How Micro Finance Affects Borrowing for Small Income Earners

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The effects of financial inclusion involve all households having access to finance. However, in developing and emerging economies, total financial inclusion is yet to be realized.

Microfinance bridges the gap between formal lending and informal lending where poor and low-income households can get a supply of basic financial services. Low-Income households have few assets that can be used as collateral and are therefore in need of other avenues of credit.

Microfinance tools encompass savings, credit, cash transfers, and insurance which are provided by a variety of institutions such as cooperatives, non-financial enterprises, and banks.

Provision of financial services for small-scale household producers help in poverty reduction and enabling such households to build assets, increase their levels of income and reduce how vulnerable they are to economic stress and external shocks and emergencies. Small-scale producers can scale up their production and improve their investments with assistance from micro-financing.

Challenges faced By Low-Income Earners in Micro-Lending

  • Most Borrowers  don’t have Sufficient Collateral

Although banks in Kenya have microcredit units that offer micro-loans to small producers, the scale of small that the banks demand may not be viewed as small by many. The low-income producers looking for micro-financing in banks are usually faced by the harsh reality that they do not qualify for such loans.

The structure of micro-loans by banks requires a degree of owning substantial assets that can be used as collateral. On the other hand, micro-finance institutions and saccos/cooperatives are now in their mature stages and they have helped bridge the gap between banks asset-backed collateral to savings backed collateral.

  • Repayment Plan is Based on Financial History

The ability to pay is another requirement for bank loans that locks out many poor and low-income producers and households from receiving financing. The ability to pay is monitored from the past businesses, past income levels, and historical evidence. No potential in future deals is put into consideration.

Micro-finance institutions advance loans based on the amount of savings one holds, with most giving three times as much or against the asset one wants to buy. An individual who holds savings worth KES 10,000 can qualify for KES 30,000. However, this also needs to be guaranteed by savings from other members to the tune of KSH 20,000. This ensures that in case of a default, the amount can be fully recovered from the savings held.

  • Getting a Guarantor Could be Difficult

This also means that you need to know other members who have access and are members to the credit facility and they have to be willing to put up their shares as a guarantee that in case you fail to pay, they will pay on your behalf. This could prove to be a challenge as to how well would you know that the other member will pay up their part or run for the hills?

Despite the challenges, micro-financing is one of the best bets we have in alleviating poverty. With the low operating costs, they help create a culture of saving, while creating the much-needed investments for small scale producers which in turn fuel the macroeconomic landscape.

With the rapid development of digital finance, the micro-financing landscape is changing and developing in a great way that is interesting for financial markets analysts to observe, with consumer loans and other mobile loans coming into play. What this translates to in the economy is yet to be closely studied, but it gives a glimmer of hope that the dream towards financial inclusion for all may be closer than it was previously thought.

I am a banker, passionate about financial inclusion, transforming how and why we practice finance and invest. Writing on issues that affect the financial sphere and propel us to better inclusion, sustainability, and investment decisions, creating awareness, with the mantra ‘knowledge is power.’

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