How banks can hack arid-based small businesses with products

Farmers producing Seed Maize in Weiwei, West Pokot County stack maize cobs in sacks ready for shelling at the Weiwei Seed Processing Plant. [File, Standard]

Mainstream financial institutions need to craft culturally sensitive products to penetrate small businesses in arid and semi-arid (Asal) populations, a public policy think tank has recommended.

These products, says the Kenya Institute for Public Policy Research and Analysis (Kippra), should go hand in glove with education, which the State-backed agency notes is a determinant of whether a startup will use internal or external finance in its business.

Internal finance is money accessed from sources such as personal savings, friends, or family. External cash is money access from bank loans, government, venture capitalists or angel investors.

The discussion paper published by Kippra, which analysed sources of financing for startup businesses in Asal areas, found that internal finance is the most preferred.

The paper is titled, Impact of Financing Inclusion on Access to Finance for Startup and Business Operations in Arid and Semi-Arid Lands of Kenya, and was published in November 2023.

"Education level of the individuals significantly impacts the individual's decision to access and use external financing for startups," the paper reads in part.

"This suggests that individuals with a higher education level are more likely to decide to access external financing for startups."

Therefore, higher education, Kippra says, may equip individuals with the knowledge and skills needed for entrepreneurial ventures.

"These findings suggest that policies and interventions aimed at promoting financial inclusion may need to focus on formalising informal financial sources and enhancing the financial literacy and education of individuals, as informal financing and education level appear to be a key determinant in their decision-making regarding external financing for startup businesses," it adds.

Internal financing

The paper found that internal financing was the go-to option as a source of capital for day-to-day business operation financing in arid and semi-arid areas ranging from 85.14 per cent to 91.3 per cent.

The highest usage of external finance was 14.86 per cent in semi-arid areas. "While internal financing is prevalent, external financing options, are less commonly chosen across all regions," the paper reads.

Almost similar figures were also shared when it comes to financing startups in the region.

Usage of external finance stood at 24.58 per cent while internal finance was predominant ranging from 76.05 to 86.41 per cent.

The preference for internal financing, Kippra says, may indicate limited access to formal financial services or a higher perceived risk associated with external financing in these regions.

"It also highlights the importance of financial inclusion efforts to improve access to credit and financial services, particularly in arid and semi-arid areas, as it may provide businesses with more diverse financing options and support economic growth," the paper reads.

In these areas, wholesale and retail is the most prevalent sector in both the semi-arid and arid areas of Kenya constituting 41.81 per cent and 44.12 per cent of economic activities, respectively.

This sector is followed by agriculture, forestry and fishing, which accounts for 28.59 per cent of economic activities in the semi-arid areas and 40.15 per cent in the arid areas.

Finance and insurance however occupy just 0.15 per cent of enterprises in the region.

Housing Census data

The countrywide survey involved 30,600 households and it utilised the Kenya Household Master Sample Frame (K-HMSF) that is based on the 2019 Kenya Population and Housing Census data.

Of the 1,588 enterprises in semi-arid, 665 used their own funding as startup finance while 562 found financial assistance from friends or family.

Of the 665 enterprises in arid areas, 315 used their own finance while 215 raised capital from friends and family.

Only 171 enterprises in semi-arid and 36 in arid areas took either bank loans with collateral or mobile money respectively.

According to the paper, if banks and microfinance institutions seek to penetrate these regions, then they need to collaborate with community-based organisations to develop culturally sensitive products.

These products should still adhere to the banking principles. "These specialised financial products should account for the absence of traditional collateral and offer alternative financing solutions such as patient capital, equity, or quasi-equity, aligning with the unique needs of Asal communities," says Kippra in the paper.

This approach should go alongside Saccos, microfinance institutions and banks opening more branches in Asal areas to make long-term finance possible.

Kippra says policymakers and financial institutions may consider targeting these areas with initiatives aimed at improving financial inclusion, increasing access to credit, and providing businesses with more diverse financing options.

"Supporting the growth of local financial institutions and offering tailored financial products for businesses in arid and semi-arid regions could be potential strategies," it adds.

Kippra recommends that public sector actors, in partnership with non-governmental organisations and educational institutions, should launch financial literacy programmes that target Asal communities.

These programmes should aim to enhance individuals' financial knowledge and skills.

"By empowering entrepreneurs with financial knowledge, they can make informed decisions about their financing options," noted the think-tank.

"Our study identified that education has a significant impact on the entrepreneurial activities within Asals. Additionally, education acts as a gateway to formal financial services."