The 14 microfinance banks (MFBs) regulated by the Central Bank of Kenya (CBK) are confronting a chequered past for which they have been loathed for their tough loan recovery methods, which left borrowers in rural villages and informal settlements scrambling at the mere scent of their approach.
However, the executives argue that the fear of microfinance institutions acting like Shylock, in William Shakespeare’s The Merchant of Venice, coming for his pound of flesh is not of their own making.
They claim that, in response to the perceived risk posed by traditional microfinance clients, such as women in informal savings groups who used to save in chamas, the State created rules requiring them to classify and pursue delinquent loans after 30 days, as opposed to 90 days for commercial banks.
In response to recent reports that microfinance banks have been selling loans to commercial banks, industry leaders told the Business Daily that, while it may appear to be asset sales, it is in fact a customer-initiated flight to safety.
“It is the other way round,” said David Mukaru, the chief executive officer for Caritas Microfinance Bank, regarding CBK reports that the deposit-taking microfinance bank sold loans to commercial banks to free up capital for lending to other borrowers.
“It is the customers who are running away from microfinance banks because they feel that commercial banks’ terms, when they are not repaying on time, are easier,” said Mr Mukaru.
Dr Joy Kiiru, an economics lecturer at the University of Nairobi who has conducted studies on microfinance programmes and poverty reduction, agrees that these regulations are unfair. She notes that micro, small and medium-sized enterprises (MSMEs) are perceived as risky.
“The thinking is that if these businesses (MSMEs) can’t pay a loan after 30 days, they can’t pay it at all,” said DR Kiiru, noting that things have since changed.
She noted that about 98 percent of businesses in the country are MSMEs — or enterprises with fewer than 100 employees — which require microloans.
She said the financing gap for MSMEs is around Sh2.2 trillion.
Perfect storm
The ‘shylock’ label is just one of several issues affecting microfinance banks, but it is a significant one. These pressures have built up to create a perfect storm, keeping the financial sub-sector in the red for the past eight years.
Pre-tax losses have more than tripled since 2018, when the industry first plunged into the loss-making zone.
The industry last made a pre-tax profit of Sh2.351 billion in 2017, after which it sank into a loss of Sh1.192 billion the following year, widening to Sh3.618 billion last year as the industry continues to grapple with myriad challenges.
Julius Wamae, Faulu’s CEO, suggests that some of this may be a distortion due to the domination by two players — Kenya Women Microfinance Bank and Faulu Microfinance Bank — which together control 80 percent of the industry.
Bangladeshi foundation
Microfinance did not begin as a commercial project. Conceived by Muhammad Yunus, a Bangladeshi economist and social entrepreneur who pioneered microcredit, microfinance grew out of a welfare mindset in which group discipline stood in for hard collateral.
Mr Yunus, who since August last year has been the chief adviser of Bangladesh’s interim government following mass protests that led to Prime Minister Sheikh Hasina’s resignation, founded Grameen Bank in the 1970s. He lent to those at the bottom of the pyramid, including women who were shunned by commercial banks for not having collateral such as title deeds or logbooks.
The Grameen model, for which Yunus was awarded the Nobel Peace Prize, would thereafter spread to other parts of the world, including Kenya, with institutions such as Kenya Women Microfinance Trust leading the way in deepening financial inclusion.
For years, these institutions have served people shunned by commercial banks, such as market traders, casual workers and informal groups saving together.
According to Dr Kiiru, financial inclusion was low in Kenya in 2006, with fewer than a third of households having an active bank account, according to a CBK survey on financial inclusion. This figure has since increased to 85 percent.
“Your competitiveness must evolve with time,” said Dr Kiiru.
Nonetheless, peer pressure kept defaults low in the microfinance sector, with members ensuring that everyone paid.
Fearing the loss of their savings, or even their assets, chama members would occasionally snitch on their defaulting peers.
While this culture enabled access for those eschewed by commercial lenders, it also created a stereotype that microfinance lenders are relentless collectors—the modern-day Shylock going after his pound of flesh.
When policy later tightened timelines for classifying and pursuing overdue loans, this stereotype became entrenched.
Financial spiral
The 30-day trigger lies at the heart of the grievance. Microfinance banks must classify a loan as non-performing after one month of missed payments. For their part, commercial banks have three months.
The Faulu CEO explains the mechanics. “The moment you classify a loan as non-performing, number one, you need to list the customer.”
A negative listing at credit reference bureaus can make it harder to borrow again. The financial spiral starts there.
“And indirectly, that means you price higher, you charge more. And it is a domino effect,” explains Mr Wamae, noting that this has to be followed by provisioning for the loan, which drains capital.
Executives also point to gaps in tax and collateral treatment that tilt the field. The Income Tax Act names commercial banks and savings societies in provisions that allow credits on withholding tax for interest, but microfinance institutions are not always referenced in the same way. The result is added uncertainty and cost.
On collateral, microfinance banks are allowed to accept movable assets such as livestock and crops, which makes sense for clients without land titles.
Yet those same assets are not consistently recognised when a lender sets provisions for bad loans. The mismatch punishes microfinance banks for serving people who live and work outside the world of formal title deeds.
When the sector digitised, many players were late. Others bought expensive software designed for big banks and tried to make it fit their operations.
Retaining information-technology experts has also been hard, since commercial banks pay more.
Another dampening effect on the industry has been how government credit programmes have shaped borrower attitudes.
Mr Mukaru noted that the Youth Enterprise Development Fund and the Women Enterprise Fund opened access to finance but also sent a message that loans could be treated like free cash.
He adds that the Hustler Fund has amplified that worry for some lenders, who say it has created a casual attitude to repayment.
At the same time, rules that bar listing very small loans with Credit Reference Bureaus—such as balances below Sh1,000—have removed a tool that once nudged borrowers to stay current. The intention was consumer protection.
The effect, according to industry voices, has been a culture shift where small defaults are normalised and then grow.
Commercial banks have also been eating MFBs’ lunch by taking up group-lending ideas and building their own microfinance departments. They have then deployed their large balance sheets and national brands.
Savings and credit co-operatives have expanded beyond their original common bond, drawing in members who were once firmly in the microfinance orbit.
Competition from digital lenders has also cut into MFBs’ market by offering speed and convenience—though executives insist that the tiny amounts lent by digital lenders mean they are not much of a threat.
Mr Wamae and Dr Kiiru stress that the mission for MFBs has not changed from extending lending to more vulnerable groups and to drive more financial inclusion and empowerment.
“So, we are allowed to have more flexibility in the types of products we give and the kind of collateral we can take,” said Mr Wamae.
However, if they are to navigate the current crisis, the Shylock tag needs to be dropped, allowing the micro-lenders a level playing field with commercial banks.
Dr Kiiru argues that MFBs should not be given special favours to fulfil their mission of ensuring financial inclusion—what Wamae prefers to call financial empowerment.
“Reinvent yourself to catch up. Provide services at competitive rates,” said Dr Kiiru.
