Introduction
In February 2023, the Kenyan government announced its intention to establish a framework that will enable Savings and Credit Cooperative Societies (SACCOs) to extend loans to each other. This inter-Sacco lending framework shall be set up by the Sacco Societies Regulatory Authority (SASRA) and was anticipated to be in effect from August 2023. This initiative aims to create a platform akin to the interbank market, typically used by commercial banks.
In the interbank market, interest rates govern short-term loans exchanged between banks. These loans serve various purposes, such as liquidity management, and help to ensure compliance with regulatory requirements like reserve mandates. Most interbank loans have brief maturities, often spanning a week or less, with many being overnight loans. Consequently, banks holding surplus funds often participate in the interbank market, earning interest on their assets.
Inter-Sacco lending is an important source of financing for many SACCOs in Kenya. Section 33 of the Sacco Societies Act No.14 of 2008 allows SACCOs to extend loans to one another for member loans or to address temporary liquidity shortfalls, subject to specific conditions. The specific conditions that currently guide lending between SACCOs are:
These conditions ensure that inter-Sacco lending is carried out responsibly, benefiting all parties involved. Simultaneously, they maintain the financial stability of the participating SACCOs and advocate for prudent management of financial affairs.
Currently, section 33 highlighted above has certain benefits to the SACCOs. First, it ensures that SACCOs can meet their liquidity needs. There are times when a SACCO may experience a sudden surge in member withdrawals or face unexpected financial obligations. In such situations, inter-SACCO lending can provide immediate access to funds; ensuring that the SACCO can meet its short-term financial commitments without resorting to drastic measures like selling off assets or disrupting member services. This liquidity support safeguards the financial stability of the SACCO and inspires member confidence.
By law, Saccos must maintain 15% of their savings deposits and short-term liabilities in liquid assets. Typically, Saccos manages liquidity needs by borrowing to cover shortfalls and lending to earn a modest interest on excess funds. According to the most recent SACCO Supervision Annual Report for 2022, 170 DT-SACCOs successfully upheld their liquidity ratios above the recommended 15%. Three other SACCOs maintained ratios between 7.5% and 15%, while an additional three SACCOs reported ratios below 7.5%. This represents a modest improvement compared to 2021 when 169 SACCOs surpassed the 15% threshold, with 5 falling within the 7.5% to 15% range and 2 SACCOs reporting ratios below 7.5%. Notably, the only increase in the numbers occurred in the category of SACCOs with ratios below 7.5%, as illustrated in Figure One.
Secondly, it helps the SACCOS in meeting member needs. One of the core objectives of Saccos is to meet the financial needs of its members. This includes providing affordable loans, competitive savings products, and a range of financial services. Inter-Sacco lending enables SACCOs to ensure that they have adequate funds available to fulfill these member-centric goals. For example, it allows SACCO to continue offering loans at competitive interest rates, helping members access credit for various purposes, such as education, housing, or business development. By meeting these needs effectively, SACCOs strengthen their member relationships and contribute positively to their members’ financial well-being.
Notably, a recent development will be the introduction of an inter-SACCO lending rate, governed by the Central Bank of Kenya (CBK) for short-term loans between two SACCOs. Currently, this rate has not been adopted and it is not clear whether it shall only be limited to Deposit Taking SACCOs or its framework shall repeal Section 33. Given the aforementioned advantages already being reaped by SACCOs, the inter-Sacco lending rate has the potential to introduce additional advantages as well as certain risks. The following points below outline the key advantages and risks, although this list is not exhaustive. It addresses the additional benefits accruing to SACCOs, their members, the broader financial sector, and the overall economy. As explained below, these benefits are intertwined.
Potential Benefits
a. To SACCOS
There are several ways that SACCOs stand to benefit. Firstly, it allows them to reduce their reliance on expensive external funding sources, such as commercial banks. By accessing capital at more favorable rates through inter-Sacco lending, Saccos can lower their borrowing costs. SACCOs derive funds from two sources, namely primary and secondary sources. The primary source is the cheapest, as it is derived from deposits by members and often incurs lower interest rates. The interest rate in this regard is the dividends that are paid annually to depositors for their savings. However, when the deposits are insufficient, SACCOs may seek alternative sources of funding, with commercial banks being the common option. However, even as they resort to funds from commercial banks, the secondary source is typically more expensive than the primary source.
Supporting this, in the year ended December 2021, the average external borrowing for deposit-taking Saccos declined to 3.61% from 3.67% recorded in the year 2020. These ratios are both below the prescribed maximum ratio of 25%, indicating that more Saccos are relying on internally generated funds to finance their assets rather than externally sourced funds that are often subject to economic volatility and high costs.
Additionally, this will enable SACCOs to diversify their sources of funding, reducing their risk exposure and thus enhancing their financing stability. Saccos will be able to access capital that they may not have otherwise obtained by diversifying their sources of funding, potentially reducing their reliance on secondary financing from commercial banks. This will make Inter-Sacco lending a cost-effective way for Saccos to borrow money compared to other secondary sources. With inter-banking rates often lower than other forms of secondary funding such as the CBR, inter-Sacco rates will likely also be lower, promoting competition between funding sources for Saccos.
Furthermore, by pooling resources, Saccos can achieve economies of scale and secure larger funding amounts, ultimately reducing their borrowing costs. Moreover, lending to other Saccos enables them to diversify their loan portfolios beyond their members’ portfolios and earn interest on the advanced amount.
Lastly, the SACCO sector has had challenges with liquidity imbalances, where some entities have excess cash while others are facing shortages. As earlier mentioned in 2022, there are still about 7 non-deposit-taking Saccos that are unable to meet the required 15% liquidity ratio. Therefore, this will help in promoting intermediation.
b. To SACCO Members
The inter-Sacco lending rate creates additional competition for the secondary source by providing SACCOs with the opportunity to obtain loans at lower rates. It will allow the sector to offer cheaper loans to its members, potentially promoting financial inclusion even further. This is because, according to Section 35(4) of the Sacco Societies Act No.14 of 2008, Saccos acquiring external borrowing for on-lending to members must charge interest at least two percentage points higher than the rate they are charged to procure the facility. It is not clear whether this provision is adopted as is. Additionally, this access to affordable credit through SACCOs enables unbanked borrowers to establish credit histories, making them eligible for other financial services like mortgages, thereby improving their financial prospects.
In comparison to banks and digital lending platforms, even without the implementation of this, Saccos typically provides loan products at lower interest rates. This can be attributed, in part, to the fact that the lending rates applied by commercial banks are highly influenced by the Central Bank Rate (CBR). Commercial banks routinely send messages to their clients indicating an adjustment of interest rates if and when the Central Bank of Kenya increases this rate. The CBR is the interest rate a nation’s Central Bank charges to its domestic banks to borrow money from them. As of 6th February 2024, Kenya’s CBR stood at 13%. It can be reasonably assumed that the inter-SACCO lending rate may depend on factors like adjustments to the CBR. However, clarity and transparency in this area are expected to improve once the regulations governing the inter-SACCO lending rate are officially released. These regulations will likely outline the specific criteria and mechanisms that will determine the rate, providing a more structured and transparent framework for this aspect of SACCO financing.
c. Financial Sector
The introduction of inter-Sacco lending brings competition to the secondary funding market for SACCOs. This competition has the potential to drive down interest rates in the sector, benefiting borrowers in general. It encourages commercial banks and other financial institutions to reassess their lending rates and services to remain competitive in the changing landscape.
Furthermore, SACCOs that find themselves holding excess liquidity often opt to deposit these funds with commercial banks. However, this choice may not be the most profitable one since commercial banks typically offer lower interest rates compared to what SACCOs could earn by facilitating lending and borrowing transactions internally among their members or each other. Consequently, unless commercial banks can provide more attractive interest rates, they are likely to miss out on business opportunities with SACCOs. SACCOs play a significant role in the Kenyan market, experiencing consistent growth in their membership, assets, and savings.
d. To the Economy
If Saccos acquires these funds at a lower rate, they can lend onward at a more affordable rate, significantly reducing the cost of credit. This, in turn, can lead to economic growth as Kenyans access credit to start or expand businesses, employ others, increase their incomes, and improve their living standards. In a plausible scenario, there could be an upturn in private-sector credit growth following a period of hindrance caused by banks channeling their investments primarily into government securities. As a response to this trend, the private sector might increasingly turn to SACCOs for financing. The initial crowding-out effect on the private sector, attributed to the perceived lower risk of government securities in the current economic climate, may thus lead to a shift in credit dynamics.
Kenya is transitioning from using traditional Credit Reference Bureaus (CRBs) to a scoring method to assess borrower creditworthiness based on timely loan repayments and other factors. Thus, the advantage of Sacco’s inter-lending rates leading to greater access to affordable credit can enable unbanked borrowers to establish credit histories, making them eligible for other financial services such as mortgages.
Potential Risks
Despite being in its early stages, the proposed inter-SACCO lending rate faces opposition from commercial banks, in their anticipation of potential loss of business as it poses a challenge to the traditional flow of funds from SACCOs to commercial banks.
a. Monetary Policy Transmission Risk
Since this system will be designed to resemble interbank rates, the expectation is that it will be monitored and published by the Central Bank. Central Banks worldwide frequently employ domestic interbank rates as a pivotal instrument for executing monetary policy. By shaping these rates, central banks can manage the broader interest rate environment in the economy, thereby influencing the dynamics of borrowing and lending activities, and consequently, impacting inflation and economic growth.
b. Concentration Risk
Concentration risk arises from having a significant portion of an organization’s assets or revenue streams tied to a single source. It is a prevalent financial risk that SACCOs can face, particularly when they hold a large portion of their loan portfolios in inter-Sacco loans. This risk is amplified when borrower SACCOs are interconnected, as the default of one large SACCO could trigger a domino effect that increases the likelihood of default by other SACCOs. This would lead to significant losses for the entire sub-sector in general, with potentially adverse effects on the economy.
Conclusion and Mitigation Measures
Inter-Sacco lending presents both opportunities and risks to the Sacco sector. It offers a viable avenue for accessing capital and fostering a more professional sub-sector, improving the financial system. However, it also poses concentration and monetary policy risks, potentially undermining financial stability. Effective risk management practices are crucial for sustaining this type of lending for financial inclusion in Kenya. To mitigate concentration risk, SACCOs should diversify their loan portfolios and avoid overreliance on inter-Sacco loans or any particular borrower sector. This practice ensures regulatory compliance under SASRA oversight. Regular credit risk assessments of inter-Sacco loans are necessary to lend to creditworthy borrowers with appropriate security measures. Furthermore, SACCOs must monitor the sector’s financial health and performance to identify early signs of potential defaults. Proactive measures like diversification and thorough risk assessments are vital for managing concentration risk and safeguarding financial stability, enhancing SACCOs’ contribution to economic growth.
Introduction The Constitutional Theory of Public Goods argues that people decide which goods are public goods at a constitutional level. This decision is based on how much their enjoyment of the good depends on others also enjoying it (Marmolo 1999).i The theory suggests that the government should provide public goods where there is significant demand […]
The National Treasury has published the latest national edition of Program-Based Budget estimates for 2024/25. My reading of the document suggests that the documents reflect a strategic investment in socio-economic advancement, highlighting the Kenyan government’s dedication to addressing the challenges women face and steadfastly promoting gender equality with determination. A quick search within this budget […]
The Houthi’s are Yemeni political actors. The Houthis, and Somali pirates have been launching direct kinetic attacks on shipping assets. The Houthi’s are understood to be allies if not proxies of Iran. They use Iranian weapons and take some level of political direction from Iran. The Houthi’s explain that their attacks are designed to offer […]
Introduction Conditional on the passage of the Finance Bill 2024, a 750 ml bottle of 37% alcohol by volume of a popular beverage gin in Kenya will now have an excise tax of Ksh 444, up from Ksh 267. On the other hand, a 500ml Tusker Cider that used to have a tax burden of […]
In a Public-public-private partnership, the private partner typically assumes many responsibilities throughout the project life cycle. In a Build-Operate-Transfer (BOT) model, the private entity is responsible for an infrastructure project’s design, construction, financing, and operation for a specific period. The private entity, called the concessionaire, operates the project and recovers construction costs through user fees, […]
Post date: Tue, Apr 2, 2024 |
Category: SACCO |
By: Fiona Okadia, |
Introduction
In February 2023, the Kenyan government announced its intention to establish a framework that will enable Savings and Credit Cooperative Societies (SACCOs) to extend loans to each other. This inter-Sacco lending framework shall be set up by the Sacco Societies Regulatory Authority (SASRA) and was anticipated to be in effect from August 2023. This initiative aims to create a platform akin to the interbank market, typically used by commercial banks.
In the interbank market, interest rates govern short-term loans exchanged between banks. These loans serve various purposes, such as liquidity management, and help to ensure compliance with regulatory requirements like reserve mandates. Most interbank loans have brief maturities, often spanning a week or less, with many being overnight loans. Consequently, banks holding surplus funds often participate in the interbank market, earning interest on their assets.
Inter-Sacco lending is an important source of financing for many SACCOs in Kenya. Section 33 of the Sacco Societies Act No.14 of 2008 allows SACCOs to extend loans to one another for member loans or to address temporary liquidity shortfalls, subject to specific conditions. The specific conditions that currently guide lending between SACCOs are:
These conditions ensure that inter-Sacco lending is carried out responsibly, benefiting all parties involved. Simultaneously, they maintain the financial stability of the participating SACCOs and advocate for prudent management of financial affairs.
Currently, section 33 highlighted above has certain benefits to the SACCOs. First, it ensures that SACCOs can meet their liquidity needs. There are times when a SACCO may experience a sudden surge in member withdrawals or face unexpected financial obligations. In such situations, inter-SACCO lending can provide immediate access to funds; ensuring that the SACCO can meet its short-term financial commitments without resorting to drastic measures like selling off assets or disrupting member services. This liquidity support safeguards the financial stability of the SACCO and inspires member confidence.
By law, Saccos must maintain 15% of their savings deposits and short-term liabilities in liquid assets. Typically, Saccos manages liquidity needs by borrowing to cover shortfalls and lending to earn a modest interest on excess funds. According to the most recent SACCO Supervision Annual Report for 2022, 170 DT-SACCOs successfully upheld their liquidity ratios above the recommended 15%. Three other SACCOs maintained ratios between 7.5% and 15%, while an additional three SACCOs reported ratios below 7.5%. This represents a modest improvement compared to 2021 when 169 SACCOs surpassed the 15% threshold, with 5 falling within the 7.5% to 15% range and 2 SACCOs reporting ratios below 7.5%. Notably, the only increase in the numbers occurred in the category of SACCOs with ratios below 7.5%, as illustrated in Figure One.
Secondly, it helps the SACCOS in meeting member needs. One of the core objectives of Saccos is to meet the financial needs of its members. This includes providing affordable loans, competitive savings products, and a range of financial services. Inter-Sacco lending enables SACCOs to ensure that they have adequate funds available to fulfill these member-centric goals. For example, it allows SACCO to continue offering loans at competitive interest rates, helping members access credit for various purposes, such as education, housing, or business development. By meeting these needs effectively, SACCOs strengthen their member relationships and contribute positively to their members’ financial well-being.
Notably, a recent development will be the introduction of an inter-SACCO lending rate, governed by the Central Bank of Kenya (CBK) for short-term loans between two SACCOs. Currently, this rate has not been adopted and it is not clear whether it shall only be limited to Deposit Taking SACCOs or its framework shall repeal Section 33. Given the aforementioned advantages already being reaped by SACCOs, the inter-Sacco lending rate has the potential to introduce additional advantages as well as certain risks. The following points below outline the key advantages and risks, although this list is not exhaustive. It addresses the additional benefits accruing to SACCOs, their members, the broader financial sector, and the overall economy. As explained below, these benefits are intertwined.
Potential Benefits
a. To SACCOS
There are several ways that SACCOs stand to benefit. Firstly, it allows them to reduce their reliance on expensive external funding sources, such as commercial banks. By accessing capital at more favorable rates through inter-Sacco lending, Saccos can lower their borrowing costs. SACCOs derive funds from two sources, namely primary and secondary sources. The primary source is the cheapest, as it is derived from deposits by members and often incurs lower interest rates. The interest rate in this regard is the dividends that are paid annually to depositors for their savings. However, when the deposits are insufficient, SACCOs may seek alternative sources of funding, with commercial banks being the common option. However, even as they resort to funds from commercial banks, the secondary source is typically more expensive than the primary source.
Supporting this, in the year ended December 2021, the average external borrowing for deposit-taking Saccos declined to 3.61% from 3.67% recorded in the year 2020. These ratios are both below the prescribed maximum ratio of 25%, indicating that more Saccos are relying on internally generated funds to finance their assets rather than externally sourced funds that are often subject to economic volatility and high costs.
Additionally, this will enable SACCOs to diversify their sources of funding, reducing their risk exposure and thus enhancing their financing stability. Saccos will be able to access capital that they may not have otherwise obtained by diversifying their sources of funding, potentially reducing their reliance on secondary financing from commercial banks. This will make Inter-Sacco lending a cost-effective way for Saccos to borrow money compared to other secondary sources. With inter-banking rates often lower than other forms of secondary funding such as the CBR, inter-Sacco rates will likely also be lower, promoting competition between funding sources for Saccos.
Furthermore, by pooling resources, Saccos can achieve economies of scale and secure larger funding amounts, ultimately reducing their borrowing costs. Moreover, lending to other Saccos enables them to diversify their loan portfolios beyond their members’ portfolios and earn interest on the advanced amount.
Lastly, the SACCO sector has had challenges with liquidity imbalances, where some entities have excess cash while others are facing shortages. As earlier mentioned in 2022, there are still about 7 non-deposit-taking Saccos that are unable to meet the required 15% liquidity ratio. Therefore, this will help in promoting intermediation.
b. To SACCO Members
The inter-Sacco lending rate creates additional competition for the secondary source by providing SACCOs with the opportunity to obtain loans at lower rates. It will allow the sector to offer cheaper loans to its members, potentially promoting financial inclusion even further. This is because, according to Section 35(4) of the Sacco Societies Act No.14 of 2008, Saccos acquiring external borrowing for on-lending to members must charge interest at least two percentage points higher than the rate they are charged to procure the facility. It is not clear whether this provision is adopted as is. Additionally, this access to affordable credit through SACCOs enables unbanked borrowers to establish credit histories, making them eligible for other financial services like mortgages, thereby improving their financial prospects.
In comparison to banks and digital lending platforms, even without the implementation of this, Saccos typically provides loan products at lower interest rates. This can be attributed, in part, to the fact that the lending rates applied by commercial banks are highly influenced by the Central Bank Rate (CBR). Commercial banks routinely send messages to their clients indicating an adjustment of interest rates if and when the Central Bank of Kenya increases this rate. The CBR is the interest rate a nation’s Central Bank charges to its domestic banks to borrow money from them. As of 6th February 2024, Kenya’s CBR stood at 13%. It can be reasonably assumed that the inter-SACCO lending rate may depend on factors like adjustments to the CBR. However, clarity and transparency in this area are expected to improve once the regulations governing the inter-SACCO lending rate are officially released. These regulations will likely outline the specific criteria and mechanisms that will determine the rate, providing a more structured and transparent framework for this aspect of SACCO financing.
c. Financial Sector
The introduction of inter-Sacco lending brings competition to the secondary funding market for SACCOs. This competition has the potential to drive down interest rates in the sector, benefiting borrowers in general. It encourages commercial banks and other financial institutions to reassess their lending rates and services to remain competitive in the changing landscape.
Furthermore, SACCOs that find themselves holding excess liquidity often opt to deposit these funds with commercial banks. However, this choice may not be the most profitable one since commercial banks typically offer lower interest rates compared to what SACCOs could earn by facilitating lending and borrowing transactions internally among their members or each other. Consequently, unless commercial banks can provide more attractive interest rates, they are likely to miss out on business opportunities with SACCOs. SACCOs play a significant role in the Kenyan market, experiencing consistent growth in their membership, assets, and savings.
d. To the Economy
If Saccos acquires these funds at a lower rate, they can lend onward at a more affordable rate, significantly reducing the cost of credit. This, in turn, can lead to economic growth as Kenyans access credit to start or expand businesses, employ others, increase their incomes, and improve their living standards. In a plausible scenario, there could be an upturn in private-sector credit growth following a period of hindrance caused by banks channeling their investments primarily into government securities. As a response to this trend, the private sector might increasingly turn to SACCOs for financing. The initial crowding-out effect on the private sector, attributed to the perceived lower risk of government securities in the current economic climate, may thus lead to a shift in credit dynamics.
Kenya is transitioning from using traditional Credit Reference Bureaus (CRBs) to a scoring method to assess borrower creditworthiness based on timely loan repayments and other factors. Thus, the advantage of Sacco’s inter-lending rates leading to greater access to affordable credit can enable unbanked borrowers to establish credit histories, making them eligible for other financial services such as mortgages.
Potential Risks
Despite being in its early stages, the proposed inter-SACCO lending rate faces opposition from commercial banks, in their anticipation of potential loss of business as it poses a challenge to the traditional flow of funds from SACCOs to commercial banks.
a. Monetary Policy Transmission Risk
Since this system will be designed to resemble interbank rates, the expectation is that it will be monitored and published by the Central Bank. Central Banks worldwide frequently employ domestic interbank rates as a pivotal instrument for executing monetary policy. By shaping these rates, central banks can manage the broader interest rate environment in the economy, thereby influencing the dynamics of borrowing and lending activities, and consequently, impacting inflation and economic growth.
b. Concentration Risk
Concentration risk arises from having a significant portion of an organization’s assets or revenue streams tied to a single source. It is a prevalent financial risk that SACCOs can face, particularly when they hold a large portion of their loan portfolios in inter-Sacco loans. This risk is amplified when borrower SACCOs are interconnected, as the default of one large SACCO could trigger a domino effect that increases the likelihood of default by other SACCOs. This would lead to significant losses for the entire sub-sector in general, with potentially adverse effects on the economy.
Conclusion and Mitigation Measures
Inter-Sacco lending presents both opportunities and risks to the Sacco sector. It offers a viable avenue for accessing capital and fostering a more professional sub-sector, improving the financial system. However, it also poses concentration and monetary policy risks, potentially undermining financial stability. Effective risk management practices are crucial for sustaining this type of lending for financial inclusion in Kenya. To mitigate concentration risk, SACCOs should diversify their loan portfolios and avoid overreliance on inter-Sacco loans or any particular borrower sector. This practice ensures regulatory compliance under SASRA oversight. Regular credit risk assessments of inter-Sacco loans are necessary to lend to creditworthy borrowers with appropriate security measures. Furthermore, SACCOs must monitor the sector’s financial health and performance to identify early signs of potential defaults. Proactive measures like diversification and thorough risk assessments are vital for managing concentration risk and safeguarding financial stability, enhancing SACCOs’ contribution to economic growth.
Introduction The Constitutional Theory of Public Goods argues that people decide which goods are public goods at a constitutional level. This decision is based on how much their enjoyment of the good depends on others also enjoying it (Marmolo 1999).i The theory suggests that the government should provide public goods where there is significant demand […]
The National Treasury has published the latest national edition of Program-Based Budget estimates for 2024/25. My reading of the document suggests that the documents reflect a strategic investment in socio-economic advancement, highlighting the Kenyan government’s dedication to addressing the challenges women face and steadfastly promoting gender equality with determination. A quick search within this budget […]
The Houthi’s are Yemeni political actors. The Houthis, and Somali pirates have been launching direct kinetic attacks on shipping assets. The Houthi’s are understood to be allies if not proxies of Iran. They use Iranian weapons and take some level of political direction from Iran. The Houthi’s explain that their attacks are designed to offer […]
Introduction Conditional on the passage of the Finance Bill 2024, a 750 ml bottle of 37% alcohol by volume of a popular beverage gin in Kenya will now have an excise tax of Ksh 444, up from Ksh 267. On the other hand, a 500ml Tusker Cider that used to have a tax burden of […]
In a Public-public-private partnership, the private partner typically assumes many responsibilities throughout the project life cycle. In a Build-Operate-Transfer (BOT) model, the private entity is responsible for an infrastructure project’s design, construction, financing, and operation for a specific period. The private entity, called the concessionaire, operates the project and recovers construction costs through user fees, […]