Effects of Inflation on Performance Microfinance Institutions

CHAPTER ONE
1.0 INTRODUCTION
1.1 Background of Study
MFIs are recognized and acknowledged as vital and significant contributors to economic
development, employment creation and technological development (mortis 2000). MFI have
therefore been given great emphasis in recent times because they are considered as essential
actors in achieving social and economic development in both developed and developing
countries.
Kenya with an estimated population of 29.6 million people and a per capita income of US $260
is categorized by the World Bank to be among the poorest countries in the world (world
development report 1992). Kenyas development challenge therefore remains in finding
sustainable poverty eradication strategies. Micro and small enterprises have been seen as one of
the strategies that can bring faster development. MFI does therefore play a big role in financing
the micro and small enterprises for faster development. MFIs enterprises are also highly rated
for employment creation. They are therefore important in Kenya where unemployment and
underemployment are estimated at between 25% and 35% respectively.
MFI s through the provision of credit influence the type of technology adopted by entrepreneurs
and even the rate of technology adoption. Small scale enterprises in the agricultural sector play a
big role in providing food, income generation and employment creation. The application of
technology is vital in enhancing growth and development of these enterprises.
Inflation is vital in the growth and development of any MFI. Both large scale and small scale
MFI depend on financial organizations for credit in order to raise capital and also finance any
development projects. The large scale organizations have found it much easier to access credit
from commercial banks and other financial institutions. The micro and small scale enterprises
have not been able to easily access credit from the Microfinance Institutions. They have been
mainly dependent on MFIs for credit.
Most of the MFI s are based in major towns which may make credit more accessible to the
micro and small enterprises in the major towns to the disadvantage of those micro and small
scale enterprises in the rural areas. This study therefore set out to establish the extent to which
inflation affects MFI s and small scale enterprises in rural areas in Kenya. The study did not
focus on inflation alone, it also covered services provided by the by the MFI s. The study
focused on effects of Inflation in MFI.
1.1.1 Profiles of Faulu Kenya Limited
According to the Faulu Kenya journal (2009) The institution initially started off in 1992 as a
pilot micro-lending program of Food for the Hungry International (FHI), an international (Non

Governmental Institution) NGO engaged in relief and development throughout the world. This
pilot program was expanded and up-scaled in 1995, by 1998 had registered significant growth.
Food for the Hungry (FHI), not being a microfinance-oriented (NGO) sought to free Faulu
Kenya and have it operate at arms length. Therefore, in 1999, Faulu Kenya Limited was
incorporated as a private capital share company owned by FHI. It has operated profitably since
its incorporation. Faulu Kenya is a Deposit Taking Micro-Finance Company, registered in Kenya
under the Micro-Finance Act which is regulated by the Central Bank of Kenya. Faulu was
founded as a program of Food for the Hungry International (FHI), a Christian relief and
development organisation based in Phoenix Arizona in USA and has grown to become an MFI
that offers both savings and credit services to millions of Kenyans www.wikipedia.com world
development report (1992)
FHI recognised that there were offering unique needs of low-income people in rural and urban
areas and that sustainable economic development for the marginalised poor people is a priority
issue in the developing world. To address these issues, FHI established Faulu Africa Network, a
regional MFI network operating in Kenya, Uganda and Tanzania. Faulu Kenya has grown
tremendously over the last 16 years, with over 90 outlets throughout Kenya. These outlets are
currently serving over 250,000 clients. There are now more than 1500 members of staff in the
outlets and at the Business Support Center Head Office. This allowed Faulu Kenya to start
sourcing commercial funding towards its portfolio growth with an initial subsidized loan of
US$145,000 from a local European Union supported program in 2000. This was followed by
another US$500,000 from the same program in 2001, and two commercial banks provided credit
lines worth US$4 million in 2002, leveraged against existing assets with some backing from one
international guarantee. IN 2003, this was supplemented by an 18-month hard currency term loan
from Blue Orchard's Dexia MFIs Fund, amounting to US$450,000. This particular loan was a
tentative step towards balance sheet based borrowing as it was based on a promissory note issued
on the strength of Faulu Kenya's balance sheet. These borrowing experiences spread over a four
year period formed the learning curve for the institution to take a bold step towards leveraging its
balance sheet for longer term borrowing at attractive pricing levels. Faulu Kenya Annual
publication Magazine (2008)
1.2 Statement of Problem
Inflation affects the operations of MFIs in Kenya. High or unpredictable inflation rates are
regarded as harmful to MFI. They add inefficiencies in the operations of MFIs, and make it
difficult for MFI s to budget or plan long-term programs. Inflation can act as a drag on
operations as finance Institutions are forced to shift resources away from products and services in
order to focus on profit and losses from currency inflation. Uncertainty about the future value for
money discourages investment and saving, and inflation can impose hidden tax increases, as
inflated earnings push taxpayers into higher income tax rates. With high inflation; financial
institution lending rates, lending capacity/policy and repayment interest rates are affected. Where
fixed exchange rates are imposed, rising inflation in one economy will cause its exports to
become more expensive and affect the balance of trade. There can also be negative impacts to
trade from an increased instability in currency exchange prices caused by unpredictable inflation.
This study will establish the effects of inflation on MFI.

1.3 Research Objectives.

1.3.1 General objectives
The general objective of this study is to establish the extent to which inflation factors affects the
operations of Microfinance Institutions.
1.3.2 Specific objectives
The study will be guided by the following specific objectives:
i. To investigate how lending capacity affects the operations of Microfinance Institutions.
ii. To identify how lending policy affects the operations of Microfinance Institutions.
iii. To find out how repayment period affects the operations of Microfinance Institutions.
iv. To evaluate the recruitment of members affects the operations of Microfinance Institutions.
1.4 Research Questions
The study seeks to answer the following research questions:
i. How does lending Capacity affects the operations of Microfinance Institution?
ii. How does loan lending policy affects the operations of microfinance Institutions?
iii. How does the repayment period affects the operations of Microfinance Institutions?
iv. How recruiting of new members affects the operations of Microfinance Institutions?
1.5 Importance of Study
This study is of benefit to the MFI in that it will guide them in policy formulation. Policies are
formulated to guide organization in day to day management of operations, it for this reason that
microfinance, institutions will be able to come up with mission and visions which are to direct
employees and managers towards achieving a common goal of success.
This study is to benefit the government because it provides recommendation on employment
creation to the jobless populations who have the required qualification for different types of jobs.
On the other hand the government will know the problems facing MFI s, in order to provide
solutions which may include donations, grants and subsidies necessary for the welfare of the
management of MFI s in Kenya.
The small scale entrepreneurs in the different sectors of the economy are to find this research
valuable since they will be more informed on how MFI, are managed, and also how these

institutions can provide short term loans to boost their businesses. The information to be
collected will categorically point out the entire requirements for one to be a member of Faulu
Kenya, and at the same time the benefits of joining this MFI s
Students will find this research work valuable. The research paper will act as a reference
document for their studies at the college. They will acquire broad knowledge and skills regarding
how MFI s are formed managed and controlled.
1.6 Limitation of Study.
1.6.1 Bureaucratic procedures
The researcher was subjected to tedious procedures especially when booking appointments with
the Faulu Kenya respondents. This was due to programmed plans on when the management was
available to fill the questionnaire.
To overcome this limitation the researcher booked appointments in good time and seek clearance
from various departments in Faulu Kenya.
1.6.2 Lack of co-operation.
The researcher was carried out in Nairobi. The target respondents were not be in a position to
respond accurately to the answers asked due to the fear of victimization by the top management.
To overcome this problem the researcher gave in writing to the respondents that whatever
information to be given was be treated as confidential and was never to be published in any form
whatsoever without their consent.
1.6.3 Communication problem
Faulu Kenya Limited is a finance institution that has opened its door to all Kenyan citizens to
apply for membership, therefore the researcher may face communication problems especially
when interviewing already registered members who may not be conversant with English
language.
To overcome this, the researcher used the national language (Kiswahili), to interpret the
questionnaire to them.
1.7 Scope of Study.
The study was conducted in the Faulu Kenya Limited in Nairobi Offices on Ngong Road
between March and June 2010. The target population for this study was Faulu Kenya Top
Management, Middle level Managers, Line Managers and members of staff.
1.8 CONCEPTUAL FRAMEWORK.

Figure 1.1 Conceptual Framework.

Independent variables Dependent variables
Source Author (2010)
1.8.1 Lending Capacity
This is the ability to give out loans to applicants, in relations to the repayment period and
applicants security or guaranteed arrangement. From the MFI of view, this terminology is used
to categorize different institution as per the members discretion to get loans, or funds available
to members, which may have been pooled together through monthly contribution to the pool.
This study will find out how inflation affects lending capacity in Faulu Kenya Limited.
1.8.2 Lending policy
A policy is a statement that is formulated by the management of an organization, to guide
employees or members on day to day organizational activities. MFIs lending policy statements
outlines to the members rules and regulations for applying for loans from the institution. This
study will look at how inflation affects lending policy in Faulu Kenya Limited.
1.8.3 Interest rates.
Interest are earning on loans given to loaners or members. The major determinants of interest
rate are the demand and supply for money in circulation. MFI s are formed by interested group,
drive by a given mission objective and vision. This study will investigate how inflation affects
interest rates in Faulu Kenya Limited.
1.8.4 Membership.
MFI s are managed as small upcoming banks. Membership refers to how individuals or groups
are recruited to these institutions, to be part and parcel of the scheme. MFI s have come up with
a detailed recruitment and selection of members who will be ready to support the institutions in
its enderviuos.This study will establish how inflation affects recruitment of new members to
Faulu Kenya Limited.
CHAPTER TWO
2.0 LITERATURE REVIEW
2.1 Introduction
The chapter presents the literature on theoretical perspectives relating to the effects of inflation
on the operation of MFI s in Kenya.
2.2 Review of past studies

Inflation is always and everywhere a monetary phenomenon. Milton Friedman, A Monetary

History of the United States (1867)-(1960), (1963) Historically, a great deal of economic
literature was concerned with the question of what causes inflation and what effect it has. There
were different schools of thought as to the causes of inflation. Most can be divided into two
broad areas: quality theories of inflation and quantity theories of inflation. The quality theory of
inflation rests on the expectation of a seller accepting currency to be able to exchange that
currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation
rests on the quantity equation of money, that relates to the money supply, and its velocity, and
the nominal value of exchanges. Adam Smith and David Hume proposed a quantity theory of
inflation for money, and a quality theory of inflation for production, Ledgerwood (1993)
Over the last 20 years, MFI s in Kenya have largely developed through concerted grant funding.
This situation prevailed up to the late 1990s when key donors started pushing M.F.Is to start
moving towards sustainability in their operations according to Business finance text by Saleemi
(2007).
In recent years, a growing number of developing countries including Kenya have embarked on
reforming and deregulating their financial systems, transforming their institutions into effective
intermediaries and extending viable financial services on a sustainable basis to all segments of
the population. By gradually increasing the outreach of their financial institutions, some
developing countries have substantially alleviated poverty lending, institutional strategies and
financial systems approaches. In the process, a new world of finance has emerged. Which is
demand-led and savings driven and conforms to sound criteria of effective financial
intermediation. There is now incipient experience with the successful integration of microfinance
strategies into micro policies, which makes banking the micro economy and the poor both viable
and sustainable, Otero (1994)
Microfinance has emerged as that sub sector of the financial system which provides financial
services to the micro economy, comprising alignments of the rural and urban population,
including small scale farmers, micro entrepreneurs, women and the poor. This micro financial
sector comprises local financial institutions, which may be formal, semiformal or informal.
Furthermore, such institutions may be owned, fully or in part, by individuals, groups or
organization sin the micro-economy. Microfinance services include savings, loans, insurance,
money transfers, remittances, etc. according to Mudinda (2006)
It is acknowledged that the need to extend the Poors access to formal financial services is not
new. Initially, in the 1950s development projects began to introduce subsidized credit programs
targeted at specific communities. For example, governments and donors provided subsidized
agricultural credit to small and marginal farmers with the goal of raising productivity and
incomes. These subsidized schemes were rarely successful because the funds seldom reached the
poor, ending up in the hands of better-off farmers. Moreover, subsidized interest rates introduced
a culture of non-repayment, which in turn made it difficult for lasting financial systems to merge,
Mudinda (2006)
The general failure of large subsidized credit schemes inspired social entrepreneurs in
developing countries to test alternative ways to offer credit to poor people. Beginning in the

1970s, experimental programs run through non-governmental organizations (NGOs) in

Bangladesh, Bolivia, and a few other countries extended tiny loans to groups of poor women
who could invest in micro-business. This type of micro enterprise credit was base don solidity
group lending in which every member of a group guaranteed the repayment of all the other
members, Mudinda (2006).
Throughout the 1980s and the 1990s, these MFI s programs improved upon the original
methodologies and bucked conventional wisdom about financing the poor. First, it was shown
that poor people, especially poor women, repay their loans. Near-perfect repayment rates,
unheard of in the formal financial sectors of most developing countries, were common among
the better credit programs. Second, the poor were willing and able to pay interest rates that
followed MFIs to cover their costs. Third, the combination of these two features; high repayment
and cost-covering interest rate enabled some MFIs to achieve long-term sustainability while
reaching large numbers of clients. The promise of microfinance as a strategy that combines
massive outreach, far reaching impact and financial sustainability makes it unique among
development interventions, according to Saleemi (2007).
In economics, inflation is a rise in the general level of prices of goods and services in an
economy over a period of time. When the price level rises, each unit of currency buys fewer
goods and services; consequently, inflation is the destruction of the purchasing power of money
a loss of real value in the internal medium of exchange and unit of account in the economy.
Constant real value non-monetary items never maintained are treated like monetary items under
historical cost accounting. Consequently their real values are destroyed at a rate equal to the rate
of inflation because inflation destroys the real value of money which is the monetary unit of
account. A chief measure of price inflation is the inflation rate, the annualized percentage change
in a general price index (normally the Consumer Price Index) over time Inflation can have
positive and negative effects on an economy. Negative effects of inflation include loss in
stability in the real value of money and other monetary items over time; uncertainty about future
inflation may discourage investment and saving, and high inflation may lead to shortages of
goods if consumers begin hoarding out of concern that prices will increase in the future. Positive
effects include a mitigation of economic recessions and debt relief by reducing the real level of
debt, according to Wanjiku (2008)
Economists generally agree that high rates of inflation and hyperinflation are caused by an
excessive growth of the money supply Views on which factors determine low to moderate rates
of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real
demand for goods and services, or changes in available supplies such as during scarcities, as well
as to growth in the money supply. However, the consensus view is that a long sustained period of
inflation is caused by money supply growing faster than the rate of economic growth, according
to Njoroge (2008)
The relationship between a countrys financial sector and its economic development has tasked
economic historians and theoreticians and development policy makers alike, although from
different perspectives and for different reasons. The 1950s and 1960s were shaped by the need
for the reconstruction and development of economies destroyed by war, leading to a concept of
financing which centred on the transfer of capital. Consequently, in the development policy of

the 1960s and 1970s, financial sector promotion was regarded in terms of the necessary capital
transfer to developing countries. This was expressed primarily in the development banks founded
in the 1950s and 1960s. However, from the start of the 1970s, a number of economists
recognised that the financial sectors of the developing economies themselves constituted a
significant obstacle to development in the way they function and their limitations. Even so, it
was not until the late 1980s that discussion broached the role of financial systems in the
development process. This discussion led to development policy interest focusing on the
functioning of national financial systems and the financial institutions operating within them.
This put development cooperation through a complete volte-face, from financing development
to developing financing.
Particularly disappointing here was the minimal success of development banks in reaching their
target groups and improving the situation of the poor. At the start of the 1980s, German
development cooperation began studying the financial institutions of the South to see how
financial services and savings and credit products could be made accessible to previously
excluded population groups. This was the beginning for microfinance in German development
cooperation. The evolution of microfinance was decisively influenced by examples of successful
financial institutions organised on a self-help basis, such as Grameen and SEWA, where
mobilising savings had proved a key feature. For German development cooperation in the
financial sector, the development of the self-help concept and its link with financial self-help
(mobilising savings and lending by local financial institutions) quickly became a central feature.
This characteristic has remained to this day, forming a sharp distinction between German
approaches to microfinance and the approaches of, for instance, US NGOs. Early examples of
approaches to develop the financial system based on self-help practices are the financial
cooperation project village savings funds in Dogon, Mali (1986) and the linkage of banks with
self-help groups in southeast Asia (1989).
Finally, the diversity of financial institutions in Germany itself - with its commercial
banks,savings banks and cooperative banks - has played a decisive role in shaping the role
ofGerman development cooperation in the financial sector. For example, the GermanAssociation
of Savings Banks and Giro Banks (Deutscher Sparkassen und Giroverband,DSGV) organised
exchange programmes in the early 1980s for representatives o
2.2.1 Lending capacity
This is the amount of money on reserve, for members to apply. Inflation is mainly caused by
sudden rise in prices of other items but mainly household commodities in the market. This has a
multiplier effects on the MFIs lending capacity, in that most loan applicants will apply for huge
sums of money, to spend on their daily needs due to high prices of basic goods. But the fixed
cost of processing loans of any size is considerable: assessment of potential borrowers, their
repayment prospects and security; administration of outstanding loans, collected from delinquent
borrowers and so on. There is a break-even point in providing loans or deposits below which
banks lose money on each transaction they make. Low income earners usually fall below the
break even point, according to Faulu Kenya Magazine (2008)

In addition, most members of Faulu Kenya Limited have few assets that can be secured by the
institution as collateral. As documented extensively by the management, even if they happen to
own land in the, they may not have effective title to it. This means that the institution will have
little recourse against defaulting borrowers from www.faulukenya.org.ke.
From a broader perspective, it has long been accepted that the development of a healthy national
financial system is an important goal and catalyst for the broader goal of national economic
development. However, the efforts of national planners and experts to develop financial services
for their nations' majorities have often failed since World War II, due to high inflation rates,
leading to financial institutions failing to have sufficient funds for their members, by Adams,
Graham & Von Pischke (1960) in their classic analysis 'Undermining Rural Development with
Cheap Credit'.
The simplest dynamic model to bring out this idea, used in Boal and Ransom (1997), is one
where the lending capacity is controlled by the Central Bank that determine how much reserve
rates should a microfinance institution posses and this has an impact on the loaners. The lending
capacity is thus a weighted average of the short- and long-run inverse as set and standardized by
the Central banks of Kenya. It follows that, as the long-run (direct) supply of money to finance
institutions tends to be much higher than the short-run one, this very simple dynamic model
predicts the need to regulate the amount of finances to be loaned to Financial institution keeping
in mind the rate of inflation has perverse effects, due to the distorted signals they send to the
market. Artificially high rates of interest charged by central bank discourages future
establishment and creation of microfinance institution, resulting in yet further shortages in
money available for the members to apply. Temporary controls may complement a recession as a
way to fight inflation. However, in general the advice of economists is not to impose lending
capacity rates controls, but to liberalize it by assuming that the economy will adjust and abandon
unprofitable economic activity.
Ledgerwood (1993 pointed out that most needs are met through mix of saving and consumption
which are influence by the inflation. A benchmark impact assessment of Grameen Bank and
two other large microfinance institutions in Bangladesh found that for every $1 they were
lending to clients to finance rural non-farm micro-enterprise, about $2.50 came from other
sources, mostly their clients savings. This parallels the experience in the West, in which family
businesses are funded mostly from savings, especially during start-up.
Rutherford (2001) argues that the basic problem relating to inflation and lending capacity is that,
low income people as money managers face is to gather a usefully large amount of money.
Building a new home may involve saving and protecting diverse building materials for years
until enough are available to proceed with construction. Childrens schooling may be funded by
buying chickens and raising them for sale as needed for expenses, uniforms, etc. Because all the
value is accumulated before it is needed, this money management strategy is referred to as
saving up. All these activities have an impact on the inflation rates.
He further noted that people dont have enough money when they face a need, so they borrow. A
low income family might borrow from relatives to buy land, from a moneylender to buy rice, or
from a microfinance institution to buy a sewing machine. Since these loans must be repaid by

saving after the cost is incurred, Rutherford (2001) called this is called saving down.
Rutherford's point is that MFIs are addressing only half the problem, and arguably the less
important half: poor people borrow to help them save and accumulate assets. MFIs should fund
their loans through savings accounts that help low income people manage their myriad risks.
The central Bank of Kenya is exploring ways of lowering the cost of money, to make lending to
the private sectors cheaper. According to the Central Bank of Kenya governor Professor Njuguna
Ndungu, Daily Nation 30th Jan 2010 during a press conference on how lending rates are
affected by inflation he said that Central Bank is exploring ways of lowering the cost of money
to make lending to the MFI s cheaper. This will in part be aimed at addressing market
inefficiencies cited by commercial banks as reasons for not lowering their lending rates, despite
the regulators earlier efforts to bring them down.
He further pointed out that the CBK will be licensing the first credit reference bureau from first
week of February, 2010, allowing banks and MFI s to share information on borrowers and
helping reduce the risk of default by weeding out serial defaulters. Collecting data to a central
point will also help reduce the cost of searching for information to assist in analyzing and pricing
debt. Professor Ndungu the Central Bank governor pointed out that It might be our turning point
in how we look at lending when addressing deliberation by the banks advisory organ, the
monetary policy committee (MPC) Daily Nation 30th January 2010. Professor Ndungu still said
that the Central bank will be opening currency centers in various towns therefore, increasing
cash dropping and picking points for financial institutions
Currently, CBK has only four branches, Eldoret, Kisumu, Mombasa and the head office in
Nairobi, a situation that makes the cost of transporting cash expensive. CBK is also planning to
introduce 25-year and 30-year bonds to help lengthen the maturity profile of the debt in the
market and offer borrowers and lenders a pricing benchmark. Says Professor Njuguna on Daily
Nation 30th January 2010.
Over the past two years CBK has successfully introduced 15 year and 20- year bonds, which are
now being used by MFI s and Corporate Banks to price bonds helping them borrow cheaper
money from the public than what commercial banks are offering The market regulator is also
seeking ways to revive development banks products in the market to compete with commercial
banks as an alternative-lending outlet for private sector.
Morris Aron Author Kenya times newspapers, pointed out that, in the depths of despair, there is
always an opportunity, or so the saying goes.Low-end money lenders seem to have taken a cue
from the saying to cash in on a gap left by mainstream financial institutions that have slowed on
lending to households for fear of possible rise in cases of loan default.Reports indicate that
micro-finance institutions are witnessing an upsurge in the number of customers looking for
small to medium value short-term loans.The latest realignment in the banking circles comes at a
time when most commercial banks posted a mixed bag of results in the first-half, with Equity
Bank reporting a 15 per cent decline in pre-tax profit, while Standard Chartered Kenya recorded
the highest growth of 43 per cent.

KCB and Barclays Kenya, ranked first and second by assets, both posted modest single-digit
increases in first half profit.
Standard Chartered, Kenyas third biggest bank (by assets), has been investing in technology
infrastructure, but it has not added many branches, unlike major rivals who moved aggressively
to rope in low-end customers.
A businessman takes his stock to the market. Mainstream banks have shied away from lending to
small sized enterprises. Customers served at one of the local banks. The hunt for low-end clients
has proved costly to some of the banks earnings.
"Banks that went gung-ho, opening all their branches last year, had their profit come down
because this has not been a good year. Banks that were conservative did pretty well," Mr Stephen
Gugu, (2010) an analyst at Stanbic Investments was recently quoted saying by Reuters.
Barclays announced that its 2009 fiscal half year profit rose 7.5 per cent. Net profit for the sixmonth period rose to Sh3.1 billion from Sh2.89 billion reported for the same period last year.
The growth was mainly attributed to a 5.5 per cent decrease in other operating expenses. Mr
Adan Mohamed, managing director of Barclays Kenya, said: "These record results were
achieved in a very challenging business environment and are largely attributed to stringent cost
management and excellent focus on the quality of our loan book. Our significant improvement in
loan loss provision indicates the high quality of Barclays loan portfolio, despite a demanding
business environment. Whilst we continue with our growth plans that started in 2007, we will
drive quality over volumes."
He further reckons that when compared to the same period last year, income was broadly flat,
reflecting this tight portfolio management and a slight change in the mix of assets. Mohamed
(2010), says operation costs have also remained flat despite high inflationary pressures
experienced during the period under review.
"This reflects managements increased focus on efficiency and resource optimisation." However,
information now filtering through indicates that not all was rosy for the banks in their hunt for
low-end clients. Only Stan-Chart that remained loyal to their tradition clients saw hefty increases
in profit.
The current changed approach to slow on the aggressive hunt for low-end clientele has been a
blessing in disguise for microfinance institutions that fortified their position in this market
segment. These institutions are able to effectively serve this market segment that is seen as high
risk, owing to the high interest charges that shield them from such risks.
South African low-end lender, Blue Financial Services, said the number of people applying for
loans has gone up almost tenfold, as many seek alternative ways to address short-term cash flow
issues in the face of harsh economic conditions after banks went easy on lending. "As you can
see from the level of enquiries, the number of customers has gone up considerably," said a
manager who deals with customer enquires and processing of loan requests and who asked not to
be quoted.

"Most people say they are opting for (our) services after attempts to secure loans from
mainstream banks proved futile. The trend has seen Blue Financial Services open more
branches across the country after signing agreements with the Government to offer credit
facilities to Civil Servants and members of the Teachers Service Commission.
As a result of the growing demand for its services, Blue Financial Services has been on an
expansion mode. The firm recently opened new branches in various towns across the country,
including Mombasa and Kisumu, in addition to launching a new product Easy Loan that allows
one to secure credit of between Sh10,000 to Sh50,000 and approval done within 20 minutes if
they comply with the terms and conditions of the organisation. The loan repayment period
average six months to a year.
The emerging trend is playing out in various other firms that specialise in small loans to the lowend of the market, including Savings and Credit Co-operatives (Saccos).At Platinum Credit, for
example, the number of customers looking for short-term credit has gone up by 30 per cent in the
last five months. The trend is the same for those looking for other financial services such as
discounting of cheques or loans.
Aron (2010 ) further noted that many customers, were opting to secure loans against shares held,
property like cars or looking to discount cheques instead of waiting for days for it to be cleared.
Analysts say the emerging trend is likely to result in another wave of market share turf wars as
banks like Equity and the latest entrant Nigerias United Bank of Africa and a number of microfinance institutions including K-Rep, Jamii Bora Trust and Kenya Women Finance Trust seek to
strengthen their dominance in the low-end lending forte. The growing trend is likely to elicit
reaction from Equity Bank that has traditionally banked on the low-end of the market, a segment
that is credited with the banks impressive growth record.
But lately, Equitys rapid growth and high profitability began showing signs of slowing down
after the economy tanked under the pressure of high food prices, skyrocketing inflation and the
effects post-election violence.
These effects hit small and medium size income earners who formed the bulk of clients in the
low-end market segment hard. "We will continue to focus on the low-end of the market and are
not going to change our banking model," said Mr James Mwangi, (2010) Equity Banks chief
executive, after the bank registered a drop in profitability in its half-year reports
2.2.2 Lending policy
According to the Faulu Kenya Limited Publication ( 2009), a lending policy is statement of its
philosophy, standards, and guidelines that its employees must observe in granting or refusing a
loan request. These policies determine which members of the industry or business will be
approved loans and which will be avoided, and must be based on the central bank relevant laws
and regulations.
From www.wikipedia.com, which pointed out that (variable rates model) to investigate the
implications of bank lending policy. In the first equation the model focuses on Microfinance

Institutions decision to grant a loan, in the second the probability of a member defaulting. The
Microfinance main task is to confirm that it provides loans to members in a way that is not
consistent with members defaulting risk minimization.
According to Rukwaro, M.W (2001), the lending policy must thus either be efficient that is able
to assess loan applicants characteristics than expected profit maximization. The lending policy
has to take into consideration the value at Risk, being a value weighted sum of individual risks,
provides a more adequate measure of monetary losses on a portfolio of loans than default risk.
Faulu Kenya Limited derives a Value at Risk measure for the sample portfolio of loans and
shows how analyzing this can enable MFI s to evaluate alternative lending policies on the basis
of their implied credit risk and loss rate, inflation and make lending rates consistent with the
implied Value at Risk.
According to wikipedia.org/wiki/Policy, Microfinance lending policies frequently have side
effects or unintended consequences. Because the environments that policies seek to influence or
manipulate are typically complex adaptive systems (e.g. governments, societies, large
companies), making a lending policy change can have counterintuitive results. For example, a
Microfinance Institution and the government may make a policy decision to raise lending rates or
interest rates, in hopes of increasing overall revenue. Depending on the size of the lending rates
policy increase, this may have the overall effect of reducing revenue by causing by creating a
rate so high that members are deterred from applying huge sums of loans from the Institution.
The lending policy formulation process typically includes an attempt to assess as many areas of
potential lending policys impact as possible, to lessen the chances that a given policy will have
unexpected or unintended consequences. Because of the nature of some complex adaptive
systems such as societies and governments, it may not be possible to assess all possible impacts
of a given lending policy formulated and adopted by MFI s
Mudinda (2006) an Economist, pointed out that the inflation has a impact on MFI s loan lending
policy unless they are inflation-adjusted to keep their real interest rates constant. In many
countries, members saving, pension benefits, and government entitlements (such as social
security) are tied to a cost-of-living index, typically to the consumer price index. A cost-of-living
allowance (COLA) adjusts salaries based on changes in a cost-of-living index. Salaries are
typically adjusted annually. They may also be tied to a cost-of-living index that varies by
geographic location if the employee moves.
According to the Kenya Times the author Kalajian (2010) wrote that, the government of Kenya
was able to pass the Finance and Microfinance Bill. The bill, drafted in 2000, requires all
microfinance institutions (MFIs) to be open to mandatory audits from the Central Bank of Kenya
(CBK), the authority that regulates the countrys commercial banks. Kenyan President Mwai
Kibaki supported the bill in an effort to curtail the entry of bogus microfinance institutions into
the market.
Before the enactment of this bill, the MFIs operating in Kenya (over 200) were unregulated
unless they optionally entered the Association for Microfinance Institutions (AMFI), based in
Nairobi and funded by a USAID grant. Under this system, MFIs like Kenya Akiba Micro-

Finance Limited were able to take advantage of the lack of regulations and fraudulently accept
deposits. Under pressure from two depositors, the CBK was able to close the organizations
office but cannot yet return any of the money.
Under the new bill, MFIs operating in Kenya are vulnerable to the fines imposed by the CBK
that can reach KES 1 mn (equivalent to USD 14,376) for every guideline to which they do not
comply.
According to Kimanthi Mutua (2010), chairman of the AMFI, the new regulations will protect
the 60 percent of the Kenyan population who are out of the scope of the formal banking services
from bogus MFIs. The National Micro and Small Enterprise Baseline Survey of 1999 reports that
20 percent of the countrys total employment in 1999 was involved in microenterprises,
contributing to 18 percent of overall gross domestic product (GDP) and 25 percent of nonagricultural GDP.
2.2.3 Interest rates
According to the January (2010) Nation Newspaper; Customers look to micro-finance
institutions for money, they are paying through the nose in terms of interest rates, as these Micro
Finance Institutions seeks to limit their level of exposure. On average, members pay interest rates
of 25 per cent to 30 per cent on the principal amount loaned compared to banks charges, whose
rates range from between 14 per cent and 18 per cent. Experts say such high interest rates are
necessary to enable Micro-financial institutions cover their level of exposure "Lending is a high
risk venture and the interest rates should reflect the level of risk," explained Mr Peter Oyando,
Daily Nation 22ND January,2010, the Managing Director of Grofin Kenya a multi-national
finance and development outfit.
According to wikipedia.org/wiki/ Low income people who borrow from micro finance
Institutions often rely on relatives or a local moneylender, whose interest rates can be very high.
An analysis of several studies of informal money lending rates in fourteen countries in Asia,
Latin America and Africa concluded that 76% of moneylender rates exceed 10% per month,
including 22% that exceed 100% per month. Moneylenders usually charge higher rates to poorer
borrowers than to less poor ones. While moneylenders are often demonized and accused of
charging high interest rates, their services are convenient and fast, and they can be very flexible
when borrowers run into problems. Hopes of quickly putting them out of business have proven
unrealistic, even in places where microfinance institutions are very active like in rural areas.
The latest migratory trends to seek loans from micro-finance institutions come after policy
makers and politicians reiterated calls to Microfinance Institutions to lower interest rates to spur
economic growth. According to Mudinda (2006) Economics simplified, interest rates are what
banks charge their customers. Also known as the lending rate, for this reason, it is usually the
best loan rate available to loan applicants. Interest rates are important because it affects liquidity
in the financial markets. A low rate increases liquidity by making loans less expensive, therefore
easier to get. When lending rates are low, businesses expand and so does the economy. He
further pointed out that similarly, when the lending rates are high, then liquidity dries up, and the
economy will start to slow. For this reason, banks will usually only raise the interest rate. This is

true even though banks would technically make more on an individual loan when rates are
higher. However, since this would decrease the number of loans applied for, this would slow the
loan business overall.
According to Ledgerwood (2007), Inflation can also be caused by international lending and
national debts. As members to microfinance institutions borrow nations borrow money, they
have to deal with interests, which in the end cause inflation rates to rise as a way of keeping up
with their debts. A deep drop of the exchange rate can also result in inflation, as microfinance
institutions will have to deal with differences in the grants and loans available to members to
apply.
There has also been much criticism of the high interest rates charged to borrowers. The real
average portfolio yield cited by the a sample of 704 microfinance institutions that voluntarily
submitted reports to the Micro-Banking Bulletin in 2006 was 22.3% annually. However, annual
rates charged to clients are higher, as they also include local inflation and the bad debt expenses
of the microfinance institution. Muhammad Yunus has recently made much of this point, and in
his latest book argues that microfinance institutions that charge more than 15% above their longterm operating costs should face penalties.
According to ledgerwood (2000) noted the role of donors has also been questioned. The
Consultative Group to Assist the Poor recently commented that "a large proportion of the money
they spend is not effective, either because it gets hung up in unsuccessful and often complicated
funding mechanisms (for example, a government apex facility), or it goes to partners that are not
held accountable for performance. In some cases, poorly conceived programs have retarded the
development of inclusive financial systems by distorting markets and displacing domestic
commercial initiatives with cheap or free money.
There has also been criticism of micro-lenders for not taking more responsibility for the working
conditions of poor households, particularly when borrowers become quasi-wage labourers,
selling crafts or agricultural produce through an organization controlled by the MFI. The desire
of MFIs to help their borrower diversify and increase their incomes has sparked this type of
relationship in several countries, most notably Bangladesh, where hundreds of thousands of
borrowers effectively work as wage labourers for the marketing subsidiaries of Grameen Bank.
Critics maintain that there are few if any rules or standards in these cases governing working
hours, holidays, working conditions, safety or child labour, and few inspection regimes to correct
abuses, some of these concerns have been taken up by unions and socially responsible
investment advocates, Peter Onyando (2010)
2.2.4 Membership
Membership refers to interested individuals or groups who have fulfilled the required procedures
to be eligible contributors and beneficiaries to a Micro finance Institution. Inflation has an
indirect impact on recruitment of new members to these institutions. When the prices are high
ssimilarly, when the prime lending rate is high, then liquidity dries up, and the economy will
start to slow. For this reason, banks will usually only raise the prime interest rate when the Fed
Funds rate is increased. This is true even though banks would technically make more on an

individual loan when rates are higher. However, since this would decrease the number of loans
applied for, this would slow the loan business overall, Saleemi (2006).
Those who earn low income may not be left with enough money to join a microfinance
institution like Faulu Kenya Limited,Mwiru and Alex Muthengi Mburi Financial Times (2010).
The registration of new members will be too low during this period of high inflation rates, at the
same time those who are already registered members may not be active, on issues regarding
monthly contribution to fund to the Institution. After the 2007 disputed presidential elections,
Faulu Kenya offices remained closed for the beginning of January 2008, due to the fact that the
inflation rates went up leading the prices of foodstuffs going up as well. This had an impact on
Faulu Kenya operations country wide, Standard newspaper June (2009).
Several studies looked at the impact of membership recruitment to a MFI s. Most found
positive, but small, impacts on the number of enrolled members in enterprises. Increases were
generally concentrated among a small proportion of members who joined with the intention of
benefiting directly from the scheme, in most cases less than 25 percent of enterprises. Most
enterprises experienced no Members enrolment. One study from rural Malawi found that the
impact on employment was primarily due to the start up of new enterprises, but this was atypical,
since most programs tend to support ongoing rather than new enterprises (Buckley 1996).
A study from Bolivia showed that new members are enrolled to the MFI s only after the
business has grown to a certain critical size in terms of sales or output. (Mosley 1996). Several
studies suggest that men are more likely than women to make a quick decision and be members
of these MFI s.
Mosley (1996) conclude that the great effects of inflation on the registration of new members to
join MFI s is a natural result of limited technological change that would demand more funds for
adopting it which makes the institution to spend a lot of money on purchasing new machinery as
compared to educating the public on the importance of coming up with small MFI s.
Faulu Kenya has achieved operational self-sufficiency: they covered administrative expenses out
of interest income and client fees. This finding leads to the important generalization that
operational efficiency can be achieved consistently in microenterprise finance, in a range of
settings, and with a variety of clientele. The prerequisites to operational efficiency appear to
include the adaptation of an effective service delivery methodology and significant institutional
competence in such areas as delinquency control, information management, and staff
development, according to the Business Magazine (2009)
Churchill, (1996)," An Introduction to Key Issues in Microfinance: Supervision and Regulation,
Financing Sources, Expansion of Microfinance Institutions," Microfinance Network,
Washington, D.C. February, argued that rising expectations of inflation can often be selffulfilling microfinance institutions. If people expect inflation to continue rising, they are unlikely
to accept to apply for loans that will earn high rates of interest less than their expected returns
from investments because they want to protect the real purchasing power of their incomes.

Average earnings for employees working with Faulu Kenya Limited comprise basic pay plus
income from overtime payments, productivity bonuses, profit-related pay and other supplements
to earned income Productivity measures output per person employed, or output per person hour.
A rise in productivity helps to keep unit costs down. However, if earnings to employees are
rising faster than productivity, then unit labour costs will increase the growth of unit labour costs
is a key determinant of inflation in the medium term, Cohen, M. (2005).
A self-help group (SHG) is a village-based financial intermediary usually composed of between
10-15 local women. Most self-help groups are located in India, though SHGs can also be found
in other countries, especially in South Asia and South east Asia. Members make small regular
savings contributions over a few months until there is enough capital in the group to begin
lending. Funds may then be lent back to the members or to others in the village for any purpose.
In India, many SHGs are 'linked' to banks for the delivery of micro-credit.
According to Robert Peck managing to go down market: regulated financial institutions and the
move into micro-savings. In Madeline Hirschland (ed.) 'Savings Services for the Poor: An
Operational Guide', Kumarian Press, Bloomfield, CT, 2005, p. 106, he poited out that self help
groups are member-based microfinance intermediaries inspired by external technical support that
lie between informal financial market actors like moneylenders, collectors, on the one hand, and
formal actors like microfinance institutions and banks on the other. Other organizations in this
transitional zone in financial market development include small micro-finance institutions in
India.
A Self-Help Group (SHG) is a registered or unregistered group of micro entrepreneurs having
homogenous social and economic backgrounds; voluntarily coming together to save regular
small sums of money, mutually agreeing to contribute to a common fund and to meet their
emergency needs on the basis of mutual help. The group members use collective wisdom and
peer pressure to ensure proper end-use of credit and timely repayment. This system eliminates
the need for collateral and is closely related to that of solidarity lending, widely used by
microfinance institutions. To make the book-keeping simple enough to be handled by the
members, flat interest rates are used for most loan calculations.
2.3 Critical Review
Critical issues associated with inflation are that lending capacity is determined by the assets and
liabilities of the issuing agency that is microfinance Institution. In real terms the issuing
authorities can issue money without causing inflation so long as the money issuer has sufficient
assets to cover redemptions.The lending policy of MFI s can adjust due to inflation risk either
by including an inflation premium in the costs of lending the money by creating a higher initial
stated interest rate or by setting the interest at a variable rate. This lending policy should not be
the case since microfinance institutions are not necessarily for profit making institution.The
primary tools for controlling the money supply are the ability to set the discount rate, the rate at
which banks can borrow from the central bank, and open market operations which are the central
bank's interventions into controlling MFI s with the aim of affecting the nominal interest rate. If
an economy finds itself in a recession with already low or even zero, interest rates, then the
microfinance should not increase these rates. A moderate level of inflation tends to ensure that

nominal interest rates stay sufficiently above zero so that if the need arises the microfinance can
lower the interest rates. Regardless of inflation rates the minimum contribution to join a MFI
should be maintained. Business environmental factors such as political factors, economic factors,
social and technological factors is to be put into consideration when advising members on how to
invest from the loans issued by the MFI s for example Faulu Kenya Limited.
2.4 Summary
Inflation has an impact on operations of MFI s in Kenya, among the interventions that may be
called for are lending policy dialogue with governments regarding supervisory standards for
microfinance, Lending capacity levels, interest rates and membership. There is need for technical
support to transforming institutions and to those who wish to develop savings services, and
support to the process of identifying and securing equity investors. As more MFI s programs
cross the hurdles of operational efficiency and then full profitability, with strategically applied
external support, they can begin to reach tens of millions of low income families with high
quality financial services. In so doing they help those families lead more secure, empowered, and
healthy lives.
CHAPTER THREE
3.0 RESEARCH DESIGN AND METHODOLOGY
3.1 Introduction
This chapter discussed the methodology that was adopted in gathering the data. Here the
researcher aimed at explaining the methods and tools and to present data in order to analyze and
get proper and maximum information related to the subject under study.
3.2 Research Design
Descriptive research design is a scientific method which involves observing and describing the
behavior of a subject without influencing it in any way, www.experiment-resources.com, it was
chosen because it enabled the researcher to generalise the findings to a larger population. This
study enabled the generalization of findings on the effects of inflation on the operation of all the
MFI s in Kenya.
3.3 Target Population
Referred to the collection of individuals or regions that were investigated in a statistical study
source, Saleemi (2008) Statistics simplified. The population of this study was made up of the top
management of Faulu Kenya and the staff. An average of 7 people from the top managements
and 38 staff members in Faulu Kenya Limited Nairobi Head office were picked. This was the
group from which the sample was drawn. In total, the populations from which the sample was
chosen comprised of 45 respondents from Faulu Kenya Limited, Nairobi Offices in Kenya.
Table 3.1: Target Population

Category Target Population Percentage (%)

Managers 7 15
Staff 38 85
TOTAL 45 100
Source: Author (2010)
3.4 Sampling Design
Sampling design is that part of statistical practice concerned with the selection of individual
observations intended to yield some knowledge about population of concern, especially for the
purposes of statistical inference. T.Lucey (2007) quantitative methods.
The study sample comprised of 40 respondents made up of managers and the staff members in
Faulu Kenya. The sample was chosen using stratified sampling technique. This technique means
that the population was first of all categorised into strata. For this study, the stratas were Top
managers and the staff. This method was considered appropriate as it would enable the
researcher to get diverse views on the effects of inflation on the operations of MFI s in Kenya.
Table 3. 2 Sample of the study at Faulu Kenya Limited, Nairobi
Category Target Population Sample size % of sample size.
Managers 7 4 10
Staff 38 36 90
TOTAL 45 40 100
Source: Author (2010)
3.5 Data Collection Procedures and Instruments
3.5.1 Data Collection Instruments.
This are the tools used to facilitate data collection from the identified population of study, to aid
this study. Questionnaires were used to obtain important information about the population.
3.5.1.1 Questionnaires
These are questionnaires designed in such a manner that the respondents were to fill in the blank
spaces or tick appropriate boxes as per the questions asked. The questionnaires were
administered using drop and pick method, meaning that the respondents were left with copies to

fill, after five days the researcher collected the filled questionnaires. The questionnaires were
used because it allowed the respondents to give their responses in a free environment and helped
the researcher get information that would not have been given out had interviews alone been
used. 40 copies of the questionnaires were be printed and distributed to the targeted group of
respondents.
3.6 Data Analysis
Data analysis is a process of inspecting, cleaning, transforming, and modeling data with the goal
of highlighting useful information, suggesting conclusions, and supporting decision making.
Data analysis has multiple approaches, under a variety of names, in different business, science,
and social science domains.
In regard to this study the data was analyzed in a way that it was easy to be understood by the
researcher. The researcher used qualitative and quantitative technique in analysing the data. After
receiving questions from the respondents, it was edited, classified, coded and tabulated to
analyze quantitative data. Tables and charts were used for further presentation.
Due to the nature of research on effects of inflation on the operations of Microfinance
institutions, questionnaires were identified to aid this study. The main reasons are that
questionnaires were cost effective as compared to kept company records, written questionnaires
were more cost effective as the number of research questions increases, questionnaires were easy
to analyze, data entry and tabulation for nearly all surveys were easily done, questionnaires were
familiar to most people, almost everyone had some experience completing questionnaires and
they generally do not make people apprehensive, they reduce biasness, there was no uniform
question presentation and no middle-man bias. The researcher's own opinions did not influenced
the respondent to answer questions in a certain manner. There were no verbal or visual clues to
influence the respondent. Questionnaires were less intrusive than telephone or face-to-face
surveys. When a respondent received a questionnaire in the mail, he/she was free to complete the
questionnaire on his own time-table. Unlike other research methods, the respondent was not
interrupted by the research instrument.
CHAPTER FOUR
4.0 DATA ANALYSIS, PRESENTATION AND INTERPRETENTATION
4.1 Introduction
This chapter deals with data analysis, presentation and interpretation of the research findings,
these explained the procedures and techniques applied to analyze and present the data obtained
through the use of the questionnaires.
4.2 Quantitative Analysis
Quantitative data analysis refers to scientific method of investigation that is based on numeric
data. This data is represented in form of numbers; numeric values numeric levels and categories.

The dominant method of quantitative research is to describe, predict and explain the
phenomenon. This can be achieved through collecting numerical data on the observable behavior
and subjecting it to statistical analysis. This study constituted quantitative methodologies
especially in the closed ended questions as shown in the following tables, graphs and charts.
4.2.1 Response Rate
The researcher administered questionnaires to the respondents for them to fill. 40 questionnaires
were issued to the respondents; the response rate was 75 % representing an impressive return
rate, which was represented by an Actual Response of 3 from the managers and 27 from the staff
adding up to 30 respondents.
Table 4.1 Response rate
Categories Sampling Size Actual response. Percentage. No response
Managers. 4 3 10 none
Staff 36 27 90 10
TOTAL 40 30 100 10
Source: Author (2010)
Figure 4.1 Response rate
Source: Author (2010)
The graph shows the analysis of the response rate; this demonstrates the relationship between the
sample size and the actual response rate. The chart shows the two respondents who were issued
with the questionnaires in each respondents category and the number of respondents who
answered and handed back the questionnaires. The chart shows that a total of 40 questionnaires
were issued to the respondents in two categories of Managers 4 questionnaires and the Members
of Staff 36 ,the actual response rate percentage was; 10%, and 90% in the two categories
respectively. The data obtained from the total response rate was further analyzed through the use
of quantitative and qualitative techniques. The response rates versus the sample group were 75%,
which was satisfactory for this study.
4.3 Quantitative Analysis
Quantitative analysis was carried out to determine the number of response rates in each of the
research questions.
4.3.1 Gender
On gender the findings were as follows;

Table 4.2 Gender

Gender Frequency Percentage
Female 10 33
Male 20 67
Total 30 100
Source; Author (2010)
Figure 4.2 Graph showing gender distributions at Faulu Kenya
Source: Author (2010)
The chart shows the number of males and females who participated in the study; there were more
males than females who participated in the study. Whereby 67% of male participated in the study
while 33% were female.
4.3.2 Age
Table 4.3 Ages
Age Response Percentage
20-30 20 66
31-40 5 17
41 and above 5 17
Total 30 100
Source: Author (2010)
Figure 4.3 Distributions of Ages
Source: Author (2010)
The graph shows the age of respondents who participated in the research study. Majority of the
respondents who were 67% were in the age bracket of 20-30 years. This indicated that majority
of the Top management and members of staff were between 20 and 30 years old.
4.3.3 Designation

Table 4.4 Designation

Designation Frequency Percentage
Accountant 20 66
Credit managers 8 26
Financial Manager 2 8
Total 30 100
Source; Author (2010)
Fig 4.4 Designation
Source: Author (2010)
The graph shows the designations of respondents who participated in the research study. Most of
the respondents who were 66% were Accountants followed by a draw of 26% of Credit
Managers and 08% of Financial Controllers.
4.5 Education level
Table 4.5 Education
Education Level Frequency Percentage
Post graduates 12 40
Graduates 10 34
A-Level 4 13
O-levels 4 13
Total 30 100
Source: Author (2010)
Fig 4.5 Educational level
Source: Author (2010)
The graph shows the education level of respondents who participated in the research study.
Majority of the respondents who were 40% had attained a minimum of Post Graduate Education.

Table 4.6 To determine the effects of lending capacity on inflation factors affecting operations of
microfinance institutions.
Introduction: The analysis on the effects of lending capacity on inflation factors affecting the
operations of microfinance institutions was as follows.
Effect on lending capacity Response Percentage
Very much 15 50
Much 6 20
Not at all 4 13
Not much 3 10
Not sure 2 07
TOTAL 30 100
Source: Author (2010)
Fig 4.6 Effects on lending Capacity
Source: Author (2010)
The graph shows the effects of lending capacity on inflation factors affecting operations of MFIs
the graph shows that majority of the respondents who were 50% indicated lending capacity has
a great effect on inflation factors affecting operations of microfinance Institutions loans lending
Capacity.
Table 4.7 Effects of lending policies on inflation factors affecting operations of microfinance
institutions.
Introduction: The analysis of the effects of lending policies on inflation factors affecting
operations of Microfinance Institutions was as follows.
Effects on lending Policy Response Percentage
Very extreme 12 40
Extreme 8 26
Moderate 6 20
Less moderate 2 7

Not at all 2 7
TOTAL 30 100
Source:Author (2010)
Fig 4.7 Effect of lending policies
Source: Author (2010)
The graph shows that lending policies has a very extreme effect on inflation factors affecting the
operations of money lending institutions. This was represented by 40% of the respondents.
Table 4.8 Effects of inflation on interest rates on inflation factors affecting operations of
Microfinance Institutions.
Introduction: The analysis on the effects of interest rates on inflation factors affecting operation
of Microfinance Institutions was as follows
Effects on interest rates Response Percentage
Very Much 20 66
Much 6 20
Not much 2 7
Not at all 2 7
TOTAL 30 100
Source Author (2010)
Figure 4.8 Effects of inflation on interest rates
Source: Author (2010)
The graph shows that interest rates have a greater effect on the operational factors affecting the
operations of microfinance institutions this was represented by 66% of the respondent.
Table 4.9 Effects of recruitment of new members on inflation factors affecting operations of
Microfinance Institutions.
Introduction: The analysis on the effects of recruitment of new members on inflation factors
affecting operations of Microfinance Institutions was as follows.

Recruitment of new members Response Percentage

Strongly disagree 5 17
Disagree 3 10
Nether agree nor disagree 5 17
Agree 15 50
Strongly disagree 2 6
TOTAL 30 100
Source; Author (2010
Figure 4.9 Effects of inflation on recruitment of new members
Source; Author (2010)
The graph shows that the recruitment of new members to a microfinance institution has effects
on inflationary factors affecting the operations of microfinance Institutions; this was represented
by 50 % respondents, who agreed that to this effect.
4.4. Qualitative Analysis
This involved the procedures that were applied to analyze, present and interpret the study
findings. This was derived from suggestions, opinions, interests, attitudes, preference and
recommendation of the respondents which was mainly found from the likert scale format
questionnaires used.
4.4.1 Lending Capacity
The respondents pointed out that inflation affects savings hence decreasing lending capacity.
They also added that inflation affects the degree at which the company retains money in its
accounts, because inflation will definitely affect the money value. A lot of money will be
pumped into savings which is exhaustive hence affects the quantity It was also noted that high
inflation rates affects the lending capacity in the sense that as inflation increases , the company
reduces its lending capacity, since it becomes expensive for people to apply for loans.
Other respondents felt the central bank is the only authority to determine the amount of money
that a MFI should have to function effectively. Generally inflation has direct effects on savings
and hence affects the lending capacity.
4.4.2 Lending policies

A good lending policy should be formulated after putting the inflation rates into consideration.
For example when the inflation rates is high finance institutions do charge high interest rates,
which are proportional to the rise in inflation rates.
A good lending policy should be flexible, in accordance to the changes in the overall business
environment. It should be easily understood and simple to apply in all ways. It has to be fair to
all members and convincing to the members.
A lending policy needs to be sound and flexible in situations which the company and the country
undergo. Inflation prepares the country to counter future challenges brought in by fluctuation of
the local currency to the foreign currency.
4.4.3 Interest Rates
Most respondents noted that when inflation rates are high, it will in turn reduce the interest rates
charged by the MFIs management institutions. When inflation rises or increases, the interest
rates charged by the MFIs automatically goes up.
Other respondents argued that inflation affects the interest rates charged by microfinance
institutions operation; in that as people apply for big amounts the interest rates are high and so
they render the institutions bankrupt, this confirms the fact that the higher the amount of loans
applied the higher the interest rates charged..
Since money has lost value microfinance institutions will be forced to revise the terms and
conditions needed to be followed before certain rates of interest is tabled down, in accordance to
the Central Bank of Kenya bank rates. It will force such institution to charge high or low interest
rates, on loans given out to members, where the bank rates are high.
4.4.4 Membership
The respondents noted that due to inflation money will lose value and the organization will
transfer this multiplier effects to the members in form of floating the MFI shares, so that the
members are encouraged to borrow loans else where in order to buy these shares. On the other
hand members will decide to off-load or sell their shares the moment they realise that the
institution is not making any progress in the market.
Lastly the management of MFI s will find it very expensive to recruit new members during a
period of high inflation, this is from the economics point of view where the public are to apply
the opportunity cost theory in making decision on how to invest the available funds.
4.5 Summary
The study analyzed 30 out of 40 questionnaires which were the major source of primary data
used in this study, hence data editing was applied as the first step of qualitative analysis. The
data obtained from the questionnaires was critically examined to detect errors and the questions
that were not answered properly, all the mistakes were corrected and poorly answered

questionnaires were exempted from analysis process. This increased accuracy, consistency and
reliability of the gathered facts. Data completeness and uniformity was maintained and this
facilitated application of other data analysis techniques like coding, data organization, data
classification and tabulation.
Coding was the second step of qualitative analysis; this involved assigning the collected data in
the questionnaires numerical values where the response rate of each respondents category was
determined, the respective response rates in each category were added together to present the
total response rate, the percentage of each respective category response rate was calculated out of
the total response rate which was 38 respondents. Coding ensured efficient analysis since it
reduced the gathered data into small number of classes which contained the most important
information. The coded data provided systematic information that easily passed a message to the
reader.
Data organization was applied, where gathered findings were organized under each respective
respondents categories, this involved putting the study findings under two categories
Management and the members of Staff at Faulu Kenya Limited
Data classification was applied and this involved grouping of data into two classes, this involved
the respondents who answered yes and respondents who answered no. The response rates from
each respondent category were grouped in each class. The relevant information was put together
to help the researcher get a solution to the research problems. Tables were used to present the
analyzed data and charts were used to give a visual presentation of the study findings.
The study applied qualitative data analysis methodology, where the qualitative analysis,
regardless of the specific approach, involves; comprehending the phenomenon under study,
synthesizing a portrait of the phenomenon that accounts for relations and linkages within its
aspects, theorizing about how and why these relations appear as they do, and re contextualizing,
or putting the new knowledge about phenomena and relations back into the context of how
others have articulated the evolving knowledge was applied. This contributed to more
understanding of the presented data answered the research questions.
This chapter discussed the data analysis and presentation of the research findings, this involved
the methods, procedures and techniques that were used to analyze and present data, which was
obtained from the questionnaires; the analysis of the response rate was made where the actual
respondents who participated in the research study were determined. The data collected through
the use of questionnaires was analyzed using quantitative techniques where tables and charts
were used to present the study findings, qualitative analysis was applied to enhance high data
validity, and this assisted interpretation of the analyzed data in a meaningful way.
CHAPTER FIVE
5.0 SUMMARY OF FINDINGS; CONCLUSION AND RECOMMENDATIONS
5.1 Introduction

This chapter brings out main findings of the study; answers research questions and objectives
and recommend what ought to be done to minimize the effects of inflation on microfinance
Institutions. This chapter narrows its focus towards giving an in-depth explanation of how
microfinance Institutions are affected by the rates of inflation. The answers to the research
questions were discussed, conclusions and research questions were explained. As an effort to
enhance or improve the management of microfinance Institutions, the study gave several
recommendations and suggestions for further studies encouraged.
5.2 Summary of findings
Microfinance institutions are affected by the rates of inflation. The variables which have been
identified in this case are lending capacity formulation of polices, interest rates and membership.
The microfinance lending capacity is controlled by the Central Bank that determines how much
reserve rates should a microfinance institution posses and this has an impact on the loaners. The
lending capacity is thus a weighted average of the short- and long-run inverse as set and
standardized by the Central banks of Kenya. It follows that, as the long-run (direct) supply of
money to finance institutions tends to be much higher than the short-run one, this very simple
dynamic model predicts the need to regulate the amount of finances to be loaned to Financial
institution keeping in mind the rate of inflation has perverse effects, due to the distorted signals
they send to the market These variable mostly affect the key influencing challenges which were
investigated by the research study, these challenges were addressed by the study objectives
where data collected under each variable stated was analyzed and presented through the use of
charts to clearly depict how each respondent felt these factor affects the operations of
microfinance institutions.
The study found out that lending capacity is a major challenge affecting the operations of
microfinance institutions. Majority of respondents outlined that lending capacity has a direct
effect on the overall operations of the microfinance. This was expressed by 44% who said that
inflation rates have an effect on the microfinance lending capacity.
The effect of formulations of microfinance policies was found to be a key problem to the
institution there exist lack of clear policies regarding how microfinance institutions .It was found
out that Microfinance lending policies frequently have side effects or unintended consequences.
Because the environments that policies seek to influence or manipulate are typically complex
adaptive systems (e.g. governments, societies, large companies), making a lending policy change
can have counterintuitive results. For example, a Microfinance Institution government may make
a policy decision to raise lending rates or interest rates, in hopes of increasing overall revenue.
These were expressed by 50% of the respondents, who noted that inflation has an extreme effect
on the lending policies adopted by the institution.
Recruitment of new members was found to depend on the rate of inflation in the economy. It was
found out that the great effects of inflation on the registration of new members to join
Microfinance institutions is a natural result of limited technological change that would demand
more funds for adopting it which makes the institution to spend a lot of money on purchasing
new machinery as compared to educating the public on the importance of coming up with small
microfinance Institutions .The registration of new members will be too low during this period of

high inflation rates, at the same time those who are already registered members may not be
active, on issues regarding monthly contribution to fund to the Institution. The effect of inflation
on the recruitment of new members was evidenced by 44% who agreed that inflation has an
effect on the recruitment on new members to the Faulu Kenya microfinance institution.
The study found out that inflation affects the interest rates charged by Microfinance institutions
on average, members pay interest rates of 25 per cent to 30 per cent on the principal amount
loaned compared to banks charges, whose rates range from between 14 per cent and 18 per cent.
Experts say such high interest rates are necessary to enable Micro-financial institutions cover
their level of exposure people who borrow from micro finance Institutions often rely on relatives
or a local moneylender, whose interest rates can be very high. The effect of inflation on interest
rates was expressed by 78% of the respondents who felt that the inflation has an effect on interest
rates charged by microfinance Institutions.
5.3 Answers to Research Questions
5.3.1 What do you think of lending capacity on inflation factors affecting the operations of
microfinance institutions?
From the study it was found out that 50% of the respondents indicated that lending capacity has a
great affect on inflationary factors affecting the operations of Microfinance. This mostly affected
the amount of money to be kept in custody by the Microfinance Institutions in Kenya.
5.3.4 What do you think of lending policies on inflation factors affecting the operations of
microfinance Institutions?
The study revealed that 40% of the respondents stated the lending policies on inflation factors
affect the operations of microfinance institutions. This is because the top management main
concern is to achieve the objectives of the established Microfinance institutions. In the same note
most policies are formulated with a consideration of environmental factors of which inflation is
one of those factors.
5.3.7 Does the interest rates charged on inflation factors affect the operations of microfinance
institutions?
Based on the study, it was revealed that 66% of the respondents demonstrated that interest rates
charged on inflation factors affects the operations of microfinance institutions. Most respondents
noted that if an economy finds itself in a recession with already low or even zero, interest rates,
then the microfinance should not increase these rates. A moderate level of inflation tends to
ensure that nominal interest rates stay sufficiently above zero so that if the need arises the
microfinance can lower the interest rates.
5.4.1 Do you agree that recruitment of new members on inflation affects the operations of
microfinance institutions?

The study revealed that 50% of the respondents agreed that the recruitment of new members on
inflation affects the operations of microfinance institutions. Most respondents noted that if
people expect inflation to continue rising, they are unlikely to accept to apply for loans that will
earn high rates of interest less than their expected returns from investments because they want to
protect the real purchasing power of their incomes. However 45% of the respondents noted that
recruitment of new members has no effect on the operations of microfinance institutions, of
which the number was considered satisfactory to the question asked
5.5 Conclusions
The lending policy should be formulated after putting into considerations the rate of inflation.
For example when the rate of inflation is high the finance institutions should charge high rates
which are proportional to the inflation rate.
A rise in inflation increases the interest rates in microfinance institution. Recruitment of new
members is slightly affected by inflation, since members shy away because of high recruitment
fee resulting from inflation.
The government policies regarding the control and regulations of Microfinance corporations
affects the operations of Faulu Kenya Limited. Various Microfinance institutions are being
established by small group as a means of savings and boosting their enterprise development
programs.
5.6 Recommendations
The study recommends the following:
5.6.1 Lending Capacity
Despite the effects of inflation on lending capacity adapted by Faulu Kenya, the institutions
should have some money in their reserve for small-scale entrepreneurs to be able to borrow in
order for them to finance their projects and also attain faster growth or development.
5.6.2 Lending Policy
Regardless of the effects of inflation, the microfinance institutions should have policies that
facilitate easy access of short term loans for the members. The micro and small scale
entrepreneurs advocated for longer repayment periods for loans and also higher loan amounts.
The repayment period ranged between 3months and 2 years. The amount of loan granted ranged
between Ksh1000 and Ksh100000. There is need to consider the loan period and the amount of
loan but this has to depend on investment requirements and repayment capacity.
5.6.3 Interest Rates
Interest rates should be maintained at minimum despite the increase of rate of inflation in the
economy. Lower interest rate encourages small scale entrepreneurs to access loans. Micro

finance institutions should play a significant role in the rural areas in Kenya especially in
providing credit to small and micro enterprises. However, there is need for lowering the interest
rates in order to encourage the establishment of production and manufacturing enterprises.
Financing the production and manufacturing enterprises especially in agriculture would benefit
more rural families for there is greater potential for employment creation.
5.6.4 Membership
Inflation affects the recruitment of new members to microfinance institutions therefore; the
contributions of individual members should be maintained at minimum, regardless of high
inflation rates. The members to Faulu Kenya were found to be credit averse. There is therefore
need to encourage the entrepreneurs to borrow from the micro finance institutions because they
will be able to attain faster growth than when they are relying on their own savings.
Microfinance institutions need to borrow a leaf from k-rep who have established an extensive
network which has covers very remote areas.
The members of this micro finance institution mainly depend on trust and default rate was found
to be very low. It is registered as a savings and credit cooperative under the ministry of
cooperative development but the members have no common bond like it happens in other
SACCOs.
5.7 Suggestion for further studies
The effect of inflation on the operations of microfinance institutions does not only depend on the
following variables, lending Capacity, lending policy, interest rates and membership. There are
other factors that affect inflation like too much money in circulation, populatiion growth and
government polices which need to be researched on.
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