TOPIC 4: MICRO-FINANCING MODELS Many of these models are indeed "formalized" versions of informal financial systems.

Informal
Microenterprise finance: Credit Lending Models" is an attempt to document the various
models currently being used by microfinance institutions throughout the world.
The Micro Finance Institutions can be categorized into
i) Deposit taking MFIS
ii) Non Deposit taking MFIS
i) Deposit Taking Microfinance Institutions: The deposit taking microfinance are
controlled by the microfinance Bill of 2006 which was implemented in 2008. They are
controlled and regulated by the Central Bank of Kenya. Licensed deposit taking
microfinance institutions include; Faulu Kenya Limited, Kenya Women Finance Trust
Limited, SMEP among others.
ii) Non-Deposit Taking Microfinance Institutions: The Non-deposit taking microfinance
institutions are not regulated by the Central Bank of Kenya but through the various Acts
under which the MFIs operate. They do not take deposits from members of the public but
only provide credit facilities to them. Some of the existing non deposit MFIs includes
Platinum Credit Ltd, Ngao Ltd, Blue limited etc. The credit facilities they offer are of
higher interest rates unlike banks due to the risk involved in giving credit without security.
This enables them to recover their money earlier without huge losses. Loans are usually
for a short-term basis with quick approvals and maturity that has proved good to the many
clients who have unforeseen needs ranging from weddings, school fees, funeral expenses,
and hospital bills. The Ministry of Finance is in the process of discussing the best way
forward for regulating the non-deposit taking microfinance businesses.
systems have historical precedents that predate modern banking systems. They are still in existence
today used mostly by low-income households who do not have access to formal banks.
1. Associations Model
This is where the target community forms an 'association' through which various microfinance
(and other) activities are initiated. Such activities may include savings. Associations or groups can
be composed of youth, women; can form around political/religious/cultural issues; can create
support structures for microenterprises and other work-based issues.
Some Examples include Uwezo fund, Youth Fund, Women fund which person forms groups to be
able to access the finances as per the laid down policies for the groups.
In some countries, an 'association' can be a legal body that has certain advantages such as collection
of fees, insurance, tax breaks and other protective measures. Distinction is made between
associations, community groups, peoples organizations, etc. on one hand (which are mass,
community based) and NGOs, etc. which are essentially external organizations.
2. Bank Guarantees
A donor or government agency guarantees microloans made by a microfinance/commercial
bank to an individual or group of borrowers. Compulsory deposits by borrowers in such banks are
also included in this model. Examples: Jamii Bora Bank, K rep Bank(sidian Bank)
3. Community Banking Model

A total of 10 models are described below. They include, Community banking model essentially treats the whole community as one unit, and establishes
semi-formal or formal institutions through which microfinance is dispensed. Such institutions are
i. Associations, usually formed by extensive help from NGOs and other organizations, who also train the
ii. Bank guarantees, community members in various financial activities of the community bank.
iii. Community banking,
iv. Cooperatives, These institutions may have savings components and other income-generating projects included
v. Credit unions, in their structure. In many cases, community banks are also part of larger community development
vi. Group model programmes which use finance as an inducement for action.
vii. Individual,
viii. Intermediaries, 4. Cooperatives Model
ix. NGOs,
x. Peer pressure, A co-operative is an autonomous association of persons united voluntarily to meet their common
xi. ROSCAs, economic, social, and cultural needs and aspirations through a jointly-owned and democratically-
controlled enterprise. Some cooperatives include member-financing and savings activities in their
In reality, the models are loosely related with each other, and most good and sustainable mandate.
microfinance institutions have features of two or more models in their activities.
The cooperative offer Loans which are Given as a multiplier of Amount saved by the Members, in
order to qualify for a loan, you are supposed to have saved for a particular minimum period and
be consistent in contributing. Most Sacco’s the Collateral is through Guarantees by members
through their Members Deposits Contributions.
Advantages of Co-operative Society
1. Easy to form: The formation of a cooperative society is very simple as compared to the
formation of any other form of business organisations. Any ten adults can join together and form
a co-operative society. The procedure involves in the registration of a cooperative society is very
simple and easy.
2. No obstruction for membership: Unless and otherwise specifically debarred, the membership
of cooperative society is open to everybody. Nobody is obstructed to join on the basis of religion,
caste, creed, sex, colour etc. A person can become a member of a society at any time he likes and can
leave the society if he does not like to continue as member. Based on one of the principles of co-
operatives of voluntary and open membership.
3. Limited liability: In most cases, the liabilities of the members of the society is limited to the extent
of capital contributed by them. Hence, they are relieved from the fear of attachment of their private
property, in case of the society suffers financial losses or goes bankrupt.
4. Service motive: In Co-operative societies members are provided with better good and services
at reasonable prices. The society also provides financial help to its members at concessional rates
unlike mainstream banks. It assists in setting up production units and marketing of produce of small
scale farmers.
5. Democratic management: The co-operative society is managed by the elected members from
and among themselves. Every member has equal rights through its single vote but can take active
part in’ the formulation of the policies of the society. Thus all member are equally important for the
society. Derived from the principle of democratic member control.
6. Stability and continuity/Perpetual succession: A co-operative society cannot be dissolved by
the death, insolvency, lunacy, permanent incapability of its members. It has got separate legal
existence from its members. New members may join and old members may quit the society but the
society continues to function unless all members unanimously decided to dissolve the society.
7. Economic operations: The operations carried on by co-operatives societies are economical due
to the eliminations of middlemen. The services of middlemen may be provided by the members of
the society at minimum cost or eliminated completely. The recurring and non-recurring expenses
are minimized. Further, the economies of scale of production or procurement, automatically
reduces the price of goods, thereby minimizes the selling price.
8. Surplus shared by the members: The society sells goods and services to its members on a
nominal profit. In some cases, the society sells goods and or services to outsiders. The profits are
utilized in meeting the day-to-day administration and other costs of the society. The procedure for
distribution of profit/surplus is stated in the Co-operatives Societies Act Cap 490. Some portion of
the surplus is distributed as dividends or interest on deposit and some kept as reserve (i.e. 20%).
9. State patronage: Government provides special assistance to co-operative societies to enable
them achieve their objectives though currently through State organs like Sasra(Sacco Societies
Regulatory Authority) which is under ministry of industry Trade & Cooperatives.
Disadvantages of Cooperative Society
Despite the many advantages, co-operative societies suffer from certain limitations or drawbacks.
Some of these limitations are:
1. Limited resources: Co-operative societies financial strength depend on the capital contributed
by its members. The membership fee is limited so is the monthly contributions in case of Saccos
as their members belong to the lower and middle class. Thus co-operatives initially are not suitable
for the large scale businesses which require huge capital. Though this can be overcome by
increasing membership with the downside of minimal returns to its members.
2. Inefficient management: A co-operative society is managed by the members only. They may
not possess any managerial and special skills. This is considered as major drawback of this sector.
3. Lack of secrecy: Co-operative societies do not maintain secrecy in their businesses because
the affairs of the societies are openly discussed in meetings. But secrecy is very important for the
success of a business organisation. This paved the way for competitors to compete in more
effective ways.
4. Excessive Government interference: Government may influence the decision of the Board
which may or may not be favorable for the interest of the society and its members. Excessive state
regulation, interference with the flexibility of its operations and therefore affecting adversely the
efficiency of the management of the society. Rare occurrence in Kenya.
5. Absence of motivation: The members may not feel enthusiastic because the law governing the
co-operatives puts some restriction on when to invest or decision making process which can be
lethargic and bureaucratic.
6. Disputes and differences: The management of the society constitutes the various types of
personnel from different social, economic and academic background. Many a times they strongly
differ with one another on many important issues. This becomes detrimental to the interest of the
society as it may lead to delayed decisions. The different opinions and disputes may paralyses the
effectiveness of the management.
5. Credit Unions Model
A credit union is a unique member-driven, self-help financial institution. It is organized by and
comprised of members of a particular group or organization, who agree to save their money
together and to make loans to each other at reasonable rates of interest.
The members are people of some common bond: working for the same employer; belonging to
the same church, labor union, social fraternity, etc.; or living/working in the same community. A
credit union's membership is open to all who belong to the group, regardless of race, religion,
color or creed.
A credit union is a democratic, not-for-profit financial cooperative. Each is owned and governed
by its members, with members having a vote in the election of directors and committee
representatives.
Advantages
i) You’re a member, not just a customer. One of the benefits of a credit union is that
you’re not just a customer, you’re a part-owner. You’ll get top-notch customer
service, voting rights and dividends.
ii) You’ll get better rates. A credit union will get you lower rates on loans and typically
enable you to earn more on deposits than traditional banks. Because credit unions are
nonprofits, they pass on surplus funds to customers in the form of higher interest rates
on deposit accounts.
iii) You’ll pay lower fees. Credit unions also pass on savings to members in the form of
lower fees. That means you’ll be saving two ways — on lower fees and discounted
loan rates.
iv) Better customer service is standard. Credit unions typically provide superb
customer service. Because they tend to be smaller organizations than banks, credit
union employees can get to know members and focus on their needs.
v) Community comes first with credit unions. Credit unions are owned and run by
members of a common community or workplace — like employees from a certain
company. Credit union services are designed to benefit the local community and
those who live there.
Disadvantages of Credit Unions
i) You must become a member. To take advantage of all a credit union offers or
services you must be a member.
ii) They offer limited branch locations and ATMs. Many credit unions operate only in
one location. Although the smaller, community-based focus is what attracts many
credit union customers, the lack of multiple bank branches could be an
inconvenience. Note, however, that many credit unions belong to shared ATM
networks, which eliminates the issue of not finding enough credit union ATMs.
iii) Not all credit unions are insured. Similar to how banks are insured most are not.
iv) Fewer services and options are available. Credit unions have come a long way in
matching big bank services but not all can. If you need a large commercial mortgage
loan, for example, your credit union might not be able to handle one.
v) Credit unions aren’t as tech-savvy as big banks. Commercial banks have much
larger assets than credit unions, which might not have enough money to fund new
technology. For example, you might find banking apps, mobile deposits and the like
only at bigger banks and credit unions.
6. Group Model
There are two modalities of group lending. One, a lender may provide funds to a group
or a collective entity such as a cooperative or a village bank which the disburses
the loan to individual members according to agreed criteria. In such a case, the group is
jointly liable for the entire amount of the loan. Second, funds may be lent to members
individually who are organized in groups, in which case the group jointly guarantees all
loans or simply furnishes information about individual participants
Advantages of Group Lending
The advantages of group lending include:
(i) Increases the lender’s outreach capacity by reducing administrative costs of reaching
dispersed individuals and processing loans. Also, a fall in transaction costs occurs
when instead of individual visits of clients, group meetings are held.
(ii) Reduces the lender’s costs by maximizing the use of insider information and by relying
on peer borrower screening.
(iii) Decreases borrowers’ costs. - Generally, group borrowers saved on fees for collateral
registration, expenses on certificates needed for loan applications, and transportation
costs for visiting lender.
(iv) Allows risk pooling through joint liability. Joint liability improves loan
repayment in two ways. First, group members can put pressure on potential
defaulters when their own interests are at stake. Secondly, the risk that the whole
group will default diminishes with increased membership, unless all of the member’s
activities are highly correlated.
(v) Group lending achieves self-selection of borrowers and because co-borrowers act as
guarantors, they screen and monitor each other and in so doing, reduce agency
problems between the microfinance institution and its borrowers.
(vi) Even if borrowers do not know each other’s type, group lending may be feasible due
to lower interest rates as a result of cross subsidization of borrowers.
(vii) Group lending has a disciplining effect: joint liability may deter borrowers from using
loans for non-investment purposes.
 (viii) Helps achieve improved bargaining. Reduced transaction costs and a lower risk of
default increase the attraction of lending to groups. Participating members improve
their access to credit and obtain better terms than they would qualify for as individuals.
In many cases, group arrangements provide financial services to individuals who
would otherwise have no access to credit
Disadvantages of Group Lending
The disadvantages of group lending include:
(i) Possibility of occurrence of moral hazard. Under a system of joint liability, all
members are liable for the costs of default by any member. This implies that the risk
is borne by the group whereas the benefit is reaped by the individual.
(ii) Though groups have a great potential for enabling members to reach their goals,
group formation is by no means an easy and costless task. Risk heterogeneity in a
borrowing group may arise due to the social identity of the agents.
(iii) Due to group formation costs, group lending programmes may not be able to reach
the poorest sections of society or some safe borrowers may get excluded from the
programme.
(iv) Joint liability microfinance programmes are less successful in areas of low
population density and weak social
(v) A potential downside to joint-liability group lending is that it often involves time-
consuming weekly repayment meetings and exerts strong pressure, making it
potentially onerous for borrowers. This is one of the main reasons why
microfinance institutions have started to move from joint to individual lending.
(vi) The condition that group members are responsible for the defaults of individual
members encourages borrowers to apply for the same loan size, rather than fitting loans
to the loan repayment capacity of individual group members. This may cause
negative solidarity in the group, which means that the whole group defaults if one
member fails to repay his loan.
(vii) Group maintenance costs are high, as group members’ needs and circumstances
diverge over time, thus weakening cohesion. Loan officers may have to
participate in regular group meetings to attempt to strengthen the loan
administration responsibilities of the group, the group cohesion and the sense of peer
responsibility amongst the group members.
(viii) Group lending offers less flexible terms and loan repayment installments. All
group members receive and repay their loans in the same cycle. Even when
graduation to individual lending is permitted, the lack of sufficient written records on
borrowers hampers individual loan appraisal.
(ix) Repayment discipline on loans obtained through group guarantees may be
hampered if collection from group members in lieu of one member’s default is
difficult, due to cumbersome legal proceedings
(x) The demand for credit within a group may change over time, forcing clients with small
loans to be liable for larger loans of their peers. it points to the higher risk borrowers
assume when they are not only liable for themselves but also for their group
partners.
(xi) The growth of group lending programmes may slow down when new borrowers with
looser social ties enter and, consequently, the group lending technology loses some
of its power.
7. Individual Model
This is a straight forward credit lending model where micro loans are given directly to the
borrower. It does not include the formation of groups, or generating peer pressures to ensure
repayment.
In individual lending, individual borrowers rather than group members are personally
responsible for the full and timely repayment of loans received. The screening of potential clients
is carried out by assessing their individual loan repayment capacity and their willingness to
repay.
Advantages of Individual Lending
The advantages of individual lending include:
(i) The personalized nature of individual lending facilitates the granting of loan
products that fit the client’s demand and his/her loan repayment capacity. This reduces
loan default risk;
(ii) Individual lending encourages the development of a closer relationship and
strengthens mutual trust between the lender and the borrower;
(iii) Individual lending increases compliance with contractual loan obligations;
(iv) Better client knowledge from individual lending simplifies the appraisal of repeat loans and
reduces the risk of loan default. Accumulated client information may reinforce current
financial services and lead to the development of new loan products.
(v) Under individual lending, borrowers are exempt from the negative effects of group
lending schemes such as bearing additional risk, loss of privacy from disclosing their
financial situation and investment projects to potential peers, or time spent on group
meetings.
(vi) By offering individual loans, a microfinance institution can attract relatively more new
clients.
(vii) Businesses funded with individual loans grow more than those funded with group loans.
(viii) Some microlenders attempt over time to introduce more individualized lending terms
for the members of joint liability groups. These initiatives combine the cost savings of working
with groups with the high quality of providing individual lending services to group
members.
Disadvantages of Individual Lending
The disadvantages of individual lending include:
(i) In individual lending, a lower number of clients is served;
ii) Although individual lenders employ both conventional guarantees and loan
collateral substitutes, the minimum guarantee requirements may still remain beyond the
capacity of most low-income households.
(iii) The process of collecting detailed information on individual clients is a costly
exercise for micro lenders.
(iv) In individual-based lending arrangements, the amount of finance available is limited.
8. Intermediaries Model
Intermediary model of credit lending positions a 'go-between' organization between the lenders
and borrowers. The intermediary plays a critical role of generating credit awareness and education
among the borrowers (including, in some cases, starting savings programmes. These activities are
geared towards raising the 'credit worthiness' of the borrowers to a level sufficient enough to make
them attractive to the lenders.
The links developed by the intermediaries could cover funding, programme links, training and
education, and research. Such activities can take place at various levels from international and
national to regional, local and individual levels.
Intermediaries could be individual lenders, NGOs, microenterprise/microcredit programmes, and
commercial banks (for government financed programmes). Lenders could be government
agencies, commercial banks, international donors, etc.
Most models mentioned here invariably have some form of organizational or operational
intermediary - dealing directly with microcredit, or non-financial services. Also called the
'partnership' model. Specifically see NGOs.
9. NGO Model
NGOs have emerged as a key player in the field of microcredit. They have played the role of
intermediary in various dimensions. NGOs have been active in starting and participating in
microcredit programmes. This includes creating awareness of the importance of microcredit within
the community, as well as various national and international donor agencies.
They have developed resources and tools for communities and microcredit organizations to
monitor progress and identify good practices. They have also created opportunities to learn about
the principles and practice of microcredit. This includes publications, workshops and seminars,
and training programmes.
10. Peer Pressure Model
Peer pressure uses moral and other linkages between borrowers and project participants to ensure
participation and repayment in microcredit programmes. Peers could be other members in a
borrowers group (where, unless the initial borrowers in a group repay, the other members do not
receive loans. Hence pressure is put on the initial members to repay); community leaders (usually
identified, nurtured and trained by external NGOs); NGOs themselves and their field officers;
banks etc.
The 'pressure' applied can be in the form of frequent visits to the defaulter, community meetings
where they are identified and requested to comply etc.
11. ROSCA Model
Rotating Savings and Credit Associations or ROSCAs, are essentially a group of individuals who
come together and make regular cyclical contributions to a common fund, which is then given as
a lump sum to one member in each cycle.
For example, a group of 12 persons may contribute Kshs 100 per month for 12 months. Amount
of Kshs 1,200 collected each month is given to one member. Thus, a member will 'lend' money
to other members through his regular monthly contributions.
After having received the lump sum amount when it is his turn (i.e. 'borrow' from the group), he
then pays back the amount in regular/further monthly contributions. Deciding who receives the
lump sum is done by consensus, by lottery, by bidding or other agreed methods.
12. Grameen Model
Grameen Bank is founded on the principle that loans are better than charity to interrupt poverty:
they offer people the opportunity to take initiatives in business or agriculture, which provide
earnings and enable them to pay off the debt.
The bank is founded on the belief that people have endless potential, and unleashing their creativity
and initiative helps them end poverty. Grameen has offered credit to classes of people formerly
underserved: the poor, women, illiterate, and unemployed people. Access to credit is based on
 reasonable terms, such as the group lending system and weekly-instalment payments, with vii) Managed by banking professional: In contrast to cooperative and CBO model, Grameen is
reasonably long terms of loans, enabling the poor to build on their existing skills to earn better managed by banking professionals. Grameen have banking culture which ensures
income in each cycle of loans. sustainability and viability of the program.
viii) Impact on marginalized groups: Grameen program has positive impact on the lives of the
Grameen's objective has been to promote financial independence among the poor. Yunus
encourages all borrowers to become savers, so that their local capital can be converted into new poor. Grameen has increased awareness on health and education among the community people.
loans to others. Since 1995, Grameen has funded 90 percent of its loans with interest income and It has been found supportive on improving living condition of the marginalized groups. The
access and control over resources and participation of women on decision making has
deposits collected, aligning the interests of its new borrowers and depositor-shareholders. Grameen
converts deposits made in villages into loans for the more needy in the villages (Yunus and Jolis improved through Grameen program.
1998). 13. The ASCA Management Model (accumulating savings and credit associations)
The Members make a minimum monthly contribution of i.e KShs100, which are called shares.
It targets the poorest of the poor, with a particular emphasis on women, who receive 95 percent of From the first meeting savings are converted into loans to members of the group. As the fund
the bank's loans. Women traditionally had less access to financial alternatives of ordinary credit grows, two types of loan are offered: short term loans called advances on which interest is paid
lines and incomes. They were seen to have an inequitable share of power in household decision at 10% per month, and longer term loans up to two years with interest payable at 17% flat. At
making. Yunus and others have found that lending to women generates considerable secondary the end of the year, dividends are calculated and profits distributed in relation to members
effects, including empowerment of a marginalised segment of society (Yunus and Jolis 1998), who shares. The dividend rate depends on the performance of the group with indicative rates
share betterment of income with their children, unlike many men. Yunus claims that in 2004, varying between 16% and 60% where dividends were actually paid.
women still have difficulty getting loans; they comprise less than 1 percent of borrowers from
commercial banks (Yunus 2004). The interest rates charged by microfinance institutes including
Grameen Bank is high compared to that of traditional banks; Grameen's interest (reducing balance
basis) on its main credit product is about 20%.
Grameen has diversified the types of loans it makes. It supports hand-powered wells and loans to
support the enterprises of Grameen members' immediate relatives. It has found that seasonal
agricultural loans and lease-to-own agreements for equipment and livestock help the poor establish
better agriculture. The bank has set a new goal: to make each of its branch locations free of poverty,
as defined by benchmarks such as having adequate food and access to clean water and latrines.
Features of Grameen Model
i) Targeted to poor: This model targets the poor based on certain criteria such as: size of the
land holding, condition of the house, and income of the households.
ii) Door step service: Bank goes to clients instead of clients to bank in this system. All the
financial services are delivered through regular meetings in the community. This has opened
the door to all the poor for financial services
iii) Collateral less: Loans are generally disbursed without collateral. Clients who are unable to
give collateral or fulfill the several documents required by other banks can get loans from
Grameen. It believes that poor are bankable, so it rather focuses on the cash flow and client's
repayment history, not on the physical collateral such as land and building.
iv) Repeated and increased volume of loans: The loan disbursement procedure of Grameen is
in cycle. Each cycle contains 1 to 1.5 years time period. The loan cycle is repeated and the
volume of the loan increases in each cycle. This makes possible for the clients to repay the
loan in different installments.
v) Good repayment: Repayment rate above 95% in Grameen. It is because of the methodology
and strong discipline in the system.
vi) Focus on women: Grameen clients are exclusively women. This has contributed to women
empowerment and is an inclusive system. Fast growing: In Nepal, Grameen has been found
fastest for outreach growth. This is due to methodology (easy access to loan, easy repayment
schedule, door step service, etc.) and strong financial discipline adopted by the system.