IMPACT OF MICROFINANCING ON THE PERFORMANCE OF SMALL AND MEDIUM SIZED ENTERPRISES (SMES) IN KISUMU CENTRAL BUSINESS DISTRICT- A STUDY

OF KISUMU LAKE MARKET.

GROUP MEMBERS BY: NAMES

1. MOHAMMED JAFFER 2. KENNEDY NYABWALA 3. SANDA DAVID WASONGA 4. ARNOLD MBALANYA 5. PATRICK NYIKA 6. JEREMIAH .O. MOKAYA 7. STEPHEN MWANGI 8. ODOTE DENNIS 9. ELSA ODENY 10. GITU DICKSON GATHU

REG. NO.

SIGN

BA/0345/06... BA/3150/06 BA/3147/06 BA/3164/06. BA/3203/07 BA/3149/06.. BA/0216/06. BA/3197/06. BA/3110/06. BA/0350/02.

A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILMENT FOR THE DEGREE OF BACHELOR OF BUSINESS ADMINISTRATION WITH INFORMATION TECHNOLOGY

DEPARTMENT OF ECONOMICS AND BUSINESS STUDIES FACULTY OF ARTS AND SOCIAL SCIENCE MASENO UNIVERSITY FEB 2010

DECLARATION
We declare that this is our original work and has not been presented in any other university or college for examination/academic purposes.
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Signature: .... Students: Date

This research project proposal has been submitted for oral presentation with my approval as the University Supervisor

Signature: . Supervisor: Mr. Nelson Obange

Date

Maseno University Department of Economics and Business studies

TABLE OF CONTENTS
DEDICATION................................................................5 ACKNOWLEDGEMENT..................................................6 CHAPTER FOUR.........................................................42 DATA ANALYSIS AND PRESENTATION........................42 4.1 INTRODUCTION...................................................................42 4.2 BUSINESS MANAGEMENT................................................42 CHAPTER FIVE...........................................................50 CONCLUSIONS AND RECOMMENDATION...................50 5.1 Summary of the Findings........................................................50 5.2 Conclusion ..............................................................................50 5.3 Recommendations ..................................................................52 5.4 Suggestions for further research..............................................52

DEDICATION
We dedicate this project to our family members who have always stood with us and to the entire body of Department of Economics and Business Studies for the academic inspiration.

ACKNOWLEDGEMENT
We acknowledge our supervisor Mr. Nelson Obange who guided us throughout the research period. We also acknowledge the spirit and willingness in terms of cooperation of our esteemed respondents to our research. Without your cooperation our research could not have been successful. Finally, we thank the Almighty God for the life and strength He has given unto us all through. Amen

LIST OF ABBREVIATIONS TERMINOLOGY OF TERMS SMEs :Small and Medium size Entrepreneurs MFI SHG :Micro-financial Institution :Self Help Group

NGO :Non Governmental Organization GB :Gremeen Bank

DCCB :District Central Co-op Bank UCCS :Urban Credit Co-op Society UCB HFI RDB :Urban Co-op Bank :Housing Finance Institution :Rural Development Bank

CHAPTER ONE 1.0 INTRODUCTION

This chapter provides the background to the study. It details the problem statement, research objectives and questions and rationale for the study. 1.1 RESEARCH BACKGROUND Micro-finance concept has operated for centuries in different parts of the world. Notable in Indonesia, cheetu in Srilonka, tontines in Ghana west Africa and pasanaku in Bolivia. One of the earliest and longest serving micro-credit organization providing small loans to rural poor dwellers with no collateral is the Irish loan Fund system initiated in the early 1700s by Jonathan swift. His idea began slowly in 1840s and became a widespread institution of about 300 branches all over Ireland in less than one decade. The principal purpose was to advance small loans based on some trust for short periods. The iris loan fund attracted about 20 percent of all Irish SMEs leading to growth of small and medium sized enterprises every year. In the 1800s various types of longer and more formal savings and credit institutions began to emerge in Europe organized primarily among the rural and urban people. These institutions were known as
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peoples banks credit unions and savings and credit cooperative. The credit unions and cooperatives were motivated by concern to assist the rural population to break out of their dependence on money leaders and to improve their welfare. From 1870 the unions expanded rapidly over a large cooperative movement and quickly spread to other countries in Europe and North America and eventually supported by the cooperative movement in developed countries and donors and also to developing countries. In the early 1900s various adoptions of these models began to appear in parts of rural Latin America. While the goal of such rural finance intentions was usually defined in terms of modernizing the agricultural sector, they usually had two specific objectives: first, Increase the commercialization of the rural sector and second, Increase the investment through credit. It is against such background and the second objective that this study sought to investigate the impact of micro financing on performance of SMEs in Kisumu. The micro finance industry in Kenya has experienced rapid growth over the years in an attempt to meet the large demand from the estimated 38 percent of Kenyans lacking access to financial services (www.kenya bureau of statistics.com).The demand for microfinance service in Kenya is high yet the industry is only able to meet

about 20 percent of their demand because of lack of financial resources and the capacity to assess risk process and monitor loans. SMEs are dynamic entities where some grow into larger enterprises, some stabilize without changing the scale of operation, while others disappears (Bhalla A.S,1992). Micro financial sectors in Kenya have rapidly expanded as a source of credit for small scale businesses. An example in Kenya is Faulu Kenya which is one of the largest MFIs (MFI) in Kenya. Initially Faulu Kenya focused on micro enterprise lending in Mathare slums of Nairobi. However, over the last 17 years, as lending methodologies and systems were improved, Faulu Kenya grew to become a company with 31 branches and a presence in most districts of Kenya

The objective of this Institution is to support SMEs in Kenya as it transforms from a credit only institution to a regulated deposit taking institution. This transformation is characterized both by the development of a broader product offering as well as by the formalization of the shareholding structure and regulatory framework the institution adheres to. The addition of liability products will provides secure savings to SMEs as well as more control over funding and asset liability management for them , this
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thus improves the performance of SMEs by making them to expand their businesses from saving and also acquiring huge loans.

1.2

STATEMENT OF THE PROBLEM

SMES (Small and medium enterprises) face challenges in obtaining funds from large and formal financial institutions, thus opt for loans from micro-financial institutions to fund their business projects. This Research seeks to explore the impact of microfinance loans on the SMEs growth of SMEs in Kisumu West District.

1.3

RESEARCH QUESTIONS

1) Have the existing SMEs been actually been financed by the MFIs or not? 2) Have the financed SMEs been able to repay their loans as per the terms and conditions of the MFIs? 3) Do financed SMEs realize growth on acquisition of credits from the MFIs?

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1.4 OBJECTIVES OF THE STUDY 1.4.1 General Objective The general objective of this research is to determine the impact of microfinance on the growth of SMES in kisumu central business district. Specific objectives 1) To establish whether the SMEs have been financed by

Microfinance institutions or not

2)

To determine if the financed SMEs have managed to repay

their loans according to terms and conditions of the microfinance institutions 3) To determine if the financed SMEs have realized business

growth since acquisition of credit from the microfinance institutions 4) To formulate policy recommendations that would enhance

micro financing for positive performance of SMEs

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1.5 SIGNIFICANCE OF THE STUDY The study is geared towards the recognition of the importance of micro finance on the growth of SMEs. SMEs have benefited from microfinance institutions through the provision of equity/capital for start ups Moreover micro finance institutions also offer Business support to the SMEs before start up by developing a business proposal of their choice and helping them in developing a saving scheme. Micro finance can benefit from this study by determining how fast they can provide funding and motivation towards spreading their ability in funding the SMEs thereby justifying their essentiality. When analyzed well this study broadens our level of thinking in sourcing equity/capital through financial institutions and develop saving scheme skills for our businesses thereby broadening our scope and ability to fund our own businesses. It will thereafter raise our living standard by enabling us develop business that may be of an increment to our normal income.

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Since the government is the backbone of the economy, microfinance will enable the government to establish the tax rates to levy on the SMEs thus generating income which they can deploy to other sectors of the economy and check the economic growth level e.g. by checking the lending rates of micro financial institutions It is also relevant to the government for the formulation of regulatory policies regarding MFI. Besides, commercial banks also get motivated in considering funding of SMEs through the collection of various statistics on their performance. Also the awareness that created on the challenges facing MFI would help create a good saving culture in Kenya thus leading to the creation of a strong capital base which can be invested in profitable ventures creating employment opportunities and uplifting the living standard of SMEs.

1.6 SCOPE AND LIMITATIONS OF THE STUDY

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This research study is targeting SMES in CBD of kisumu town .the scope of the study is to research on the impact of micro finance on the growth of SMEs for the past 5 years. Limitations of the study Due to lack of time and access to resources e.g. bus fare to cater for the transport around Kisumu west district, access to information in Kisumu west district concerning the impact of micro finance on the growth of SMEs. To curb this limitation we got the information relevant to our study from the Kenya national bureau of statistics thus easening our work. It also proved to be difficult to access information from the MFIs thus we managed to get detailed information through questionnaires to the SMEs. We also

experienced hostile weather condition and this made us to carry out our survey in the morning hours and in the evening.

1.7 DEFINITION OF KEY TERMS

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Micro-financing Micro-financing is the provision of financial services to low income clients including customers and self employed that traditionally lack access to banking and related services. SME The research will consider a small enterprise to be that consisting of 10-50 employees, a turnover of 0.5m annually and an asset base of shs 100,000. A medium enterprise is assumed to consist of less than 250 employees, a turnover of 5m annually and a set of shs 500,000. MFI (micro finance institutions) These are financial institution that offer credit facilities to individuals and businesses for an agreed period of time

CBD (central business district) The CBD in kisumu is main center of kisumu town where majority of business activities take place

SMEs performance
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This is the measure of the growth, profits and stability of the SMEs in relation to business environment in which they operate

CHAPTER TWO LITERATURE REVIEW 2. 1 Introduction This chapter discusses literature related to micro financing and SMEs growth. It focuses on two substantive literature aspects. First, theoretical reviews of the conceptual theories so far advanced in the field of microfinance and SMEs and second, the empirical review for evidences about micro financing and SMEs performance in various parts of the world. 2.2 Theoretical Review

2.2.1 Micro credit theory The psychological component of the micro credit theory - known as social consciousness-Driven capitalism - has been advanced by the most ardent promoter of micro finance, Muhammad Yunus (1998). His theory argues that a species of profit-making private venture that cares about the welfare of its customers can be conceived. In other words, it is possible to develop capitalist
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enterprises that maximize private profits subject to the fair interests of their customers. (Journal of political and military sociology, summer by Elahi, Khandakar Q, Danopoulos, Constantine P2004 edition) The rationale of the theory is straightforward. Although altruism is not totally absent, Capitalism is founded mainly on the premise that human beings are selfish by nature. Accordingly, individuals interested in businesses are naturally motivated by the principle of profit-maximization, with little consideration for the interests of their clients. This premise is too limited to be a general model for capitalism, however, because it excludes individuals who are concerned about the welfare of their fellow human beings. A more generalized principle would assume that an entrepreneur maximizes a bundle consisting of financial return or profit and social return. This assumption creates three groups of entrepreneurs (Elahi, 2002). The first group consists of traditional capitalists who mainly maximize financial returns or profits. The second group consists of philanthropic organizations (like traditional microcredit NGOs) and public credit agencies that mainly maximize social returns. The third group consists of entrepreneurs who combine both rates in making their investment decisions under the additional constraint that financial return cannot be negative. This group includes the microfinance enterprisers who are to be treated as socially
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concerned people, and microfinance, which is to be treated as a social consciousness-driven capitalistic enterprise. Microfinance theoreticians have advanced two theories regarding their aims-an economic and a psychological. The economic theory treats microfinance institutions (MFIs) as infant industries, while the psychological theory differentiates microfinance entrepreneurs from traditional money lenders by portraying them as "social consciousness driven people." According to Remenyi (2000:65), the gist of the economic argument is that success in any business venture, including MFIs, is determined by the entrepreneurs' ability to deliver appropriate services and profitably. However, studies conducted in different parts of the TW show that there are no successful MFIs by this definition. At best, some MFIs cover their operating costs while some of the better known among them are able to cover in part the subsidized cost of capital employed. This situation suggests that the MFIs will not become financially viable in the long run. One solution to this problem is to treat MFIs as infant industries, so that micro-lending businesses can be subsidized during their initial stages of operation. This subsidization would be beneficial to both the economy and society because this will help micro lenders realize economies of scale and the productivity fillip that comes with profitability. The logic goes as follows: Over time, as clients of MFIs, micro entrepreneurs will establish their economic

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contracts with banks, retailers, government employees, and suppliers of production inputs, which will improve their skills dealing with money management, contractual obligations, and resource management. These skills should reduce the cost of transaction, disseminate information, and increase the micro entrepreneurs' ability to assess effectively available information to make sound business decisions. In this respect, society benefits from what is, in effect, a productive process leading to the creation of public goods as spin-offs from the growth of microfinance. To the extent that these public goods have value, they are a legitimate basis on which to provide subsidies to MFIs while the transition to widespread outreach to poor households is ongoing (Remenyi, 2000: 46).The Wealth of Nation says little about the psychological aspect of the theory. Smith articulates the psychological components in his other book, The Theory of Moral Sentiments. Published seventeen years before is Wealth of Nations, this book deals with moral theory. Smith advances the maxim that human self-interest acts as a prime mover of the capitalist development. Moral Sentiments is an inquiry into moral psychology, for which the main concern is the nature of moral judgment (Raphael, 1985; Sprague, 1967). Smith finds the original source of moral judgment in the conception of sympathy, which he makes sufficiently clear in the first paragraph of the book: How selfish so ever, man may be supposed, there are
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evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it. Of this kind is pity or compassion, the emotion, which we feel for the misery of others, when we either see it, or are made to conceive it in a very lively manner. That we often derive sorrow from the sorrow of others is a matter of fact too obvious to require any instances to prove it; for this sentiment, like all other original passions of human nature, is by no means confined to be virtuous and humane, though they perhaps may feel it with the most exquisite sensibility. The greatest ruffian, the most hardened violators of the laws of society, is not all together without it. (Smith, 1976:9) This opening paragraph is both an attack on the ethical theories of Thomas Hobbes and Bernard Mandeville and an indication of the central idea of his work on moral philosophy (Weinstein, 2001). In The Leviathan, Hobbes, a die-heart materialist in his methods of philosophical investigation, paints a very negative picture of human nature. His materialistic conception of human nature may be understood from his interpretation of human life. He sees human life simply as motion of limbs. The human heart is simply a spring; nerves are nothing but a complex system of strings; and joints are just wheels which give motion to the whole body (Hobbes, 1960). In

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other words, Hobbes conceives human beings as nothing more than living machines. National development is the fundamental objective of trade policy. Accordingly, international trade theory and policy are basically founded on a normative criterion that seeks to improve the economic health of society. Trade policies either facilitate or impede the flows of voluntary exchanges of goods and services between nations undertaken by private nationals. The generic term, free trade policy, is used to describe government measures that facilitate these exchanges. Government measures aiming to do the opposite go by the generic term "protectionism". It follows that discourses in international trade theory and policy revolve around two thematic ideas-free trade and protectionism-both of which seek the same objective, national development. Historically, protectionism is regarded as a conservative economic idea that precedes the liberal economic idea of free trade. Protectionism is often traced to the 16th century, while the history of free trade definitely begins in the 18th century (Ellsworth, 1950). The original protectionist argument is mercantilism, while the French Physiocrats are the original authors of free trade that received its fuller exposition in the able hands of Adam Smith. The infant-industry argument was developed later to accommodate

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mercantilist sentiments within the framework of Smith's liberal economic theory. Since the infant-industry argument has been invoked to justify the establishment of the microfinance industry in the TW, the following brief discussion of the theory of mercantilism is in order. Mercantilism is associated with five leading features (Alien, 1987; Blaug, 1978). First, bullion and treasure are the essence of wealth of nations. Second, foreign trade should be regulated to produce an inflow of specie. Third, domestic industries are to be promoted by inducing cheap raw-material imports. Fourth, the importation of manufactured goods is to be discouraged through custom duties, while the exportation of domestic manufactured goods is to be encouraged by exempting them from such duties. Finally, population growth is to be encouraged to keep wages low. These features suggest that the core doctrine of this trade theory is the favorable balance of trade as desirable and essential for national prosperity. This theory, however, clearly involves a dual policy regime of taking advantages from trading partners. This is the reason mercantilism is popularly described in economic literature as the "beggar thy neighbors" policy. Mercantilism is without a doubt a very unfair trade policy regime; it might, and it did, trigger trade wars. In addition to its negative

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political implications, the theory is economically unsound as a policy for national development. Adam Smith was the first to expose this weakness. He argued that "mercantilism is nothing but a tissue of protectionist fallacies foisted upon a venal Parliament by our merchant and manufacturers, grounded upon the popular notion that wealth consists in money. Like an individual, a country must spend less than its income if its wealth is to increase. What tangible form does this surplus over consumption take? The mercantilist authors identified it with the acquisition of hard money or treasure. Money was falsely equated with capital and the favorable balance of trade with the annual balance of income over consumption (Blaug, 1978: 10-11). The publication of The Wealth of Nations was a severe blow to the mercantilist idea of improving national economic welfare through protection. Yet, this idea soon reappeared under different designations, the most influential of which is the infant-industry argument. Modern writers (Chacholides, 1978; Ellswoth, 1950) credit John Stuart Mill with the clearest articulation of this influential protectionist trade policy argument, which can be summarized as follows: "temporary" protective duties may be justified in cases where foreign suppliers' comparative advantages lie mainly in starting the production of these items sooner. This suggests that the present superiority is due to acquired skill and
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experience. Under certain conditions, a protecting duty might be the least inconvenient method for national development. However, Mill warns very emphatically about the use and abuse of his theory. He states that "it is essential that the protection should be confined to cases in which there is good ground of assurance that the industry which it fosters will after a time be able to dispense with it; nor should the domestic producer ever be allowed to expect that it will be continued even beyond the time necessary for a fair trial of what they are capable of accomplishing" (Mill, 1961: 922). In Kenya like in many other countries, approaches to the regulation of MFI are complicated by the fact many institutions are involved in providing MF services under different legal structures. The present a challenge in identifying an appropriate regulating approach, which is conducive to the development of the sector while providing adequate facility to the MFI activities. The tiered approach recommended for Kenya recognizes the inappropriateness of the existing banking legalization for the regulation of specialized activities of MFI and the diversity of the institutions engaged in the less regulated sector. However MFI operating as banking institutions, SACCOs and Kenya Post Office Saving Bank are already regulated by the act of parliament that specifies their different supervisory authority

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2.2.2 Realities of microfinance Apart from subsidies the poor need access to credit. Absence of formal employment make them non `bankable'. This forces them to borrow from local money lenders at exorbitant interest rates. Many innovative institutional mechanisms have been developed across the world to enhance credit to poor even in the absence of formal mortgage. The present paper discusses conceptual framework of a microfinance institutions in India, Bangladesh and Indonesia. 2.3 Empirical Reviews 2.3.1 Formal banking in India Traditionally, the formal sector Banking Institutions in India have been serving only the needs of the commercial sector and providing loans for middle and upper income groups. Similarly, for housing, the HFIs have generally not evolved a lending product to serve the needs of the Very LIG primarily because of the perceived risks of lending to this sector. The following risks are generally perceived by the formal sector financial institutions: Credit Risk, High transaction and service cost, Absence of land tenure for financing housing, irregular flow of income due to seasonality, Lack of tangible proof
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for assessment of income and Unacceptable collaterals such as crops, utensils and jewellery As far as the formal financial institutions are concerned, there are Commercial Banks, Housing Finance Institutions (HFIs), NABARD, Rural Development Banks (RDBs), Land Development Banks and Co-operative Banks (CBs). As regards the Co-operative Structures, the Urban Co-op Banks (UCB) or Urban Credit Co-op Societies (UCCS) are the two primary co-operative financial institutions operating in the urban areas. There are about 1400 UCBs with over 3400 branches in India having 14 million members, their total lending outstanding in 199091 has been reported at over Rs 80 billion with deposits worth Rs 101 billion. Similarly there exist about 32000 credit co-op societies with over 15 million members with their total outstanding lending in 1990-91 being Rs 20 billion with deposits of Rs 12 billion. Few of the UCCS also have external borrowings from the District Central Co-op Banks (DCCBs) at 18-19%. The loans given by the UCBs or the UCCS are for short term and unsecured except for few which are secured by personal guarantees. The most effective security being the group or the peer pressure.

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The Government has taken several initiatives to strengthen the institutional rural credit system. The rural branch network of commercial banks have been expanded and certain policy prescriptions imposed in order to ensure greater flow of credit to agriculture and other preferred sectors. The commercial banks are required to ensure that 40% of total credit is provided to the priority sectors out of which 18% in the form of direct finance to agriculture and 25% to priority sector in favour of weaker sections besides maintaining a credit deposit ratio of 60% in rural and semi-urban branches. Further the IRDP introduced in 1979 ensures supply of credit and subsidies to weaker section beneficiaries. Although these measures have helped in widening the access of rural households to institutional credit, vast majority of the poor rural have still not been covered. Also, such lending done under the poverty alleviation schemes suffered high repayment defaults and left little sustainable impact on the economic condition of the beneficiaries. 2.3.2 The Grameen Bank in Bangladesh The concept is the brainchild of Dr Muhammad Yunus of Chittagong University who felt concern at the pittance earned by landless women after a long arduous day's work labouring for other people. He reasoned that if these women could work for themselves

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instead of working for others they could retain much of the surplus generated by their labour, currently enjoyed by others. Established in 1976, the Grameen Bank (GB) has over 1000 branches (a branch covers 25-30 villages, around 240 groups and 1200 borrowers) in every province of Bangladesh, borrowing groups in 28,000 villages, 12 lakh borrowers with over 90% being women. It has an annual growth rate of 20% in terms of its borrowers. The most important feature is the recovery rate of loans, which is as high as 98%. A still more interesting feature is the ingenious manner of advancing credit without any "collateral security". The Grameen Bank lending system is simple but effective. To obtain loans, potential borrowers must form a group of five, gather once a week for loan repayment meetings, and to start with, learn the bond rules and "16 Decisions" which they chant at the start of their weekly session. These decisions incorporate a code of conduct that members are encouraged to follow in their daily life e.g. production of fruits and vegetables in kitchen gardens, investment for improvement of housing and education for children, use of latrines and safe drinking water for better health, rejection of dowry in marriages etc. Physical training and parades are held at weekly meetings for both men and women and the "16 Decisions" are chanted as slogans. Though according to the Grameen Bank

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management, observance of these decisions is not mandatory, in actual practice it has become a requirement for receiving a loan. Numbers of groups in the same village are federated into a Centre. The organization of members in groups and centers serves a number of purposes. It gives individuals a measure of personal security and confidence to take risks and launch new initiatives. The formation of the groups - the key unit in the credit programme is the first necessary step to receive credit. Loans are initially made to two individuals in the group, who are then under pressure from the rest of the members to repay in good time. If the borrowers default, the other members of the group may forfeit their chance of a loan. The loan repayment is in weekly instalments spread over a year and simple interest of 20% is charged once at the year end. The groups perform as an institution to ensure mutual accountability. The individual borrowing member is kept in line by considerable pressure from other group members. Credibility of the entire group and future benefits in terms of new loans are in jeopardy if any one of the group members defaults on repayment. There have been occasions when the group has decided to fine or expel a member who has failed to attend weekly meetings or willfully defaulted on repayment of a loan. The members are free to

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leave the group before the loan is fully repaid; however, the responsibility to pay the balance falls on the remaining group members. In the event of default by the entire group, the responsibility for repayment falls on the centre. The Grameen Bank has provided an inbuilt incentive for prompt and timely repayment by the borrower i.e. gradual increase in the borrowing eligibility of subsequent loans. 2.3.3 Linking Banks with Self-Help Groups: A Pilot Project

from Indonesia. In Indonesia, financial liberalization since 1988, disenchantment with traditional subsidized credit programs and an openness to innovative approaches led the Central Bank to support a pilot project in which 13 participating banks, with the assistance of 12 NGOs, have lent to about 420 self-help groups (SHGs) in the first phase, to be onlent to their members. Some of the principles underlying the project and the guidelines that were issued to the implementing groups are listed below:

The SHGs are to use part of their funds (almost 60%) for lending to their members and the rest for depositing in a bank to serve as the basis for refinancing from the bank.

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Savings are to come first: no credit will be granted by the SHG without savings by the individual members of the SHG. These savings are to serve as partial collateral for their loans. The joint and several liabilities of the members are to serve as a substitute for physical collateral for that part of loans to members in excess of their savings deposits. Credit decisions for on lending to members are to be taken by the group collectively. Central Bank refinance is to be at an interest rate equal to the interest rate at which the savings are mobilized. All the intermediaries (the Central Bank, banks, NGOs and SHGs) will charge an interest margin to cover their costs. Interest rates on savings and credit for members are to be market rates to be determined locally by the participating institutions. Instead of penalties for arrears, the banks may impose an extra incentive charge to be refunded in the case of timely repayments. The ratio of credit to savings will be contingent upon the credit worthiness of the group and the viability of the projects to be implemented, and is to increase over time with repayment performance.

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SHGs may levy an extra charge on the interest rate for internal fund generation (which would be self-imposed forced savings).

Within the first ten months of the implementation period, by March 1990, 7 private banks and 11 branches of government banks had made 229 group loans to SHGs, which had retailed them to about 3500 members. Loans totalling about $0.4 million had been disbursed, on an average of about $2000 per group and $118 per member. SHG savings deposits with the bank amounted to about $400 per group, giving a credit to savings ratio of about 5. NGOs have received loans from the banks at 22 to 24 per cent which is only slightly higher than the refinancing rate of large to small banks. Rates to end users have been between 30 to 44 per cent after the NGOs and SHGs have added their margins to cover costs and build funds to cover joint and several liability. Only one of the participating banks had sought a guarantee under the scheme from the Central Bank.

2.4 CONCEPTUAL FRAMEWORK

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Figure 1
MFI loans repayment period. capital

Advisory services

ENVIRONMENT Political Economic Social economic Legal

Microloan

Security

STRATEGY Borro w Intern al financ ing

Sal es

PERFORMANCE Profit

Investment Expand SMALL SCALE BUSINESS License Employment

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In

developing this proposal, we came up with the above conceptual

framework which shows the environment in which the SMEs and micro financial institution are set up. The government regulates SMEs through issuance of licenses. The government will also impose limits on the minimum capital that the micro finance institutions are supposed to maintain at any period. In advancing the loans to SMEs, the micro finance institutions require securities for the business like title deed, Business registration certificates, certificate of life insurance policy etc. The business may also borrow or use internal funds in their financing. In return, the microfinance institutions will offer advisory services to business such as viable projects to invest in. From funds acquired by SMEs they may opt to expand the business or to invest in new line of business. This will result into higher sales to increase in demand and expansion from the economies of scale. This will results into increased profits resulting to higher level of performance of the business and hence contribute to the economic development.

CHAPTER THREE RESEARCH METHODOLOGY 3.1 INTRODUCTION This chapter presents a detailed descriptions of the methodology used in the study. It includes research design, description of the study area, target population, sample population, sampling procedure, data collection methods and data analysis methods.

3.2 RESEARCH DESIGN The research will be carried out in form of a cross section survey of SMEs that have accessed loans from microfinance institutions.

3.3 RESEARCH AREA The research will be conducted in the central business district kisumu town, the CBD covers an area of about 300 sq meters the research will focus on SMEs at lake market within the CBD.

3.4 TARGET POPULATION The target area of this research will be the small and medium enterprises in kisumu CBD Lake market that receive credit from the microfinance. Lake market has about 110 SMES and The target population of the research will be 80 SMES consisting of 20, 40 and 20 salons, Electronics and hotels respectively. The research targets 80 SMEs who have actively been in their areas of business for the last 5 years.

3.5 SAMPLE AND SAMPLING TECHNIQUES For convenience, the target population will be clustered into groups of similar SMES, i.e. salons, electronics and hotel enterprises; this is because of limited time and resources. The table below shows the target population and the sample size .for each target population the research will focus on the SME who have managed to get a loan from the MFI this year.

Table
SME (members of population) Salons Electronics Hotels(food joints) Totals Population 20 40 20 80 Sample size 10 15 8 33

Chart view
40 35 30 25 20 15 10 5 0 population sample size salon electronics hotels

There are a total of 80 SMES targeted, and the survey will aim at investigating eight of these.

3.6 DATA COLLECTION TECHNIQUES 3.6.1 QUESTIONAIRE AND SCHEDULE METHOD The researchers will use the questionnaire and the schedule in form of questions in a set form to draw information from respondents. The questionnaire will be self administered while the schedule will be administered by trained interviewers to the respondents. 3.6.2 INTERVIEW METHOD The researcher will use interviews to obtain required information orally or face to face. It will be easy to apply since it would only require a notepad, a sound tape recorder and the part of researchers the skill to hold a conversation. The researcher may apply individual interview by meeting face to face with the respondents or by use of telephone communication. Also group interview may be used, in particular the focused group interview that will involve all stakeholders.

3.6.3 OBSERVATION METHODS This will involve the researchers to draw direct evidence of the eye by witnessing events first hand. Information will be sought by way of direct observation without asking from the respondents.

3.6.4 DOCUMENTARY REVIEWS The researcher will seek data from records, reports, printed foms, letters, autobiography, diaries, compositions, periodicals, bulletins, court decisions, and academic works such as books and journals e.t.c.

3.7 DATA ANALYSIS AND PRESENTATION Both descriptive and inferential methods that will be used include; measures of central tendency (mean, median mode), measures of dispersion (range, variance, standard deviation, coefficient of variation), measures of relative position and measures of relations and associations, correlation and regression.

Data analyzed will be presented in form of graphs, charts and tables, a PowerPoint presentation will be designed for presentation etc.

CHAPTER FOUR DATA ANALYSIS AND PRESENTATION

4.1 INTRODUCTION This chapter presents the findings of the study and the analysis of the data collected from questionnaire which was distributed to the small and medium size entrepreneurs. The questionnaire was distributed to 33 SMEs out of which all were fully completed with few difficulties experienced here and there and collected by the researcher for data analysis. This gives a response rate of 95%. 4.2 BUSINESS MANAGEMENT The respondentss were asked to state their relation with the business in existence. It was found that 33 per cent of the respondents were employees while 67 per cent were owner of the business. This is presented in the figure below.

Figure 4. 1: Respondents relation to the Business

f 11 22 33 % 33 67 100

Employee owner Total

33%

67%
OWNERS EMPLOYEE

The study also found out that 33 per cent of the respondentss are partnership while 50 per cent are sole proprietorship. Only 17 per cent of the respondentss are in form of joint venture. This is presented in the figure below. Figure 4. 2: Business Formation
Type of business f.(%) Joint venture Sole proprietorship Partnership Total 7. (17) 17. (50) 9. (33) 33 (100%) Hotels f (%) 0.(0) 30. (91) 3.(9) 33.(100) Electronic f (%) 0.(0) 32. (97) 1.(3) 33. (100) Salons f (%) 0.(0) 28. (85) 5.(15) 33.(100)

17% 33%

50%
joint venture sole proprietorship partnership

The researcher also sought to know the line of operation of the business. From the analysis, it was found that 37% of the respondents dealt with electronic kind of business, 36% indulged in hair dressing whereas 27% operated hotel businesses. The analysis of the line of business of respondentss can be observed from the figure below. Figure 4. 3: Line of business of the respondents

27%

37%

36%
electronic hair dressing hotel

The researcher sought to find out the source of capital for their business before the start or operation of the business. Statistically in the perception of the respondentss, 75%, said that the business obtained its capital from micro-financial institutions while 25% from other financial institutions that were stated. The results are shown in the table below. Table 4. 1: source of capital Response Micro-financial institution Other financial institution Total Frequency 20 13 33 Percent (%) 75% 25% 100%

The researcher also sought to investigate whether the respondents have ever benefited from the services of micro-financial institutions and those who had obtained their capital from MFI had some reasons, major ones being the offer of cheap loans and financial services advices. As to what measures would you like the MFIs to implement so that loans repayment can be favorable to all SMEs, the study found out from the respondentss opinions that MFIs should a little flexible towards the members who do not meet the MFIs deadline of loan repayment and this they should do by lengthening their repayment periods. It was also proposed that they should also adjust their loan interest charges, relaxing their security requirements and offer proper training to the illiterate

citizens to be acquainted with their terms and conditions. 25 respondents who said that they have benefitted from the services of the micro-financial institutions as to obtaining loans claimed to have experienced a favorably shorter loan repayment period as per the conditions of the MFIs. This is illustrated in the table below whereby, 25% were subjected to 2-5 years, and 62.5% were subjected to 6 months-1 year, while 12.5% were subjected to 5 years and above.

Table 4. 2: Loan repayment period as per the conditions of MFIs Loan Repayment Period 2 5 years 6 months 1 year Above 5 years Total Frequency 8 13 4 25 Percent (%) 25% 62.5% 12.5% 100%

As evident from the table below, 83.3% of the respondents claimed that although they have benefitted from MFIs, they also faced some challenges as loan beneficiaries, majority with the reason being long periods of waiting for the loan processing, while the remaining 16.7% were of the suggestion of having experienced no challenges as loan beneficiaries. Table 4. 3: challenges as loan beneficiaries Response Frequency Percent (%)

Yes No Total

20 5 25

83.3% 16.7% 100%

The findings presented in the table below are based on the question, rate the performance of your business operation? 85% of the respondents answered average, 10% answered high, while 5% answered that their business performance was yet to regain its stands after facing stiff competition thus rated their performance to be low.

Table 4. 4: Rate of performance of the business Answer High Moderate Low Total Frequency 3 28 2 33 Percent (%) 10% 85% 5% 100%

As evident from the table below, 66.6% of the respondents said to be making savings in their business operation through realization of profits when extracting their business balance sheets and profit and loss account, while the remaining 33.7% are yet to realize profits thus no savings since they are fresh in the business field. Table 4. 5: Impact of political environment on the company Response Yes No Frequency 25 8 Percent (%) 66.6 33.7

Total

33

100.0

58.3% of the interviewed clients claimed to be having an external business outlet apart from their business thus attaining business diversity and expansion through the realized savings, while the remaining 41.7% had no any business outlet apart from the one in existence. This is presented in the table below.

Table 4. 6: Other Business outlets Response Yes No Total Frequency 15 18 12 Percent (%) 58.3% 41.7% 100%

The findings on the table below are based on the question, How do you rate the loan services from the MFIs? 8% of the respondents answered excellent, 25% of the respondents answered very good, 55% of the respondentss answered good while 12% answered poor. All these were based on the terms and conditions laid upon before accessing loan by the MFIs. Table 4. 7: Response Excellent Frequency 5 Percent (%) 8

Very good Good Poor Total

10 14 4 33

25 55 12 100%

The findings on table 4.10 below are based on the question, What would you wish the MFIs to do so as to improve your business performance? 33.3% of the respondents opted for MFIs in offering training, while 66.7% of the respondents opted for MFIs in increasing their lending rate.

Table 4.9: Perception on the type of strategy adopted by the company Response Increase lending rate Offer training Total Frequency 18 15 33 Percent (%) 33.3% 66.7% 100.0%

CHAPTER FIVE CONCLUSIONS AND RECOMMENDATION

5.1 Summary of the Findings This study was designed with three main objectives. One, to establish whether the SMEs have been financed by MFIs, two, to determine if the financed SMEs have managed to repay their loans according to the terms and conditions of MFIs and three to determine if the financed SMEs have realized business growth since acquisition of credit from MFI. The general objective formulated was to find out the impact of MFIs on the performance of SMEs. From the study, the researcher found out that 5.2 Conclusion Some valuable lessons can be drawn from the experience of successful Microfinance operation. First of all, the poor repay their loans and are willing to pay for higher interest rates than commercial banks provided that access to credit is provided. The solidarity group pressure and sequential lending provide strong repayment motivation and produce extremely low default rates. Secondly, the poor save and hence microfinance should provide both savings and loan facilities. These two findings imply that banking on the poor can be a profitable business.

However, attaining financial viability and sustainability is the major institutional challenge. Deposit mobilization is the major means for microfinance institutions to expand outreach by leveraging equity (Sacay et al 1996). In order to be sustainable, microfinance lending should be grounded on market principles because large scale lending cannot be accomplished through subsidies A main conclusion of this paper is that microfinance can contribute to solving the problem of inadequate housing and urban services as an integral part of poverty alleviation programmes. The challenge lies in finding the level of flexibility in the credit instrument that could make it match the multiple credit requirements of the low income borrowers without imposing unbearably high cost of monitoring its end-use upon the lenders. A promising solution is to provide multi-purpose loans or composite credit for income generation, housing improvement and consumption support. Consumption loan is found to be especially important during the gestation period between commencing a new economic activity and deriving positive income. Careful research on demand for financing and savings behavior of the potential borrowers and their participation in determining the mix of multi-purpose loans are essential in making the concept work (tall 1996).

5.3 Recommendations For MFIs to succeed in the global sector, it should loosen their terms and conditions for SMEs to easily access loans and also create awareness to the people through civic education on the services offered by them.

5.4 Suggestions for further research The research proposes that a similar research be undertaken focusing on strategies adopted by MFIs in bringing their services to the rural population .Further, the research proposes a study on the impact of MFIs on savings.

REFERENCES

Barry, N.(1995), "The Missing Links: Financial System that Works for the Majority," Women's World Banking, New York.

Barry, Nancy, Armacost, Nicola and Kawas Celina (1996) "Putting Poor people's Economics at the Center of Urban Strategies," Women's World Banking, New York.

Chriseten, R.Peck Rhyne, Elisabeth and Vogel, Robert C (1994) "Maximizing the Outreach of Microenterprise Finance: The Emerging Lessons of Successful Programs," September IMCC, Arlington, Virginia.

Churchill, C.F. (1996)," An Introduction to Key Issues in Microfinance: Supervision and Regulation, Financing Sources, Expansion of Microfinance Institutions," Microfinance Network, Washington, D.C. February

Grameen Trust (1995) Grameen Dialogue No.24, Dhaka, October. Otero, M. and Rhyne, E.(1994) The New World of Microenterprise Finance -Building Healthy Financial Institutions for the Poor, Kumarian Press, West Harford, Connecticut.

Phelps, P.(1995) "Building Linkages Between the Microenterprise and Shelter Sectors: An Issues Paper," GEMINI, Betuesda, Maryland.

Women's World Banking (1994) "United Nations Expert Group on Women and Finance," New York.

QUESTIONAIRE

LETTER OF TRANSMITTAL We the students of Maseno University would like to appeal to the respondents of this questionnaire to participate fully and your cooperation will be highly appreciated, This questionnaire is aimed at collecting data required for the study entitled: IMPACT OF MICRO FINANCE ON THE PERFORMANCE OF SMES IN KISUMU CBD LAKE MARKET The data collected would be strictly for academic purposes and any correspondence given be treated as confidential. Respondents are requested to give any information that is necessary for the topic. The interviewer is in any case not allowed to force any respondent to give information. Thanks This questionnaire is aimed at collecting data required for the study entitled: IMPACT OF MICRO FINANCE ON THE PERFORMANCE OF SMES IN KISUMU CBD LAKE MARKET.

Name of the interviewer

Please give the following details 1) Name of business. 2) Ownership a. Employee b. Owner 3) Year of establishment 4) Type of Business a. Joint venture b. Sole proprietorship c. Partnership Others state. 5) State your line of business.. SECTION 1 1) Select sources of capital to your business (tick any appropriate) a. Micro financial institutions b. Other financial institutions If none of the above state

2) Do you benefit from micro financial institutions? a. Yes b. No If Yes, how .. 3) If you obtain loan from MFIs what made you to seek financial assistance from the MFIs a. Easy loan repayment b. Good services Others state What is the loan repayment period as per the conditions of MFI? a. 6 months-1 year b. - 5 yrs c. Above 5 yrs SECTION 2 4) How loan has it taken you to repay the amount awarded to you by the MFIs (tick one) a) 1-3yrs

b) 4 10 yrs 5) How do you rate the loan services from the MFIS? (Tick one) a. Poor b. Good c. Very good d. Excellent 6) Do you face any challenges as a loan beneficiary from the MFIs? (tick one) a) Yes b) No If yes state.. SECTION 3 7) How many employees did the business employ at the start of its operation? a) 1-10 b) Above 10 8) How many employees are there currently? ..

9) Do you have any other business outlet (branch) that is part of this business? a) Yes b) No If yes (tick one) a) 1 -5 b) 6-10 c) Above 10 10) Do you make any savings from your business? a) YES b) NO If no, what could be the reasons? 11) How do you rate the performance of your business? a) High b) Low c) Average

SECTION 4 12) What would you wish the MFIs to do so as improve your business performance? (Tick one) a. Increase lending rates b. Offer training Others specify.. 13) What do you think should be done so that the MFIs can easily award loans to any SME equally? .............................................................................................

14) What challenges do you face when trying to access loans from the MFIs?(tick ) a) Lack of security

b) Lack of proper knowledge

c) Conditions on repayment

Others state End*************End************* End ************* End

Thank you very much for participating!!!!