Microfinance Institutions: Definition, History, How It Works, Principles, Benefits, Drawbacks, Types, and Examples

 Microfinance institutions (MFIs) have been a part of the Kenyan Financial ecosystem for some time, but most of you do not understand what sets them apart from other providers.  Nonetheless, they play a central role in providing financial services to individuals and small businesses that do not have access to commercial banking services. Let us then explore the definition, history, operational mechanisms, principles, benefits, drawbacks, and various MFIs in Kenya, along with examples of notable local institutions.

MFIs-Growth-Drive-in-Kenya

What Are Microfinance Institutions?

Microfinance institutions (MFIs) offer financial services, such as loans, savings, and insurance, to low-income individuals or groups who lack access to traditional banking services. The primary goal of MFIs is to promote financial inclusion by providing resources that help alleviate poverty and stimulate economic growth.

Microfinance Institutions History in Kenya

Microfinance in Kenya has evolved significantly over the decades:

MFIs Founding in Kenya

The 1970s: The roots of microfinance in Kenya can be traced back to the 1970s with the emergence of informal savings and credit groups known as "chamas." These groups were community-driven and allowed members to pool resources, which were then lent to those in need. The fundamental principles of these chamas were based on trust, mutual assistance, and social cohesion.

·         Chamas: Informal table banking groups where members contributed regularly to a common fund, which could then be borrowed by members at agreed terms. They were prevalent among women, who used them to finance small businesses and household needs.

1980s-1990s: The 1980s and 1990s marked the beginning of formal microfinance in Kenya. Non-governmental organizations (NGOs) and community-based organizations began to establish more structured microfinance institutions to address the limitations of informal chamas.

• NGO-Led Initiatives: Many NGOs recognized the potential of microfinance to alleviate poverty and promote entrepreneurship. They established formal MFIs to provide structured financial services.
• First Formal MFIs: These early MFIs focused on providing small loans to micro-entrepreneurs and small businesses, helping them to expand their operations and improve their livelihoods.

MFIs Growth and Regulation in Kenya

The microfinance sector in Kenya saw substantial growth in the 2000s, driven by increased demand for financial services and the recognition of microfinance as a critical tool for economic development.

• Microfinance Act of 2006 was a landmark in Kenya's microfinance history. It provided a legal framework for regulating and supervising deposit-taking MFIs, bringing much-needed credibility to the sector.
• Regulatory Framework: The Central Bank of Kenya (CBK) oversaw the sector, ensuring that MFIs adhered to sound financial practices and protected consumer interests.
• Licensing: The act required MFIs to obtain licenses from the CBK, which helped to weed out unscrupulous operators and build public confidence in the microfinance sector.

MFIs, Technology, and Expansion in Kenya

2010s to Present: The 2010s and beyond have seen significant technological advancements that have revolutionized the microfinance sector in Kenya.

• Digital Microfinance Services: Mobile technology has transformed microfinance, making it more accessible to the masses.
• M-Pesa: M-Pesa was launched in 2007 by Safaricom and revolutionized financial transactions in Kenya. It enabled people to transfer money, pay bills, and access loans via mobile phones, even in remote areas.
• Mobile Banking Apps: Various MFIs have developed mobile banking applications, allowing customers to save, borrow, and transact digitally.
• Increased Financial Inclusion: These technological innovations have boosted financial inclusion, enabling millions of Kenyans to access financial services for the first time.
• Enhanced Regulation: The Central Bank of Kenya, under the Central Bank of Kenya Act - cap.491 and the CBK Digital Credit Providers Regulations Act 2022, and industry bodies continue to evolve their frameworks to keep pace with technological advancements, ensuring the sector's stability to protect consumers.
• Consumer Protection: Regulatory bodies have introduced measures to protect consumers from predatory lending practices and ensure transparency in microfinance operations.
• Financial Literacy Programs: There has been a concerted effort to improve financial literacy among Kenyans, helping them to make informed financial decisions and effectively utilize microfinance services.

How Microfinance Institutions Work in Kenya

MFIs provide small loans to individuals or groups who may not qualify for traditional bank loans, often called microloans. Here’s how they generally work:

Loan Disbursement:

• Group Lending: Many MFIs use group lending models where small groups of borrowers guarantee each other's loans, reducing the risk of default.
• Individual Lending: Some MFIs provide loans to individuals based on their creditworthiness, account activity, and business plans.

Savings and Insurance:

• Savings Accounts: MFIs offer savings accounts to help clients build financial security.
• Micro-Insurance: Some institutions provide insurance products tailored to low-income clients, covering health, life, vehicle, and property risks.

Training and Support:

• Financial Literacy: MFIs often provide training in financial literacy and business management to help clients succeed.
• Ongoing Support: Continuous support and monitoring are provided to ensure borrowers use loans effectively and repay on time.

Principles of Microfinance Institutions

MFIs operate on several principles that guide their activities and ensure they meet their objectives:

Financial Inclusion:

• Aim to provide financial services to underserved populations to promote economic development and reduce poverty.

Sustainability:

• Strive for financial sustainability to continue serving clients without relying on external funding.

Client-Centric Approach:

• Focus on understanding and meeting clients' needs, ensuring services are accessible, affordable, and relevant.

Social Impact:

• Emphasize creating positive social outcomes, such as improved living standards, education, and healthcare access.

Benefits of Microfinance Institutions

Microfinance institutions offer several benefits that contribute to their popularity:

Access to Credit:

• Provide access to financial resources for those traditionally excluded from the formal banking sector.

Economic Empowerment:

• Enable entrepreneurs and small businesses to grow, creating jobs and stimulating local economies.

Financial Inclusion:

• Promote financial inclusion by offering savings accounts, insurance, and payment services to low-income populations.

Capacity Building:

• Enhance financial literacy and business skills through training and support services.

Microfinance Institutions Drawbacks

Despite their benefits, MFIs also face several challenges:

High Interest Rates:

• The cost of providing small loans can result in higher interest rates than commercial bank loans.

Over-Indebtedness:

• Borrowers may take multiple loans from different MFIs, leading to over-indebtedness and financial stress.

Limited Reach:

• Despite their growth, MFIs still struggle to reach the most remote and marginalized communities.

Operational Challenges:

• High operating costs and risks associated with lending to low-income clients can affect the sustainability of MFIs.

Types of Microfinance Institutions in Kenya

MFIs in Kenya can be categorized into several types based on their structure and services:

Non-Governmental Organizations (NGOs):

• These are typically not-for-profit organizations that provide microloans and other financial services to low-income communities. Example: Tumanini Fund.

Credit-Only MFIs:

• These institutions provide loans but do not accept deposits. They often focus on specific sectors or regions. Example: Faulu Kenya.

Deposit-Taking MFIs:

• Regulated by the Central Bank of Kenya, these institutions offer savings and loan products. Example: Kenya Women Microfinance Bank (KWFT).

Cooperative Societies (SACCOs):

• Member-owned financial cooperatives that provide savings and credit services to their members. Example: Stima SACCO.

Digital MFIs:

• Leveraging technology to provide financial services through mobile platforms and apps. Example: Tala.

Examples of Microfinance Institutions in Kenya

Several prominent MFIs operate in Kenya, each playing a role in financial inclusion and economic empowerment:

Kenya Women Microfinance Bank (KWFT):

• One of the largest MFIs in Kenya focuses on women entrepreneurs.

Faulu Kenya:

• A well-known credit-only MFI provides a range of loan products to small businesses.

K-Rep Development Agency:

• An NGO that has been instrumental in developing the microfinance sector in Kenya.

GDC SACCO:

• A cooperative society serving energy sector employees with savings and loan products.

Tala:

• A digital MFI providing quick and convenient loans through a mobile app.

 

Microfinance institutions in Kenya play a critical role in enhancing financial inclusion and empowering low-income individuals and SMEs. While they offer numerous benefits, such as access to credit, economic empowerment, and capacity building, they also face challenges like high interest rates and operational difficulties. Understanding the history, principles, and various types of MFIs, as a stakeholder/borrower, you can appreciate their impact on Kenya's financial sector and work towards addressing and spotting their challenges for a sustainable financial future.