SUPPLIERS OF FINANCIAL INTERMEDIATION SERVICES

Financial intermediation is an important process through which

funds are channeled from suppliers to prospective users.
Two major economic functions include: -
1. They create money
2. They administer the payment mechanism

Types of financial intermediaries

• Commercial banks
• Savings and credit associations
• Credit unions
• Pension funds
Existing microfinance providers
There are 24 large micro finance institutions in Kenya which provide us $
1.5 billion to approximately 1.5 million active borrowers in 2010.
According to their gross loan portfolio the five largest institutions are: -
• Equity bank (has a market share of 73.5%
• Kenya women microfinance bank (has a market share of 6.3%)
• K-Rep bank (has a market share of 6.39%)
• Faulu (has a market share of 3.5%
• Jamii bora (has a market share of 0.8%)
These 24 institutions offer business loans on a large-scale specific
agriculture loans, education loans and loans for any other purpose.
Understanding the country context
To analyze a country’s financial system, it is
necessary to look at both the demand for and the
supply of financial services.
 MICROFINANCE PLAYERS AND ROLE OF DONORS
Microfinance providers are found in both the public and private sectors.
Private sector MFI are often indigenous groups of NGOs operated by local
leaders in their communities, they are frequently supported by
international donors and international NGO that provide technical
assistance or funding, particularly in the startup phase.

Financial systems are generally divided into the formal, semiformal and
informal sectors.
Formal Markets
Formal markets are markets subjected to not only general laws but also to
specific regulations and supervision. Examples include Rural banks,
Commercial Banks and postal saving banks.

Merits
• Regulate status by ensuring better quality of services
• Access to commercial funding
• Potential to serve more people and offer greater loans.

Demerits
• Interest rates
• Forma requirements may increase costs
• Potential mission drift towards less poor clients
Semi-Formal market
• Like the formal market, semi-formal markets are also subjected to
general laws since they are registered entities but they are under few
exceptions. Examples include financial cooperatives, NGO’s,
registered self-help groups (SHG etc.

Merits
• Focus more on poorer markets
• Not constrained by regulations
• Subsidiary assistance

Demerit
• No access to commercial funding may restrict outreach
• Usually not allowed to offer saving account
• Possible inefficiency and lack of transparency
Informal Markets
• The type of player does not take in consideration any general rules or
regulations. The operations also conducted are so informal. Examples
do include; local traders, landlords, shylocks and other money
lenders.

Merits
• Potential to reach remote areas
• Free of observation regulation
• Greater potential to experiment with new innovative services

Demerits
• Strong dependence on donor and subsidies
• Restricted potential for outreach
What role do donors play in microfinance
Donors interest in micro finance has increased substantially over the
past few years. Virtually all donors including local bilateral,
multilaterals government donors and local and international NGOs
support microfinance activities in some way, providing one or more of
the following services: -
• Grants institutional capacity building
• Grants to cover operating shortfalls
• Grants for loan capital or equity
• Concessional loans to fund on lending
• Lines of credit
• Guarantees for commercial funds
• Technical assistance.
FINANCIAL SECTOR POLICIES

The financial sector is a section of the economy made up of firms and

institutions that provide financial services to commercial and retail
customers. The policies are the guidelines which regulate the functions
of this financial sectors.

FINANCIAL SECTOR POLICY CONSIERATION INCLUDE:

• Interest rate policies
Interest rate restrictions usually undermine an institutions ability to
operate efficiently and competitively. The restrictions disable the
ability of a firm to compete efficiently in the market and sometimes
they do not achieve the objectives intended: For instance, Kenya’s
current interest rate restrictions that is benefiting the rich instead of
the low-income earners.
MFIs need to price their loan products to allow for full cost recovery.
MFIs operating in countries that impose usury laws often have to
establish pricing mechanism that exceed the usury law.
• Government credit allocations
Most financial institutions set aside a particular amount of funds to the
informal segments of the society. For instance, most banks in Kenya
prefer to pay the penalty than risk giving out credits to the customers
who have a higher default rate. However, such customers are usually
the majority borrowers of micro-loans and other microfinance
services. Therefore, this allows business to keep going even during
times of crisis. It also increases the country’s ability to eradicate
poverty.
In addition, microfinance institutions do not have complicated systems
and steps to follow for one to access their services. This is done to
benefit the vulnerable groups in the country, such as youth, women
and poor communities. With simple ways to borrow money, such
entrepreneurs are able to finance their businesses more easily, helping
them grow and strive in the economy.
Another important point is that microfinance institutions usually have
to have a good target for the market they are trying to penetrate.
During this procedure, they perform ‘indirect targeting’. This is where
they give special types of services, which are customized for a specific
customer’s ability to pay. This may greatly benefit the people in society
who are unable to access the microfinance services ordinarily.
• Legal enforcement of financial contracts
For microfinance institutions, it is quite risky since they can give micro-
loans that do not even need much collateral. This means that it is very
easy for a borrower to default payment. Some governments therefore
enforce these contracts by giving legal sanctions and rules of
punishment in their laws. It is therefore useful for the microfinance
providers to determine various legal sanctions available when clients
do not adhere to their agreements, Usually, after default, the
punishment may be to convict the borrower who did not pay back in
due time. Sometimes just the threat of jail or a visit from the police
can work effectively for those considering defaulting on the loan.
FINANCIAL SECTOR REGULATION AND SUPERVISION

There are several reasons as to why Microfinance institutions should

be regulated. Some of this reason causing them to be regulated do
include;
 1. Consumer Protection
The rapid commercialization of the industry has largely contributed to
the need for consumer due to excessive focus on growth and returns
instead of asset quality, misleading contractual information, excessive
interest rates, etc. but it is not the only reason. Group lending
technologies, which form the basis of many microfinance programs,
have also led to severe abuses as a result of their peer pressure
mechanism. Examples include aggressive loan collection techniques
(e.g., daily harassment, public humiliation, social exclusion, etc.) as
well as individual privacy issues
2. Control of Entry of New Providers and Credit Delivery Mechanisms
The microfinance sector has become increasingly more diverse. New
actors have entered the market with new products (saving facilities,
money transfer services, insurance) and credit/payment delivery
mechanisms. This is generally considered to be a positive development
for the poor, as new means are being introduced to better meet their
needs in a safer and more flexible way and at a lower cost. Even so,
these new products and services are not without risk, and efforts to
control the potentially negative side effects of these innovations have
so far been limited. One good example in this context is the emergence
of mobile banking. Use of this new credit/payment delivery
mechanism has grown impressively in many countries, significantly
broadening the opportunities to “bank the unbanked.” Initiatives such
as M-PESA in Kenya, Wizz it in South Africa and Smart Money in the
Philippines are all good illustrations of this successful development.
Some form of regulation is therefore considered necessary to control
for these negative side effects. The challenge, though, is how to
regulate this sector without jeopardizing innovation.
3. Preventing Fraud and Financial Crimes
Two major concerns in regard to fraud are about securities and abusive
investment arrangements such as pyramid schemes, and money
laundering. In addressing these, it is generally agreed that the same
rules should apply to MFIs as to control and prevent such cases.
Existing anti-fraud and financial crime regulation will be adequate to
address abuse in the base of MFIs. Often, the most pressing need is to
improve enforcement of existing laws rather than to create new rules.

4. Avoid a banking crisis and maintain integrity of payment systems

This can be carried out through monitoring and evaluation of various
MFIs. Auditing should be carried out on a regular and regulatory
updates and practices be maintained. Regulations in the form of capital
adequacy requirements, reserve requirements, loan loss provisions,
and loan documentation are all examples of measures to ensure an
MFI will be able to maintain its operations and avoid bankruptcy.
5. Encourage financial sector competition and efficiency
• This is achieved by MFIs partnering and collaborating with existing
institutions e.g. an NGO working with a bank to provide group loans
to a community organization, an MFI could also be incorporated as a
different organization, for which finance is just one activity for
instance training/vocational school that provides loans for its
students to set up their own enterprise.
Considerations when regulating MFIs

It’s important to establish minimum standards for MFIs while at the

same time remaining flexible and innovative. At a minimum when
regulating and supervising MFIs, five issues need to be considered
(adopted from (CGAP 1996)

1. Minimum capital requirement

They are set for all organizations entering the financial sector meaning
financial organizations wanting to formalize must have a minimum
amount of capital to support the activities (states as a currency
amount rather than as a percentage of assets). Since MFIs rely
primarily on donor funds for capital contributions, they may not have
sufficient capital to meet these rules which can limit the formalization
of micro finance organizations.
2. Capital adequacy
Refers to the level of capital in any organization that is available to
cover its risks. Conventional capital adequacy concept assumes that it’s
clear what constitutes equity and debt. In non-bank MFIs it’s necessary
to distinguish equity and debt

3. Liquidity requirements
Liquidity is the amount of cash available (or near cash) relative to the
MFI’s demand for cash. MFIs are exposed to high level of liquidity risks
seasonal factors influence many of the clients; MFIs tends to depend
on donors whose funding can be unpredictable and their non-donor
liabilities tends to be short term. If the time organization is operating
in a stable financial market, it may be able to deal with liquidity risk
through short term borrowing
• 4. Asset quality
Represents the risk to earnings derived from loans made by the
organization I.e. it measures the degree of risk that some of the loan
portfolio will be repaid. Most MFIs don’t require formal collateral and
instead base their loan decisions on character, group solidarity and
past repayment history.

5. Portfolio diversification
Refers to financial institutions’ needs to ensure that they have not
concentrated their portfolio in one geographic sector or one market
segment. Unlike other financial institutions, most MFIs have highly
specialized portfolios that consist solely of short -term working capital
loans to informal sectors clients. Although an MFI may have thousands
of loans to diverse industries externalities could affect the entire
market. Regulations should encourage MFIs to diversify their loan
portfolios through development of guidelines that limit sector
concentration
ECONOMIC AND SOCIAL POLICY ENVIRONMENT

Economic development is considered as a process by which policy

makers’ work to improve the conditions of a developing state.
Development economics covers the financial expansion, economic
growth and improvements in the general well-being of the people,
usually referred as social development. So, in general economic
development is an amalgamation of socioeconomic improvements. It is
important to understand that for a country to do well, all the sectors
need proper and equal effort at a national level. Disparities in the
sectors takes countries towards coordination failures and poor values
of social and economic indicators such as GDP, employment,
investment, trade, balance of payments, literacy rate, health facilities,
infant mortality, population and access to credit etc
Investment in infrastructure and Human resource
An important consideration when providing microfinance services is
the existence of adequate infrastructure (roads, communications
facilities, water and sewer systems) and of affordable social services
such as health, education, and nutrition. Upgrading rural primary
education and health facilities can achieve longer-term benefits for the
rural poor, especially for the poorest of the poor, by increasing the
productivity of labor. A lack of roads, electricity, communication
facilities and other infrastructure will affect the means by which an MFI
and the microenterprises it supports operate and should be taken into
consideration by both donors and practitioners.

Poverty Level
• Poverty is referred to a state or a situation in which an individual or a
community is deficient in its financial resources and rudiments to
have the benefit of minimum standards of living and well-being that’s
considered acceptable in society. Poverty depicts the level of
necessities available to the people in the developing countries. In this
context microfinance has played a significant role and has been
considered as a tool to assuage poverty level.
Government View of the Microenterprise Sector
Microenterprises and small businesses may be affected by government
policies, including excessive regulation prohibitive levels of taxation,
inadequate government protection against cheap imported products,
laxity about black markets (which results in unfair competition for the
microbusiness sector), harassment by government officials for
operating businesses on the streets, and inadequate services and high
user fees in public market structures.
Many of these regulations work effectively to encourage
microenterprises to remain outside the legal or formal mainstream.
When policies and practices negatively affect clients’ businesses, an
MFI or donor may choose to undertake environment-level
interventions, such as policy and advocacy work, in addition to
providing or supporting the provision of financial services. Advocacy
can include helping clients organize to protest unfair policies or
treatment. MFIs can influence policy by working alone.
Conclusion

Most donors have moved away from subsidized lending and are
focusing more on capacity building and the provision of loan capital.
Since microfinance is perceived by some as a panacea for poverty
alienation, donors may want to take on the same kinds of activities,
especially lending to the poorest of the poor. Meanwhile, areas in
which donors may have real advantages such as capacity building and
policy dialogue; are greatly in need of resources.
A danger of widespread donor interest in microfinance is an
oversupply of funds for on-lending in the face of limited institutional
capacity to take on these funds.
The objectives of MFI’s include providing employment, reducing
poverty, empowering women etc. This is done under government
supervision depending on the category the MFI is categorized.
Donors can also be instrumental in directing governments to various poverty
alleviation initiatives that further the development of microenterprises such
as infrastructure development and land transfer programs.
THANK YOU