinance model is the managed ASCA model operated by three
organizations in 1999, but many more by 2003. In this model, women form groups and
on-lend their own savings to each other in the form of a revolving loan fund (RLF) which
is essentially an Accumulating Savings and Credit Association (ASCA). They meet
monthly and the role of the NGO is to provide management services to the group. These
organizations are entirely independent of donor funding. This model is characterized by
high interest rates on short-term advances (called gubasho)—at 10 per cent per month.
However, longer-term loans are also offered at much lower rates for a period of a year or
6Data for savings held by the Post Office were not available because accounts are held centrally and not on abranch basis.
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more. A key feature of this model is that the high interest on these short-term loans
accumulates in the women’s fund and is used to pay out dividends at the end of the year
which can be quite high—20–60 per cent of savings, but this of course depends on the
overall performance of the fund. If the fund does perform well, then these dividends also
substantially reduce the net interest rate being paid on loans.
Table 1 indicates that the mainstream MFIs accounted for approximately 1 per cent of
deposits by value, 4 per cent of outstanding loans and 2 per cent of savings accounts in
1999. By contrast, estimates for the managed ASCA organizations suggest that they
accounted for 3 per cent of deposits by value, 10 per cent of loans outstanding and
10 per cent of the number of savings accounts. This is somewhat surprising, as the managed
ASCA model is little known (see (Johnson et al., 2002)). It is fully sustainable—indeed it
grew out of the need for a local NGO operating with women’s groups to survive after
donor funding was withdrawn in 1994. The excess of loans over deposits (see loan to
deposit ratio in table one) reflects the accumulated margin in the fund between interest
earned and dividends on loans. According to these figures its outreach is greater than the
mainstream MFIs—who have developed with considerable donor funding although their
operations in the Mt Kenya Region are in general now financially self-sustaining. However
by early 2003, mainstream MFIs had increased their membership by 49 per cent over 1999
representing some reasonably aggressive expansion during the period.
The main development in the products of the mainstream MFIs has been the introduc-
tion of school fees, emergency and medical loans usually at similar interest rates and very
similar terms and conditions and similar repayment frequencies to the main working
capital loan products. In addition, most of the MFIs are experimenting with or gradually
introducing individual lending products. This changing product mix reflects a new interest
in listening to clients and responding to their needs, in part in response to competition
among the MFIs. This has been accompanied by a concern to improve service quality and
customer care. They all reported initiatives or intentions to cut their application to
disbursement times, some have paid attention to the quality of records reaching the group
on a weekly basis, along with emphasis on the honesty and integrity of staff. KREP is the
only MFI not to have introduced medical, school fee or emergency products. Rather it has
used its newly acquired banking status to experiment with going up market with individual
lending against collateral. Unfortunately, this strategy resulted in poorer repayment
performance than in their familiar microfinance market and they have now decided to
concentrate on the market they know best.
While membership increased by 49 per cent between 1999 and 2003, the outstanding
loan value of the MFIs increased by 77 per cent. However outstanding loan balance is
Kshs23 000 compared with Kshs20 000 in 1999, a nominal increase of 15 per cent in a
period when prices increased by at least 17 per cent.7 If this is used as a proxy for depth of
outreach, then this data suggests that the expansion has not tended to bring in poorer clients.
The managed ASCAs have been facing significant problems of portfolio management in
particular with the poor macroeconomic performance of the Kenyan economy. Poor
repayment has resulted in the stagnation of the revolving funds. It has been difficult to
fully establish their financial performance. The ability of the ASCA managers to enforce
repayment can be limited, costly and face objections from the members themselves.
Despite this, the model demonstrates that there is a large market that the MFIs with their
7The New Kenya Overall Price index indicates that prices rose by 17.3 per cent between December 1999 and June2002, (see CBK Statistical Bulletin June, 2002).
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concentration on small business lending have not reached. Table one suggests that
managed ASCA membership fell by 44 per cent. However, the 2003 figure reported here
is probably a significant underestimate of membership since a number of new organiza-
tions offering the service had been set up and in a number of cases these took groups from
the bigger organizations with them. A best guess would suggest that membership has
remained static or fallen slightly. However, these new organizations have also also taken
the model into new areas beyond Karatina.
The proliferation of this model to new organizations in and beyond Karatina is evidence
of the low barriers to entry involved in its replication and its attractiveness to users. To
offer the service only requires knowledge of how the model operates and the printing of
some stationery along with sufficient funds to enable free service to be offered to groups
for a period of three months when they are first recruited. For the providers, this is usually
facilitated by paying a small commission to a field officer when she recruits a group
and only paying her a salary once the group is actually paying management service
fees. While the figures above reflect the outreach of the model in Mathira alone, estimates
for mid-2003 suggested that the model was reaching some 36 000 across Central Province,
reaching as far as Nyahururu and Nanyuki moving north, and Njoro moving south.
On the demand side, its extensive take up is because of the small size of savings and
loans that it can deal with, the ease with which loans are accessed at meetings, the
periodicity of meetings and the ability to negotiate repayment. This makes it useful to a
wider range of clients, in particular those in rural areas such as farmers, and those with less
steady income streams. The negotiability point is key. When people face livelihood shocks
they need to be able to use their social networks to either find funds to repay, delay
repayment or even negotiate a new loan. User-owned groups offer this possibility and
directly contrast to the mainstream MFI model (Johnson, 2004). In the user-owned model
the group can allow delays in repayment or a new loan because it is allowing its own funds
to be held for longer. In the mainstream MFI model the MFI uses the group to enforce
repayment of its own funds and there is little scope for negotiation as it is the other group
members who are forced to pay for the member who cannot.
4.3 The SACCO Sector
The third main sector is the co-operative sector. SACCO regulation was gradually
weakened over the 1990s, first with the reduced interference of government officers and
then these changes were eventually institutionalised in the 1997 Co-operative Act. This
liberalization has given rise to new SACCOs based on common bonds such as transport
operators or business people. Here we categorize the SACCOs with reference to the
common bond and highlight three types—those based in cash crops, employment and a
new and growing set of SACCOs mainly based in the transport sector among matatu
(public taxi) owners. As an example, Kenyan employee SACCOs operate with members
buying shares on a regular basis—usually deducted monthly direct from salary. These
shares can only be withdrawn on leaving the SACCO, and maximum loan amounts are
usually a fixed multiple of shares. In rural SACCOs, a single share is usually bought in
order to join and non-withdrawable deposits made as deductions from regular income e.g.
tea or coffee payments.
Two cash crop SACCOs based on the common bond of tea farming were started in the
1990s and are competing for the membership of the division’s approximately 6000 tea
farmers. The coffee co-operative system has been in a state of transition in the late 1990s
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with the splitting up of the divisional level marketing co-operative covering some 25 000
farmers into 13 small co-operative societies. Further, as a result of government directives,
the Union Banking Section of the District level marketing co-operative has been
transformed into an independent Nyeri Farmer’s Society SACCO, which has a branch
in Karatina. The combination of low international coffee prices and this re-organization
has been the cause of relatively low lending volumes in the past three years, since many
farmers have had insufficient income from coffee to repay past loans, and the re-
organization has provided opportunities to avoid doing so as the links between the
factories and the SACCO weakened.
There are four small employee-based SACCOs in and around Karatina with between 50
and 300 members each, which are based in medium-sized institutional employers such as
the Town Council, hospitals and schools. Alongside these is the much larger Nyeri District
Teacher’s SACCO which caters for primary school teachers in the district. While there are
also members of national level SACCOs for teachers and government officials living in
Karatina, these were not captured in the supply side data.
The SACCO sector as a whole accounted for 17 per cent of the value of deposits,
18 per cent of the value of outstanding loans and 39 per cent of the number of savings
accounts in 1999. This sector therefore accounted for a relatively high proportion of the
number of savings accounts but a low proportion of deposits by value, suggesting much
lower average deposits than the banking sector and the fact that SACCOs—especially
those based in cash crops—tend to deal with poorer clients. By 2003, the SACCO sector
as a whole had suffered a fall in the total number of accounts of 21 per cent. However, this
decline was almost entirely attributable to the transformation of the coffee co-operative
Union Banking Section to SACCO as this now required farmers to buy shares in the
SACCO, whereas previously they were automatically given accounts through which to
receive their payments. However deposits in the SACCOs have increased by 46 per cent
over 1999 since they have been developing front office services (called FOSAs) with
deposit services for both members and non-members in open competition with the banks.
In Karatina there are now three SACCOs with branches offering these services and two are
in the same street as the banks where there were none in 1999. They offer computerised
services, can give their customers chequebooks (which even though not part of the clearing
system allows payees to come and draw cash and hence gives added convenience), and
offer services such as school fees cheques. It is difficult to gauge the numbers of accounts
that might have moved from the banks to the FOSAs. This is because many SACCOs have
front office accounts for members through which dividends, loans etc are paid but which
they may not actually use in the way they would a bank or NBFI savings account e.g.
having their salaries paid through them. However, approximate figures suggest this is
probably at least 5000 (approximately 15 per cent) since 1999 and this is probably a
conservative estimate since SACCOs such as Nyeri Teachers have been aggressively
marketing their FOSA services to their members. This development of FOSA services has
been unregulated to date, although supported by the Co-operative Bank which has also
provided technical assistance in many instances.
The banks and SACCOs are actively competing over salaried employees, such as
teachers and government workers, and tea farmers since these are the people who have
regular incomes in the area. As a result, the SACCOs are also changing their by-laws to
extend their common bonds to include these people and offering them unsecured advances
against income streams. There has been aggressive competition between the FOSAs and
Equity over this segment, but it is a segment that the banks are also interested in.
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4.4 Interest Rates
Providers quote lending interest rates in declining or flat rate terms and table two details
these rates for particular institutions in 1999. The main change in rates since 1999 has been
in the banking sector where base rates have fallen significantly. All other lending rates in
the market have remained virtually unchanged. In 1999, commercial bank base rates were
in the range 20 to 25 per cent but by the end of 2002 these had fallen to 14–18 per cent.
Treasury bill rates—which have been the main underlying determinant of bank base
rates—underwent further falls in the early part of 2003 to 7–8 per cent by February and
dropping further to 3 per cent by mid-2003.
The MFIs quote annual flat interest rates and in the late 1990s these were therefore—in
headline number terms—lower than bank base rates quoted on a declining balance basis.
Since few customers are aware of the difference, MFIs were perceived to be cheaper than
the banks. This is now changing. Since bank base rates are falling, some clients are now
aware that banks are quoting lending rates over than the MFIs. With this development,
MFIs are likely to start coming under much heavier pressure from clients regarding
interest rates.
5 CONCLUSIONS
The evidence presented here indicates that the mainstream MFIs have relatively limited
market outreach by comparison with other models both in terms of clients and volumes.
They have expanded outreach in a relatively well-off part of the country by almost
50 per cent8 in the last four years and at a time when the economy was performing poorly
but this seems to underline the outreach limitations of the model commented on by others
Table 2. Interest rates quoted and effective 1999
Financial intermediary Interest rate quoted Equivalent annual decliningbalance interest rate*
KWFT 22% flat per annum 82%
KREP 18% flat per annum 69%
Faulu 22% flat per annum 102%
SMEP 22% flat per annum 66%
Co-operative
Bank—Biashara loan 2.5% flat per month 61%
Equity 1.5% flat per month N/a
2% per month reducing N/a
Employee SACCO 12% declining per annum
(for a 3 year loan) 49%
Managed ASCA 10% per month on > 240%
outstanding balance
Bank (model case) 25% declining per annum 41%
*Effective annual rates have been calculated using an IRR method for a loan of Kshs20 000 over a year andinclude the effect of fees levied and compulsory savings where these are part of the product. They will inevitablychange when calculated for different amounts over different periods.
8The data in table one does not take into account multiple membership of MFIs (or similarly of multiple use ofother services). There was some evidence to suggest that over the period 2001–02 clients had taken multiple loansand over-exposed themselves with a consequent rise in default. MFIs in the area started to more systematicallyshare information on defaulters as a result.
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due to the relatively inflexible design of the loan product on offer (Hulme, 1999; Wright,
2000). By contrast the little-known managed ASCA model has much wider coverage
although it has suffered in recent economic conditions.
The more dynamic players in the market have been the banks (particularly Equity
Building Society) and SACCOs. However, the key factor driving these developments has
been competition amongst them in the context of changing macroeconomic conditions and
SACCO deregulation. For the banks, a rush to target the high net worth individual retail
market led to its saturation, again in the context of macroeconomic decline in which public
and private sector employees were being retrenched. High treasury bill rates in the late
1990s and the problems of collateral-based landing—particularly against land—led them
to neglect lending to rural people. But this is no longer possible with the precipitous fall in
these rates over the last three years and they are again having to learn how to lend with
credit scoring and cash flow lending beginning to take hold.
Although evidence is limited, the view that mainstream MFIs are serving a different
market segment to the banks and SACCOs appears increasingly less defensible. While it
may be argued that neither the banks nor SACCOs are targeting poor people or business
people, it is not clear that MFI services are suited to or used by poor clients. A borrower
profile of five Kenyan MFIs including KREP, KWFT and Faulu (McGregor et al., 1999)
compared education and income profiles with those reported by the GEMINI survey of a
nationally representative sample of small and micro-enterprises. This showed that MFI
clients tended to be better educated and a significant proportion had annual incomes above
Kshs200 0009 compared to the national average—see Table 3.
Results of the CGAP poverty assessment tool for KWFT clients further supports the
view that MFI coverage is skewed towards the better off. The proportion of their clients in
the poorest tercile (i.e. 33 per cent by national standards) is approximately 16 per cent. In
the middle less-poor tercile is approximately 33 per cent with some 50.5 per cent of their
clientele in the better-off tercile (Microfinance Gateway, 2003). With this evidence and the
fact that MFIs are developing individual loan products in order to keep their older clients,
and given that MFI clients often have multiple identities, for example, as business people,
farmers and sometimes employees also, we can suggest that banks and SACCOs are now
more likely to be targeting the same clients.
In terms of demonstration effects, it is hard to identify any such effects of group-based
approaches to other financial intermediaries. While Equity experimented a little with
group lending in Karatina in 1999 this did not yield good results. Equity’s identity as a
microfinance provider is therefore not associated with a narrow understanding of group-
based lending or demonstration effects from the mainstream MFIs. Rather, it has been
engaged with donors and a wider discourse about how to move beyond this rather narrow
view of microfinance and has been improving its savings products as well as developing
loan products and mechanisms for unsecured lending. Being able to term this ‘micro-
finance’ seems to have in itself provided a rationale, focus and further motivation to serve
this market (see also (Coetzee et al., 2002). Similarly the Co-operative Bank’s move into
microfinance has been stimulated at this level. Indeed, it may seem redundant to consider
demonstration effects at this local level when the products and services of most
organizations—especially banks—are managed from headquarters. Recent debates
over the commercialization of microfinance suggest that moves by commercial banks to
‘downscale’ into microfinance markets result from demonstration effects at national rather9The overall poverty line in 1998 per adult equivalent was approximately Kshs23 808. The annual averageexchange rate for 1998 was US$1¼Kshs 60.4.
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than local levels (see Drake and Rhyne, 2002; Woller, 2002)). However, this study has
exposed providers and dynamics—especially the SACCOs and ASCAs—whose presence
and operations would tend to be missed in a national level analysis.
There is limited evidence of a demonstration effect regarding ASCAs. In an area where
group-based finance has long been practiced, local people realize that in ASCAs and
SACCOs rather than in MFIs the interest they pay comes back to them in the form of
dividends. This is one reason for the popularity of the managed ASCA model and, while
difficult to establish in quantitative terms, our research continually came across newly set
up independent ASCA groups. User-ownership offers a range of features that are attractive
to users. The negotiability of loans in these systems in the event of livelihood shocks was
pointed out above. When circumstances arise which result in repayment difficulties,
members know that they will have a range of options in dealing with the situation. In
SACCOs, loan products include school fees and emergency loans. In informal groups,
members have the opportunity to explain themselves (‘voice’) which can result in
negotiating an alternative payment schedule; in some cases the member may be given
an additional loan to overcome the circumstances; or that the member can use the social
networks that arise in the group to gain support—whether that support is financial or
social and whether from the group or individuals. In addition, members set the interest rate
on loans and know that it will not change without them knowing or voting for it—a point
that was particularly important during the late 1990s when both economic conditions and
bank rates were volatile and uncertain. Finally, when borrowing, the member is usually
risking only her existing savings, future income (from salaries or cash crops) or possibly
household items—land is not at risk (see Johnson, 2004).
The main conclusion is therefore that MFIs have had only very limited demonstration or
competition effects on other players in the financial market. Rather, it is becoming
increasingly clear that there are a number of ways in which the wider dynamics of the
financial market are having, and are likely to continue to have, significant impact on the
MFIs. The changing macroeconomic environment has put pressure on the formal sector
financial intermediaries to change their strategy and consider how to tailor their products
to the middle-income market. In doing this they are finding new ways to lend primarily
based on assessment of income flows. Christen and Drake have, moreover, pointed out that
the ‘ultimate irony’ might be that it is the mainstream financial intermediaries that are
ultimately more effective at this provision than microfinance NGOs (Christen and Drake,
2002, p. 14).
Table 3. Comparative indicators for clients of 5 MFIs and a nationalsample of small and micro-entrepreneurs
Five MFIs GEMINI
Education (%):
None 4.2 20.4
Primary 37.9 55.3
Secondary 49.3 23.2
Post-secondary 8.6 1.2
% with annual income less than:
Kshs10 000 7.9 62.0
Kshs200 000 24.6 1.5
Note: The Gemini study used slightly different income ranges so the percentagesreported are for amounts less than Kshs12 840 and above Kshs240 000.Source: (McGregor, Alila et al., 1999).
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Further, the familiarity and abundance of group-based financial systems in this area,
means that local people are also prepared to set up groups to respond to their financial
needs and recognise the advantages of doing this. In addition, as MFIs move to individual
loans—as they are under pressure from their clients to do—they are increasingly moving
to meet the banks on their own ground.
In Karatina’s financial markets, MFIs appear to be operating amongst competitors
increasingly interested in the same customers for their loan products who can also offer an
array of savings products. While there is no reason to think that clients will necessarily
stop borrowing from more than one provider, the loan terms and conditions (including
interest rates) are increasingly attractive elsewhere and lack the requirements for group
meetings and guarantees. The microfinance mantra that it is access rather than price that
matters, may no longer be true for the clients of these MFIs. In addition, the Microfinance
Bill may now become law within a year and provide a basis for the formal regulation of
MFIs by the Central Bank and hence enable them to intermediate deposits. The process of
conversion for those that decide to do so will present them with significant costs and work
to meet governance and financial requirements. In the meantime, competition for deposit
accounts is strong and players such as Equity Building Society and the SACCOs are
learning how to serve this market—and how to link loan products to their savings
accounts. After conversion, the MFIs may find that they are competing in a well-served
market with high service standards and must be ready for this. Might they become the
casualties of ‘creative destruction’?
ACKNOWLEDGEMENT
This paper draws on data gathered under two research projects. The first round of data was
collected between 1999 and 2001 with funding from the Finance and Development
Research Programme funded by the UK’s Department for International Development (see
www.devinit.org/findev). The second round of research was carried out in 2003 with
funding provided by the ImpAct programme (see www.ImpAct.org). I am grateful to
James Copestake and Gary Woller for comments on earlier versions of this paper. I am
particularly grateful to George Muruka and Edward Kinyungu who assisted with the field
research in 2003. All errors and omissions remain my own.
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