While perhaps not the most intriguing of subjects, the lending behaviour of Kenyan banks should interest anyone interested in development. The implications for poverty reduction in this context may well be applied to other developing country banking systems – that is, if they exist at all, Kenya has one the region’s most well-developed financial systems; neighbouring countries struggle to even bring bank branches to their people. But despite being one the most
sophisticated in the region, the Kenyan banking system has inbuilt mechanisms designed to ensure the banks’ survival, but work to create a number of barriers that keep small and medium-sized entrepreneurs with potential for reducing poverty from accessing meaningful capital:
Firstly, formal banks tend to be exactly that: formal. This means bureaucracy, forms to fill out, procedures to be adhered to, people in suits behind desks and teller windows using difficult vocabulary, detailed information to be provided, verified by records and promises about future behaviour to be kept, all of which can intimidate even the strongest businessperson with little or no education, and whose business and personal life is typically characterised by high unpredictability of income flows and generally bad experiences dealing with formal bureaucracies – corruption is daily occurrence in any Kenyan bureaucracy. That is not to say, however, that poor and lowly educated people do not use financial services, they do, perhaps even more so than the rest of us: Kenyan villages and towns are lousy with communal savings and loan provision setups such as merry-go-rounds, communal saving schemes, table banking, revolving funds, mutual insurance systems, credit extensions to family and friends and widespread sharing of unexpected income. What these grassroots-institutions have in common is that they rely on social ties and trust to enforce behaviour. What they also have in common is that they are small, highly vulnerable to opportunism and theft and will never leave the village setting. Not much help if you are looking for a loan of a certain size to grow a business. The formality and intimidation of the banks thus force many people to rely on inefficient and small-scale financing options which in turn limits the size of the business and its potential positive impact on the community.
Secondly, if a small- or medium-scale entrepreneur does manage to overcome the formalities and intimidation of bank bureaucracies, the conditions placed on loans are strict and largely impossible for such entrepreneurs to fulfil. It is common practise for Kenyan banks to demand at least one guarantor, collateral worth 1.5x the loan amount, offer loan durations of maximum one year with no grace period and hence high monthly repayments, charge hefty fees and interest rates, require additional savings and most importantly, to not tailor the loan to the individual business; the bank dictates the loan conditions, take it or leave it. Effectively this means that unless you have a rich friend or relative willing to back your business, title deeds of some property and enough cash to pay fees, interest (often charged upfront) and the first instalments before the investment starts to pay off, you wont qualify for a loan. Under these circumstances, if an entrepreneur is able to repay such a loan of a meaningful size – i.e. big enough to increase the revenue generating capacity of his/her business – it is questionable whether he or she needed the loan in the first place or if the capital could have been acquired through savings within a reasonably short period of time. What is more, small and medium-sized businesses are characterised by highly volatile income flows, and therefore especially need space in their budgets to have a bad month without being delinquent or defaulting. High and inflexible instalments are the opposite of that and can drive poor people on the edge into poverty. This kind of loan is not the financial service that will reduce poverty in Kenya, and they certainly won’t help the economy grow. Furthermore, the way interest rates in Kenya are quoted are incredibly misleading to anyone without a degree accounting and finance. While in most countries like the United Kingdom, US and Canada, there are strict rules for how interest rates should be stated – to enable consumers to compare like with like – there is no such thing in Kenya. Banks generally understate the interest charged on a loan by not accounting for management and account fees, savings deposits and the fact that the loan is paid back throughout the loan period but continue to calculate interest as though the full amount is still outstanding. A quoted interest rate of 20% is therefore, when all this is accounted for, easily an effective rate of easily more than 50%! Unless you know you way around the jungles of paperwork, you wont realise that you are in fact paying a lot more that the figure quoted.
Thirdly, banks do not look at social impact, i.e. how many people are actually affected by the loans in a positive – or negative – way. In order to benefit the wider community and reduce poverty, the loan must to be invested in such a way that jobs are created, new services provided and backward linkages to suppliers strengthened. There is nothing guaranteeing that a loan to a business entrepreneur, regardless of the size of the business’ size. will change this person’s life or that of others for that matter. If poverty reduction is the objective of the loan, financial soundness is only one of two criterion said loan must fulfil, the other being verifiable and positive social impact. The formality and inflexibility of bank loans in Kenya thus ensure that the very entrepreneurs who need their capital the most – and who could have the biggest social impact – cannot readily access it, and that therefore much poverty reduction potential is not realised.
What about other microfinance institutions (MFIs) you might ask? Surely they are more flexible and concerned with poverty reduction. In Oyugis where most of TradeRelief’s clients run their businesses, there are two other MFIs: Kenyan Women Finance Trust and Adok Timo. While both officially MFIs, both have similar loan conditions and charge similar fees and interest rates to the banks – and quote them in similar, misleading ways. The main difference is that
they do not have the strict collateral requirements that banks do, but in terms of the loan conditions there is not much difference: Loan duration is still a maximum of one year, there is no grace period given, interest is usually charged upfront, loan sizes are restricted to typically three times size that of existing savings, new saving accounts must be opened and paid for and monthly deposits made – which in effect increases the monthly instalments even if they can withdraw that money later. Furthermore, Oyugis has seen its fair share of MFIs opening, accepting deposits with the promise of future access to loans, only to suspend loaning operations, ever increase requirements or outright disappearing with depositors’ money. Entrepreneurs are, understandably, wary of engaging with MFIs that require savings over long periods time before credit is made available.
At TradeRelief we pride ourselves in tailoring the loan conditions to the individual business to have the biggest possible social impact. Looking at each business’ historic and predicted future revenue, cost of doing business and fixed expenditures, we create loans for sound businesses according to what the businesses can manage. We do not require savings deposits nor collateral and charge minimal interest, hence we take on most of the risk from any given loan. We minimise this risk by selecting loans that are financially sound and used to acquire tangible, revenue generating assets while at the same time have demonstrable social impacts. Not that it’s a big deal really, it makes good sense if you are trying to reduce poverty through business finance to make loans big enough to be meaningful and to set conditions so that the loans actually boost and not hinder the businesses’ growth. The businesses will do the rest.