Empowering Micro, Small, and Medium Enterprises: The Influence of Microfinance Group Lending

By the MicroSave Consulting and FSD Uganda teams

Across the globe, the lack of collateral is a primary barrier that economically excludes individuals notably young people especially women from accessing formal banking services. To get around this obstacle, the underserved population has resorted to establishing informal community-based financial systems to fulfill their financial requirements. These alternative arrangements, such as Village Savings and Loans Associations, Rotating Savings and Credit Associations, and Table Banking, have emerged as a means for the marginalised to access the financial resources they lack from traditional banking institutions. To extend financial services to the underbanked and unbanked, formal financial institutions have emulated and adopted some of the positive practices in the informal financial systems.

Informal or formal, financial institutions that offer loans use one of two approaches, individual or group lending. This is the same with the Tier III and IV financial institutions that are on-lending under the Mastercard Foundation Micro and Small Enterprises (MSE) Recovery Fund, a five-year program implemented in partnership with the Financial Sector Deepening Uganda. This initiative was launched in February 2022 and is under the Young Africa Works strategy, which seeks to facilitate direct access to finance 50,000 MSEs (at least 40% women, 30% youth). Designed during the aftermath of the COVID-19 pandemic, this revolving fund provides concessional capital to participating financial institutions for onward lending to micro, small, and medium enterprises negatively impacted at a reduced borrowing rate. The participating financial institutions follow their in-house credit processes to assess the enterprises given their needs.

Group lending vs individual lending

The Fund is working with both Tier 3 and Tier 4 financial institutions. Based on the data so far, one Tier 3 Microfinance institution has effectively employed the group lending methodology for a broader client outreach. Since the Fund’s commencement (just under two years), over 26,000 MSEs have successfully accessed credit, and 60% of this has been disbursed by the Microfinance, a testament to its distinctive strategy. The Microfinance has disbursed UGX 7 billion to 16,166 majority of them youth and women-led enterprises within 12 months. Conversely, two SACCOs that employ an individual lending approach, have managed to extend credit to 842 and 503 enterprises and disbursed UShs 3.4 billion and UShs 2.25 billion respectively within 12 months.

For both approaches, the critical difference is in the collateral criteria. With group lending, all that’s needed is a group guarantee, unlike individual lending products that demand traditional collateral. The Microfinance’s group methodology

explores unique features that have positively impacted young people, especially women, and offers lessons for other financial institutions: Here is what makes this institution’s group lending approach work.

How the Mircofinance’s group lending approach works

Central to the approach is that the institution has dealt with the access to finance obstacle created by the need for traditional collateral. To do this, the institution employs the segmented and combined group strategy, coupled with the delegation of credit approval authority to group members.

To implement this, the Microfinance employs a two-fold group methodology: branch-based and community-based groups. The former gathers at the bank, while the latter convenes locally, delivering tailored flexibility to diverse client needs.

The institution looks out for people organised in groups and creates sub-groups of six to seven members to whom loans are exclusively accessible. These sub-groups operate like well-coordinated “cabinets,” complete with designated leaders. This structure not only encourages governance but also strengthens bonds among members. The institution’s loan officers play a modest role in the lending process. Group members collectively greenlight loans without the intervention of the bank. This empowers the groups, enabling them to take charge of credit underwriting, member selection, and loan recovery. This proactive approach ensures that disbursed amounts grow, and the quality of loans improves over time.

Once the groups have been formed, members of branch-based groups can access loans up to UShs 5 million per member without the need for collateral. On the other hand, community-based groups can borrow up to UShs 3 million per member, securing approvals at the group level—an embodiment of the Microfinace’s dedication to client empowerment. For more substantial loan amounts, up to UShs 30 million, collateral is a requisite to manage potential risks. This balanced approach ensures that prudent risk mitigation measures are also upheld while empowering clients

A client’s story

Emily a 28-year-old tailor in Bukoto whose business was adversely affected by the Covid-19 pandemic is one of the Microfinance’s clients served under the group ledning model. Her faulty manual sewing machine didn’t help matters as it affected her output’s quality, efficiency, and income so much that she could hardly meet her daily basic needs. “Things changed when through my savings group which banks with the Microfinance, I received a loan of UGX 800,000 and bought an electric sewing machine,” she says.

The tailor is now efficient, and her turnaround time has been reduced from three hours to one hour for some jobs. “This has helped me regain my client’s confidence and also get new clients. I now make at least UGX 15,000 daily and I can meet all my basic needs. This wasn’t the case before when I made no money on many days and had to skip some meals and move in with a relative because I couldn’t afford rent. Because of the increased volume of work, Emily is planning to employ one other person to support her.

As a result, this dynamic formula has enabled the bank to extend credit to a broader spectrum of customers, especially women and youth who lack conventional collateral. Given that women are more likely to belong to groups, the group lending approach is one that financial institutions from Tier 1 to IV should learn from and integrate in order to reach young people, especially women