A Glimpse into Informal Finance: Self-Help Group Savings and Lending

In September, I had the opportunity to attend a meeting of a rural based self-help group in the Rift Valley through the assistance of the Chelma Advisory Institute, a grassroots non-governmental organization. This particular self-help group consists of twelve women who first joined together during their participation in Chelma’s microcredit program. 

This was my third trip to the rural communities of Nakuru. I first worked with the women of this group as a SHARE Institute international intern in the summer of 2010 to help create a microcredit pilot program. Even though their loan period ended in June 2011, the group continues to meet at the home of a different member each month to expand upon and continue their group activities. A few examples of the businesses and activities that the collaboration helped to create or improve include poultry, tailoring, basket weaving and the production of soap to sell door to door in their village. 

I was honored to be welcomed again into their community to learn about their merry-go-round savings program that the group organized to sustain their group activities and to give members the opportunity to gain access to small scale loans. Due to the remote location of the group and the lack of household or business items (that are required security by most Kenyan microfinance programs) owned by the members, the majority of the group does not participate in the Kenyan microfinance industry other than the Chelma Advisory Institute. 

Since February, each member has contributed an estimated 1,300 Ksh to the group for loans and group activities. A total of 17,100 Ksh has revolved, meaning the group members have been able to borrower from a sum of 17,100 Ksh. The loan size is much smaller than most microcredit programs ranging from as low as 500 Ksh to 3,000 Ksh. The loan duration is one month and the interest is 5% flat rate paid when the loan is disbursed to the member. 

This is a form of informal finance has existed across the world, especially as low income individuals have traditionally been excluded from formal finance. Even now as the Kenyan government and the financial sector is attempting to increase financial inclusion of low income women, many Kenyan are opting to continue to save and lend within their own community groups. Such individuals do sacrifice the opportunity of receiving continual training and borrowing larger amounts of capital available within the microfinance industry, but the groups who do operate their own lending programs do benefit from their increased decision making power regarding loan requirements and terms.                                                        

For many rural communities, most microfinance programs are often located in urban areas or establish requirements, including interest rates, fees and payment terms, in which many women and men are not capable of servicing. For many reasons described above, this particular self-help group has decided to become their own form of development on their terms in order to save together and lend to one another to continue to grow their businesses, educate their children, and support their group activities. 

 

Informal Finance: Group Based Savings and Lending Summary

Monthly Group Savings: Amount: -Every month, each member contributes 100 Ksh. Details: -Amount collected is contributed for group based loans offered to every member.

Monthly Group Contributions: Amount: -Every month, each member contributes 60 Ksh.  Details: -First, 20 Ksh is contributed by each member for the purchase of 12 tea cups for each member. -Second, 35 Ksh is contributed for meals at the meeting. -Third, 5 Ksh is contributed by each member to purchase mobile time that is used to communicate with the NGO personnel regarding training or loans.  Method:   -First, for the purchase of the cups, a lottery is drawn once per month. One member per month takes the money (240 Ksh) to purchase cups. This ensures that the every member is able to host a monthly group meeting in which each member is able to drink a cup of tea. Is also contributes toward the domestic needs of each woman and their families.  -Second, for the purchase of the meals, one member takes the sum (420 Ksh) to purchase food for the following meeting.   -Third, for the mobile time, the secretary of the group uses the sum (60 Ksh) to organize training or contact the NGO. This person is elected by the group.

Monthly Group Based Loans: Amounts available each month: -500 to 3,000 Ksh Details:   -First, loan duration is one month.   -Second, interest for each loan is 5% of the loan amount. Interest is paid when the loan is issued. -Third, if a member cannot pay, the member is loaned the amount needed to pay off the current loan. Method: -All money collected at each meeting must be re-lent to the group members.

Perspectives from the Top: A Discussion of Contracts, Collateral and Client Over Indebtedness within the Kenyan Microfinance Industry

On Friday, September 18^th, I attended a conference held by MicroJustice4All, an organization that provides legal aid assistance to low income populations throughout the developing world. At the conference, the FairKampaign in Kenya was launched to establish collaborative relationships with microfinance institutions to create fair contracts for clients.

Different stake holders from the Kenyan microfinance industry, including microfinance investors, microfinance institutions, wholesale microfinance companies, local and international lawyers, and researchers were invited to discuss the possibility of contract reform along with the issue of over indebtedness of microfinance clients. 

At the conference, the FairKampaign in collaboration with the Clifford Chance law firm offered to review contracts of microfinance institutions on a pro-bono basis. As discussed during the conference, most microfinance institutions started as non-governmental organizations or trusts, but some have not reviewed or redrafted their contracts even though their internal structures, operations and clientele have changed over time. This includes commercial banks that still provide microfinance services, including Equity Bank that was once a building society, K-Rep that was once an NGO, and Co-Operative Bank that was once a co-operative society. 

The microfinance institutions present at the conference discussed their views of the suggested contract changes. 

First, microfinance institutions argued that training is provided in which clients learn about the loan fees, contract conditions, group requirements and default mechanisms to ensure that all clients are well prepared to take on a loan.

Of the five microfinance programs that have I researched, all provide training. Within each program, the material taught and time required varies. Rafiki DTM Limited requires 4 hours of training, Opportunity Kenya requires 6 hours of training, K-Rep Bank requires 6-10 hours of training, Jamii Bora Bank requires training with non-specified time requirement and Faulu Kenya DTM Limited requires a few hours a day for 3 days of training. It is assumed through this training that clients will have full knowledge and understanding of the requirements, the risks and the investment involved. 

Second, even though the majority of microfinance contracts are in English, many microfinance institutions claimed that verbal translation from English to Swahili is provided to every client. Unfortunately, contracts or a summary of loan requirements, guidelines and fees are never provided to clients. The institutions also failed to address the suggestion of redrafting their contracts into “plain language” and omitting technical microfinance jargon.   

Third, in regard to over indebtedness of microfinance clients, microfinance institutions claimed that institutions face a higher risk when lending compared to microcredit borrowers. Their argument was based on the fact that collateral of microcredit loans are rarely sufficient to cover the loan total when default occurs as many microfinance clients borrow from one than one institution using the same collateral to cover multiple loans and over value their collateral items. 

The argument was also made that managing microcredit loans is costly and stressful for most staff members who are required to attend group meetings, manage group behavior and loan payments, conduct training, process loans, and evaluate individual borrowers and applications. Often, staff members cannot manage all of the responsibilities described above to the best of his or her ability. 

Despite the limited participation of Kenyan microfinance institutions at the conference, I hope that microfinance institutions take advantage of the FairKampaign and come forward voluntarily to have their contracts reviewed. After all, suggestions made by the FairKampaign are voluntary. Such participation has the potential to increase the credibility among microfinance borrowers many of whom have lost faith in the industry. 

Part I) Commercial Banks: Servers of the Poor? An Oxymoron No Longer

Traditionally, microcredit in Kenya was first provided by non-governmental organizations (NGOs) through donor support as a poverty alleviating initiative. Many of these NGOs over the last several decades have became microfinance institutions (MFIs) in search for sustainability and improving service delivery, including mobilizing the deposits of its clients. 

The microfinance delivery channel is still expanding. Many commercial banks operating in Kenya are now competing to win over low income clients, particularly borrowers in the microfinance sector.  Chase Bank Limited is one of the latest commercial banks in Kenya that is becoming a major player in microfinance by opening Rafiki Deposit Taking Microfinance (DTM) Limited, the newest deposit taking microfinance institution in Kenya.

An employee within one of the largest microfinance institutions stated to me that the Kenyan microfinance industry is more competitive than ever before. One reason for this could be the fact that there are more players than ever within the microfinance field as some form of microfinance is offered by almost every type of financial institution operating in Kenya. 

One institution that exemplifies the transformation of microfinance in Kenya is K-Rep Bank Limited. Once called the Kenya Rural Enterprise Program, it started as a non-governmental organization more than twenty years ago serving other non-profit organizations with microfinancial services. Soon after, it began lending directly to individual Kenyan borrowers. In 1999, K-Rep Bank was created and became a licensed commercial bank that still exists today. [1]  

An important question to consider is why are commercial banks, such as K-Rep Bank Limited, continuing or expanding its role in this once donor-supported poverty initiative? Many commercial banks once believed that microfinance was unprofitable and risky. The latter concern stems from the fact that microfinance clients often lack physical collateral traditionally used to secure a loan, the education to understand loan terms and businesses with substantial cash flow to support a loan (2-3). [2]

The answer is profit, profit, profit.

Despite the concerns listed above, commercial banks have proven to be successful players in the microfinance industry by creating profitable loan portfolios with high returns (3). [3] In fact, many researchers have found that commercial banks engaged in microfinance have several advantages over the other players in the industry. Such advantages include owning a large network of branches, thus increasing access for clients, sustainability and financial independence from donors, well-established accounting systems thus more efficiency and experienced staff (3). [4]

There are also challenges that commercial banks must overcome, including maintaining cost effectiveness as managing small loans is costly and time consuming (4). [5]  As a result, such institutions pass the high cost of microfinance operations to clients.

This leads to another question, if commercial banks maintain sustainability and profitability in microfinance despite the high cost and risk, are microfinance clients who were once excluded from the very same institutions that are now serving them also benefiting from the risk that they take on when participating in microfinance?

In part two of this blog post, I will use K-Rep Bank Limited as a case study to discuss the reality of the microcredit participation in commercial banks by focusing on the numerous fees, time commitment, and penalties of default for which borrowers are held accountable, but may not be aware.

[1] K-Rep Bank Limited. “K-Rep History.” 2011. Accessed on September 1, 2011. http://www.k-repbank.com/about-us/history.html.

[2] [3] [4] [5] Baydas, Mayada M., Douglas H. Graham and Liza Valenzuela. “Commercial Banks in Microfinance: New Actors in the Microfinance World.” Washington DC: U.S. Agency for International Development, 2007. www.uncdf.org/mfdl/readings/CommBanks.pdf.

Part II) Commercial Banks: Servers of the Poor? An Oxymoron No Longer

During research for this project, I found that taking on a microfinance loan is very complex and expensive for not only the lending institution, but the borrower. Most best practices in microfinance are centered on whether microfinance is sustainable and profitable for institutions, but the same consideration is rarely given to microfinance clients. So, I pose the same question that is at the end of part one of this blog post.

If commercial banks maintain sustainability and profitability in microfinance despite the high cost and risk, are microfinance clients who were once excluded from the very same institutions that are now serving them also benefiting from the risk that they take on when participating in microfinance?

Last summer, I interviewed a woman named Catherine who became a borrower of one of the leading microfinance providers in Kenya. She explained to me that she still does not understand why she owed the company 4,000 Ksh more than she borrowed. There are often numerous fees, time commitment, and penalties for default that borrowers are not aware of or do not understand.

For example, the costs attached to a K-Rep microfinance loan, either a Chama Baishara Loan (group based) or Individual Microfinance (IMF) Loan, include the following:

Account fees: -Individual account opening: 300 Ksh per person (both loans). -Group collateral account: 40 Ksh per month (waived if amount is over 30,000 Ksh). -Group collateral account closing: 100 Ksh. -Group collateral refund: 100 Ksh.

Group membership registration fee: -200 Ksh per person (only group based loans).

Passbook fee: -Included in the group membership fee (only needed for group based loans).

Application fee: -1.5% of the principle loan amount (both loans).

Additional expenses for application: -A copy of the borrower’s national identification card (estimated cost about 5 Ksh).   -Passport sized photo is required (estimated cost for a set of passport photos about 100-200 Ksh). [1]

Insurance fee: -1% of the principle loan amount (both loans).

Commitment Fee: -1.5% of the principle loan amount (only individual loans).

Interest rate: -16.5% per year for group loans (flat rate) -21% per year for individual loans (reducing balance).

Required security for Chama Baishara loans: -Savings of at least 300 Ksh for eight weeks per borrower is required. The total amount saved must equal 20%-30% of the principle loan amount before loan disbursement. -Savings of at least 300 Ksh a week per borrower is also required for the loan duration. -Household or business items are also required to be pledged by every borrower. -All members of the borrower’s group must serve as guarantors.

Required security for Individual Microfinance loans: -Physical security such as land title deed, share certificate, and log book.

Required Training: -No fee is charged for required orientation and training for group based loans. -But, the required time commitment is 6-8 weeks of training with a K-Rep Business Development Officer. -No training required for individual microfinance loans.

Penalty for late payment or default: -No monetary penalty, but the borrower risks losing social capital/community relations. -For defaulters, further loans are suspended. The group decides if and when the defaulted member of the group is eligible to borrower another loan. If another loan is approved, the loan amount must be lower than the first loan for which the member defaulted.  -The group has the authority to confiscate the collateral used to secure the defaulted loan. -If 5% of a group defaults, all loan disbursements of the group are suspended until the business development officer investigates and concludes that the group is capable of borrowing once again. -For individual microfinance loans, the bank has the authority to confiscate the collateral used to secure the defaulted loan.

According to research conducted by microfinance transparency (MFI), a non-governmental organization dedicated to increasing transparency in microfinance worldwide, the annual APR rates (which includes the sum of the interest, fees, insurance, taxes, and security deposit) for microfinance loans offered by K-Rep Bank Limited range from 46%[2] to as high as 63.4%[3] of the principle loan amount.

I argue that borrowers such as Catherine may not realize the investment and planning required to apply and pay off a microfinance loan. There are several possible microfinance practices that may be at fault. 

During my research, I learned that not all fees and commitments (such as those describe above) are included in microcredit contracts, microcredit borrowers generally do not receive a copy of their loan contract and microcredit contracts are only written in English. It is in the interest of the borrower and the lending institution to alter such practices by becoming more transparent and increasing user friendly information for clients. 

This is where my current project, the consumer education manual, comes into play. The purpose of the consumer education manual is to prepare borrowers to understand the total investment in terms of monetary and time commitment along with the risk when taking a microfinance loan. 

Such an initiative is not to deter innovative business women and men from participating in microfinance, but to allow them to make an educated decision whether it is beneficial for their businesses and financial well being to participate and take a loan. Kenyan business men and women are capable, if given the necessary resources, to make that decision on their own. Just as financial institutions are aware of the risks of participating in microfinance, borrowers deserve the same.  

 
[1] Fees are required to be posted in every branch of every financial institution regulated by the Central Bank of Kenya. All fees are quoted in Kenyan Shilling (Ksh). 

[2] Microfinance Transparency. “K-Rep Bank Limited: Katikati Loan Interests Rates.” 2010. Accessed August 5, 2011. http://www.mftransparency.org/data/products/394/?calculationType=apr&currencyType=74. 

[please note that the data taken from this source is based on K-Rep's KatiKati loan-a microfinance product that is no longer available. K-Rep recently changed its microfinance products as of September 2011].

[3] Microfinance Transparency. “K-Rep Bank Limited: Juhudi Loan Interests Rates.” 2010. Accessed August 5, 2011. http://www.mftransparency.org/data/products/392/?calculationType=apr&currencyType=74.

[please note that the data taken from this source is based on K-Rep's Juhudi loan-a microfinance product that is no longer available. K-Rep recently changed its microfinance products as of September 2011].