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Kenya: Meeting the Challenge of Creating an Inclusive Financial Sector 1

Kenya: Meeting the Challenge of Creating an Inclusive Financial Sector 1. Summary: When Kenya’s new government came to power in 2002, it inherited a poorly performing economy and a weak financial system. Its programme of economic reform set out a clear commitment to a market economy and private sector led growth. Policy for financial sector development sought to improve stability, increase efficiency and expand access. Following a long period of poor economic performance through the 1980s and 1990s, Kenya’s economy has started to show signs of a sustained recovery. Growth has exceeded 5% per annum for the last three years. Emboldened by this performance, the Government is developing a long term national vision for transforming Kenya into a middle income country by 2030. Sustained economic growth of 10% annually is required to achieve the goals of Vision 2030. An inclusive financial sector can enable all Kenyans to participate in, contribute to and benefit from this significantly rising growth rate and mobilize the necessary savings and investments needed to realize the national vision. A recent study on access to financial services in Kenya, FinAccess, reveals that fewer than one in five of the Kenyan adult population is currently formally banked. Alternative financial institutions such as SACCOs (credit unions) and micro-finance institutions (MFIs) reach one in seven. Collectively these institutions provide services to only just over a quarter of the population – the ‘formally financial included’. Half the population uses informal financial services. Together Formal and informal financial institutions serve just over three fifths of the population, but this leaves nearly two Kenyans in five financially excluded. While these figures compare favourably with Kenya’s regional neighbours on overall financial inclusion, the new economic vision calls for greater ambition. Better macro economic management and improved regulatory capacity have been critical in stimulating a private sector driven expansion in financial access. This is reflected in increasing number of accounts, and growing bank branch and ATM networks. Innovating financial institutions such as Equity Bank have rapidly expanded outreach and demonstrated the ability to meet a significant unmet demand. Kenya’s recent performance is strongly consistent with the argument that a market based approach can deliver on financial inclusion. Government and its donor partners need to respond to the challenges of poverty, isolation and weak infrastructure which drive financial exclusion. While doing so, they need to adopt approaches which further encourage market based solutions. This paper was prepared by Sukhwinder Arora and David Ferrand based on extensive analysis undertaken by Financial Sector Deepening Kenya and other sources listed at the end of the paper. David Cracknell has provided valuable support.

This paper was commissioned by Financial Sector Team, DFID as background material for the DFID and HM Treasury Financial Inclusion Conference, London (19 June 2007) and does not constitute official DFID views or policy.


Table 1: Key Country Data Population 34 million Land Area 0.58 million km2 GDP $ 19 Billion GDP (average annual

growth) 2.1% 1995-2000 3.4% 2000-05

Population below the poverty line (1997 data)

23% population below $1/day 58% population below $2/day

Domestic Credit to the private sector

26% of GDP in 2005 33% of GDP in 1990

Bank Branches 1.4 per 100,000 people

Phones 14300 Per 100,000 people (2005)

Formally Included 27% adult population has access to financial products supplied by legally governed institutions (19% formal banks and 8% others)

Informally served 35% adult population is only served by informal arrangements such as Rotating Savings and Credit Associations (ROSCAs)

Financially Excluded 38% Source: World Development Indicators 2006, online; FinAccess Data 2007 2. Background Following a long period of poor economic performance through the 1980s and 1990s, Kenya’s economy has started to show signs of a sustained recovery. Growth has exceeded 5% per annum for the last three years. In 2006 the growth rate reached 6.1%. While Kenya remains strongly dependent on agriculture, these growth rates have been achieved despite adverse weather over this period. The level of poverty is starting to reduce with 45.9% of the population below the national poverty line (2005/06), down from a peak of 52.3% (1997). From independence to the late 1980s, the Government intervened significantly in the financial sector, through both regulation and direct participation in markets. Commercial banks, constituting the largest part of the financial sector, were subject to interest rate controls, required to lend minimum proportions of their portfolio to the agricultural sector as well as open rural branches in strict proportion to those opened in urban areas. Policy directed lending to priority sectors including agriculture, tourism, industry and small enterprise, was routed through state owned commercial banks and development finance institutions. During this period, the overall policy thrust was strongly oriented towards increasing access to finance by emergent Kenyan business, which a foreign bank dominated system was felt to serve poorly. Reflecting economic development thinking at the time, this policy emphasised access by the formal economy. By contrast the livelihoods of most Kenyans were dependent and continue to depend on the informal economy. Policy therefore effectively gave rather less attention to the broader issue of financial inclusion. Echoing experience across the world, after some early gains, this interventionist approach proved counterproductive. Kenya embarked on a general programme of economic liberalisation from the late 1980s. Weak regulation during the 1980s combined with poor growth performance, resulted in a succession of banking crises with the collapse of many small locally owned institutions. With the large banks well entrenched in mainstream


markets, these institutions had a greater incentive to innovate and unlock new markets. The loss of these institutions is therefore believed to have resulted in a set-back for developing a more inclusive financial system. Better regulation might have prevented this loss. As a part of financial sector liberalisation, interest rates and exchange controls were removed in the early 1990s. However in the context of an already poorly performing economy, lack of discipline in macro-economic management and a weak banking system, the move to liberalise financial markets produced disappointing results. The macro-economic crisis of the mid-nineties produced a spike in interest rates which pushed many businesses into difficulties and generated a large non-performing portfolio which persisted into the following decade. Subjected to political direction, the state owned and influenced financial institutions performed especially badly. A lack of real commitment to the liberalisation programme resulted in only partial privatisation of the state-owned banks and reform of the development finance institutions was deferred. Reflecting a growing emphasis in the banking industry on improving cost structures, there was a contraction in branch networks in the less profitable rural areas and the minimum account operating requirements were raised. While accurate data is unavailable for this period, there was thought to be a significant contraction in access as a consequence. During 1990-2003, the credit to private sector as a proportion of GDP actually fell from 33% to 24%. Closely linked to the perceived abandonment of lower income markets by commercial banks, this period saw the emergence of Savings and Credit Co-operatives (SACCOs - Kenya’s credit union movement) and microfinance institutions, seeking to fill the gap. A new government inherited a weak financial system and a weak economy in December 2002. The Economic Recovery Strategy for Wealth and Employment Creation for 2003-07 (ERS) sets out a clear commitment to a market economy and private sector led growth. The ERS emphasised the importance of the financial system and improving access across the economy – especially in the agriculture sector and among micro and small enterprises. Policy with respect to financial sector development was developed around three inter-dependent objectives: improving stability, increasing efficiency and expanding access. The immediate focus was on getting the fundamentals right. Early policy actions included reduced government borrowing, a reduction in the central bank cash ratio and strengthening financial sector regulation. The Government has also resisted calls for the re-introduction of interest rate controls, despite strong political pressure. A new economic strategy – the Vision 2030 – has been developed to follow on from the ERS. Ambitious goals have been set to achieve middle income country status by 2030. Sustained economic growth of 10% annually is required to achieve this vision. In order to generate this level of growth, the World Bank notes that “unprecedented increases in investment and productivity growth are required” that require major changes “in policies and institutions that mobilize producers, investors, savers, donors, and the government to make this possible” (World Bank 2007). As part of the planning process, a comprehensive financial sector reform and development


strategy is to be adopted. An inclusive financial sector can enable all Kenyans to participate in, contribute to and benefit from this significantly rising growth rate and mobilize the necessary savings and investments needed to realize the national vision. 3. Access to financial services in Kenya 3.1 Defining the access baseline: In developing a bold strategy for financial sector development, which will for the first time explicitly address financial inclusion, it is vital to clearly understand the extent and nature of the challenge faced and to provide a credible means of measuring progress. A Financial Access Partnership was formed in 2005 to tackle an information gap. Composed of key stakeholders in the financial sector from Government, Central Bank of Kenya, banks, micro-finance institutions, SACCOs, development partners and research institutions, the partnership has guided the creation of a national survey on access to financial services - FinAccess. The first FinAccess study, carried out in August 2006 and financed by the multi-donor funded Financial Sector Deepening Kenya (FSD Kenya) programme, provides nationally representative data on financial service usage and financial exclusion. 3.2 Headline findings on Access: The FinAccess study reveals that just over a quarter of Kenyans can be regarded as ‘formally financially included.’ Less than one in five (18.5%) of the Kenyan adult population are banked, that is using a regulated commercial bank, building society or the Post Bank. Only a small number of institutions were responsible for a significant proportion of this outreach. The Post Bank alone accounted for 5.6% of the usage. The Savings and Credit Co-operatives (SACCOs) provide services to 13.1%, while the currently unregulated micro-finance institutionsi (MFIs) reach 1.7%. Based on either large scale formal employment or smallholder commercial agricultural commodity production, the SACCOs are able to offer both basic credit and savings services to their members. The MFIs, strongly oriented towards informal business or micro-enterprise, have been limited until very recently to offering credit services – primarily through group-based non-collateralised lending. A large number (42.9%) of those using SACCOs also maintained accounts with a bank. Many people borrow from SACCOs perceiving them as offering a cheaper or more accessible source of credit. Collectively the formal institutions, banks, SACCOs and MFIs, provide services to just over a quarter (26.6%) of the population.


Half the population (50.6%) make use of various forms of informal financial service. The most common of these are rotating savings and credit associations (ROSCAs), often referred to as merry-go-rounds or tontines in Africa. These provide a simple means through which to save and accumulate a lump sum through the regular pooling of usually small contributions in a group which is taken by each group member in turn. More sophisticated arrangements allow for a less regimented approach with members contributing and borrowing from a group more according to their needs rather than the dictates of their turn. Interestingly a significant proportion of those with access to the formal providers also use informal mechanisms. Over a third of those with a bank account also use an informal service. The use of informal systems increases the level of total financial inclusion in Kenya by 35.0% to reach 61.7%. This however leaves over a third of the population (38.3%) financially excluded. 3.3 Patterns of inclusion and exclusion: The aggregate figures conceal considerable variations in access according to gender, age and geographical location. Only 14.0% of adult women in Kenya are banked and 20.6% are formally financially included. Banks and SACCOs have notable gender imbalances in usage and equal usage is only seen among micro-finance institutions which have tended to explicitly target women to address concerns over exclusion. Overall levels of financial exclusion are however reduced as a result of the strong usage of informal mechanisms by women. Patterns of usage vary significantly between rural and urban areas. As would be expected, the banks concentrate activities in the urban centres. Nearly a third (31.0%) of Kenya’s urban population is banked while the level of penetration drops by half to 14.4% usage in the rural. However SACCOs, largely driven by the agriculturally based societies, help to partly redress the balance. 14% of the rural population makes use of a SACCO (compared with 10% in the urban areas). Informal group usage is only slightly lower in the rural as compared with urban population.

Figure 1: Financial access strata

Source: FinAccess 2007

Formal, 18.5%

Formal others, 8.1%

Informal, 35.0%

Excluded, 38.3%

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%


Disaggregated regional data reveal significant gaps in formal sector outreach across regions. Population density, remoteness and wealth levels have a strong influence. The arid, sparsely populated areas of the country in the north have especially low levels of formal access. North Eastern province which is entirely composed of arid and semi-arid areas, with very high levels of poverty, is largely ignored by the formal financial system outside the administrative centre. By contrast Central province, which is geographically close to Nairobi and characterised by relatively high population density and low poverty levels has the highest level of bank usage.

3.4 Product offers and inclusion: The product offers from different institutional types are often not strictly comparable. For example, the type of flexible saving build up (or draw down) possible through the basic bank account differs significantly from the temporary store achievable through contribution to a rotating savings and credit association (ROSCA). Both have their strengths and weaknesses. The former provides a long-term safe store but comes at a cost and may be difficult to access for many. On the other hand, the latter has no user charge and is highly accessible but the store of money is temporary and users can face a loss if other members fail to pay. Access to credit has long been a concern from a policy perspective given its importance to economic

Table 2: Dis-aggregated regional data on Poverty, Bank Branches and % of Banked Population

Adult Population (million)

% below poverty lineii

% banked No. of bank branches

% Branches

Nairobi 1.88 34% 38% 194 44%Central 2.23 30% 24% 51 12%Coast 1.61 70% 15% 63 14%Eastern 2.75 51% 15% 30 7%North Eastern 0.59 74% 0% 3 1%Nyanza 2.45 48% 12% 25 6%Rift Valley 4.09 49% 20% 63 14%Western 1.81 52% 11% 14 3%Total 17.41 46% 19% 443 100%Source: FinAccess 2007

Box 1 - The Quality of Access to Financial Services

Increasing the spotlight on measuring financialaccess in a particular country is welcome andlong overdue. At a macro level these figures arevaluable and demonstrate the broad trends onaccess to financial services. However, caution isneeded that in focussing on the headlineinclusion figures, there is no loss of attention onthe quality of that access and usage, especially atthe financial organisation level. As we focus onissues of access to financial services by themajority, we need to consider the quality ofaccess and usage, especially at the financialorganisation level. Continuous improvement inquality of access is a significant contributor to therapid expansion of Equity Bank in Kenya. Byconsidering quality of access, financial institutionsare forced to understand their customers andtheir needs, and to respond appropriately. It isindeed surprising how relatively simple tools,such as basic qualitative market research orsegmentation analysis can inform managers andfundamentally and irrevocably change seniormanagement views of the performance of theirinstitution. Quality and not just quantity of accessmatters. Contributed by David Cracknell, MicroSave


growth. The FinAccess study found that 30.8% of the population is currently using credit and a total of 38.3% have ever used credit. While this is not inconsistent with the widely held view that the majority of Kenyans do not have access to credit, these figures need to be interpreted with care. There may be many people who could access credit but do not wish to do so. Others may get a short term loan but may want to make a medium term investment. Nevertheless the pattern of usage is potentially revealing with the majority of users relying on informal sources. Nearly three-quarters (74.2%) of those currently accessing credit have done so through a shop or supplier providing goods and services on credit terms. Use of formal financial institutions is limited. Box 1 points to the limited analysis of information held by the formal financial organisations or efforts to understand what the customers are saying. SACCOs are the most commonly used formal source of credit, but still only account for 13.4% of those accessing credit or 4.1% of usage by the total population. Bank provided credit accounts for 10.4% of current credit access or 3.2% of the total population. Roughly half of those using informal sources perceive banks as costly and that the requirements to obtain a loan are difficult to meet. By contrast on this measure SACCOs and MFIs are regarded more favourably. 3.5 Remittance Transfers: Remittances have received growing attention internationally with the realisation of how many low income households depend on transfers from family members working away from home. The FinAccess survey found that 16.8% of the population had received money from another person within Kenya and 3.0% from outside the country. Clearly in Kenya domestic transfers are considerably more important than international. Again there is strong reliance on informal mechanisms. 58% of domestic transfers were sent through a friend or family member and 27% through a public service vehicle (bus or matatu). The most popular formal mechanism used – a money transfer service such as Western Union or MoneyGram – accounts for 9% of the domestic transfers. While informal methods were reported by respondents to be the riskiest, they are also held to the cheapest and most accessible. Formal services were rated highly on security and speed but less well on cost and accessibility. 4. Addressing the challenge 4.1 The Vision for Financial Inclusion: The FinAccess data shows starkly the scale of the challenge Kenya faces in developing an inclusive financial system. While levels of access compare favourably to Kenya’s regional neighbours, Uganda and Tanzania, these are no longer the economies Kenya compares itself against. In the context of the Vision 2030, Kenya seeks to benchmark its economic performance either with rapidly growing countries (such as Vietnam) or middle-income countries (South Africa, Namibia or Thailand) which have considerably higher levels of access (see Figure 2).. Against these benchmarks, a conservative target for formal access by 2030 would be doubling formal financial inclusion to reach 50%. Less easy to target is the reduction in the overall level of financial exclusion. With the development of better models of informal service provision and proposed new social protection programmes, a halving of financial exclusion to less than


20% would seem a reasonable ambition. In seeking to meet such targets, Kenya faces some strong contextual constraints. Current poverty levels are high and entrenched inequality suggests that even with the targeted rates of growth, these levels will not reduce rapidly. The population remains overwhelmingly rural, with a significant proportion highly geographically dispersed across a country characterised by weak infrastructure. Despite these constraints, Kenya has already embarked on a path towards improving financial inclusion. The early results are promising and give strong pointers to how the longer-term vision might be realised. 4.2 Role of Government: Recent experience confirms convincingly that Government has a key role to play. This role is not in the delivery of services, but in laying out a clear policy direction and creating an enabling environment. The private sector players can then identify, invest and respond to opportunities in the market. Better macro economic management and notably the reduction in Government borrowing, has already had a significant effect. Following reductions in Government borrowing and a sharp reduction in the cash ratio, there has been an increase in lending to the private sector and signs of greater competition. Domestic credit to the private sector recovered from a low of 23.9% in 2003 to reach 26.6% in 2006. By 2005, bank lending rates had reduced to 12.9% from 19.6% in 2001 and average spreads to 7.8% from 13.0%. Crucially this has been accompanied by the effective implementation by regulators of Government policy to tighten prudential regulation and improve core financial sector stability. As a result the Central Bank successfully managed the non-performing loan problem which had threatened a banking crisis. Directly related to these policy moves, the commercial banks growing interest in new markets is demonstrated through product innovation and increased investment in new delivery channels in the

Figure 2

ACCESS ST RANDS

0% 20% 40% 60% 80% 100%

S A

NAMIB IA

B OTS W A NA

K E NYA

TA NZA NIA

ZA MB IA

% a

du

lts

Formally included Semi forma llyInfo rmally included Excluded

Source: FinScope, FinAccess


form of branches and ATMs. All of this has been strongly positive for financial inclusion. With the maturation of the micro-finance sub-sector, the Government is now moving to provide a regulatory framework with legislation recently enacted to allow the Central Bank to license and regulate deposit-taking MFIs. A number of institutions have now developed to the point where deposit taking from the public is a viable proposition. This will allow MFIs to broaden their product offer to include savings services – often the most important financial service demanded by low-income clients. This gradualist approach to regulation is important. Early regulation could have stifled an emerging industry. However, as the industry grows, regulation is vital to ensure systemic stability and provide adequate protection to consumers. The Government is also moving to put in place an appropriate regulatory framework for SACCOs. This will recognise the heterogeneity of this sub-sector and the need for a pragmatic and risk-based approach. Very small community based SACCOs present no systemic threat, cannot be prudentially supervised cost-effectively and members usually take an active role in management and can more directly look after their interests. By contrast the largest SACCOs in Kenya are the size of mid-sized commercial banks in terms of assets and have a membership which would put them in the top ten financial institutions by market share. Prudential supervision of these institutions is essential to protect members and the wider financial system. Table 3: Examples of Stakeholder Action to support Financial Inclusion

Stakeholder Examples of actions to support Financial Inclusion Government • Management of macro-economic policy to control inflation and

public borrowing • Developed a market based approach to financial sector

development • Various regulatory reforms, including development of legislation to

regulate micro-finance and SACCOs • Provided greater operational independence for regulators • Signalling space for innovation (eg not rushing to regulate mobile

banking before the model is tested) • Created space for stakeholder feedback • Participation in the FinAccess Survey

Regulators • Strengthened regulation and supervision of the banking system • On-going development of capacity to regulate micro-finance

institutions appropriately • Created space for stakeholder consultation and feedback • Encourage competition through compilation and dissemination of

information on pricing Banks, SACCOs, micro-finance and other financial institutions

• Rapid expansion of delivery channels (branch expansion reactivated since 2003 and ATMs have expanded from 200 in 2003 to over 600 in 2006)

• Innovation (see box 1 and 2) in products, channels and process often in partnership with others, such as mobile phone operators.

• Annualised growth rate of 20% in the number of accounts from 2005

• Active participation in discussions on regulatory changes, especially for micro-finance and SACCOs


Box 2: Development of specialist service providers: ATM services - PesaPoint A specialist provider, PayNet, now offers a national network of over 100 ATMs branded as PesaPoint. This offers the potential to significantly increase the efficiency of ATM operation by effectively allowing sharing of machines across a number of financial institutions. It directly supports improved access by allowing ATMs to be profitably located in areas which would not be viable for a single institution operating a proprietary network. Again competition is enhanced since smaller institutions, including SACCOs and MFIs, are able to participate in a delivery channel with national reach, previously only accessible to the larger banks. PayNet has also developed a specialist ATM based product – WagePoint – which provides an efficient solution to paying low-income workers in areas remote from banks, such as on flower farms. The WagePoint account allows workers to draw their pay at their workplace at their own convenience through specially adapted ATMs.

Table 3: Examples of Stakeholder Action to support Financial Inclusion

Stakeholder Examples of actions to support Financial Inclusion • Participation in the FinAccess Survey

Donors and International Financial Institutions

• IMF/World Bank Financial Sector Assessment Program (FSAP) – benchmarking of financial system

• World Bank and DFID support to reforms in the enabling environment for financial sector development through a Government Financial and Legal Sector Technical Assistance Project

• World Bank, DFID, SIDA support to the Financial Sector Deepening (FSD) Trust to support market driven financial inclusion

• FSD funded the FinAccess Survey and is supporting a number of initiatives to build inclusive markets at the sectoral and retail levels

• MESP Trust and Jitegemee Trust providing wholesale finance to low-income market oriented retail providers

• Support for sectoral capacity building (eg through the MicroSave programme to develop market based micro-finance)

• Making Finance Work for Africa initiative to share insights and undertake benchmarking

4.3 Building the support providers: At financial sector level, the flow of information lies at the heart of market function and development. It is vital to competition which provides the fundamental incentive to develop new market segments. FinAccess makes a valuable contribution in providing clearer information on the extent of the market, highlighting gaps to policy makers and potential opportunities to financial institutions. The recent move to allow sharing of credit information across banks is set to reduce the transaction costs of lending which should directly support increased access. It will also encourage greater competition as consumers are able to switch institutions more readily. There has been a growing awareness of the need for better information to consumers. A clearer understanding among consumer of the relative pricing and service offers by providers will sharpen competition. Also critical are the business service providers (such as business consultants and training providers) who support the financial sector. The recent emergence of specialised providers is an important development. For example, PayNet now offers a national system of ATMs to a wide range of banks and other financial institutions. Growing interest in the Kenyan market by information technology providers has resulted in greater choice and improved support for automation of


institutions. Technology is set to play an increasing role in reducing unit transaction costs which is central to improving financial inclusion. This technology is becoming increasingly accessible to smaller institutions with a focus on lower income markets. 4.4 Expanding and Diversifying Retail Capacity: The development of retail institutions is at the sharp-end of increasing access. Micro-finance institutions have played a pioneering role demonstrating convincingly that there is a market at the ‘base of the pyramid’. Where once the mainstream banks had seen the lower-end of the market as ‘unbankable’, micro-finance institutions such as K-Rep, Kenya Women Finance Trust and Faulu Kenya have shown that these markets can be reached profitably. Equity Bank has taken this to the next level, building a mass market business and simultaneously becoming one of the most dynamic, profitable and admired financial institutions in the country (see box 2). This sort of explosive growth has not escaped the notice of other mainstream banks who are now increasingly looking to expand at the lower end of the market. In less than two years, the number of accounts in the banking system has grown by 50%.

Box 3: Equity Bank crosses the one million customer landmark

Equity Building Society was set up in 1984 to provide financial services to under-served, low-income Kenyan consumers. However by 1993, in common with many other small, locally owned institutions, Equity was in financial difficulties. Technically insolvent, its non-performing loans amounted to 54% of the portfolio and the accumulated losses (KShs 33 million) were 11 times the paid up capital (KShs 3 million). Forbearance by the regulator, the Central Bank of Kenya, gave Equity an opportunity to re-invent itself. Equity seized this chance and began to transform itself from 1994. While technically a building society, Equity found its real market opportunity was in providing basic financial services to the low income rural market. Today it is demonstrating its ability to meet a hitherto largely unmet demand for financial services. Within five years Equity increased its client base ten-fold to cross the one million customer landmark late in 2006. It converted to become a full commercial bank in December 2004 and listed at the Nairobi stock exchange in August 2006.

While Equity has received significant external donor assistance since 1999, the foundations of its achievements lie in the strong vision and leadership of a committed management and board. In a recent paper on the market-led revolution in Equity, Wright and Cracknell concluded “The lessons Equity offers are complex, and yet in their core essence simple: success is dependent on putting the customer at the centre of a professionally managed and governed organisation”. The table below provides data on the explosive growth that Equity has achieved over 2003-06.

Equity Bank Performance Indicators 2003-06 Dec 2003 Dec 2006 % Growth Depositors 252,000 1,018,000 304 Total Assets (KShs million) 3,924 20,024 410 Loan Portfolio (KShs million) 1,734 10,929 530 Branches (number) 18 42 133 ATM Machines 0 100 - Staff (number) 360 1,395 288 Profit after tax (KShs million) 143 1,103 671


Expansion of number of distribution points has been essential for improving access. The trend of declining number of bank branches has been reversed and ATMs are being rapidly expanded (tripling in last three years). Both mobile phone companies in Kenya, Safaricom and Celtel, have launched mobile phone based money transfer products (see box 3). While currently limited to providing money transfers, this nevertheless opens up a potentially huge number of new points of presence for the financial system. Safaricom started its system with over 300 agents – two-thirds of the total number of bank outlets in the country. With many retailers across the country having the basic capacity to offer cash services and a mobile phone, this number is anticipated to grow rapidly. In 2006, the Post Office launched a technology based low cost instant money transfer system within the country. Again this immediately created 100 new points of presence for financial service provision. A key challenge moving forward is to see the effective integration of these various systems with the financial system. 4.5 Community based institutions: The FinAccess survey has shown the huge role played by informal systems in providing services. Although definitive data is not yet available, the indications are that it is poorer Kenyans who depend most on these systems. In Kenya, as elsewhere, efforts to enhance the functioning of informal or community based finance have had mixed results. Much of the success of informal finance lies in the intrinsic simplicity of the services and their embeddedness within local communities. A number of recent initiatives in Kenya have shown however that there is potential to both extend the reach of community based finance and increase its effectiveness. K-Rep Development Agency has been supporting the development of village based financial service associations (FSAs) for nearly a decade. Offering basic savings and lending services in areas far beyond the reach of formal banks or even MFIs, the model proved popular. However it was found that the community owned and run organisations rapidly hit performance problems once K-Rep support was withdrawn. The challenge has been to provide the

Box 4: Mobile Phone Banking generates excitement in Kenya Kenya has witnessed rapid explosion of mobile phones outreach – from a narrow base of 0.3 million phones in 2000, there are 9 million mobile phones currently (see Kenya: up ordown?, Economist June 2007). 19% of the populations in rural areas (52% urban) already own a mobile and an additional 29% can use someone else’s. Vodafone won a DFIDChallenge Fund grant to test a mobile phone based microfinance data communicationsplatform in unbanked areas. The partnership to test the product included Safaricom (Vodafone’s partner) , Faulu Kenya (a microfinance institution) and the Commercial Bank ofAfrica. Launched in Kenya in March 2007, M-Pesa (mobile money) enables an M-Pesa account holder to send money to others with or without a M-Pesa account as well as deposit or withdraw cash from the nearby M-Pesa agent. M-Pesa has already registered 100,000 customers through 450 agents in three months. Vodafone and Citigroup have alsoannounced the use of M-Pesa to facilitate international remittances (initially from UK to Kenya).


required support on a sustainable basis. K-Rep has now created a specialist management services provider – K-Rep Fedha Services – which offers a complete package of management and oversight services to FSAs. Carefully tailored to the needs of the FSA model and minimising costs, the service allows performance of FSAs to be managed at a high level while retaining community ownership and governance. There are encouraging signs that this market based approach will offer a sustainable solution with significant potential for scaling up. Realistically for many in Kenya access to formal financial services remains a very distant prospect. In some of the poorest communities in the country, CARE Kenya has been supporting the formation of group based savings and loan associations. These only offer the most basic saving and lending services within small groups. However their very simplicity allows them to be operated by communities without further support after an initial training period. The strong community basis encourages some of the poorest to participate – often among the most difficult to reach with financial services. Early results offer encouragement that this model can be used as one way to reduce financial exclusion. 5. Lessons from the Kenya experience It would be difficult to attempt to draw definitive lessons from the case of Kenya. Clearly confronting the levels of exclusion outlined earlier gives little cause for complacency. With only just over one in four Kenyans having access to a formal service, it is hard to claim that a viable path to reducing exclusion has been found. Nevertheless the indications from the last few years are encouraging. Kenya’s recent financial sector development is strongly consistent with the argument that a market development based approach can deliver on financial inclusion. Indeed the case of Kenya shows clearly the comparative poverty of state interventionist approaches. However the experience also shows the vital role to be played by the Government in encouraging inclusive financial sector development. Without the right policies it is difficult to see how the recent gains could have been made. Maintaining this policy direction will not be easy. The current financial system is currently far from meeting the aspirations of many Kenyans and pressure for a reversion to the perceived ‘quick fixes’ of interest rate controls or Government funded lending schemes can reoccur. It will be essential to demonstrate more clearly in future how the market based strategy is really working. A comprehensive approach is needed which does not only focus on the formal financial system but recognises the significance of the informal sector. The use of informal systems is important most immediately from the perspective of reducing overall financial exclusion. However the continued use of informal services by those with access to the banking system points to some of the intrinsic strengths of these approaches. The formal system can certainly learn something from this. Options for support to these mechanisms can continue to be explored.


One clear message to take from recent Kenyan experience has been the demonstration of the potential capacity of the private financial sector to contribute to increasing inclusion. The success of Equity Bank and more recently other banks in expanding services prove that the private sector can and will reach new markets. Innovations of the type exemplified by the Vodafone M-Pesa project show that technology can also help to deliver at the bottom of the pyramid. Donors can play a modest role in encouraging these developments but knowing when to step back and allow markets to function is probably more important than judging when to support. Government and its development partners need to respond to the challenges of poverty, isolation and weak infrastructure which drive financial exclusion. While doing so, they need to adopt approaches which further encourage market based solutions. Based on past experience in Kenya, both donors and Government must first keep to the fore the imperative to ‘first do no harm’.


References David, P., (2004): “Making Financial Markets Work for the Poor”, FinMark Trust David, P. (2005): “The Access Frontier as an approach and tool in Making Financial Markets Work for the Poor”, FinMark Trust Genesis Analytics (2006): “Identifying an enabling environment for Government to Person transfers through the Banking Sector”, FSD Kenya Government of Kenya (2003): “The Economic Recovery Strategy for Wealth and Employment Creation for 2003-07” Honohan,P., and T. Beck (2007): “Making Finance Work for Africa”, World Bank Steadman (2007): “Results of a National Financial Access Survey”, Financial Access Partnership and Financial Sector Development Trust World Bank, 2006: “Doing Business Indicators 2007: How to Reform” Wright, G.A.N., and D. Cracknell (2007): “A Market-led Revolution: Equity Bank’s Continuing Story”, MicroSave Africa Web Resources www.centralbank.go.ke www.equitybank.co.ke www.fsdkenya.org

i The term micro-finance institution (MFI) needs to be treated with care. Here it refers to those institutions which are currently not regulated under the Banking Act. K-Rep, Equity and Family Banks target a similar mass market and are sometimes also referred to as MFIs. K-Rep started as an unregulated non-governmental organisation (NGO), transforming to become a bank and continuing to use the classic MFI group based lending approach. ii These figures are not strictly fully comparable – the poverty data distinguishes between rural and urban populations within provinces. However the figures still provide a useful indicator given that urbanisation is relatively low in all provinces except Nairobi (entirely urban) and Coast which includes the city of Mombasa.