Informal vs formal: The need for financial services to complement, not compete

October 28th, 2016

Our third “Field Friday” exercise reveals lessons for formal financial service providers to learn from informal services.

“SACCO haina stress. Huwezi kosa usingizi sababu ya deni ya SACCO (A SACCO has no stress. You can’t lack sleep because of a SACCO loan)”, said Macharia, a plastic container vendor in Thika town, the location of our recent Field Friday exercise.

While Macharia owns a bank account, he says that he only borrows from his bank for emergencies. He thinks SACCOs are a better option for him because of their friendlier interest rates.

In this Field Friday exercise, five FSD staff members set out into the scorching sun and dusty streets of Makongeni, Thika, to learn what financial services –– formal or informal –– are commonly used. We specifically tried to find out what makes their chosen services attractive to Kenyans. Like Macharia, our respondents used a combination of both formal and informal services, with each serving a different purpose.

Macharia told us that he uses chamas, informal savings groups, as well as SACCOsHe has one in Thika town and the other in Nairobi. When we asked him why he uses chamas in addition to a SACCO and a bank account, Macharia responded with a hearty laugh saying, “Huwezi umia ukiwa kwa chama (You cannot suffer if you are in a chama)”. He explained that, because chamas are welfare-based, they help members during times of need such as funerals and sickness as well as to pay for weddings, school fees and emergencies. He further noted that his chama also offers members instant loans with interest charged at 1% per month, significantly better than banks. Through their contributions, Macharia and his chama have also invested in buying and selling land. They now own a school, which they renovated recently.

Maintaining a mixed bag

We also met Francis, a truck driver we found chatting with his friends as they waited for clients. He owns a bank account and is a member of a merry-go-round group (ROSCA) and a chama. After a slight pause, he smiled shyly and added that he also keeps some money under his mattress. “I use the bank to save money for big projects. That way I cannot misuse it,” he said. On the other hand, his merry-go-round helps him and his seven friends accumulate lump sums. When it is his turn to receive the money, he uses the funds to upgrade household items and spends any extra on leisure.

A little further down the road was Mwangi and his Boda Boda operator friends. They have a savings group where members can get loans. However, their model is to build up a lump sum and then share out the funds each December, according to how much each member saved. This allows them to tackle big goals, and the leftover funds are used over the festive season to entertain their families. Mwangi and his friends have individual bank accounts and a separate one for the savings group. They say that getting loans from banks is a cumbersome process full of bureaucratic formalities. They are especially put off by the many pre-conditions to qualifying for a loan, and don’t bother trying anymore.

The benefits of mobile credit

With only limited options left, Mwangi and his friends had begun to rely on informal channels like chamas and saving groups. The launch of M-Shwari, however, provided a significant lifeline: “M-Shwari does not ask for a guarantor or collateral when you request for a loan. Tena unaipata hapo hapo (you also get it instantly),” Mwangi told us.

Nowadays, he and his friends push whatever they earn into mobile money accounts as savings and borrow from it when need arises. The fact that no one else needs to know they have had to borrow money is also an appealing feature of the mobile bank account. “Siyo kila mtu atajua shida zako” (Not everyone will know your problems),” said Alfred, Mwangi’s friend.

Serving the employed

On consideration of these conversations, we wondered whether the mixed use of both formal and informal services was only for those who are self-employed or working in informal services. Then we met Ambrose (pictured above with Mutua and Fausto), a recent college graduate who was employed as a shop attendant at an auto parts store. Ambrose has both M-Pesa and a bank account but has never considered taking a bank loan, citing high interest rates. Now that the interest rate caps bill is signed into law, he said that he might finally consider taking a bank loan if the need arises. Ambrose is a member of a chama in his rural home –it was formed by Boda Boda operators with the objective of buying land –– but after moving to the city for college, he stopped sending contributions.

Ambrose said that coming to the city gave him exposure and easier access to information about financial services. In his rural home, there was hardly information about banks. The only active players there were SACCOs, who would go around villages reaching out to residents with information about their services. “SACCOs would ‘come down’ to the people’s level but banks were ‘up there’ and not interested in the common person,” he said. According to Ambrose, this is the biggest lesson for banks to learn from chamas and SACCOs: Go to the grassroots, talk to people and understand their challenges. He also greatly appreciates that chamas and SACCOs support long-terms goals and visions such as buying land or other investments for members to work towards together.

On the other hand, Florence, a saleslady for a juice distribution company, exclusively uses banks. As a recipient of an educational loan, she has no negative bank experience to speak of. “I am not in a Chama because I don’t see any need for it; I have a solid bank account” she told us. It turned out that she once had a bad experience with chamas in the past. Some group members had taken loans and defaulted on payments, ruining her trust in informal financial services.

Learning from the informal market

It is clear that Kenyans choose formal and informal financial services for an array of reasons. As we concluded our conversations in Thika, however, the key question was: Are the formal financial services useful, trustworthy and cost friendly to the people?

If they want to be deemed so then it appears that they need to complement rather than compete with existing informal services. As financial service providers and industry players think about new innovations for the Kenyan financial market, they should consider learning from the informal mechanisms that are so widely trusted and valued by their users.



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