Working paper 25 - Rural Financial Services in Kenya: What is Working and Why?

Author(s):  Kibaara, Betty


Agriculture contributes 23.9% percent of national Gross Domestic Product (GDP) and 60 percent of the total export earnings. In addition, 80 per cent of the population derives their livelihood from agriculture. In spite of the significant contribution, agriculture has experienced low productivity in the past decade. The Poverty Reduction Strategy Paper (PRSP) prioritized agriculture and rural development sector as one of the key sectors that needs urgent intervention. In order to attain the targeted five percent annual growth in this sector, financial systems, extension services, rural infrastructure, marketing and distribution systems need to be addressed.

Promoting an efficient, sustainable and widely accessible rural financial systems remains a major development challenge in most sub Sahara African countries. With about 73% of Africa’s population living in the rural areas and experiencing a high incidence of rural poverty, improved rural finance is crucial in achieving pro-poor growth and poverty reduction goals. However, the development of rural financial systems is hampered by the high cost of delivering the services to small, widely dispersed customers; as well as a difficult financial terrain – characterized by high covariant risks, missing markets for risk management instruments and lack of suitable collateral (Onumah, 2002).

Lack of working capital and low liquidity limit the farmer’s ability to purchase productivity enhancing inputs like seeds, fertilizers and pesticide. Inspite of the relatively high adoption rates of inputs like fertilizers, the quantities used are low and therefore, hybrid variety crops that are dependent on fertilizers may not attain their potential production (Nyoro, 2002). The average production efficiency levels are higher among producers who have access to formal credit, (Awudu and Richard, 2001). Access to credit resulted to higher technical efficiency in maize production in Kenya, (Kibaara, 2005).

Kenya has not developed a comprehensive rural financial services strategy. The rural financial sector is governed by the Banking Act, Building Society Act and the Post Bank Act. The proposed Deposit Taking Micro Finance Bill 2005 and the proposed SACCO Societies Regulatory bill, 2004 are still to be debated in parliament. Through the Economic Recovery Strategy for Wealth and Employment Creation (ERSWC) the government has identified poor access to farm credit and financial services as a contributing factor to the decline in agricultural productivity. The Strategy for Revitalizing Agriculture (SRA) proposes to encourage an orderly development of microfinance institutions through the enactment of facilitative legislation, encourage commercial banks to set up operations in the rural areas by providing appropriate incentives, encourage banks to lend to agriculture by reviewing and repealing legal provisions that have undermined banks lending to the sector, recapitalize and streamline the management of Agricultural Finance Corporation so that it can perform its function of providing affordable credit to farmers ( Republic of Kenya, 2004). As a follow up on SRA, the Agricultural Sector Co-ordination Unit (ASCU) has fast tracked the rural financial services by establishing a thematic group on inputs and rural financial services with an overall objective of developing an Integrated Farm Input Strategy.

Rural financial services refer to all financial services extended to agricultural and non-agricultural activities in rural areas; these services include money deposit/savings, loans, money transfer, safe deposit and insurance. Demanders/beneficiaries of rural financial services are mainly households, producers, input stockists/suppliers, traders, agro-processors and service providers. Rural financial services help the poor and low income households increase their incomes and build the assets that allow them to mitigate risk, smoothen consumption, plan for future, increase food consumption, invest in education and other lifecycle needs. These needs can be broadly categorized into working capital, fixed asset financing, income smoothing and life cycle events. Access to credit and financial services has the potential to make a difference between grinding poverty and economically secure life. Inspite of the importance of a savings account, 77 percent of Kenyan households have no access to a bank account (Kodhek, 2003). In the late 1990’s, most mainstream commercial banks closed down some rural branches in order to cut costs and improve profits. The non-traditional financial institutions have emerged to fill the gap created by the mainstream banks which locked out low income and irregular earners.

The primary objective of this study was to examine the evolving models of rural financial service providers with a broad aim of understanding models that are working, why they are working, characteristics, opportunities and constraints. It seeks to understand the extent to which these models have improved access to the rural financial services for producers and traders in the rural areas. The study proposes some policy some interventions that could improve access to financial services.

Rural Financial Services in Kenya: What is Working and Why?