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].