UPDATE:  here are the differences between SACCOs, MFIs and banks summarized in a table format.

Today we had an interesting discussion with one of the village elders in Korogocho – who also has a small retail business and lots of experience in local markets – about the credit “options” available to micro-enterprises. He was particularly keen to discuss the differences between microfinance institutions (MFIs) and credit cooperatives (SACCOs), and the difference between “necessity” loans (i.e. need for cash in the short term) and consistent financial planning.

He made us realize that an overlooked area of research is how entrepreneurs choose their source of credit. Once upon a time, the infamous “informal sector paradigm” hypnotized us with the idea that micro enterprises completely lacked access to credit (because they do not have legal property rights), but the reality is that local firms not only have access to credit, but they also can choose between a multitude of suboptimal credit sources, both formal and informal, market and non-market, but we still don’t know what factors make people choose between a credit institution or the other.

As the financial sector in Kenya is increasingly embedded into local communities, entrepreneurs have a wide spectrum of financial options: from informal saving clubs and rotating credit schemes to credit cooperative and MFIs. Banks are targeting the low income population as well, and they are spreading in urban areas.

According to the elder in Korogocho, the choice between credit sources is simply a matter of entrepreneurial time/financial management. MFIs provide loans in a shorter amount of time, as low as 6 to 8 weeks of regular savings, but they charge higher interest rates for loans, up to 20 percent. SACCOs require a much longer time before they provide credit, up to 6 months, but the interest rate is often minimal and the repayment period is much longer, even two years! Other informal credit networks and saving clubs are a pillar of local economies, but they often lack flexibility.

The “immediate necessity” for cash seems to be the main driver for choosing MFIs whereas “good” (i.e. long term) financial planning make entrepreneurs go for SACCOs. The “necessity” factor is well known in local markets, and that’s probably why MFIs do not have a great reputation. On the other hand, flexible loans are very important for growth-oriented microenterprises, especially those who intend to make “high-return, higher-risk” investments in their business.