Part 2 - Micro-Finance

Continuing from Social Entrepreneurship 101 - 2009, Part 1, Professor Nancy Langton and I met with a number of micro-finance institutions and banks in Nairobi, Kenya over the summer.

Group Lending Model

I learned more about the group-lending circle model in which up to 20 members guarantees the loans to individuals in the group. Each member takes turns borrowing money and once he/she pays back the money, another member is able to borrow money. If one member defaults on the loan, no other loans are disbursed until the outstanding loan is repaid. In the end, this model helps to build a credit history for each participant and reduces the need for collateral in that some MFIs perform spot checks of small business assets. For the first loan, the group must pool their savings to cover 100% of the loan, which can be a maximum of 20,000 KSH or about $260 US. Furthermore, all loan recipients must take a 3-day training program on leadership, loan management, recordkeeping, group dynamics, marketing, and business fundamentals. Even more important than basic business training to demonstrate credit-worthiness is actual experience running a business. For those without demonstrated entrepreneurial experience, they must start up and run a micro-business for up to six months before they can qualify for loans. If they eventually qualify for a business loan and their business fails, at least they will have the micro-business to fall back on. Once all the pre-requisites have been met, loan proceeds are typically distributed in 4 weeks. Thereafter, MFI representatives try to meet with loan groups on a weekly or bi-weekly basis but the sheer number of groups makes regular monitoring difficult.

Another Funding Model

Even with these methods to reduce credit risks, loan interest rates can climb close to a crippling 30% and likely contributes to the near 30% default rate (the economic downturn has also played a large role). We spent hours ruminating the possibilities between ourselves and with our Kenyan business associates about other ways to reduce risk, and therefore, provide loans @ lower interest rates to SE 101 participants with viable business plans. One model is a shared ¼, ¼, ¼ model where a local partner (such as a church or school), MFI, and the Sauder School of Business could each deposit a fixed sum of money (for example, $1,000) as security deposits for the loans. The remaining ¼ of the loan would need to be covered by the qualified borrower. We pitched this option to a few MFIs and while in principle they support the idea, we are still awaiting word from the respective decision-makers.

A potential drawback of this model is that those entrepreneurs who are not affiliated with one of our partners could be tasked with raising 1/2 or more of the loan as collateral. A key part of the risk reduction is a community group vouching for the character of the applicant. In rural areas there are a strong community bonds, but in the urban areas we need to find a surrogate community support system for a changing population.

Another way to help reduce loan risk is to help MFIs and banks train their staff in business planning, in order to help them properly evaluate the plans submitted by their clients. Furthermore, we could help them learn how to properly monitor and evaluate a business, to deal with issues early on before they threaten the viability of the business. Currently, many financial institutions simply lack the in-house knowledge and training. Many small business clients are evaluated based on "presence of simple assets", with monitoring sporadic at best. We could collaborate with the financial institutions to identify effective ways to monitor businesses effectively, given the limited resources. In return, not only could SE 101 clients be given lower interest rate loans, but also non-SE 101 clients.

A question to our readers: What other ways are there to reduce loan risk in urban areas of developing countries?


5-year Plan

We spent considerable time in Kenya developing the major parts of the 5-year plan. I’ll describe the plan in my next blog.
Posted by Kirby Leong