GVN Foundation Australia - Micro Finance Project

During my recent April 2009 trip to Pipeline, the IDP camp (internally displaced persons) in Kenya I asked the local committees of these camps whether they would be interested in 'soft loans' or micro financing. The answer was a resounding yes. Micro financing was a concept they had already contemplated and were very much in favour of. They voiced how important it was for them to be helped to achieve employment. As much as they are grateful for, and still need short term assistance with food, they were very aware that such donations did not achieve their goal of independence.

Accordingly, this proposal sets out how Global Volunteer Network Foundation Australia (GVNFA) would offer micro finance to the IDP camp.

Background

Micro financing involves lending small amounts of money to people in developing countries with little or no collateral in an effort to enable them to build their own livelihood and become self sufficient.

Many big micro financing organisations lend to those who already have an established idea or business and are looking to grow that. This proposal addresses the least favoured market of 'start up loans' to people with no collateral, therefore the highest risk of default. In KADET, the Kenyan World Vision micro financing division, there is a 50% default rate with these start up loans.

The interest charged and guarantees of the loans are crucial to empower and incentivise the client.

The initial loan is acquired by GVNFA as a donation that is non refundable to the donor.

IDP Camps

The 20,500 internally displaced persons (IDPs) who were initially at Nakuru Showground camp following the post election violence in 2007 are now residing at Pipeline and Gilgil IDP camps. The government supported them with 10,000ksh (about $130 USD) per family and they united as a group and bought land in both these sites.

The IDPs have resettled at Pipeline and Gilgil and there are many challenges ahead of them. They are still living in emergency tents, in many cases two families per tent, which were provided by the UNHCR and have a life of 6 months. It has been over one year. The tents are worn, torn and with the rainy season now starting they pose an enormous health risk to the camp, not to mention miserable conditions. The government and aid agencies have also stopped supplying the camp with food.

The IDPs at the Camp want to become self sufficient and not rely on donations. They want to work and they want to rebuild their lives here but they need outside support to do this.

Proposal - Initial Trial Period

GVNFA is proposing to test the success of the micro financing concept with 100 clients (10 groups of 10 clients) in Pipeline IDP camp in Kenya. If the trial period is a success we will look to offer loans to Gilgil IDP camp.

Each client forms a group of 10 clients. The 10 guarantee each other, making the group liable for any defaulters.

Each client receives an initial loan of up to $US50, ie $US500 per group. They take out the loan for six months at 20% per annum with repayment of the interest and capital ($US550) being required to be paid in full at the end of the six months. If successful they would then be offered a second loan of an increased amount.

GVNFA needs to raise $US8,000 to finance this initial trial. $US5,000 would be loaned. With the remaining $3000 paying for auditing, reporting, viability research and in country client managers who would micro manage clients in this initial phase.

In order to reduce the 50% default rate seen in these start up loans in Kenya by KADET, GVNFA clients would be micro managed by the in country contractor. Rather than giving the client's money directly, the client manager would take the money and the client to buy the goods for the business, ensuing there was an adequate amount saved for interest repayments.

The role of the in country contractor is crucial to this initiative. When in Kenya I spent the week with Irene Ngatia, Executive Director of Volunteer International Community Development Africa (VICDA) based in Nairobi. Global Volunteer Network in New Zealand has successfully used VICDA as their in country partner for four years. Irene is going to personally manage this micro financing trial period, spending initially three days at the Pipeline IDP camp each fortnight (three hours out of Nairobi) to micro manage the start up of the businesses. Irene has essential local knowledge, runs her own successful organisation employing up to ten staff members, is passionate about those in need in Kenya, has integrity and a great sense of humour.

Why is micro finance successful?

By reducing vulnerability and increasing earnings and savings, financial services allow poor households to make the transformation from "every-day survival" to "planning for the future." Households are able to send more children to school for longer periods and to make greater investments in their children's education. Increased earnings from financial services lead to better nutrition and better living conditions, which translates into a lower incidence of illness. Increased earnings also mean that clients may seek out and pay for health care services when needed, rather than go without or wait until their health seriously deteriorates." (The international micro finance research centre, CGAP, www.cgap.org). "Empirical evidence shows that, among the poor, those participating in microfinance programs who had access to financial services were able to improve their well-being-both at the individual and household level-much more than those who did not have access to financial services.

1. In Bangladesh, Bangladesh Rural Advancement Committee (BRAC) clients increased household expenditures by 28% and assets by 112%. The incomes of Grameen members were 43% higher than incomes in non-program villages.
2. In El Salvador, the weekly income of FINCA clients increased on average by 145%.
3. In India, half of SHARE clients graduated out of poverty.
4. In Ghana, 80% of clients of Freedom from Hunger had secondary income sources, compared to 50% for non-clients.
5. In Lombok, Indonesia, the average income of Bank Rakyat Indonesia (BRI) borrowers increased by 112%, and 90% of households graduated out of poverty.
6. In Vietnam, Save the Children clients reduced food deficits from three months to one month." (CGAP)

Why are the interest rates of micro finance institutions (MFIs) so high?

The nature of microcredit - small loans - is such that interest rates need to be high to return the cost of the loan.

"There are three kinds of costs the MFI has to cover when it makes microloans. The first two, the cost of the money that it lends and the cost of loan defaults, are proportional to the amount lent. For instance, if the cost paid by the MFI for the money it lends is 10%, and it experiences defaults of 1% of the amount lent, then these two costs will total $11 for a loan of $100, and $55 for a loan of $500. An interest rate of 11% of the loan amount thus covers both these costs for either loan.

The third type of cost, transaction costs, is not proportional to the amount lent. The transaction cost of the $500 loan is not much different from the transaction cost of the $100 loan. Both loans require roughly the same amount of staff time for meeting with the borrower to appraise the loan, processing the loan disbursement and repayments, and follow-up monitoring. Suppose that the transaction cost is $25 per loan and that the loans are for one year. To break even on the $500 loan, the MFI would need to collect interest of $50 + 5 + $25 = $80, which represents an annual interest rate of 16%. To break even on the $100 loan, the MFI would need to collect interest of $10 + 1 + $25 = $36, which is an interest rate of 36%. At first glance, a rate this high looks abusive to many people, especially when the clients are poor. But in fact, this interest rate simply reflects the basic reality that when loan sizes get very small, transaction costs loom larger because these costs can't be cut below certain minimums." (CGAP)

CGAP found:

1. MFI interest rates averaged about 28 percent in 2006, declining by 2.3 percent a year since 2003.
2. MFI rates are lower than consumer and credit card rates in most countries, and usually far lower than rates charged by informal moneylenders.
3. At an average 12.7 percent of portfolio in 2006, operating costs are the largest single contributor to interest rates, declining by one percentage point per year since 2003.

If successful

Future costs if successful would include a full time salary payment to the in country client manager. The client manager's job requirements include: an assessment of the viability of the business and its market; the initial physical purchasing of goods required for the business; weekly meetings with the client group to mentor them; collection of interest and capital on a regular basis and the provision of weekly reports and audits.

Once the client has proved they are capable of repaying the loan and the interest after the six months, and the client manager believes they are skilled to be more independent, the second loan will go directly to the client.

Over time the accumulation of donations and the subsequent repayment of principle and interest build the loan pool to the extent that the scheme becomes self-sustaining.

By donating to this micro finance initiative you are instrumental in finally breaking the poverty cycle.

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