Innovative lending patterns of microfinance institutions (MFIs) are often considered as a challenge to conventional financial institutions. MFI services are expected to force these institutions to pay greater attention to the banking needs of the poor and are therefore seen as instrumental in expanding the supply of financial services. However MFIs in Kenya serve a small proportion of the market and the regular financial institutions such as banks are moving towards catering to the lower-income customers, in response to wider pressures.

If MFI services are to influence other providers they can do this either by competing with them in innovative ways on the basis of price or service quality and hence affect the business and profitability of others in the market (i.e. have a competition effect) or they may encourage other financial organisations to change their own products and services to copy aspects of MFI’s services (i.e. have a demonstration effect). Research from the University of Bath examining financial markets in and around the Kenyan town of Karatina casts doubts on the view that MFIs have had a significant impact on the financial market through either of these mechanisms.

The 1990’s microfinance revolution - which changed the approach from being a service that provided finance on subsidised rates to one based on the principles of a cost-effective and profit-making financial system - was based on assumptions that:

• poor people can pay relatively high interest rates for loans
• the poor were more concerned about access to financial services rather than cost
• despite their poverty, people can and do save money
• making loan access dependent on compulsory savings can provide funds for on-lending group-based methods, reduce costs incurred for providing loans and allow greater numbers of poor people to be reached

Karatina is a relatively prosperous town on the slopes of Mount Kenya and enjoys fertile volcanic soils and good rainfall. The town has a lot of group based financial arrangements that are particularly used by women. Non-governmental organisation and church-affiliated MFI programmes compete with banks, a building society, parastatals, savings and credit cooperatives (SACCOs) and other microfinance institutions.

Interventions in the financial market – such as the microcredit projects – are expected to have wider impacts, on the structure and functioning of those markets, which go beyond the direct impact on users. In Karatina, however, locally operational MFIs serve a very small proportion of the market and do not seem to have had any competition or demonstration effects on other providers. In particular, it is not apparent that other financial institutions have found it useful to adopt group-based approaches. Rather, it is worsening macroeconomic conditions that seem to have influenced other financial service providers to change their products and services to attract middle and lower income clients.

The author describes recent changes to this crowded financial market:

• Banks have reduced their minimum deposits significantly, abandoning the strategy of targeting wealthy individual customers – an increasing rarity in the wake of recession and retrenchment in both public and private sectors.
• Banks have started offering unsecured personal loans using new online credit-scoring techniques to enable quick decision-making.
• Two banks have started to lend small businesses using stock and household assets as collateral but based on an assessment of cash flows.
• MFIs have started offering individual loans and expanding their range of group-based products to school fees and medical emergencies.
• Reform of the Co-operative sector regulation and legislation has led to a rapid increase of SACCOs in sectors such as transport, tea, coffee and among employees of small scale local organisations such as hospitals.
• Bank base interest rates have been falling and clients are aware that banks are now quoting lending rates below those offered by MFIs: as a result, MFIs are likely to start coming under heavier pressure from clients regarding interest rates.

In Karatina, MFIs are operating amongst competitors increasingly interested in the same customers. MFIs have relatively limited outreach by comparison with other models both in terms of numbers of clients and volume of business. The view that MFIs are serving a different section of the population to the banks and SACCOs or that poorer clients use them appears increasingly less defensible. MFI users are in general better educated and wealthier than most Kenyans. The assumption that it is access rather than price that matters to clients may no longer be true in places like Karatina. Loan terms and interest rates are increasingly attractive elsewhere and are available without the group meetings and guarantees that are obligatory in MFIs.

Source(s):
‘The impact of microfinance institutions in local financial markets: a case study from Kenya’, Journal of International Development, 16 (3) pp 467-501, by Susan Johnson, 2004

Funded by: Department for International Development, UK

id21 Research Highlight: 7 November 2004

Further Information:
Susan Johnson
Centre for Development Studies
University of Bath
Claverton Down
Bath BA2 7AY
UK

Tel: +44 (0) 1225 386497
Fax: +44 (0) 1225 383423
Contact the contributor: S.Z.Johnson@bath.ac.uk

Centre for Development Studies, University of Bath

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