THE EXTENT TO WHICH DEPOSIT TAKING SACCOS PROVIDE FINANCIAL SERVICES TO MICRO, SMALL AND MEDIUM ENTERPRISES. Final Report

2014 THE EXTENT TO WHICH DEPOSIT TAKING SACCOS PROVIDE FINANCIAL SERVICES TO MICRO, SMALL AND MEDIUM ENTERPRISES Final Report Prepared by Associate Consulting Africa Ltd July-Sep 2014

Consulting Team John Wamugunda Team Leader/CEO Ephraim Njega Lead Consultant/Principal Author Mwangi Maina Consultant Joshua Owuoche Research Manager Elizabeth Nyakwea Contact and Quality Assurance DISCLAIMER We wish to point out that the opinions expressed in this report are solely those of the authors. Whereas extreme care and effort have been deployed to ensure that this work is of the highest quality possible we nonetheless take responsibility for any errors or omissions that may remain. Further, we submit that the sentiments presented hereinafter do not in any way represent the official position of The SACCO Societies Regulatory Authority (SASRA) or its associates. Signed: Date: Name: Ephraim Njega Designation: Lead Consultant Signed: Date: Name: John Wamugunda Designation: Team Leader/CEO For and on behalf of Associate Consulting Africa Ltd, Nairobi Kenya http://www.associateconsultingafrica.com/ Copyright 2014. The SACCO Societies Regulatory Authority All Rights Reserved. Proper acknowledgement must be provided whenever the work is quoted All brand names quoted are property of their respective owners II P a g e

ACKNOWLEDGEMENT We would like to thank The SACCO Societies Regulatory Authority for providing finances for the survey and for giving us the opportunity to undertake it. We would also like to acknowledge all the support received from the many staff in SASRA who we approached for support during the assignment period. The research team at SASRA was led by Mr John Mwaka. Further, we wish to acknowledge the team of data collectors, research assistants and data entry clerks who traversed the country collecting the data and spent numerous hours processing the same. This team was led by Joshua Owuoche. Finally we are deeply indebted to all the respondents who took time off their busy schedules to respond to the survey questions. Be assured that your input will greatly impact the supervision, regulation and promotion of Deposit Taking SACCOs and enhance their capacity in offering financial services to Micro Small and Medium Enterprises. ACAL Team Jul-Sep 2014 III P a g e

TABLE OF CONTENTS ACKNOWLEDGEMENT... III LIST OF FIGURES... V LIST OF TABLES... VI ACRONYMS AND ABBREVIATIONS... VII EXECUTIVE SUMMARY... VIII CHAPTER ONE: INTRODUCTION... 1 CHAPTER TWO: OVERVIEW AND SURVEY BACKGROUND... 3 CHAPTER THREE: FINANCING OF MSMES BY SACCOS... 11 CHAPTER FOUR: ACCESS TO SACCO FUNDS BY MSMES... 19 CHAPTER FIVE: PROVISION OF BUSINESS FINANCE SERVICES BY SACCOS... 26 CHAPTER SIX: CHALLENGES OF MSME FINANCING BY SACCOS... 31 CHAPTER SEVEN: REGULATORY ENVIRONMENT ISSUES... 35 CHAPTER EIGHT: CONCLUSIONS AND RECCOMMENDATIONS... 38 REFERENCES... 40 APPENDICES... 41 Appendix A: Sampling Plan... 41 Appendix B: List of Respondent Saccos... 43 Appendix C: Data Collection Tools... 46 IV P a g e

LIST OF FIGURES Figure 1: Graph of GDP Growth Rate... 3 Figure 2: Commercial Banks Weighted Average Lending Rates... 4 Figure 3: Overall Rate of Inflation... 5 Figure 4: Exchange Rates for Key Select Currencies... 5 Figure 5: Assets Held by Players in the Financial Services Sector... 7 Figure 6: Kenya s Proportionate Contribution to Africa Sacco Subsector... 9 Figure 7: Availability of MSME Loans in Saccos... 11 Figure 8: Percent of Loan Portfolio Disbursed to MSMEs... 12 Figure 9: Willingness to Scale up Lending to MSMEs... 13 Figure 10: Sources of Funds for MSME Lending... 13 Figure 11: Availability of Untapped Sources of Funds... 14 Figure 12: Preferred Alternative Sources of Funds for MSME Lending... 15 Figure 13: Challenges in Accessing Alternative Sources of Funding... 15 Figure 14: Support Needed by Saccos to Access more Funding for Lending to MSMEs... 16 Figure 15: Perception on Repayment Rate of MSME Loans... 17 Figure 16: Disaggregation of MSME Loans by Enterprise Categories... 18 Figure 17: Extent to Which Development Loans are Used for Business Purposes... 18 Figure 18: Respondents Duration in Business... 19 Figure 19: Type of Business the Respondents are Engaged in... 20 Figure 20: Duration of the Respondent s Sacco Membership... 20 Figure 21: Factors Motivating MSMEs to Join Saccos... 21 Figure 22: Access to Financial Services... 22 Figure 23: Past Borrowing from Sacco for Business Purpose... 22 Figure 24: Security Mechanisms Utilized by MSMEs in Borrowing from Saccos... 23 Figure 25: Purpose of Borrowing from Saccos by MSMEs... 24 Figure 26: Reasons for Preferring to Borrow from Saccos... 25 Figure 27: Availability of Core Business Finance Services by Saccos... 26 Figure 28: Availability of Other Financial Services... 27 Figure 29: Willingness by Saccos to Offer More Business Finance Services... 27 Figure 30: Business Finance Services Saccos are willing to Offer in the Future... 28 Figure 31: Support Saccos need to offer More Business Services... 29 Figure 32: Ability to Access Services Using Mobile Phone... 29 Figure 33: Financial Services Available to MSMEs via Mobile Phone... 30 Figure 34: Challenges Faced by Saccos in Servicing MSMEs... 31 Figure 35: Support Needed by Saccos to Overcome Challenges in Serving MSMEs... 32 Figure 36: Challenges Faced by MSMEs while Accessing Services from Saccos... 33 Figure 37: Suggestions by DTS on Improvement of Regulatory Environment... 35 Figure 38: Suggestions by MSMEs on Improvement of Regulatory Environment... 36 V P a g e

LIST OF TABLES Table 1: Composition of Financial Institutions... 6 Table 2: Performance of the Sacco Subsector in 2013... 8 Table 3: Performance of the Deposit Taking Saccos in 2013... 8 Table 4: Extent of Sacco Lending to MSMEs... 12 Table 5: Lending to Businesses by Banks as at 31 st December 2014... 12 Table 6: Characteristics of MSME Lending by Saccos... 16 Table 7: Ability to Disaggregate Loans by Given Business Criteria... 17 Table 8: Sampling Plan... 41 Table 9: Respondent Saccos... 43 VI P a g e

ACRONYMS AND ABBREVIATIONS ACAL APR ATM BOSA CBK CMA CRB DTs FOSA FSRF GDP ICT IRA KBRR KFSSR KIPPRA KNBS MFI MPC MSME RBA SACCOs WOCCU Associate Consulting Africa Ltd Annual Percentage Rate Automatic Teller Machine Back Office Savings Activity Central Bank of Kenya Capital Markets Authority Credit Reference Bureau Deposit Taking Saccos Front Office Savings Activity Financial Sector Regulators Form Gross Domestic Product Information Communication Technologies Insurance Regulatory Authority Kenya Bank s Reference Rate Kenya Financial Sector Stability Report Kenya Institute of Public Policy Research and Analysis Kenya National Bureau of Statistics Micro Finance Institution Monetary Policy Committee Micro Small and Medium Enterprises Retirement Benefits Authority Savings and Credit Cooperatives World Council of Credit Unions VII P a g e

EXECUTIVE SUMMARY The survey was undertaken in July-September 2014 by Associate Consulting Africa Ltd. Data was collected in July-August 2014. In view of the critical role played by both the Saccos and MSMEs it was found necessary to conduct a research with the overall objective of determining the extent to which Saccos provide financial services to MSMEs. Findings in relation to funding of MSMEs by Saccos include the following; i. Majority of the Saccos at 63.7% had loan products targeted at MSMEs while 36.3% did not have such products ii. A huge bulk of the allocation i.e. 64.1% is currently available to non business customers while 35.9% is allocated to business customers iii. Going by the volume of Sacco loans in 2013 the above percentages show that at least KShs 70.7 billion was lent to businesses by Saccos in 2013 iv. Majority of the respondent Saccos would be willing to expand their lending to MSMEs at 67% while 8% were unwilling while 25% did not respond to the question v. The major source of funds used for lending is member contributions/savings at 76%. Other internal sources include non-withdrawable deposits at 6%, Fosa deposits at 2% and other Sacco income at 3%. Thus internal sources account for 87% of funds lent to MSMEs while the other 13% is accounted for by external sources such as loans vi. Majority of the Saccos at 60% have other sources of funds they would like to tap into and are currently unable to, 25% do not have such while 15% did not respond vii. Saccos in seeking alternative funding sources face a number of challenges key amongst them being strict requirements/bureaucracy at 33%, inadequate government support at 29% and legal restrictions/sasra regulations at 21% viii. Regarding suggestions on support to enhance access to more funds key suggestions include government funding and support at 35%, enhancement of member education at 32% and provision of information and linkages with creditors at 21%. ix. Regarding perceptions on repayment rate by MSMEs 2% of the respondents view it as excellent, 30% as very good and 51% as good. A further 16% perceive it as fair while 1% perceives it as poor x. Majority of the loans availed to MSMEs are issued to micro enterprises at 29% and small enterprises at 40%. Thus micros and small enterprises account for 69% of such lending with the balance being accounted for by medium enterprises at 22% and large enterprises at 9% xi. Regarding the use of development loans for business purposes 10% think that development loans are to a very large extent used for business, 53% to a large extent, 25% to a small extent and 5% to a very small extent while 7% did not respond. Key findings in terms of borrowing from Saccos by MSMEs are as follows; i. The key factors motivating MSMEs to join Saccos include; to borrow from the Sacco at 40%, to develop a saving culture at 28% and low interest rates at 24% ii. The respondents had access to various financial services during the previous business year with access to Sacco being the highest at 97%, banks at 66% and mobile financial services at 45% VIII P a g e

iii. Since joining the Sacco majority of the respondents had at one point or other taken a business loan. This constitutes 91% of the respondents, 6% hadn t taken business loans while 3% didn t respond to the question iv. The most common methods of guaranteeing the loans are guarantors at 81%, salary at 16% and collateral at 14% v. Key reasons for borrowing the funds include business expansion at 34%, cash flow enhancement at 28% and buying of business assets at 16%. vi. The main reasons for preferring Saccos are low interest rates at 71% followed by favourable terms and conditions at 16% and easy security options at 13% Key findings with regard to access to business financial services are as follows; i. The provision of business finance services is relatively low in Saccos. The common services are asset financing and cheque discounting each at 46%. Others are overdraft facilities at 45% and insurance premium financing at 32% ii. Other business essential financial services available include cheque deposit at 81%, access to ATM at 71% and insurance products at 42% iii. Majority of the Saccos would be willing to offer more financial services. Up to 68% responded positively, 20% responded negatively while 12% didn t respond iv. Some of the business finance services Saccos are desirous to offer include asset finance at 29%, business loans and mortgage each at 17% and cheque clearance/deposit at 15%. v. The key support needed so as to offer more services include capacity building at 40%, access to more/cheaper funds at 39%, clear/flexible legal framework at 20% and government support also at 20% vi. Up to 45% of the respondents were able to access services via the phone while 50% were not and 5% didn t respond to the question vii. Services commonly available via the phone include deposits/withdrawals at 58%, checking balance at 17%, access to statement and loan repayment each at 13% and mobile alerts/notifications at 9% With regard to challenges encoutered in offering services to Saccos the findings are thus; i. The key challenges encountered by Saccos while offering services to MSMEs include default risks/poor repayment at 51%, inadequate funds to lend at 38% and securing loans i.e. guarantors/collateral at 23%. Others are lack of proper legal framework at 23% and difficulties in evaluating the MSMEs at 21% ii. The key suggestions on overcoming above challenges are capacity building and expanding sources of external funds each at 30% and making the legal framework flexible and clear at 23%. Other suggestions are education of members on use of funds at 20% and access to full credit information from CRBs at 15% iii. The key challenges faced by the MSMEs in accessing services from the Saccos include delay in processing loan request at 31%, limitation in amount of money that can be borrowed at 29% and getting guarantors for a loan at 24%. Others are poor service at 12% and repayment period being too short at 8% With regard to improving the regulatory environment the key findings are as follows; i. The key issues suggested by the Saccos include capacity building for Saccos at 16%, make regulations facilitative not restrictive at 13% and regulations to expand access to IX P a g e

ii. external sources of funds at 10%, facilitating sharing of defaulter s information at 9% and strengthening of MSME regulation and laws at 6%. Key suggestions by MSMEs on the improvement of the regulatory Environment include lower/regulate interest rates and fees at 28%, review restrictive Sacco bylaws and terms at 27% and assist Saccos improve efficiency at 15% In view of the above the following recommendations are made; i. SASRA should assist Saccos through regulatory and other support to access diverse sources of funds including but not limited to capital markets ii. Saccos through their umbrella bodies should lobby national and county government to provide them with cheap funding for onward lending to MSMEs iii. Saccos should have a way of accessing a centralized lender to cater for short-term gaps like is the case with banks iv. The provisions in the Sacco Societies Act need to be reviewed to provide for prudential guidelines on lending to MSMEs v. Saccos should allow for diverse loan guarantee mechanisms other than guarantors so that MSMEs can use collateral to secure loans without any need for guarantors vi. Saccos should be allowed unfettered access to full borrower information from the credit referencing bureaus. The CRB law needs to be amended accordingly vii. Saccos should keep proper records and disclosures on business lending and categorize business loans according to type of businesses financed. viii. There is need for a policy guideline/framework on lending to MSMEs by SACCOs ix. Saccos capacity needs to be enhanced to ensure they take full advantage of the regulated environment. This includes civic education on legal framework, training on MSME financing and improvement of technology and corporate governance x. Saccos should be allowed access to the national payment system to ensure they can seamlessly offer various payment solutions required by businesses xi. Saccos should exploit the SASRA license to mainstream themselves in the national financial system. The current regulation regime has improved stability and outlook of the sector and Saccos should take advantage of that to position themselves xii. Promoting Saccos ability to offer a broad array of services will minimize the need for Saccos to want to convert into banks or acquire banks xiii. Players seem to have many issues with the regulatory environment. SASRA should consider creating a stakeholders forum that can work to ensure the laws and regulations are clear and flexible and that they are understood and accepted xiv. SASRA should create regulations that enhance speedy resolution of disputes and conflicts. A responsive complaint handling mechanism should be put in place xv. The supervision needs to be tightened and more frequent reporting of Saccos and publishing of results is needed to enhance transparency and confidence in the sector xvi. SASRA needs to create more awareness on its roles and mandate and to enhance its image among stakeholders so that it is viewed as a facilitator rather than a road block. This should begin with DTS followed by SACCO members and the general public xvii. The Sacco movement needs to be better organized and to have a strong umbrella body like other financial sectors. This will ensure laws and regulations accommodates the sector s interests and also promote self regulation where possible X P a g e

1 CHAPTER ONE: INTRODUCTION 1.1 Background T he financial services sector plays a crucial role in the economy. According to Kenya Financial Sector Regulators Forum (2014) the Banking subsector by total assets accounted for 160 percent of the country s Gross Domestic Product at Constant Market Prices in 2013; Pension subsector accounted for 41 percent of GDP; Insurance subsector accounted for 20 percent; while Saccos subsector accounted for 17 percent of GDP. Capital Markets measured by market capitalization accounted for 114 percent of GDP in 2013. Sacco s are critical in ensuring financial inclusion and to achievement of Kenya s national development blue print Vision 2030. Sacco membership in 2013 rose to 3.3 million and savings in Saccos accounted for 48.55% of gross national savings, (SASRA, 2014). As of December 2013 there were 1,995 active Saccos. Out of these 135 were licensed as Deposit Taking Saccos out of 215 which have applied to be licensed as such. On their part MSMEs play a crucial role in job and wealth creation accounting for majority of new jobs created. According to Kenya Institute for Public Policy Research and Analysis (KIPPRA, 2013), the Micro and Small Enterprise (MSE) sector in Kenya is an important and fast growing sector employing 42 per cent of the working population, and accounting for 75 per cent of all modern establishments in Kenya as at 2011. Most of these enterprises operate informally thus making informal sector critical to the economy. According to Kenya National Bureau of Statistics (KNBS, 2014) the informal sector is estimated to have created 625,900 new jobs in 2013 accounting for 84.3% of all new jobs. Thus in view of the critical role played by both the Saccos and MSMEs it was found necessary to conduct a research with the overall objective of determining the extent to which DT Saccos provide financial services to MSMEs. 1.2 Purposes of the Study In view of the financing gaps and challenges faced by MSMEs there is need to explore how such gaps can be closed through better matching of demand and supply. The purpose of the study therefore is to determine the baseline situation as far as financing of MSMEs by SACCOs is concerned and to explore how this can be enhanced. 1.3 Objectives of the Study i. To determine the extent to which SACCOs finance MSMEs ii. To establish the challenges SACCOs encounter in financing MSMEs iii. To determine the challenges MSMEs face in accessing financing from SACCOs iv. To make recommendation on policy direction that SASRA can pursue to ensure increased role of SACCOs in financing and promoting MSMEs 1 P a g e

1.4 Definitions According to the Micro and Small Enterprises Act 2012 the following summarized definitions have been adopted; i. micro enterprise means a firm, trade, service, industry or a business activity (a) whose annual turnover does not exceed KShs 500,000; (b) which employs less than ten people; ii. small enterprise means a firm, trade, service, industry or a business activity (a) whose annual turnover ranges between KShs 500,000 and KShs 5M; and (b) which employs between 10 and 50 people; iii. Though a medium enterprise is not defined in this Act the common definition based on the above definition would be turnover of between KShs 5M and KShs 500M and employing between 50 and 100 people 1.5 Research Methodology The study employed both secondary and primary research methodologies. Primary research involved collecting data from the Deposit Taking SACCOs and MSMEs. A total of 113 DTS were sampled. The total number of MSMEs sampled was 492. The focus on the DTS was based on the fact that they control up to 78% of the industry s total assets (SASRA, 2013). The DTS were selected from a list provided by SASRA on a random basis. On the other hand the MSMEs were obtained from lists provided by the Saccos and the actual respondents randomly selected and thereafter harmonized to ensure proportionate representation of each category of the enterprises. The geographical coverage included all the counties where the DTS exist however Lamu and Tana River counties were omitted due to security reasons. The data was collected in August 2014. Data for the DTS was collected using selfadministered questionnaire whereas the data for the MSMEs was collected using interviewer administered questionnaire. The questionnaires comprised both close and open ended questions. The data was entered and analyzed using Microsoft Excel. 1.6 Structure of the Report Chapter One of the report deals with introduction of survey and the research methodology. Chapter Two deals with literature review and macro economic updates. On the other hand Chapter Three deals with funding of MSMEs by Saccos while Chapter Four explores how the MSMEs access funds from Saccos. Chapter Five addresses itself on the issue of provison of business financial services to MSMEs by Saccos while Chapter Six explores how the challenges encountered in offering the services can be resolved. Chapter Seven delves into the regulatory environment and explores how it can be improved for the benefit of players in the sector. Finally Chapter Eight deals with conclusions and recommendations on the way forward. 2 P a g e

2 CHAPTER TWO: OVERVIEW AND SURVEY BACKGROUND 2.1 Kenya Macroeconomic Update 2.1.1 GDP Growth Rate According to rebased GDP figures the economy grew by by 5.7% in 2013. The growth rates for preveious years are shown below depicting both the previous and revised GDP Figures Figure 1: Graph of GDP Growth Rate Sources: KNBS, 2014 While these positive trends are expected to be sustained over the coming years they are still way below the over 10% growth rate needed to achieve Vision 2030 targets. Various risks such as uncertainty regarding growth in key world economies persist. There also risks of insecurity, regional political instability and climate change in agriculture dependent economy. However opportunities also exist among them political stability brought about by Constitution of Kenya 2010, discovery and exploitation of critical natural resources in the oil, minerals and gas sectors. Opportunities also exist due to increasing regional integration. All in all the GDP outlook remains positive for the medium term. Furthermore the rebased GDP figures have catapulted the country into middle income status and positioned us among Africa s top ten economies. This will be critical in attracting new investments and buttressing Kenya s position as a regional hub. 3 P a g e

% Rate 2.1.2 Interest Rates The interest rates for the 12 months to July 2014 have been fairly stable. Concerns still remain regarding the high interest rate spread between interest on deposit and interest on loans. However the introduction of the Kenya Bank s Reference Rate (KBRR) and the Annual Percentage Rate (APR) framework are expected to introduce certainty and transparency in pricing of loans. This will make credit affordable and spur growth. The interest rates are shown in the figure below; Figure 2: Commercial Banks Weighted Average Lending Rates 20 18 16 14 12 10 8 6 4 2 0 Commercial Banks Weighted Average Interest Rates Deposit Savings Lending Overdraft Month Sources: Data CBK, Illustrations by the Author The major commercial banks in the country were charging interest rates between 19% and 25% for unsecured loans while Saccos interest rate ranged between 12% and 14% (before considering attractive dividends and interest on members savings). On the other hand, commercial bank prime lending rate (the upper rate of interest charged on unsecured loans by commercial banks to private individuals and companies) averaged 17.1% comparing unfavourably to the average Saccos lending rate of 15% in the same year (SASRA, 2014). This highlights the preference of Saccos over commercial banks by borrowers. The government has spoken of its determination to reduce borrowing from the domestic market in order to increase access to credit by the private sector and put a downward pressure on interest rates. However, rising inflation if not checked may result in higher interest rates. In its September 2014 meeting CBK Monetary Policy Committee resolved to retain the CBR at 8.5% arguing that monetary policy operations coupled with effective liquidity management will moderate the pressures arising from adverse inflation expectations. 2.1.3 Inflation Inflation remains a key concern to the financial sector due to its adverse impact on consumer s purchasing power as well as erosion of gains made on savings. Inflation has generally been on upward trend in the recent months. Average overall inflation between 4 P a g e

Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Exchage Rate % Rate January and August 2014 stands at 7.18% well over the CBK preferred target of 5%. The figure below shows inflation trends for 12 months to August 2014; Figure 3: Overall Rate of Inflation 9 8 7 6 5 4 3 2 1 0 Overall Rate of Inflation Month Sources: Data CBK, Illustrations by the Author 2.1.4 Exchange Rates Exchange rates remain fairly stable supported by diaspora inflows and investor participation at the Nairobi Securities Exchange. As at 3 rd of September 2014 usable foreign reserves stood at USD 6376.95 million equivalent to 4.21 months of import cover thus above the required 4 months of import cover 1. Foreign exchange stability remains key to overall confidence on the economy and positive sentiments. The figure below shows the prevailing exchange rates for key select currencies for 12 months to August 2014; Figure 4: Exchange Rates for Key Select Currencies 160 140 120 100 80 60 40 20 0 Unweighted Average of Buying and Selling Rates United States dollar Sterling pound Euro South Africa Rand Japanese yen (100) Chinese Yuan Month Sources: Data CBK, Illustrations by the Author 1 Central Bank Monetary Policy Committee Meeting Press Release 5 P a g e

2.2 Kenya Financial Services Sector Overview 2.2.1 Key Players in Kenya Financial Services Sector The Kenya Financial Services Sector is a key anchor of the economy. It is composed of the following institutions; Table 1: Composition of Financial Institutions Institution Type No. of Licensees Regulator Banking Sub-sector Banks 43 CBK Mortgage Finance Company 1 CBK Representative Offices 7 CBK Bank Agents CBK Forex Bureaus 112 CBK Money remittance providers 2 CBK Microfinance Banks 9 CBK Credit Reference Bureaus 2 CBK Sacco Sub-sector Deposit Taking Saccos 215 (184 licensed) SASRA Non-deposit Taking Saccos 1,780 Commissioner of Cooperatives Insurance Sub-sector Insurance Agents 4,631 IRA Insurance Brokers 187 IRA Insurance Investigators 134 IRA Motor Assessors 105 IRA Insurance Companies 48 IRA Medical Insurance Providers 29 IRA Insurance Surveyors 27 IRA Loss Adjusters 22 IRA Risk Managers 8 IRA Reinsurance Companies 3 IRA Claims Settling Agents 2 IRA Capital Markets Subsector General Institutions e.g. NSE 5 CMA Investment Banks 13 CMA Stock Brokers 10 CMA Fund Managers 24 CMA Investment Advisers 17 CMA Authorized Depositories 14 CMA REIT Managers 5 CMA REIT Trustees 2 CMA Collective Investment Schemes 18 CMA Pension Sub-sector Fund managers 16 RBA Administrators 31 RBA Custodians 10 RBA Sources: Compiled by the Author based on annual regulator s reports 6 P a g e

KShs 'million 2.2.2 Assets Held by the Subsectors The assets held by the various financial subsectors continue to grow over the years as shown in the figure below; Figure 5: Assets Held by Players in the Financial Services Sector Assets of Financial Services Sector 4,500,000 4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 2010 2011 2012 2013 Saccos Insurance Pension Banking Year Source: Compiled by the author from annual Financial Sector Stability Reports Banks constitutes the biggest share of total assets with an average of 66%, followed by the Pension subsector at 16% and Insurance and Saccos accounting for 9% each. 2.3 Overview of the Sacco Subsector 2.3.1 Background According to the Financial Sector Regulators (2012) Saccos have continued to play a critical role in Kenya s financial sector in terms of access, savings mobilization and wealth creation. Representing a considerable part of the Kenya financial sector, Sacco societies are memberbased organizations focusing on meeting financial needs of members for personal and enterprise development. Membership cuts across different economic activities, both in rural and urban areas. The Saccos are engaged either in Back Office Savings Activities (BOSAs) or the Front Office Savings Activities (FOSAs), or both. The Sacco societies operating FOSAs reflect near retail banking business operations. These deposit taking Saccos pose additional risks and are therefore subject to closer regulation and supervision. The Sacco Societies Act, 2008 and Sacco Societies (Deposit-Taking Sacco Business) Regulations, 2010 provide legal, regulatory and supervisory framework commensurate to the risks in deposit taking business of Saccos. The Sacco Societies Regulatory Authority (SASRA) is mandated under this Act of parliament, to license, regulate and supervise Sacco 7 P a g e

societies. Thus the DTS are under the regulation and supervision of SASRA. Other SACCOs (unable to meet SASRA regulatory compliance requirements) are under the supervision of Commissioner for Cooperative Development. Nonetheless all the SACCOs including those regulated by SASRA must be registered by the commissioner. SACCOs play a key role in promoting financial inclusivity and access. According to FSD Kenya (2013) access to financial services was as follows; Bank, 29.2% SACCO 10%, Microfinance Institution (MFI), 3.5%, Informal group 27.7% and Mobile Financial Service Provider (MSFP) at 61.6%. 2.3.2 Performance of the Sacco Subsector 2013 The subsector performed well recording double digit growth rates in all metrics assessed as shown in the table below; Table 2: Performance of the Sacco Subsector in 2013 MEASURE 2013 2012 CHANGE (%) Number of Saccos 1,995 1,989 0 Membership 3,294,829 2,968,688 10.9 Total Assets (KShs) 335,436,856,311 293,826,703,786 14.2 Member Deposits (KShs) 240,805,097,772 213,079,983,639 13.0 Loans and Advances (KShs) 251,878,980,092 221,554,214,917 13.7 Total Capital (KShs) 25,296,642,787 21,323,641,429 18.6 Turnover (KShs) 43,271,424,815 37,286,448,460 16.1 Source: Sacco Supervision Annual Report, 2013 The 215 DTS account for 78.0% and 77.1% of the assets and deposits for the Sacco subsector respectively. The 135 licensed DTS account for 92.4% and 92.9% of the assets and deposits of the 215 DTS respectively and this translates to 72.0% and 71.6% of the assets and deposits for the Sacco subsector (SASRA, 2014). This depicts the higher competitiveness of the DTS in attracting members and deposit. This can be attributed to new business models which offer members an array of financial services. As well enhanced regulation by SASRA reduces the DTS credibility challenges thus increasing consumer confidence. The performance of DTS is shown in the table below; Table 3: Performance of the Deposit Taking Saccos in 2013 Performance 135 Licensed DTS 215 DTS 1,995 Saccos Indicator Membership 2,612,250 2,822,553 3,294,829 Assets 241,621,964,970 261,586,510,112 335,436,856,311 Deposits 172,526,183,751 185,787,909,090 240,805,097,772 Loans and Advances 184,538,572,411 196,857,599,555 251,878,980,092 Source: Sacco Supervision Annual Report, 2013; Figures in KShs 8 P a g e

2.3.3 Key Trends in the Saccos Subsector i. Saccos are becoming more and more bank like in terms of activities and products. As a result Sacco clients are demanding nearly the same services as they are used expecting from a bank such as cheque clearing, RTGS, ATMs etc. This is forcing Saccos to contemplate acquiring banks or converting to banks ii. Saccos through FOSA are becoming more open in terms of membership thus breaking the concept of the common bond. Consequently the guarantee mechanism dependent on social collateral is being undermined iii. Enhanced scrutiny and regulation is helping increase transparency and accountability and thus raise the confidence of members and potential clients. This is likely to see an increase in contribution of Saccos to the economy iv. Increased formalization of the subsector and integration with the other subsectors. This will increase the need for Saccos to be included in the national payment system, credit referencing system and a centralized external financing mechanism v. Subsequent to the above, competition between Saccos and other financial institutions is will remain intense. This will call for innovation among Saccos while at the same time requiring the regulator to be more responsive, vigilant and robust 2.3.4 Comparison of the Kenya Sacco Subsector with other Countries According to the World Council of Credit Unions (2014) Kenya is ranked first in Africa in terms of various metrics such as members, savings & shares, loans, reserves and assets. Further analysis shows that Kenya accounts for a huge proportion of Africa s Saccos movement. It accounts for 22% of all credit unions, 28% of the membership and 54% of all savings and shares. It also accounts for 63% of loans, 55% of reserves and 62% of all assets held by the African Saccos. This is shown in the figure below; Figure 6: Kenya s Proportionate Contribution to Africa Sacco Subsector Kenya's Proportion of Africa Sacco Subsector Assets 62% Reserves Loans Savings and Shares 55% 54% 63% Members Credit Unions 28% 22% 0% 20% 40% 60% 80% 100% Kenya Others African Countries Sources: Data by World Council of Credit Unions 2 Analysis and Illustration by Author 2 World Council of Credit Unions is the global trade association and development agency for credit unions and financial cooperatives. 9 P a g e

2.4 Overview of Micro, Small and Medium Enterprises (MSMEs) The Micro Small and Medium Enterprises sector plays critical role in the Kenyan economy. This is especially so as far as creation of employment is concerned. According to Kenya National Bureau of Statistics (2014) the informal sector constituted 89.7 per cent of total employment in 2013. This can be attributed mainly to the micro-enterprises most of which are informal in nature. It is in view of MSME s critical role that the Micro and Small Enterprises Act, 2012 was enacted with the following objectives; i. providing an enabling business environment; ii. facilitating access to business development services by micro and small enterprises; iii. facilitating formalization and upgrading of informal micro and small enterprises; iv. promoting an entrepreneurial culture; and v. promote representative associations Due to their size and often informal nature MSMEs face many financial challenges. A paper prepared by Capital Markets Authority identified some of the financial access challenges for MSMEs to include the following; difficulty in employing competent people with techniques in financial management because of the salaries such people would demand, financial problems arising from late payments by debtors, and inability to raise own finance and access financial services from formal sources. Furthermore, most are unable to meet the strict financial requirements posed by banks (CMA, 2010). The enterprises also suffer a myriad of other challenges that constraints their growth. Many MSMEs employ less than 5 people, mostly family members who are usually not legally registered, apply simple and relatively rudimentary technology in production and, therefore, the quality of their products is likely to be poor. They may suffer from limited market access and fierce competition from many rival producers. This category of MSMEs usually does not have proper physical structures such as premises from which to operate business, accessible roads and other essential utilities, which are major catalysts to accessing formal sector credit. In addition, there is a general lack of professionalism within this category of enterprises in terms of strategic planning procedures, decision-making processes and business planning, and management in general. In view of the critical role played by the MSMEs in the economy and further considering their challenges in accessing finances there is need to scale up the financing of MSMEs by institutions such as Saccos. This survey thus looks at the interactions of MSMEs with Saccos in accessing funding and financial services and explores the challenges encountered and what needs to be done to enhance the situation. 10 P a g e

3 CHAPTER THREE: FINANCING OF MSMES BY SACCOS 3.1 Introduction This section deals with how Saccos provide funds to MSMEs. The size of loan portfolio currently committed to MSMEs and the characteristics of such lending. It also looks at the sources of funds available for MSME lending and explores ways in which the volume of the funds can be scaled up. 3.2 Extent of MSMEs Financing by Saccos 3.2.1 Availability of MSMEs Loans Majority of the Saccos at 63.7% had loan products targeted at MSMEs while 36.3% did not have such products. This is shown in the figure below; Figure 7: Availability of MSME Loans in Saccos Do you have loan products targeted at micro, small and medium enterprises? 36.28% 63.72% Yes No This is an encouraging outcome since majority of Saccos have products for MSMEs. This is likely to rise as more Saccos adopt a bolder commercial orientation unlike the traditional social orientation. Nonetheless as seen later in this report the Saccos need to diversify their business finance products and services to accord with the needs of MSMEs. 3.2.2 Percent of Loan Portfolio Disbursed to MSMEs Despite the high percentage of the Saccos having MSME loan products the situation is not as encouraging when it comes to the percentage of the portfolio currently lent to MSMEs. A huge portion of the lent funds i.e. 64.1% is currently disbursed to non business customers while 35.9% is disbursed to business customers. This is shown in the figure below; 11 P a g e

Figure 8: Percent of Loan Portfolio Disbursed to MSMEs Going by the performance in 2013 the above figures can be analysed as in the table below; Table 4: Extent of Sacco Lending to MSMEs Item Value Total Loans and Advances by 215 DTs 196,857,599,555 Percent allocated to business borrowers 36% Percent allocated to non-business borrowers 64% Amount allocated to business borrowers 70,716,447,685.54 Amount allocated to non-business borrowers 126,141,151,869.46. Amounts in Kenya Shillings The above figures show that at least KShs 70.7 billion was lent to businesses by Saccos in 2013. This does not compare well with banks which had in the same duration lent up to KShs 1.2 trillion. However this is to be seen in the light of the limited deposit mobilization options hitherto available to Saccos. Going forward this is expected to change as Saccos now have access to FOSA deposits which will improve their deposit volumes and in future the size of funds available for business lending. The table below shows the volume of business lending by banks as at 31 st December 2013. Table 5: Lending to Businesses by Banks as at 31 st December 2014 Banks Lending as at 31st Dec 2013 Amount (KShs billion) Total Available to Private sector 1,541.74 Less Private households (230.01) Less Consumer durables (94.67) Total available to businesses 1,217.06 Sources: Financial Sector Regulators Forum. (2014). Further Analysis by Author 12 P a g e

3.3 Expanding Lending to MSMEs 3.3.1 Willingness to Scale up MSME Lending A significant majority of the respondents Saccos would be willing to expand their lending to MSMEs at 67% while 8% were unwilling. A further 25% did not respond to the question. This is shown in the figure below; Figure 9: Willingness to Scale up Lending to MSMEs Would you be willing to increase the percentage of your lending capacity available to MSMEs in the future? 25% 8% 67% Yes No No response The high non-response is due to the fact that 36% didn t have MSME loan products and may not be willing to commit on this due to lack of experience in dealing with the sector. 3.3.2 Sources of Funds for MSME Lending The major source of funds used for lending is member contributions/savings at 76%. Other internal sources include non-withdrawable deposits at 6%, Fosa deposits at 2% and other Sacco income at 3%. Thus internal sources of funds account for 87% while the other 13% is accounted for by external sources such as loans. This is shown in the figure below; Figure 10: Sources of Funds for MSME Lending 13 P a g e

The issue of increasing lending to MSMEs is tied to sources of funds available for lending. Thus Saccos need to be assisted to expand sources of funds. While access to external sources poses many compliance risks access to internal sources especially in view of FOSA regime can be scaled up with less challenges. However there are other less risky sources of external funds such as government funds. In view of devolved government Saccos can work with county governments to strengthen their kitty and lend more to businesses. Some counties such as Kiambu have set aside funds for lending to businesses. Since the government lacks the infrastructure and manpower for such lending Saccos should explore the opportunities to participate in such business funds. 3.3.3 Availability of Untapped Sources of Funds Majority of the Saccos at 60% have other sources of funds they would like to tap into and are currently unable to. A further 25% responded negatively to the question while 15% did not respond. This is shown in the figure below; Figure 11: Availability of Untapped Sources of Funds Are there other sources of funds you would like to utilize but are currently not able to? 15% Yes 25% 60% No No response This shows Saccos are yet to ascend to full potential as far accessing the broad range of financial sources available. They therefore require regulatory and administrative support to access such sources. 3.3.4 Preferred Extra Sources of External Funds The most preferred sources of external funds are government funds at 65% followed by donors and international lenders at 32% and borrowing as per SASRA regulations at 14%. Others are capital markets at 8% and fixed deposits at 6%. These and others are shown in the figure below; 14 P a g e

Figure 12: Preferred Alternative Sources of Funds for MSME Lending Preferred Alternative Sources of Funds for MSME Lending Funding from SASRA Coop holding deposit Fixed deposits (members and others) Capital markets e.g. bonds Borrowing as per SASRA regulations Donors and international lenders Government Funds e.g. Uwezo fund 2% 3% 6% 8% 14% 32% 65% 0% 20% 40% 60% 80% Percent Responding 3.3.5 Challenges Encountered in Accessing Alternative Sources of Funds Saccos in seeking alternative funding sources face a number of challenges key amongst them being strict requirements/bureaucracy at 33%, inadequate government support at 29% and legal restrictions/sasra regulations at 21%. Other challenges are lack of information on alternative sources at 17% and high interest rates at 12%. These and other challenges are shown in the figure below; Figure 13: Challenges in Accessing Alternative Sources of Funding Challenges in Accessing Alternative Funding Forex fluctuations Lack of adequate collateral Poor perception of SACCOs High interest rates Lack of information on sources of funds Legal restriction/sasra regulations Inadequate government support Strict requirements/bureaucracy 3% 8% 11% 12% 17% 21% 29% 33% 0% 10% 20% 30% 40% Percent Responding 15 P a g e

3.3.6 Support Needed by Saccos in Accessing Alternative Sources of Funds Regarding suggestions on support to enhance access to more funds key suggestions include government funding and support at 35%, enhancement of member education at 32% and provision of information and linkages with creditors at 21%. Others are clarifying laws and relaxing restrictions at 17% and easing process of accessing such funds at 15%. These and more suggestions are as shown in the figure below; Figure 14: Support Needed by Saccos to Access more Funding for Lending to MSMEs Support Needed to Access More Funding Allow access to capital markets (NSE) Reduce taxes on FOSA income Provide guarantees for international borrowing Donor support/grants Provide access to cheaper funds Reduce interest rates Centralised lender dedicated to SACCOs Ease process of accessing such funds Clarify laws and relax restrictions Provide information and linkages with creditors Enhance member education e.g. joint marketing Government funding and support 3% 5% 6% 9% 12% 14% 14% 15% 17% 21% 32% 35% 0% 10% 20% 30% 40% Percent Responding 3.4 Characteristics of MSME Lending by Saccos 3.4.1 Key Characteristics of MSME Loans The table below highlights some of the characteristics of MSME loans offered by Saccos. Table 6: Characteristics of MSME Lending by Saccos Item Value Average Upper Limit KShs 8,061,190.00 Average Duration 29 months Average Interest Rate 15 percent This further highlights the need for Saccos to access more funds in order to raise the caps on the loans and also lend for longer durations. Strict limitations on amount and durations may make MSMEs shy away from approaching Saccos for loans. Some of these issues are raise don the section dealing with challenges MSMEs face in seeking funding from Saccos. 16 P a g e

3.4.2 Perceptions on Repayment by MSMEs Regarding perceptions on repayment rate 2% of the respondents view it as excellent, 30% as very good and 51% as good. This shows that 83% of the respondents perceive the repayment rate positively. A further 16% perceive it as fair while 1% perceives it as poor. This is shown in the figure below; Figure 15: Perception on Repayment Rate of MSME Loans 1% How would you rate repayment rate for MSME loans? 30% 2% 16% 51% Excellent While these are perceptions and do not represent the exact repayment rate in terms of percentages the positive perceptions debunks the perceptions by some Saccos that lending to MSMEs carries excess default risks. Saccos should therefore be encouraged to lend to MSMEs since fears of default risk aren t substantiated by experience. MSME lending may also be more profitable in view of the higher interest rate charged compared with loans to the salaried members. Fair Good Poor Very Good 3.4.3 Disaggregation of MSME Loans Most of the Saccos are unable to disaggregate the loans by various categories. There is need for SASRA to encourage such disaggregation as it will be critical in issuing prudential guidelines as far as lending to MSMEs is concerned. The table below shows the ability of Saccos to disaggregate MSME loans by various criteria. Table 7: Ability to Disaggregate Loans by Given Business Criteria Response % that can disaggregate by business type % that can disaggregate by business size Yes 34% 29% No 43% 42% No response 23% 29% 100% 100% 17 P a g e

Majority of the loans availed to MSMEs are issued to micro enterprises at 29% and small enterprises at 40%. Thus micro and small enterprises account for 69% of such lending with the balance being accounted for by medium enterprises at 22% and large enterprises at 9%. This is shown in the figure below; Figure 16: Disaggregation of MSME Loans by Enterprise Categories How would you disaggregate your business lending by 9% enterprise categories? 29% 22% Micro Enterprises Small Enterprises Medium Enterprises Large Enterprises 40% 3.5 Use of Development Loans for Business Purposes Regarding the use of development loans for business purposes 10% think that development loans are to a very large extent used for business, 53% to a large extent, 25% to a small extent and 5% to a very small extent while 7% did not respond. This is shown in the figure below; Figure 17: Extent to Which Development Loans are Used for Business Purposes 25% To what extent do you think development loans are used for 5% 7% business related purpose 10% This shows that apart from direct business lending Saccos also contribute indirectly to business financing through development loans. It will be important in future for SASRA to enhance reporting and disclosure to ensure that whenever development loans are applied to business purposes proper classification is done. This will ensure that the full extent to which Saccos finance MSMEs is established. 53% To a large extent To a small extent To a very large extent To a very small extent No response 18 P a g e

4 CHAPTER FOUR: ACCESS TO SACCO FUNDS BY MSMES 4.1 Introduction This chapter deals with how MSMEs access funding from Saccos, how such funds are utilized and reasons why the MSMEs prefer Saccos as compared to other financial institutions. It also deals with other aspects of the borrowing such as mechanism used in securing the borrowed funds. Understanding the salient features underlining MSME borrowing from Saccos is useful for SASRA s development of regulatory environment and for other Saccos currently developing MSME loan products. 4.2 Characteristics of Respondent Enterprises 4.2.1 Duration of Time in Business Majority of the respondents had been in business for a long enough period of time with 61% having been in business for more than 5 years and 29% for less than 5 years while 10% didn t respond. This is shown in the figure below; Figure 18: Respondents Duration in Business How long have you been in business? 10% 29% Less than 5 yrs More than 5 yrs No response 61% Considering that majority of MSMEs do not live to see their 5 th birthday it is noteworthy that longevity of the respondent in business adds weight to their responses. It can be expected that with lengthy business experience the respondents are in a better position to offer useful insights. 4.2.2 Type of Business Engaged In Majority of the respondents were in the trade and hospitality services at 42.07%, a further 32.32% were in agriculture, 14.23% were in other services such as beauty, professionals, repair etc while 7.32% were in transport. The real estate had 5.69% of the respondents involved in it. These and other business types engaged in are shown below; 19 P a g e

Figure 19: Type of Business the Respondents are Engaged in What type of business are you involved in? Mining and quarrying Electricity and water Manufacturing Communication Financial services e.g. agent Construction Real estate Transport Services (beauty, professional, repairs etc) Agriculture Wholesale/retail trade, restaurant/hotels 0.20% 0.20% 0.41% 1.42% 2.64% 3.05% 5.69% 7.32% 14.23% 32.32% 42.07% 0% 10% 20% 30% 40% 50% Percent responding This reinforces the fact that MSMEs are more likely to operate in sectors with lower barriers of entry in view of the challenges earlier discussed. As such Saccos developing MSMEs products should pay more attention to these sectors and the inherent characteristics that drive and inform the need for various types of financial services. For instance some sectors such as retail are more inclined to seeking working capital while others such as manufacturing and even farming are likely to manifest capital expenditure needs. 4.2.3 Sacco Membership All the respondents interviewed were Sacco members with 66% having been members for more than 5 years, 32% for less than 5 years while 2% didn t respond to the question. This is shown in the figure below; Figure 20: Duration of the Respondent s Sacco Membership For how long have you been a member of the SACCO? 2% 32% 66% Less than 5 years More than 5 years No response 20 P a g e

The respondent had been in the Saccos long enough for them to make meaningful contribution in the survey. Their views therefore carry substantial weight. 4.2.4 Factors Motivating Sacco Membership The key factor motivating MSMEs to join Saccos include; to borrow from the Sacco at 40%, to develop a saving culture at 28% and low interest rates at 24%. Others are social economic benefits at 14% and quick, efficient service at 12%. These and more are shown below; Figure 21: Factors Motivating MSMEs to Join Saccos What factors motivated you to join the SACCO as a businessperson? Affordable charges Favourable repayment terms Proximity to the SACCO Easy borrowing process High interest on deposits (dividend) To grow my business Quick, efficient service Social economic benefits Low interest rates Develop saving culture To borrow from the SACCO 1.4% 2% 2% 5% 5% 6% 12% 14% 24% 28% 40% 0% 10% 20% 30% 40% 50% Percent Responding Considering that borrowing is a key motivating factor for MSMEs Saccos keen on serving this market segment require adequate sources of funds to meet the demand. Therefore promoting of MSMEs lending by Saccos must go hand in hand with promoting mobilization of funds both from internal and external sources. Saccos also play a crucial role in encouraging a saving culture among MSMEs. This is crucial considering our low savings to GDP ratios. Regarding expectation of low interest rates it is important for Saccos serving MSMEs to maintain this competitive advantage. This will require access to cheap sources of funds. A situation where Saccos lending to MSMEs opt to levy high interest rates might dampen demand for Sacco loans by MSMEs. 4.3 Current Access to Financial Services The respondents had access to various financial services during the previous business year with access to Sacco being the highest at 97%, banks at 66% and mobile financial services at 45%. Other key financial services used included borrowing from individuals at 24% and informal groups at 17%. These are shown in the figure below; 21 P a g e

Figure 22: Access to Financial Services Which of the following services have you used in the last one year? Micro finance institution Pension e.g. NSSF, Mbao pension etc Insurance company e.g. NHIF Informal group e.g. chama/rosca Borrowing from individuals Mobile Financial Service e.g. M-pesa Bank SACCO 8% 9% 13% 17% 24% 46% 66% 97% 0% 20% 40% 60% 80% 100% Percent Responding The MSMEs have a higher than average access to financial services when compared with the results of FinAccess National Survey 2013. The lower than expected percentage attributed to mobile financial services can be explained by the fact that most of the respondents assumed that the use is in line with business purposes as opposed to other personal use. MSMEs with Sacco membership utilize the Sacco services more compared to other financial services. 4.4 Borrowing from Saccos by MSMEs Since joining the Sacco majority of the respondents had at one point or other taken a business loan. This constitutes 91% of the respondents, 6% hadn t taken business loans while 3% didn t respond to the question. This is shown in the figure below; Figure 23: Past Borrowing from Sacco for Business Purpose Since joining the SACCO have you ever taken a loan for business purposes? 6% 3% Yes No No response 91% This by any standards is a huge percentage. This presents both challenges and opportunities. It shows there is high demand for loans which is a good thing. However it also means that Saccos serving MSMEs need to have sufficient fund to meet demand else the ensuing 22 P a g e

Percent responding customer dissatisfaction may undermine the Saccos future success. This is more so for Saccos adopting a purely commercial approach thus lacking the constant inflows from salaries. 4.4.1 Security Mechanisms Used in Borrowing by MSMEs The most common methods of guaranteeing the loans are guarantors at 81%, salary at 16% and collateral at 14%. Other guaranteeing mechanisms were utilized by 8% of the borrowers. This is shown in the figure below; Figure 24: Security Mechanisms Utilized by MSMEs in Borrowing from Saccos If you have taken a business loan from the SACCO how did you guarantee the loan? 100% 81% 50% 0% 16% 14% Guarantors Salary Collateral e.g. logbook or title 8% Other As expected use of guarantors is the most common type of security. This poses a challenge for Saccos with less common bond since the borrowers will have challenges getting guarantors. Such Saccos will need to utilize collateral based lending. Considering that Saccos lack experience in such many challenges are expected as will be seen later in the report. This issue of security is critical and SASRA needs to look into it critically with purposes of eliminating unnecessary restrictions and building capacity of Saccos to lend on the basis of diverse loan security mechanisms. This will require working hard to change Sacco s mentality and to array fears of default risks and difficulties in realizing security in the event of default. Saccos capacity to improve lending mechanisms to MSMEs can be enhanced further through policy guidelines on MSMEs lending. 4.4.2 Purpose of Borrowing Key reasons for borrowing the funds include business expansion at 34%, cash flow enhancement at 28% and buying of business assets at 16%. These and other purposes are illustrated in the figure below; 23 P a g e

Figure 25: Purpose of Borrowing from Saccos by MSMEs What was the purpose of borrowing the money for the business in your latest borrowing? Building or refurbishment of premises Capital to start a business Other purposes Buying business assets Enhance cashflow Business expansion 8% 8% 13% 16% 28% 34% 0% 10% 20% 30% 40% Percent Responding These purposes of borrowing are key to development of loan products for MSMEs by Saccos. Need for funds to expand business for instance points to demand for substantial amounts and for longer repayment duration. On the other hand cash flow enhancement points to needs for short term borrowing such as overdraft. It also points to a need for trade finance products such as LPO financing, bid bonds, letter of credit guarantees and such like. Furthermore, preference for borrowing to buy assets points to a need for asset financing products. Also the purpose of borrowing is somehow related to the age of the enterprise. Since most of the respondents had been in business for more than 5 years preference for expansion funds is to be expected. Businesses at growth stages also require a lot of cash flow support. 4.4.3 Reasons for Preferring to Borrow from Saccos The main reason for preferring Saccos is low interest rates at 71% followed by favourable terms and conditions at 16% and easy security options at 13%. Others are quick loan processing time and Saccos being more friendly/understanding each at 11%. This is shown in the figure below; 24 P a g e

Figure 26: Reasons for Preferring to Borrow from Saccos Reasons for Preferring Saccos to other Lenders Interest rate is constant It is the only option I have Dividend paid on savings Members have a say in SACCO affairs SACCO is more understanding/friendly Loan processing time is quick Easy collateral/i have shares Favourable terms and conditions Low interest rates 2% 3% 3% 5% 11% 11% 13% 16% 71% 0% 20% 40% 60% 80% Percent Responding Once again much value is attached to low interest rates. Thus the interest rates are at the core of the competitiveness of Saccos. Saccos need to maintain and strengthen these characteristics that make them more preferable. Thus, even as Saccos become more bank-like they should be advised not to compromise the factors upon which their competitiveness is anchored. Such compromise would result in Saccos losing appeal and with it ability to mobilize deposits thus threatening their success and even existence. 25 P a g e

5 CHAPTER FIVE: PROVISION OF BUSINESS FINANCE SERVICES BY SACCOS 5.1 Introduction Saccos do not just provide MSMEs with loans but also with other essential business services. Due to the influence of FOSA activities MSMEs are demanding more from Saccos. As Saccos operate more and more like banks expectations are increasingly raised. MSMEs now expect to be served in more or less the same way in a Sacco as happens in traditional banks. Considering that the option of Saccos converting into banks may result in the loss of the core principles that define Saccos and undermine the movement there is need to bridge the gaps as far as these expectations are concerned. This section explores the non-lending services available to MSMEs in order to expose any gaps and provide the stakeholders with a starting point in charting the way forward. 5.2 Availability of Business Finance Services by Saccos 5.2.1 Availability of Core Business Finance Products The provision of business finance services is relatively low in Saccos. The common services are asset financing and cheque discounting each at 46%. Others are overdraft facilities at 45% and insurance premium financing at 32%. The availability of other services is shown below; Figure 27: Availability of Core Business Finance Services by Saccos Business finance products provided to MSMEs by Saccos Letter of credit, guarantee and bid bonds Invoice discounting LPO finance Insurance premium financing Overdraft Cheque discounting Asset finance 17% 17% 24% 32% 45% 46% 46% 0% 20% 40% 60% 80% 100% Yes No No response The Saccos need to scale up the availability of financial services to serve MSMEs better and also manage competition from other financial institutions. 26 P a g e

5.2.2 Availability of Other Business Finance Products Other business essential financial services available include cheque deposit at 81%, access to ATM at 71% and insurance products at 42%. Availability of other services is as shown in the figure below; Figure 28: Availability of Other Financial Services Provision of business essential services to MSMEs Cheque deposit Access to ATM Insurance products Pension products Cheque book Investment products 31% 30% 29% 42% Provision of basic services such as cheque books and ATM access are critical for MSMEs. Saccos not currently offering such services should be encouraged and supported to roll them out. This will boost their competitiveness in service delivery. They also need to explore opportunities to offer a broad range of financial services that would be of interest to MSMEs. 71% 81% 0% 20% 40% 60% 80% 100% Yes No No response 5.3 Willingness to Offer More Business Finance Services Majority of the Saccos would be willing to offer more financial services. Up to 68% responded positively as far as this is concerned, 20% responded negatively while 12% didn t respond. This is shown in the figure below; Figure 29: Willingness by Saccos to Offer More Business Finance Services Are there any business finance products you would like to offer but are not currently able to offer? 12% 20% Yes No No response 68% 27 P a g e

Majority of the Saccos are willing to expand their product offering. This augurs well for the future of the subsector since it is a pointer to growth orientation. Saccos need to explore the opportunities provided by the more organised and better regulated business environment. 5.4 Business Services Saccos are Willing to Offer in the Future Some of the business finance services Saccos are desirous to offer include asset finance at 29%, business loans and mortgage each at 17% and cheque clearance/deposit at 15%. Others are trade financing, insurance premium financing and forex each at 8%. Other services are as shown in the figure below; Figure 30: Business Finance Services Saccos are willing to Offer in the Future Other service or products Saccos would wish to offer to MSMEs Cheque books FOSA/collateral Loans Mobile banking International transfers Investment products Group loans Overdraft ATM Access Forex Insurance Premium Financing Trade financing e.g. Invoice discounting Cheque deposit/clearance Mortgage Business loans Asset finance 3% 3% 4% 4% 4% 4% 5% 5% 8% 8% 8% 15% 17% 17% 29% 0% 10% 20% 30% Percent Responding The services the Saccos are willing to offer are critical to MSMEs. Offering such services will make Saccos compete more effectively with other players in the MSME financing business. There is need to ensure that the existing legal and regulatory framework does not constraint Saccos from offering such services. Where the laws are silent Saccos should be bold to lead legislation and regulation. Where laws are restrictive the regulator should work with stakeholders to review such laws. 5.5 Support Saccos Need to Offer more Business Finance Services The key support needs include capacity building at 40%, access to more/cheaper funds at 39%, clear/flexible legal framework at 20% and government support also at 20%. These and more are as shown in the figure below; 28 P a g e

Figure 31: Support Saccos need to offer More Business Services Support Saccos need to offer more services to MSMEs Be allowed access to capital markets Be allowed to use more guarantee methods Access to borrower credit information Data/research on funding MSMEs Access to National Payment System Government support Clear/flexible legal framework More/cheaper funding Capacity building 1% 3% 3% 4% 4% 20% 20% 39% 40% Saccos need capacity building to improve their ability to offer services to MSMEs. This is mainly in terms of being assisted to understand the sector and being equiped with training on how to handle MSMEs. Saccos also need capacity enhancement through peer learning from others that have succeeded in MSME lending and in receiving research and statistics to guide them. Since the issue of clarity of legal framework may not be about the laws but how they are understood civic education among Sacco actors is needed. 5.6 Access to Financial Services Via Mobile Phone 5.6.1 Ability to Access Services 0% 10% 20% 30% 40% Percent Responding Use of mobile phones to access financial services has revolutionized the way business is done in Kenya. For Saccos to serve the MSMEs better they need to facilitate such access. Up to 45% of the respondents were able to access services via the phone while 50% were not and 5% didn t respond to the question. This is shown in the figure below; Figure 32: Ability to Access Services Using Mobile Phone Are you able to access any financial services from your SACCO through your mobile phone? 5% 45% 50% 29 P a g e Yes No No response

It is good that a significant number are able to use mobile phones to access services. This should be scaled up as it will save Saccos costs and allow them to serve more people across expansive geographical areas. 5.6.2 Services Available Services commonly available via the phone include deposits/withdrawals at 58%, checking balance at 17%, access to statement and loan repayment each at 13% and mobile alerts/notifications at 9%. These and others are shown in the figure below; Figure 33: Financial Services Available to MSMEs via Mobile Phone What financial services are you able to access from the SACCO through your mobile phone? Transfer funds to others Spot cash Bill payment/airtime purchase Mobile alerts/notifications Loan repayment Access statement Check balance Withdraw or deposit money 4% 5% 5% 9% 13% 13% 17% The Sacco clients are able to access many services through the mobile phone. This widens and deepens financial access and improves convenience. It also ensures Saccos can compete effectively with banks which provide similar services. As well, it improves Saccos profitability as costs are reduced. However, not all the Saccos have the infrastructure to support the provision of such services. Such Saccos need to be assisted to build the requisite technical capacity since their viability may be threatened by failure to provide the conveniences of mobile banking. 58% 0% 20% 40% 60% 80% Percent Responding 30 P a g e

6 CHAPTER SIX: CHALLENGES OF MSME FINANCING BY SACCOS 6.1 Introduction Both MSMEs and Saccos encounter various challenges in their business relationship. Understanding these challenges is key to their resolution. Both SASRA and stakeholders in the Sacco sector need to look into ways of eradicating or minimizing these challenges. Apart from citing the challenges the respondents also provide suggestions on how these challenges can be addressed. From a regulatory perspective it is important to look into issues that can be addressed by tinkering with the regulatory regime to make it friendlier to MSMEs financing. Other issues require a multisectoral approach and the regulator, umbrella bodies and all stake holders need to come together and determine the way forward. 6.2 Challenges Faced by Saccos in Offering Services to MSMEs The key challenges encountered by Saccos while offering services to MSMEs include default risks/poor repayment at 51%, inadequate funds to lend at 38% and securing loans i.e. guarantors/collateral at 23%. Others are lack of proper legal framework at 23% and difficulties in evaluating the MSMEs at 21%. Other challenges are as shown in the figure below; Figure 34: Challenges Faced by Saccos in Servicing MSMEs Challenges faced by Saccos in offering services to MSMEs No access to credit information/referencing Disposal of collateral e.g. legal issues Dishonesty by the business onwers Lack of awareness among customers Irregular/prolonged repayment MSMEs not well managed Competition from other financial institutions Evaluating them is difficult/costly Lack of proper legal framework Securing the loans i.e. guarantors Inadequate funds to lend Default risks/poor repayments 7% 11% 13% 13% 14% 17% 20% 21% 23% 37% 38% 51% 0% 20% 40% 60% Percent Responding 31 P a g e

6.3 Support Needed by Saccos to Overcome Challenges Faced while Serving MSMEs In view of the above challenges the Saccos made suggestions on how they can be empowered to overcome. The key suggestions are capacity building and expanding sources of external funds each at 30% and making the legal framework flexible and clear at 23%. Other suggestions are education of members on use of funds at 20% and access to full credit information from CRBs at 15%. The other suggestions are as shown in the figure below; Figure 35: Support Needed by Saccos to Overcome Challenges in Serving MSMEs Support Needed by Saccos to Overcome Challenges Encountered in Serving MSMEs Reduction of taxation Support in improving ICT systems Fast-track dispute resolution in Coop Tribunal Business development services to MSMEs Create awaress on SASRA to boost confidence Ease realisation of collateral upon default Lower bank lending rates Prudential guidelines on MSME lending Access to full credit information from CRBs Education of members on use of funds Flexible and clear legal framework Expand sources of external funds Capacity building e.g. training 1% 3% 3% 4% 6% 6% 8% 10% 15% 20% 23% 30% 30% 0% 10% 20% 30% Percent Responding 32 P a g e

6.4 Challenges Faced by MSMEs in Accessing Services from Sacccos The key challenges faced by the MSMEs in accessing services from the Saccos include delay in processing loan request at 31%, limitation in amount of money that can be borrowed at 29% and getting guarantors for a loan at 24%. Others are poor service at 12% and repayment period being too short at 8%. Other challenges are shown in the figure below; Figure 36: Challenges Faced by MSMEs while Accessing Services from Saccos What challenges have you faced in accessing financial services for you business from SACCOs? Only one long term loan at a time Low/delayed dividend Refusing to accept collateral Difficulties in repayment Corruption, nepotism, tribalism High interest rates Bureaucratic borrowing process Lack of some products and services Incompetent staff Lack of collateral Repayment period too short Poor service Getting guarantors for a loan Limited amount that can be borrowed Delay in processing request 2% 2% 2% 2% 2% 3% 3% 3% 4% 6% 8% 24% 29% 31% The following challenges were also reported by less than 2% of the respondents i. Defaulting guarantors ii. High loan processing fees iii. Change of interest rates iv. No business loans v. Accessibility of the Sacco vi. Not recognized as a legitimate bank account e.g. NSE vii. Forced to join FOSA 12% 0% 10% 20% 30% 40% Percent Responding 6.5 Analysis, Summary and Conclusions The challenges encountered in offering services to MSMEs are summarized into key points as follows; i. Most of the challenges revolve around Saccos lending capacity which causes issues such as delays in disbursing loans, limitation of amounts and shortening of the loan duration. Supporting Saccos to access external funds is critical in resolving this. Also Saccos can have their capacity build to mobilize deposits 33 P a g e

ii. The legal framework requires to be reviewed to align with the challenges and risks of lending to MSMEs iii. The capacity of MSME needs to be developed to make it easier to serve them. While this is not an issue for SASRA alone there is need to work with the MSE Authority and MSMEs associations to explore ways of enhancing the operations of MSMEs iv. The issue of guaranteeing MSMEs loans causes major concerns. While MSMEs find it hard to get guarantors some Saccos refuse to accept collateral even when it is available to secure a loan by a business. With the common bond in Saccos being relaxed the access to social collateral will be undermined further. Exploring alternative ways and means of guaranteeing loans is crucial. Cases of inability to realize collateral having been irregularly disposed by borrower or the Sacco being prevented from doing so due to court processes does not help the case for scaling up MSME lending by Saccos v. There are serious concerns about default risks as far as lending to MSMEs is concerned. There is need to ensure Saccos have access to credit referencing information of borrowers. Sharing of borrower information amongst Saccos should also be enhanced. Since MSME focused Saccos may not have the advantage of common bond, they should be assisted to develop capacity to assess MSMEs and evaluate alternative means of securing loans. vi. Since lending to MSMEs is an emerging issue away from how Saccos traditionally operated their capacity needs to be built to ensure they offer better services and not encounter serious issues. This includes but is not limited to: a. Training of Saccos on MSME lending b. Provision of guidelines on MSME lending c. Availing research on MSME lending to ensure peer learning vii. There are also governance challenges that SASRA needs to look into. A better complaints management system needs to be put into place. This will boost consumer confidence and create an early warning system where Sacco may be facing issues that are not captured via reporting on financials 34 P a g e

7 CHAPTER SEVEN: REGULATORY ENVIRONMENT ISSUES 7.1 Introduction Financing of MSMEs by Saccos poses extra challenges and risks. Consequently there is need for SASRA to provide focused attention on this aspect of lending. Unlike lending to salaried workers lending to MSMEs brings extra default risks. Also, MSMEs require different products and solutions in line with their unique business needs. Ensuring that these needs are met and that no risks are posed to the sector calls for robust regulation while at the same time ensuring Saccos are not overly restricted in serving MSMEs. This is a delicate balancing act. Below are the views of the players which need to be taken into account while assessing the regulatory framework for purposes of improvements and alignment with MSMEs needs. 7.2 Suggestions by DTS on Improvement of Regulatory Environment The key issues suggested by the Saccos include capacity building for Saccos at 16%, make regulations facilitative not restrictive at 13% and regulations to expand access to external sources of funds at 10%. Other suggestions are facilitating sharing of defaulter s information at 9% and strengthening of MSME regulation and laws at 6%. Other suggestions are as shown in the figure below; Figure 37: Suggestions by DTS on Improvement of Regulatory Environment Suggestions by DTS on how SASRA can improve the regulatory environment to ensure more/better service to MSMEs Review capital adequacy ratios Relax laws on activities SACCO can engage in Make laws and regulation clear and flexible Strengthen MSME regulation and laws 5% 5% 6% 6% Facilitate sharing of defaulters information Regulations to expand access to external funds 9% 10% Make regulation facilitative not restrictive 13% Capacity building for SACCOs 16% 0% 5% 10% 15% 20% Percent Responding Other suggestions on improving the regulatory environment include the following; 35 P a g e