Effects of Inflation on Performance Microfinance Institutions

CHAPTER ONE

1.0 INTRODUCTION

1.1 Background of Study

MFIs’ are recognized and acknowledged as vital and significant contributors to economic development, employment creation and technological development (mortis 2000). MFI have therefore been given great emphasis in recent times because they are considered as essential actors in achieving social and economic development in both developed and developing countries.

Kenya with an estimated population of 29.6 million people and a per capita income of US $260 is categorized by the World Bank to be among the poorest countries in the world (world development report 1992). Kenya’s development challenge therefore remains in finding sustainable poverty eradication strategies. Micro and small enterprises have been seen as one of the strategies that can bring faster development. MFI does therefore play a big role in financing the micro and small enterprises for faster development. MFI’s enterprises are also highly rated for employment creation. They are therefore important in Kenya where unemployment and underemployment are estimated at between 25% and 35% respectively.

MFI s’ through the provision of credit influence the type of technology adopted by entrepreneurs and even the rate of technology adoption. Small scale enterprises in the agricultural sector play a big role in providing food, income generation and employment creation. The application of technology is vital in enhancing growth and development of these enterprises.

Inflation is vital in the growth and development of any MFI. Both large scale and small scale MFI depend on financial organizations for credit in order to raise capital and also finance any development projects. The large scale organizations have found it much easier to access credit from commercial banks and other financial institutions. The micro and small scale enterprises have not been able to easily access credit from the Microfinance Institutions. They have been mainly dependent on MFI’s for credit.

Most of the MFI s’ are based in major towns which may make credit more accessible to the micro and small enterprises in the major towns to the disadvantage of those micro and small scale enterprises in the rural areas. This study therefore set out to establish the extent to which inflation affects MFI s’ and small scale enterprises in rural areas in Kenya. The study did not focus on inflation alone, it also covered services provided by the by the MFI s’. The study focused on effects of Inflation in MFI.

1.1.1 Profiles of Faulu Kenya Limited

According to the Faulu Kenya journal (2009) The institution initially started off in 1992 as a pilot micro-lending program of Food for the Hungry International (FHI), an international (Non

Governmental Institution) NGO engaged in relief and development throughout the world. This pilot program was expanded and up-scaled in 1995, by 1998 had registered significant growth. Food for the Hungry (FHI), not being a microfinance-oriented (NGO) sought to free Faulu Kenya and have it operate at arms length. Therefore, in 1999, Faulu Kenya Limited was incorporated as a private capital share company owned by FHI. It has operated profitably since its incorporation. Faulu Kenya is a Deposit Taking Micro-Finance Company, registered in Kenya under the Micro-Finance Act which is regulated by the Central Bank of Kenya. Faulu was founded as a program of Food for the Hungry International (FHI), a Christian relief and development organisation based in Phoenix Arizona in USA and has grown to become an MFI that offers both savings and credit services to millions of Kenyans www.wikipedia.com world development report (1992)

FHI recognised that there were offering unique needs of low-income people in rural and urban areas and that sustainable economic development for the marginalised poor people is a priority issue in the developing world. To address these issues, FHI established Faulu Africa Network, a regional MFI network operating in Kenya, Uganda and Tanzania. Faulu Kenya has grown tremendously over the last 16 years, with over 90 outlets throughout Kenya. These outlets are currently serving over 250,000 clients. There are now more than 1500 members of staff in the outlets and at the Business Support Center Head Office. This allowed Faulu Kenya to start sourcing commercial funding towards its portfolio growth with an initial subsidized loan of US$145,000 from a local European Union supported program in 2000. This was followed by another US$500,000 from the same program in 2001, and two commercial banks provided credit lines worth US$4 million in 2002, leveraged against existing assets with some backing from one international guarantee. IN 2003, this was supplemented by an 18-month hard currency term loan from Blue Orchard's Dexia MFI’s Fund, amounting to US$450,000. This particular loan was a tentative step towards balance sheet based borrowing as it was based on a promissory note issued on the strength of Faulu Kenya's balance sheet. These borrowing experiences spread over a four year period formed the learning curve for the institution to take a bold step towards leveraging its balance sheet for longer term borrowing at attractive pricing levels. Faulu Kenya Annual publication Magazine (2008)

1.2 Statement of Problem

Inflation affects the operations of MFIs’ in Kenya. High or unpredictable inflation rates are regarded as harmful to MFI. They add inefficiencies in the operations of MFIs’, and make it difficult for MFI s’ to budget or plan long-term programs. Inflation can act as a drag on operations as finance Institutions are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation. Uncertainty about the future value for money discourages investment and saving, and inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates. With high inflation; financial institution lending rates, lending capacity/policy and repayment interest rates are affected. Where fixed exchange rates are imposed, rising inflation in one economy will cause its exports to become more expensive and affect the balance of trade. There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation. This study will establish the effects of inflation on MFI.

1.3 Research Objectives.

1.3.1 General objectives

The general objective of this study is to establish the extent to which inflation factors affects the operations of Microfinance Institutions.

1.3.2 Specific objectives

The study will be guided by the following specific objectives:

i. To investigate how lending capacity affects the operations of Microfinance Institutions.

ii. To identify how lending policy affects the operations of Microfinance Institutions.

iii. To find out how repayment period affects the operations of Microfinance Institutions.

iv. To evaluate the recruitment of members affects the operations of Microfinance Institutions.

1.4 Research Questions

The study seeks to answer the following research questions:

i. How does lending Capacity affects the operations of Microfinance Institution?

ii. How does loan lending policy affects the operations of microfinance Institutions?

iii. How does the repayment period affects the operations of Microfinance Institutions?

iv. How recruiting of new members affects the operations of Microfinance Institutions?

1.5 Importance of Study

This study is of benefit to the MFI in that it will guide them in policy formulation. Policies are formulated to guide organization in day to day management of operations, it for this reason that microfinance, institutions will be able to come up with mission and visions which are to direct employees and managers towards achieving a common goal of success.

This study is to benefit the government because it provides recommendation on employment creation to the jobless populations who have the required qualification for different types of jobs. On the other hand the government will know the problems facing MFI s’, in order to provide solutions which may include donations, grants and subsidies necessary for the welfare of the management of MFI s’ in Kenya.

The small scale entrepreneurs in the different sectors of the economy are to find this research valuable since they will be more informed on how MFI, are managed, and also how these

institutions can provide short term loans to boost their businesses. The information to be collected will categorically point out the entire requirements for one to be a member of Faulu Kenya, and at the same time the benefits of joining this MFI s’

Students will find this research work valuable. The research paper will act as a reference document for their studies at the college. They will acquire broad knowledge and skills regarding how MFI s’ are formed managed and controlled.

1.6 Limitation of Study.

1.6.1 Bureaucratic procedures

The researcher was subjected to tedious procedures especially when booking appointments with the Faulu Kenya respondents. This was due to programmed plans on when the management was available to fill the questionnaire.

To overcome this limitation the researcher booked appointments in good time and seek clearance from various departments in Faulu Kenya.

1.6.2 Lack of co-operation.

The researcher was carried out in Nairobi. The target respondents were not be in a position to respond accurately to the answers asked due to the fear of victimization by the top management.

To overcome this problem the researcher gave in writing to the respondents that whatever information to be given was be treated as confidential and was never to be published in any form whatsoever without their consent.

1.6.3 Communication problem

Faulu Kenya Limited is a finance institution that has opened its door to all Kenyan citizens to apply for membership, therefore the researcher may face communication problems especially when interviewing already registered members who may not be conversant with English language.

To overcome this, the researcher used the national language (Kiswahili), to interpret the questionnaire to them.

1.7 Scope of Study.

The study was conducted in the Faulu Kenya Limited in Nairobi Offices on Ngong Road between March and June 2010. The target population for this study was Faulu Kenya Top Management, Middle level Managers, Line Managers and members of staff.

1.8 CONCEPTUAL FRAMEWORK.

Figure 1.1 Conceptual Framework.

Independent variables Dependent variables

Source Author (2010)

1.8.1 Lending Capacity

This is the ability to give out loans to applicants, in relations to the repayment period and applicants’ security or guaranteed arrangement. From the MFI of view, this terminology is used to categorize different institution as per the members’ discretion to get loans, or funds available to members, which may have been pooled together through monthly contribution to the pool. This study will find out how inflation affects lending capacity in Faulu Kenya Limited.

1.8.2 Lending policy

A policy is a statement that is formulated by the management of an organization, to guide employees or members on day to day organizational activities. MFIs’ lending policy statements outlines to the members rules and regulations for applying for loans from the institution. This study will look at how inflation affects lending policy in Faulu Kenya Limited.

1.8.3 Interest rates.

Interest are earning on loans given to loaners or members. The major determinants of interest rate are the demand and supply for money in circulation. MFI s’ are formed by interested group, drive by a given mission objective and vision. This study will investigate how inflation affects interest rates in Faulu Kenya Limited.

1.8.4 Membership.

MFI s’ are managed as small upcoming banks. Membership refers to how individuals or groups are recruited to these institutions, to be part and parcel of the scheme. MFI s’ have come up with a detailed recruitment and selection of members who will be ready to support the institutions in its enderviuos.This study will establish how inflation affects recruitment of new members to Faulu Kenya Limited.

CHAPTER TWO

2.0 LITERATURE REVIEW

2.1 Introduction

The chapter presents the literature on theoretical perspectives relating to the effects of inflation on the operation of MFI s’ in Kenya.

2.2 Review of past studies

Inflation is always and everywhere a monetary phenomenon. Milton Friedman, A Monetary History of the United States (1867)-(1960), (1963) Historically, a great deal of economic literature was concerned with the question of what causes inflation and what effect it has. There were different schools of thought as to the causes of inflation. Most can be divided into two broad areas: quality theories of inflation and quantity theories of inflation. The quality theory of inflation rests on the expectation of a seller accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation rests on the quantity equation of money, that relates to the money supply, and its velocity, and the nominal value of exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production, Ledgerwood (1993)

Over the last 20 years, MFI s’ in Kenya have largely developed through concerted grant funding. This situation prevailed up to the late 1990s when key donors started pushing M.F.Is to start moving towards sustainability in their operations according to Business finance text by Saleemi (2007).

In recent years, a growing number of developing countries including Kenya have embarked on reforming and deregulating their financial systems, transforming their institutions into effective intermediaries and extending viable financial services on a sustainable basis to all segments of the population. By gradually increasing the outreach of their financial institutions, some developing countries have substantially alleviated poverty lending, institutional strategies and financial systems approaches. In the process, a new world of finance has emerged. Which is demand-led and savings driven and conforms to sound criteria of effective financial intermediation. There is now incipient experience with the successful integration of microfinance strategies into micro policies, which makes banking the micro economy and the poor both viable and sustainable, Otero (1994)

Microfinance has emerged as that sub sector of the financial system which provides financial services to the micro economy, comprising alignments of the rural and urban population, including small scale farmers, micro entrepreneurs, women and the poor. This micro financial sector comprises local financial institutions, which may be formal, semiformal or informal. Furthermore, such institutions may be owned, fully or in part, by individuals, groups or organization sin the micro-economy. Microfinance services include savings, loans, insurance, money transfers, remittances, etc. according to Mudinda (2006)

It is acknowledged that the need to extend the Poor’s access to formal financial services is not new. Initially, in the 1950’s development projects began to introduce subsidized credit programs targeted at specific communities. For example, governments and donors provided subsidized agricultural credit to small and marginal farmers with the goal of raising productivity and incomes. These subsidized schemes were rarely successful because the funds seldom reached the poor, ending up in the hands of better-off farmers. Moreover, subsidized interest rates introduced a culture of non-repayment, which in turn made it difficult for lasting financial systems to merge, Mudinda (2006)

The general failure of large subsidized credit schemes inspired social entrepreneurs in developing countries to test alternative ways to offer credit to poor people. Beginning in the

1970s, experimental programs run through non-governmental organizations (NGOs) in Bangladesh, Bolivia, and a few other countries extended tiny loans to groups of poor women who could invest in micro-business. This type of micro enterprise credit was base don solidity group lending in which every member of a group guaranteed the repayment of all the other members, Mudinda (2006).

Throughout the 1980s and the 1990s, these MFI s’ programs improved upon the original methodologies and bucked conventional wisdom about financing the poor. First, it was shown that poor people, especially poor women, repay their loans. Near-perfect repayment rates, unheard of in the formal financial sectors of most developing countries, were common among the better credit programs. Second, the poor were willing and able to pay interest rates that followed MFIs to cover their costs. Third, the combination of these two features; high repayment and cost-covering interest rate enabled some MFIs to achieve long-term sustainability while reaching large numbers of clients. The promise of microfinance as a strategy that combines massive outreach, far reaching impact and financial sustainability makes it unique among development interventions, according to Saleemi (2007).

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is the destruction of the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. Constant real value non-monetary items never maintained are treated like monetary items under historical cost accounting. Consequently their real values are destroyed at a rate equal to the rate of inflation because inflation destroys the real value of money which is the monetary unit of account. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time Inflation can have positive and negative effects on an economy. Negative effects of inflation include loss in stability in the real value of money and other monetary items over time; uncertainty about future inflation may discourage investment and saving, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include a mitigation of economic recessions and debt relief by reducing the real level of debt, according to Wanjiku (2008)

Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth, according to Njoroge (2008)

The relationship between a country’s financial sector and its economic development has tasked economic historians and theoreticians and development policy makers alike, although from different perspectives and for different reasons. The 1950s and 1960s were shaped by the need for the reconstruction and development of economies destroyed by war, leading to a concept of financing which centred on the transfer of capital. Consequently, in the development policy of

the 1960s and 1970s, financial sector promotion was regarded in terms of the necessary capital transfer to developing countries. This was expressed primarily in the development banks founded in the 1950s and 1960s. However, from the start of the 1970s, a number of economists recognised that the financial sectors of the developing economies themselves constituted a significant obstacle to development in the way they function and their limitations. Even so, it was not until the late 1980s that discussion broached the role of financial systems in the development process. This discussion led to development policy interest focusing on the functioning of national financial systems and the financial institutions operating within them. This put development cooperation through a complete volte-face, from” financing development” to “developing financing”.

Particularly disappointing here was the minimal success of development banks in reaching their target groups and improving the situation of the poor. At the start of the 1980s, German development cooperation began studying the financial institutions of the South to see how financial services and savings and credit products could be made accessible to previously excluded population groups. This was the beginning for microfinance in German development cooperation. The evolution of microfinance was decisively influenced by examples of successful financial institutions organised on a self-help basis, such as Grameen and SEWA, where mobilising savings had proved a key feature. For German development cooperation in the financial sector, the development of the self-help concept and its link with financial self-help (mobilising savings and lending by local financial institutions) quickly became a central feature. This characteristic has remained to this day, forming a sharp distinction between German approaches to microfinance and the approaches of, for instance, US NGOs. Early examples of approaches to develop the financial system based on self-help practices are the financial cooperation project “village savings funds in Dogon, Mali” (1986) and the linkage of banks with self-help groups in southeast Asia (1989).

Finally, the diversity of financial institutions in Germany itself - with its commercial banks,savings banks and cooperative banks - has played a decisive role in shaping the role ofGerman development cooperation in the financial sector. For example, the GermanAssociation of Savings Banks and Giro Banks (Deutscher Sparkassen und Giroverband,DSGV) organised exchange programmes in the early 1980s for representatives o

2.2.1 Lending capacity

This is the amount of money on reserve, for members to apply. Inflation is mainly caused by sudden rise in prices of other items but mainly household commodities in the market. This has a multiplier effects on the MFI’s lending capacity, in that most loan applicants will apply for huge sums of money, to spend on their daily needs due to high prices of basic goods. But the fixed cost of processing loans of any size is considerable: assessment of potential borrowers, their repayment prospects and security; administration of outstanding loans, collected from delinquent borrowers and so on. There is a break-even point in providing loans or deposits below which banks lose money on each transaction they make. Low income earners usually fall below the break even point, according to Faulu Kenya Magazine (2008)

In addition, most members of Faulu Kenya Limited have few assets that can be secured by the institution as collateral. As documented extensively by the management, even if they happen to own land in the, they may not have effective title to it. This means that the institution will have little recourse against defaulting borrowers from www.faulukenya.org.ke.

From a broader perspective, it has long been accepted that the development of a healthy national financial system is an important goal and catalyst for the broader goal of national economic development. However, the efforts of national planners and experts to develop financial services for their nations' majorities have often failed since World War II, due to high inflation rates, leading to financial institutions failing to have sufficient funds for their members, by Adams, Graham & Von Pischke (1960) in their classic analysis 'Undermining Rural Development with Cheap Credit'.

The simplest dynamic model to bring out this idea, used in Boal and Ransom (1997), is one where the lending capacity is controlled by the Central Bank that determine how much reserve rates should a microfinance institution posses and this has an impact on the loaners. The lending capacity is thus a weighted average of the short- and long-run inverse as set and standardized by the Central banks of Kenya. It follows that, as the long-run (direct) supply of money to finance institutions tends to be much higher than the short-run one, this very simple dynamic model predicts the need to regulate the amount of finances to be loaned to Financial institution keeping in mind the rate of inflation has perverse effects, due to the distorted signals they send to the market. Artificially high rates of interest charged by central bank discourages future establishment and creation of microfinance institution, resulting in yet further shortages in money available for the members to apply. Temporary controls may complement a recession as a way to fight inflation. However, in general the advice of economists is not to impose lending capacity rates controls, but to liberalize it by assuming that the economy will adjust and abandon unprofitable economic activity.

Ledgerwood (1993 pointed out that most needs are met through mix of saving and consumption which are influence by the inflation. “A benchmark impact assessment of Grameen Bank and two other large microfinance institutions in Bangladesh found that for every $1 they were lending to clients to finance rural non-farm micro-enterprise, about $2.50 came from other sources, mostly their clients’ savings”. This parallels the experience in the West, in which family businesses are funded mostly from savings, especially during start-up.

Rutherford (2001) argues that the basic problem relating to inflation and lending capacity is that, low income people as money managers face is to gather a ‘usefully large’ amount of money. Building a new home may involve saving and protecting diverse building materials for years until enough are available to proceed with construction. Children’s schooling may be funded by buying chickens and raising them for sale as needed for expenses, uniforms, etc. Because all the value is accumulated before it is needed, this money management strategy is referred to as ‘saving up’. All these activities have an impact on the inflation rates.

He further noted that people don’t have enough money when they face a need, so they borrow. A low income family might borrow from relatives to buy land, from a moneylender to buy rice, or from a microfinance institution to buy a sewing machine. Since these loans must be repaid by

saving after the cost is incurred, Rutherford (2001) called this is called ‘saving down’. Rutherford's point is that MFI’s are addressing only half the problem, and arguably the less important half: poor people borrow to help them save and accumulate assets. MFI‘s should fund their loans through savings accounts that help low income people manage their myriad risks.

The central Bank of Kenya is exploring ways of lowering the cost of money, to make lending to the private sectors cheaper. According to the Central Bank of Kenya governor Professor Njuguna Ndungu, Daily Nation 30th Jan 2010 during a press conference on “how lending rates are affected by inflation” he said that Central Bank is exploring ways of lowering the cost of money to make lending to the MFI s’ cheaper. “This will in part be aimed at addressing market inefficiencies cited by commercial banks as reasons for not lowering their lending rates, despite the regulators earlier efforts to bring them down”.

He further pointed out that the CBK will be licensing the first credit reference bureau from first week of February, 2010, allowing banks and MFI s’ to share information on borrowers and helping reduce the risk of default by weeding out serial defaulters. Collecting data to a central point will also help reduce the cost of searching for information to assist in analyzing and pricing debt. Professor Ndungu the Central Bank governor pointed out that “It might be our turning point in how we look at lending” when addressing deliberation by the banks advisory organ, the monetary policy committee (MPC) Daily Nation 30th January 2010. Professor Ndungu still said that the Central bank will be opening currency centers in various towns therefore, increasing cash dropping and picking points for financial institutions

Currently, CBK has only four branches, Eldoret, Kisumu, Mombasa and the head office in Nairobi, a situation that makes the cost of transporting cash expensive. CBK is also planning to introduce 25-year and 30-year bonds to help lengthen the maturity profile of the debt in the market and offer borrowers and lenders a pricing benchmark. Says Professor Njuguna on Daily Nation 30th January 2010.

Over the past two years CBK has successfully introduced 15 year and 20- year bonds, which are now being used by MFI s’ and Corporate Banks to price bonds helping them borrow cheaper money from the public than what commercial banks are offering The market regulator is also seeking ways to revive development banks products in the market to compete with commercial banks as an alternative-lending outlet for private sector.

Morris Aron Author Kenya times newspapers, pointed out that, in the depths of despair, there is always an opportunity, or so the saying goes.Low-end money lenders seem to have taken a cue from the saying to cash in on a gap left by mainstream financial institutions that have slowed on lending to households for fear of possible rise in cases of loan default.Reports indicate that micro-finance institutions are witnessing an upsurge in the number of customers looking for small to medium value short-term loans.The latest realignment in the banking circles comes at a time when most commercial banks posted a mixed bag of results in the first-half, with Equity Bank reporting a 15 per cent decline in pre-tax profit, while Standard Chartered Kenya recorded the highest growth of 43 per cent.

KCB and Barclays Kenya, ranked first and second by assets, both posted modest single-digit increases in first half profit.

Standard Chartered, Kenya’s third biggest bank (by assets), has been investing in technology infrastructure, but it has not added many branches, unlike major rivals who moved aggressively to rope in low-end customers.

A businessman takes his stock to the market. Mainstream banks have shied away from lending to small sized enterprises. Customers served at one of the local banks. The hunt for low-end clients has proved costly to some of the banks’ earnings.

"Banks that went gung-ho, opening all their branches last year, had their profit come down because this has not been a good year. Banks that were conservative did pretty well," Mr Stephen Gugu, (2010) an analyst at Stanbic Investments was recently quoted saying by Reuters.

Barclays announced that its 2009 fiscal half year profit rose 7.5 per cent. Net profit for the six-month period rose to Sh3.1 billion from Sh2.89 billion reported for the same period last year. The growth was mainly attributed to a 5.5 per cent decrease in other operating expenses. Mr Adan Mohamed, managing director of Barclays Kenya, said: "These record results were achieved in a very challenging business environment and are largely attributed to stringent cost management and excellent focus on the quality of our loan book. Our significant improvement in loan loss provision indicates the high quality of Barclays’ loan portfolio, despite a demanding business environment. Whilst we continue with our growth plans that started in 2007, we will drive quality over volumes."

He further reckons that when compared to the same period last year, income was broadly flat, reflecting this tight portfolio management and a slight change in the mix of assets. Mohamed (2010), says operation costs have also remained flat despite high inflationary pressures experienced during the period under review.

"This reflects management’s increased focus on efficiency and resource optimisation." However, information now filtering through indicates that not all was rosy for the banks in their hunt for low-end clients. Only Stan-Chart that remained loyal to their tradition clients saw hefty increases in profit.

The current changed approach to slow on the aggressive hunt for low-end clientele has been a blessing in disguise for microfinance institutions that fortified their position in this market segment. These institutions are able to effectively serve this market segment that is seen as high risk, owing to the high interest charges that shield them from such risks.

South African low-end lender, Blue Financial Services, said the number of people applying for loans has gone up almost tenfold, as many seek alternative ways to address short-term cash flow issues in the face of harsh economic conditions after banks went easy on lending. "As you can see from the level of enquiries, the number of customers has gone up considerably," said a manager who deals with customer enquires and processing of loan requests and who asked not to be quoted.

"Most people say they are opting for (our) services after attempts to secure loans from mainstream banks proved futile.” The trend has seen Blue Financial Services open more branches across the country after signing agreements with the Government to offer credit facilities to Civil Servants and members of the Teachers Service Commission.

As a result of the growing demand for its services, Blue Financial Services has been on an expansion mode. The firm recently opened new branches in various towns across the country, including Mombasa and Kisumu, in addition to launching a new product Easy Loan that allows one to secure credit of between Sh10,000 to Sh50,000 and approval done within 20 minutes if they comply with the terms and conditions of the organisation. The loan repayment period average six months to a year.

The emerging trend is playing out in various other firms that specialise in small loans to the low-end of the market, including Savings and Credit Co-operatives (Saccos).At Platinum Credit, for example, the number of customers looking for short-term credit has gone up by 30 per cent in the last five months. The trend is the same for those looking for other financial services such as discounting of cheques or loans.

Aron (2010 ) further noted that many customers, were opting to secure loans against shares held, property like cars or looking to discount cheques instead of waiting for days for it to be cleared. Analysts say the emerging trend is likely to result in another wave of market share turf wars as banks like Equity and the latest entrant Nigeria’s United Bank of Africa and a number of micro-finance institutions including K-Rep, Jamii Bora Trust and Kenya Women Finance Trust seek to strengthen their dominance in the low-end lending forte. The growing trend is likely to elicit reaction from Equity Bank that has traditionally banked on the low-end of the market, a segment that is credited with the bank’s impressive growth record.

But lately, Equity’s rapid growth and high profitability began showing signs of slowing down after the economy tanked under the pressure of high food prices, skyrocketing inflation and the effects post-election violence.

These effects hit small and medium size income earners who formed the bulk of clients in the low-end market segment hard. "We will continue to focus on the low-end of the market and are not going to change our banking model," said Mr James Mwangi, (2010) Equity Bank’s chief executive, after the bank registered a drop in profitability in its half-year reports

2.2.2 Lending policy

According to the Faulu Kenya Limited Publication ( 2009), a lending policy is statement of its philosophy, standards, and guidelines that its employees must observe in granting or refusing a loan request. These policies determine which members of the industry or business will be approved loans and which will be avoided, and must be based on the central bank relevant laws and regulations.

From www.wikipedia.com, which pointed out that (variable rates model) to investigate the implications of bank lending policy. In the first equation the model focuses on Microfinance

Institution’s decision to grant a loan, in the second the probability of a member defaulting. The Microfinance main task is to confirm that it provides loans to members in a way that is not consistent with members defaulting risk minimization.

According to Rukwaro, M.W (2001), the lending policy must thus either be efficient that is able to assess loan applicants’ characteristics than expected profit maximization. The lending policy has to take into consideration the value at Risk, being a value weighted sum of individual risks, provides a more adequate measure of monetary losses on a portfolio of loans than default risk. Faulu Kenya Limited derives a Value at Risk measure for the sample portfolio of loans and shows how analyzing this can enable MFI s’ to evaluate alternative lending policies on the basis of their implied credit risk and loss rate, inflation and make lending rates consistent with the implied Value at Risk.

According to wikipedia.org/wiki/Policy, Microfinance lending policies frequently have side effects or unintended consequences. Because the environments that policies seek to influence or manipulate are typically complex adaptive systems (e.g. governments, societies, large companies), making a lending policy change can have counterintuitive results. For example, a Microfinance Institution and the government may make a policy decision to raise lending rates or interest rates, in hopes of increasing overall revenue. Depending on the size of the lending rates policy increase, this may have the overall effect of reducing revenue by causing by creating a rate so high that members are deterred from applying huge sums of loans from the Institution.

The lending policy formulation process typically includes an attempt to assess as many areas of potential lending policy’s impact as possible, to lessen the chances that a given policy will have unexpected or unintended consequences. Because of the nature of some complex adaptive systems such as societies and governments, it may not be possible to assess all possible impacts of a given lending policy formulated and adopted by MFI s’

Mudinda (2006) an Economist, pointed out that the inflation has a impact on MFI s’ loan lending policy unless they are inflation-adjusted to keep their real interest rates constant. In many countries, members saving, pension benefits, and government entitlements (such as social security) are tied to a cost-of-living index, typically to the consumer price index. A cost-of-living allowance (COLA) adjusts salaries based on changes in a cost-of-living index. Salaries are typically adjusted annually. They may also be tied to a cost-of-living index that varies by geographic location if the employee moves.

According to the Kenya Times the author Kalajian (2010) wrote that, the government of Kenya was able to pass the Finance and Microfinance Bill. The bill, drafted in 2000, requires all microfinance institutions (MFIs) to be open to mandatory audits from the Central Bank of Kenya (CBK), the authority that regulates the country’s commercial banks. Kenyan President Mwai Kibaki supported the bill in an effort to curtail the entry of bogus microfinance institutions into the market.

Before the enactment of this bill, the MFIs operating in Kenya (over 200) were unregulated unless they optionally entered the Association for Microfinance Institutions (AMFI), based in Nairobi and funded by a USAID grant. Under this system, MFIs like Kenya Akiba Micro-

Finance Limited were able to take advantage of the lack of regulations and fraudulently accept deposits. Under pressure from two depositors, the CBK was able to close the organization’s office but cannot yet return any of the money.

Under the new bill, MFIs operating in Kenya are vulnerable to the fines imposed by the CBK that can reach KES 1 mn (equivalent to USD 14,376) for every guideline to which they do not comply.

According to Kimanthi Mutua (2010), chairman of the AMFI, the new regulations will protect the 60 percent of the Kenyan population who are out of the scope of the formal banking services from bogus MFIs. The National Micro and Small Enterprise Baseline Survey of 1999 reports that 20 percent of the country’s total employment in 1999 was involved in microenterprises, contributing to 18 percent of overall gross domestic product (GDP) and 25 percent of non-agricultural GDP.

2.2.3 Interest rates

According to the January (2010) Nation Newspaper; Customers look to micro-finance institutions for money, they are paying through the nose in terms of interest rates, as these Micro Finance Institutions seeks to limit their level of exposure. On average, members pay interest rates of 25 per cent to 30 per cent on the principal amount loaned compared to banks’ charges, whose rates range from between 14 per cent and 18 per cent. Experts say such high interest rates are necessary to enable Micro-financial institutions cover their level of exposure "Lending is a high risk venture and the interest rates should reflect the level of risk," explained Mr Peter Oyando, Daily Nation 22ND January,2010, the Managing Director of Grofin Kenya a multi-national finance and development outfit.

According to wikipedia.org/wiki/ Low income people who borrow from micro finance Institutions often rely on relatives or a local moneylender, whose interest rates can be very high. An analysis of several studies of informal money lending rates in fourteen countries in Asia, Latin America and Africa concluded that 76% of moneylender rates exceed 10% per month, including 22% that exceed 100% per month. Moneylenders usually charge higher rates to poorer borrowers than to less poor ones. While moneylenders are often demonized and accused of charging high interest rates, their services are convenient and fast, and they can be very flexible when borrowers run into problems. Hopes of quickly putting them out of business have proven unrealistic, even in places where microfinance institutions are very active like in rural areas.

The latest migratory trends to seek loans from micro-finance institutions come after policy makers and politicians reiterated calls to Microfinance Institutions to lower interest rates to spur economic growth. According to Mudinda (2006) Economics simplified, interest rates are what banks charge their customers. Also known as the lending rate, for this reason, it is usually the best loan rate available to loan applicants. Interest rates are important because it affects liquidity in the financial markets. A low rate increases liquidity by making loans less expensive, therefore easier to get. When lending rates are low, businesses expand and so does the economy. He further pointed out that similarly, when the lending rates are high, then liquidity dries up, and the economy will start to slow. For this reason, banks will usually only raise the interest rate. This is

true even though banks would technically make more on an individual loan when rates are higher. However, since this would decrease the number of loans applied for, this would slow the loan business overall.

According to Ledgerwood (2007), Inflation can also be caused by international lending and national debts. As members to microfinance institutions borrow nations borrow money, they have to deal with interests, which in the end cause inflation rates to rise as a way of keeping up with their debts. A deep drop of the exchange rate can also result in inflation, as microfinance institutions will have to deal with differences in the grants and loans available to members to apply.

There has also been much criticism of the high interest rates charged to borrowers. The real average portfolio yield cited by the a sample of 704 microfinance institutions that voluntarily submitted reports to the Micro-Banking Bulletin in 2006 was 22.3% annually. However, annual rates charged to clients are higher, as they also include local inflation and the bad debt expenses of the microfinance institution. Muhammad Yunus has recently made much of this point, and in his latest book argues that microfinance institutions that charge more than 15% above their long-term operating costs should face penalties.

According to ledgerwood (2000) noted the role of donors has also been questioned. The Consultative Group to Assist the Poor recently commented that "a large proportion of the money they spend is not effective, either because it gets hung up in unsuccessful and often complicated funding mechanisms (for example, a government apex facility), or it goes to partners that are not held accountable for performance. In some cases, poorly conceived programs have retarded the development of inclusive financial systems by distorting markets and displacing domestic commercial initiatives with cheap or free money.

There has also been criticism of micro-lenders for not taking more responsibility for the working conditions of poor households, particularly when borrowers become quasi-wage labourers, selling crafts or agricultural produce through an organization controlled by the MFI. The desire of MFIs to help their borrower diversify and increase their incomes has sparked this type of relationship in several countries, most notably Bangladesh, where hundreds of thousands of borrowers effectively work as wage labourers for the marketing subsidiaries of Grameen Bank. Critics maintain that there are few if any rules or standards in these cases governing working hours, holidays, working conditions, safety or child labour, and few inspection regimes to correct abuses, some of these concerns have been taken up by unions and socially responsible investment advocates, Peter Onyando (2010)

2.2.4 Membership

Membership refers to interested individuals or groups who have fulfilled the required procedures to be eligible contributors and beneficiaries to a Micro finance Institution. Inflation has an indirect impact on recruitment of new members to these institutions. When the prices are high ssimilarly, when the prime lending rate is high, then liquidity dries up, and the economy will start to slow. For this reason, banks will usually only raise the prime interest rate when the Fed Funds rate is increased. This is true even though banks would technically make more on an

individual loan when rates are higher. However, since this would decrease the number of loans applied for, this would slow the loan business overall, Saleemi (2006).

Those who earn low income may not be left with enough money to join a microfinance institution like Faulu Kenya Limited,Mwiru and Alex Muthengi Mburi Financial Times (2010). The registration of new members will be too low during this period of high inflation rates, at the same time those who are already registered members may not be active, on issues regarding monthly contribution to fund to the Institution. After the 2007 disputed presidential elections, Faulu Kenya offices remained closed for the beginning of January 2008, due to the fact that the inflation rates went up leading the prices of foodstuffs going up as well. This had an impact on Faulu Kenya operations country wide, Standard newspaper June (2009).

Several studies looked at the impact of membership recruitment to a MFI s’. Most found positive, but small, impacts on the number of enrolled members in enterprises. Increases were generally concentrated among a small proportion of members who joined with the intention of benefiting directly from the scheme, in most cases less than 25 percent of enterprises. Most enterprises experienced no Members enrolment. One study from rural Malawi found that the impact on employment was primarily due to the start up of new enterprises, but this was atypical, since most programs tend to support ongoing rather than new enterprises (Buckley 1996).

A study from Bolivia showed that new members are enrolled to the MFI s’ only after the business has grown to a certain critical size in terms of sales or output. (Mosley 1996). Several studies suggest that men are more likely than women to make a quick decision and be members of these MFI s’.

Mosley (1996) conclude that the great effects of inflation on the registration of new members to join MFI s’ is a natural result of limited technological change that would demand more funds for adopting it which makes the institution to spend a lot of money on purchasing new machinery as compared to educating the public on the importance of coming up with small MFI s’.

Faulu Kenya has achieved operational self-sufficiency: they covered administrative expenses out of interest income and client fees. This finding leads to the important generalization that operational efficiency can be achieved consistently in microenterprise finance, in a range of settings, and with a variety of clientele. The prerequisites to operational efficiency appear to include the adaptation of an effective service delivery methodology and significant institutional competence in such areas as delinquency control, information management, and staff development, according to the Business Magazine (2009)

Churchill, (1996)," An Introduction to Key Issues in Microfinance: Supervision and Regulation, Financing Sources, Expansion of Microfinance Institutions," Microfinance Network, Washington, D.C. February, argued that rising expectations of inflation can often be self-fulfilling microfinance institutions. If people expect inflation to continue rising, they are unlikely to accept to apply for loans that will earn high rates of interest less than their expected returns from investments because they want to protect the real purchasing power of their incomes.

Average earnings for employees working with Faulu Kenya Limited comprise basic pay plus income from overtime payments, productivity bonuses, profit-related pay and other supplements to earned income Productivity measures output per person employed, or output per person hour. A rise in productivity helps to keep unit costs down. However, if earnings to employees are rising faster than productivity, then unit labour costs will increase the growth of unit labour costs is a key determinant of inflation in the medium term, Cohen, M. (2005).

A self-help group (SHG) is a village-based financial intermediary usually composed of between 10-15 local women. Most self-help groups are located in India, though SHGs can also be found in other countries, especially in South Asia and South east Asia. Members make small regular savings contributions over a few months until there is enough capital in the group to begin lending. Funds may then be lent back to the members or to others in the village for any purpose. In India, many SHGs are 'linked' to banks for the delivery of micro-credit.

According to Robert Peck ‘managing to go down market: regulated financial institutions and the move into micro-savings’. In Madeline Hirschland (ed.) 'Savings Services for the Poor: An Operational Guide', Kumarian Press, Bloomfield, CT, 2005, p. 106, he poited out that self help groups are member-based microfinance intermediaries inspired by external technical support that lie between informal financial market actors like moneylenders, collectors, on the one hand, and formal actors like microfinance institutions and banks on the other. Other organizations in this transitional zone in financial market development include small micro-finance institutions in India.

A Self-Help Group (SHG) is a registered or unregistered group of micro entrepreneurs having homogenous social and economic backgrounds; voluntarily coming together to save regular small sums of money, mutually agreeing to contribute to a common fund and to meet their emergency needs on the basis of mutual help. The group members use collective wisdom and peer pressure to ensure proper end-use of credit and timely repayment. This system eliminates the need for collateral and is closely related to that of solidarity lending, widely used by microfinance institutions. To make the book-keeping simple enough to be handled by the members, flat interest rates are used for most loan calculations.

2.3 Critical Review

Critical issues associated with inflation are that lending capacity is determined by the assets and liabilities of the issuing agency that is microfinance Institution. In real terms the issuing authorities can issue money without causing inflation so long as the money issuer has sufficient assets to cover redemptions.The lending policy of MFI s’ can adjust due to inflation risk either by including an inflation premium in the costs of lending the money by creating a higher initial stated interest rate or by setting the interest at a variable rate. This lending policy should not be the case since microfinance institutions are not necessarily for profit making institution.The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which banks can borrow from the central bank, and open market operations which are the central bank's interventions into controlling MFI s’ with the aim of affecting the nominal interest rate. If an economy finds itself in a recession with already low or even zero, interest rates, then the microfinance should not increase these rates. A moderate level of inflation tends to ensure that

nominal interest rates stay sufficiently above zero so that if the need arises the microfinance can lower the interest rates. Regardless of inflation rates the minimum contribution to join a MFI should be maintained. Business environmental factors such as political factors, economic factors, social and technological factors is to be put into consideration when advising members on how to invest from the loans issued by the MFI s’ for example Faulu Kenya Limited.

2.4 Summary

Inflation has an impact on operations of MFI s’ in Kenya, among the interventions that may be called for are lending policy dialogue with governments regarding supervisory standards for microfinance, Lending capacity levels, interest rates and membership. There is need for technical support to transforming institutions and to those who wish to develop savings services, and support to the process of identifying and securing equity investors. As more MFI s’ programs cross the hurdles of operational efficiency and then full profitability, with strategically applied external support, they can begin to reach tens of millions of low income families with high quality financial services. In so doing they help those families lead more secure, empowered, and healthy lives.

CHAPTER THREE

3.0 RESEARCH DESIGN AND METHODOLOGY

3.1 Introduction

This chapter discussed the methodology that was adopted in gathering the data. Here the researcher aimed at explaining the methods and tools and to present data in order to analyze and get proper and maximum information related to the subject under study.

3.2 Research Design

Descriptive research design is a scientific method which involves observing and describing the behavior of a subject without influencing it in any way, www.experiment-resources.com, it was chosen because it enabled the researcher to generalise the findings to a larger population. This study enabled the generalization of findings on the effects of inflation on the operation of all the MFI s’ in Kenya.

3.3 Target Population

Referred to the collection of individuals or regions that were investigated in a statistical study source, Saleemi (2008) Statistics simplified. The population of this study was made up of the top management of Faulu Kenya and the staff. An average of 7 people from the top managements and 38 staff members in Faulu Kenya Limited Nairobi Head office were picked. This was the group from which the sample was drawn. In total, the populations from which the sample was chosen comprised of 45 respondents from Faulu Kenya Limited, Nairobi Offices in Kenya.

Table 3.1: Target Population

Category Target Population Percentage (%)

Managers 7 15

Staff 38 85

TOTAL 45 100

Source: Author (2010)

3.4 Sampling Design

Sampling design is that part of statistical practice concerned with the selection of individual observations intended to yield some knowledge about population of concern, especially for the purposes of statistical inference. T.Lucey (2007) quantitative methods.

The study sample comprised of 40 respondents made up of managers and the staff members in Faulu Kenya. The sample was chosen using stratified sampling technique. This technique means that the population was first of all categorised into strata. For this study, the strata’s were Top managers and the staff. This method was considered appropriate as it would enable the researcher to get diverse views on the effects of inflation on the operations of MFI s’ in Kenya.

Table 3. 2 Sample of the study at Faulu Kenya Limited, Nairobi

Category Target Population Sample size % of sample size.

Managers 7 4 10

Staff 38 36 90

TOTAL 45 40 100

Source: Author (2010)

3.5 Data Collection Procedures and Instruments

3.5.1 Data Collection Instruments.

This are the tools used to facilitate data collection from the identified population of study, to aid this study. Questionnaires were used to obtain important information about the population.

3.5.1.1 Questionnaires

These are questionnaires designed in such a manner that the respondents were to fill in the blank spaces or tick appropriate boxes as per the questions asked. The questionnaires were administered using drop and pick method, meaning that the respondents were left with copies to

fill, after five days the researcher collected the filled questionnaires. The questionnaires were used because it allowed the respondents to give their responses in a free environment and helped the researcher get information that would not have been given out had interviews alone been used. 40 copies of the questionnaires were be printed and distributed to the targeted group of respondents.

3.6 Data Analysis

Data analysis is a process of inspecting, cleaning, transforming, and modeling data with the goal of highlighting useful information, suggesting conclusions, and supporting decision making. Data analysis has multiple approaches, under a variety of names, in different business, science, and social science domains.

In regard to this study the data was analyzed in a way that it was easy to be understood by the researcher. The researcher used qualitative and quantitative technique in analysing the data. After receiving questions from the respondents, it was edited, classified, coded and tabulated to analyze quantitative data. Tables and charts were used for further presentation.

Due to the nature of research on effects of inflation on the operations of Microfinance institutions, questionnaires were identified to aid this study. The main reasons are that questionnaires were cost effective as compared to kept company records, written questionnaires were more cost effective as the number of research questions increases, questionnaires were easy to analyze, data entry and tabulation for nearly all surveys were easily done, questionnaires were familiar to most people, almost everyone had some experience completing questionnaires and they generally do not make people apprehensive, they reduce biasness, there was no uniform question presentation and no middle-man bias. The researcher's own opinions did not influenced the respondent to answer questions in a certain manner. There were no verbal or visual clues to influence the respondent. Questionnaires were less intrusive than telephone or face-to-face surveys. When a respondent received a questionnaire in the mail, he/she was free to complete the questionnaire on his own time-table. Unlike other research methods, the respondent was not interrupted by the research instrument.

CHAPTER FOUR

4.0 DATA ANALYSIS, PRESENTATION AND INTERPRETENTATION

4.1 Introduction

This chapter deals with data analysis, presentation and interpretation of the research findings, these explained the procedures and techniques applied to analyze and present the data obtained through the use of the questionnaires.

4.2 Quantitative Analysis

Quantitative data analysis refers to scientific method of investigation that is based on numeric data. This data is represented in form of numbers; numeric values numeric levels and categories.

The dominant method of quantitative research is to describe, predict and explain the phenomenon. This can be achieved through collecting numerical data on the observable behavior and subjecting it to statistical analysis. This study constituted quantitative methodologies especially in the closed ended questions as shown in the following tables, graphs and charts.

4.2.1 Response Rate

The researcher administered questionnaires to the respondents for them to fill. 40 questionnaires were issued to the respondents; the response rate was 75 % representing an impressive return rate, which was represented by an Actual Response of 3 from the managers and 27 from the staff adding up to 30 respondents.

Table 4.1 Response rate

Categories Sampling Size Actual response. Percentage. No response

Managers. 4 3 10 none

Staff 36 27 90 10

TOTAL 40 30 100 10

Source: Author (2010)

Figure 4.1 Response rate

Source: Author (2010)

The graph shows the analysis of the response rate; this demonstrates the relationship between the sample size and the actual response rate. The chart shows the two respondents who were issued with the questionnaires in each respondent’s category and the number of respondents who answered and handed back the questionnaires. The chart shows that a total of 40 questionnaires were issued to the respondents in two categories of Managers 4 questionnaires and the Members of Staff 36 ,the actual response rate percentage was; 10%, and 90% in the two categories respectively. The data obtained from the total response rate was further analyzed through the use of quantitative and qualitative techniques. The response rates versus the sample group were 75%, which was satisfactory for this study.

4.3 Quantitative Analysis

Quantitative analysis was carried out to determine the number of response rates in each of the research questions.

4.3.1 Gender

On gender the findings were as follows;

Table 4.2 Gender

Gender Frequency Percentage

Female 10 33

Male 20 67

Total 30 100

Source; Author (2010)

Figure 4.2 Graph showing gender distributions at Faulu Kenya

Source: Author (2010)

The chart shows the number of males and females who participated in the study; there were more males than females who participated in the study. Whereby 67% of male participated in the study while 33% were female.

4.3.2 Age

Table 4.3 Ages

Age Response Percentage

20-30 20 66

31-40 5 17

41 and above 5 17

Total 30 100

Source: Author (2010)

Figure 4.3 Distributions of Ages

Source: Author (2010)

The graph shows the age of respondents who participated in the research study. Majority of the respondents who were 67% were in the age bracket of 20-30 years. This indicated that majority of the Top management and members of staff were between 20 and 30 years old.

4.3.3 Designation

Table 4.4 Designation

Designation Frequency Percentage

Accountant 20 66

Credit managers 8 26

Financial Manager 2 8

Total 30 100

Source; Author (2010)

Fig 4.4 Designation

Source: Author (2010)

The graph shows the designations of respondents who participated in the research study. Most of the respondents who were 66% were Accountants followed by a draw of 26% of Credit Managers and 08% of Financial Controllers.

4.5 Education level

Table 4.5 Education

Education Level Frequency Percentage

Post graduates 12 40

Graduates 10 34

A-Level 4 13

O-levels 4 13

Total 30 100

Source: Author (2010)

Fig 4.5 Educational level

Source: Author (2010)

The graph shows the education level of respondents who participated in the research study. Majority of the respondents who were 40% had attained a minimum of Post Graduate Education.

Table 4.6 To determine the effects of lending capacity on inflation factors affecting operations of microfinance institutions.

Introduction: The analysis on the effects of lending capacity on inflation factors affecting the operations of microfinance institutions was as follows.

Effect on lending capacity Response Percentage

Very much 15 50

Much 6 20

Not at all 4 13

Not much 3 10

Not sure 2 07

TOTAL 30 100

Source: Author (2010)

Fig 4.6 Effects on lending Capacity

Source: Author (2010)

The graph shows the effects of lending capacity on inflation factors affecting operations of MFIs ’the graph shows that majority of the respondents who were 50% indicated lending capacity has a great effect on inflation factors affecting operations of microfinance Institutions loans lending Capacity.

Table 4.7 Effects of lending policies on inflation factors affecting operations of microfinance institutions.

Introduction: The analysis of the effects of lending policies on inflation factors affecting operations of Microfinance Institutions was as follows.

Effects on lending Policy Response Percentage

Very extreme 12 40

Extreme 8 26

Moderate 6 20

Less moderate 2 7

Not at all 2 7

TOTAL 30 100

Source:Author (2010)

Fig 4.7 Effect of lending policies

Source: Author (2010)

The graph shows that lending policies has a very extreme effect on inflation factors affecting the operations of money lending institutions. This was represented by 40% of the respondents.

Table 4.8 Effects of inflation on interest rates on inflation factors affecting operations of Microfinance Institutions.

Introduction: The analysis on the effects of interest rates on inflation factors affecting operation of Microfinance Institutions was as follows

Effects on interest rates Response Percentage

Very Much 20 66

Much 6 20

Not much 2 7

Not at all 2 7

TOTAL 30 100

Source Author (2010)

Figure 4.8 Effects of inflation on interest rates

Source: Author (2010)

The graph shows that interest rates have a greater effect on the operational factors affecting the operations of microfinance institutions this was represented by 66% of the respondent.

Table 4.9 Effects of recruitment of new members on inflation factors affecting operations of Microfinance Institutions.

Introduction: The analysis on the effects of recruitment of new members on inflation factors affecting operations of Microfinance Institutions was as follows.

Recruitment of new members Response Percentage

Strongly disagree 5 17

Disagree 3 10

Nether agree nor disagree 5 17

Agree 15 50

Strongly disagree 2 6

TOTAL 30 100

Source; Author (2010

Figure 4.9 Effects of inflation on recruitment of new members

Source; Author (2010)

The graph shows that the recruitment of new members to a microfinance institution has effects on inflationary factors affecting the operations of microfinance Institutions; this was represented by 50 % respondents, who agreed that to this effect.

4.4. Qualitative Analysis

This involved the procedures that were applied to analyze, present and interpret the study findings. This was derived from suggestions, opinions, interests, attitudes, preference and recommendation of the respondents which was mainly found from the likert scale format questionnaires used.

4.4.1 Lending Capacity

The respondents pointed out that inflation affects savings hence decreasing lending capacity. They also added that inflation affects the degree at which the company retains money in its accounts, because inflation will definitely affect the money value. A lot of money will be pumped into savings which is exhaustive hence affects the quantity It was also noted that high inflation rates affects the lending capacity in the sense that as inflation increases , the company reduces its lending capacity, since it becomes expensive for people to apply for loans.

Other respondents felt the central bank is the only authority to determine the amount of money that a MFI should have to function effectively. Generally inflation has direct effects on savings and hence affects the lending capacity.

4.4.2 Lending policies

A good lending policy should be formulated after putting the inflation rates into consideration. For example when the inflation rates is high finance institutions do charge high interest rates, which are proportional to the rise in inflation rates.

A good lending policy should be flexible, in accordance to the changes in the overall business environment. It should be easily understood and simple to apply in all ways. It has to be fair to all members and convincing to the members.

A lending policy needs to be sound and flexible in situations which the company and the country undergo. Inflation prepares the country to counter future challenges brought in by fluctuation of the local currency to the foreign currency.

4.4.3 Interest Rates

Most respondents noted that when inflation rates are high, it will in turn reduce the interest rates charged by the MFI‘s management institutions. When inflation rises or increases, the interest rates charged by the MFIs’ automatically goes up.

Other respondents argued that inflation affects the interest rates charged by microfinance institutions operation; in that as people apply for big amounts the interest rates are high and so they render the institutions bankrupt, this confirms the fact that the higher the amount of loans applied the higher the interest rates charged..

Since money has lost value microfinance institutions will be forced to revise the terms and conditions needed to be followed before certain rates of interest is tabled down, in accordance to the Central Bank of Kenya bank rates. It will force such institution to charge high or low interest rates, on loans given out to members, where the bank rates are high.

4.4.4 Membership

The respondents noted that due to inflation money will lose value and the organization will transfer this multiplier effects to the members in form of floating the MFI shares, so that the members are encouraged to borrow loans else where in order to buy these shares. On the other hand members will decide to off-load or sell their shares the moment they realise that the institution is not making any progress in the market.

Lastly the management of MFI s’ will find it very expensive to recruit new members during a period of high inflation, this is from the economics point of view where the public are to apply the opportunity cost theory in making decision on how to invest the available funds.

4.5 Summary

The study analyzed 30 out of 40 questionnaires which were the major source of primary data used in this study, hence data editing was applied as the first step of qualitative analysis. The data obtained from the questionnaires was critically examined to detect errors and the questions that were not answered properly, all the mistakes were corrected and poorly answered

questionnaires were exempted from analysis process. This increased accuracy, consistency and reliability of the gathered facts. Data completeness and uniformity was maintained and this facilitated application of other data analysis techniques like coding, data organization, data classification and tabulation.

Coding was the second step of qualitative analysis; this involved assigning the collected data in the questionnaires numerical values where the response rate of each respondent’s category was determined, the respective response rates in each category were added together to present the total response rate, the percentage of each respective category response rate was calculated out of the total response rate which was 38 respondents. Coding ensured efficient analysis since it reduced the gathered data into small number of classes which contained the most important information. The coded data provided systematic information that easily passed a message to the reader.

Data organization was applied, where gathered findings were organized under each respective respondents categories, this involved putting the study findings under two categories Management and the members of Staff at Faulu Kenya Limited

Data classification was applied and this involved grouping of data into two classes, this involved the respondents who answered yes and respondents who answered no. The response rates from each respondent category were grouped in each class. The relevant information was put together to help the researcher get a solution to the research problems. Tables were used to present the analyzed data and charts were used to give a visual presentation of the study findings.

The study applied qualitative data analysis methodology, where the qualitative analysis, regardless of the specific approach, involves; comprehending the phenomenon under study, synthesizing a portrait of the phenomenon that accounts for relations and linkages within its aspects, theorizing about how and why these relations appear as they do, and re contextualizing, or putting the new knowledge about phenomena and relations back into the context of how others have articulated the evolving knowledge was applied. This contributed to more understanding of the presented data answered the research questions.

This chapter discussed the data analysis and presentation of the research findings, this involved the methods, procedures and techniques that were used to analyze and present data, which was obtained from the questionnaires; the analysis of the response rate was made where the actual respondents who participated in the research study were determined. The data collected through the use of questionnaires was analyzed using quantitative techniques where tables and charts were used to present the study findings, qualitative analysis was applied to enhance high data validity, and this assisted interpretation of the analyzed data in a meaningful way.

CHAPTER FIVE

5.0 SUMMARY OF FINDINGS; CONCLUSION AND RECOMMENDATIONS

5.1 Introduction

This chapter brings out main findings of the study; answers research questions and objectives and recommend what ought to be done to minimize the effects of inflation on microfinance Institutions. This chapter narrows its focus towards giving an in-depth explanation of how microfinance Institutions are affected by the rates of inflation. The answers to the research questions were discussed, conclusions and research questions were explained. As an effort to enhance or improve the management of microfinance Institutions, the study gave several recommendations and suggestions for further studies encouraged.

5.2 Summary of findings

Microfinance institutions are affected by the rates of inflation. The variables which have been identified in this case are lending capacity formulation of polices, interest rates and membership. The microfinance lending capacity is controlled by the Central Bank that determines how much reserve rates should a microfinance institution posses and this has an impact on the loaners. The lending capacity is thus a weighted average of the short- and long-run inverse as set and standardized by the Central banks of Kenya. It follows that, as the long-run (direct) supply of money to finance institutions tends to be much higher than the short-run one, this very simple dynamic model predicts the need to regulate the amount of finances to be loaned to Financial institution keeping in mind the rate of inflation has perverse effects, due to the distorted signals they send to the market These variable mostly affect the key influencing challenges which were investigated by the research study, these challenges were addressed by the study objectives where data collected under each variable stated was analyzed and presented through the use of charts to clearly depict how each respondent felt these factor affects the operations of microfinance institutions.

The study found out that lending capacity is a major challenge affecting the operations of microfinance institutions. Majority of respondents outlined that lending capacity has a direct effect on the overall operations of the microfinance. This was expressed by 44% who said that inflation rates have an effect on the microfinance lending capacity.

The effect of formulations of microfinance policies was found to be a key problem to the institution there exist lack of clear policies regarding how microfinance institutions .It was found out that Microfinance lending policies frequently have side effects or unintended consequences. Because the environments that policies seek to influence or manipulate are typically complex adaptive systems (e.g. governments, societies, large companies), making a lending policy change can have counterintuitive results. For example, a Microfinance Institution government may make a policy decision to raise lending rates or interest rates, in hopes of increasing overall revenue. These were expressed by 50% of the respondents, who noted that inflation has an extreme effect on the lending policies adopted by the institution.

Recruitment of new members was found to depend on the rate of inflation in the economy. It was found out that the great effects of inflation on the registration of new members to join Microfinance institutions is a natural result of limited technological change that would demand more funds for adopting it which makes the institution to spend a lot of money on purchasing new machinery as compared to educating the public on the importance of coming up with small microfinance Institutions .The registration of new members will be too low during this period of

high inflation rates, at the same time those who are already registered members may not be active, on issues regarding monthly contribution to fund to the Institution. The effect of inflation on the recruitment of new members was evidenced by 44% who agreed that inflation has an effect on the recruitment on new members to the Faulu Kenya microfinance institution.

The study found out that inflation affects the interest rates charged by Microfinance institutions on average, members pay interest rates of 25 per cent to 30 per cent on the principal amount loaned compared to banks’ charges, whose rates range from between 14 per cent and 18 per cent. Experts say such high interest rates are necessary to enable Micro-financial institutions cover their level of exposure people who borrow from micro finance Institutions often rely on relatives or a local moneylender, whose interest rates can be very high. The effect of inflation on interest rates was expressed by 78% of the respondents who felt that the inflation has an effect on interest rates charged by microfinance Institutions.

5.3 Answers to Research Questions

5.3.1 What do you think of lending capacity on inflation factors affecting the operations of microfinance institutions?

From the study it was found out that 50% of the respondents indicated that lending capacity has a great affect on inflationary factors affecting the operations of Microfinance. This mostly affected the amount of money to be kept in custody by the Microfinance Institutions in Kenya.

5.3.4 What do you think of lending policies on inflation factors affecting the operations of microfinance Institutions?

The study revealed that 40% of the respondents stated the lending policies on inflation factors affect the operations of microfinance institutions. This is because the top management main concern is to achieve the objectives of the established Microfinance institutions. In the same note most policies are formulated with a consideration of environmental factors of which inflation is one of those factors.

5.3.7 Does the interest rates charged on inflation factors affect the operations of microfinance institutions?

Based on the study, it was revealed that 66% of the respondents demonstrated that interest rates charged on inflation factors affects the operations of microfinance institutions. Most respondents noted that if an economy finds itself in a recession with already low or even zero, interest rates, then the microfinance should not increase these rates. A moderate level of inflation tends to ensure that nominal interest rates stay sufficiently above zero so that if the need arises the microfinance can lower the interest rates.

5.4.1 Do you agree that recruitment of new members on inflation affects the operations of microfinance institutions?

The study revealed that 50% of the respondents agreed that the recruitment of new members on inflation affects the operations of microfinance institutions. Most respondents noted that if people expect inflation to continue rising, they are unlikely to accept to apply for loans that will earn high rates of interest less than their expected returns from investments because they want to protect the real purchasing power of their incomes. However 45% of the respondents noted that recruitment of new members has no effect on the operations of microfinance institutions, of which the number was considered satisfactory to the question asked

5.5 Conclusions

The lending policy should be formulated after putting into considerations the rate of inflation. For example when the rate of inflation is high the finance institutions should charge high rates which are proportional to the inflation rate.

A rise in inflation increases the interest rates in microfinance institution. Recruitment of new members is slightly affected by inflation, since members shy away because of high recruitment fee resulting from inflation.

The government policies’ regarding the control and regulations of Microfinance corporations affects the operations of Faulu Kenya Limited. Various Microfinance institutions are being established by small group as a means of savings and boosting their enterprise development programs.

5.6 Recommendations

The study recommends the following:

5.6.1 Lending Capacity

Despite the effects of inflation on lending capacity adapted by Faulu Kenya, the institutions should have some money in their reserve for small-scale entrepreneurs to be able to borrow in order for them to finance their projects and also attain faster growth or development.

5.6.2 Lending Policy

Regardless of the effects of inflation, the microfinance institutions should have policies that facilitate easy access of short term loans for the members. The micro and small scale entrepreneurs advocated for longer repayment periods for loans and also higher loan amounts. The repayment period ranged between 3months and 2 years. The amount of loan granted ranged between Ksh1000 and Ksh100000. There is need to consider the loan period and the amount of loan but this has to depend on investment requirements and repayment capacity.

5.6.3 Interest Rates

Interest rates should be maintained at minimum despite the increase of rate of inflation in the economy. Lower interest rate encourages small scale entrepreneurs to access loans. Micro

finance institutions should play a significant role in the rural areas in Kenya especially in providing credit to small and micro enterprises. However, there is need for lowering the interest rates in order to encourage the establishment of production and manufacturing enterprises. Financing the production and manufacturing enterprises especially in agriculture would benefit more rural families for there is greater potential for employment creation.

5.6.4 Membership

Inflation affects the recruitment of new members to microfinance institutions therefore; the contributions of individual members should be maintained at minimum, regardless of high inflation rates. The members to Faulu Kenya were found to be credit averse. There is therefore need to encourage the entrepreneurs to borrow from the micro finance institutions because they will be able to attain faster growth than when they are relying on their own savings. Microfinance institutions need to borrow a leaf from k-rep who have established an extensive network which has covers very remote areas.

The members of this micro finance institution mainly depend on trust and default rate was found to be very low. It is registered as a savings and credit cooperative under the ministry of cooperative development but the members have no common bond like it happens in other SACCOs.

5.7 Suggestion for further studies

The effect of inflation on the operations of microfinance institutions does not only depend on the following variables, lending Capacity, lending policy, interest rates and membership. There are other factors that affect inflation like too much money in circulation, populatiion growth and government polices which need to be researched on.

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