|Guidelines for the Formation of Small Enterprise: Loan, Policies and Procedures (K-REP, 18 p.)|
Kenya Rural Enterprise Programme
K-REP Technical Paper Series No. l
P.O. Box 39312, Nairobi Kenya
Telephone: 722792, 720173
Fax: 711645, Telex: 25765 WEI REP
Many NGOs have mounted projects intended to improve the standard of living of the poorer segments of the Kenyan population. Some of these projects have focused on small-scale economic activities, otherwise referred to as income generating or small-scale enterprise development. The basic problem addressed by these projects is the lack of access that the poor have to training, technical; and financial resources, which are necessary for the development and expansion of small enterprises. In many instances, NGOs have established loan funds to provide credit finance to poorer people to up-grade existing economic activities and/or start new ones. In this paper, guidelines ate presented for NGOs to Use in formulating loan policies and procedures of their loan schemes, either newly planned or existing, NGOs will have to closely review any policies or procedures formulated to ensure that they contribute to rather than inhibit: the realization of their aims.
The list can be Used as a planning tool both before the programme is started and while it is on-going (to pin-point areas in which the programme might be strengthened). It is hot a complete list in that it does not include all the alternative possible policies and procedures from Which NGOs might want to select theirs. The intention of this document is to aid NGO Boards and staff in thinking through the issues and practicalities related to credit projects.
The list is laid out in a manner which will make easier the process of thinking and deciding about what guidelines your programme will have in order to focus your energy and resources. The list is divided into three sections. In the first, "Client Characteristics", policies which pertain to the people to Whom you intend to make loans and/or provide services are considered: These policies identify those people and the economic activities (income generation and/or small businesses) Which you Will want to assist.
The section, "Loan Characteristic", identifies the conditions and limits within which you will make loans to those borrowers. None of these should be arbitrary; they should be determined by that which will meet borrower's needs. We all know we are not in a position to be able to respond to everybody's request for assistance, so we have to make decisions that will help us maximize or, better yet, optimize what we can do with the limited funds and other resources we have to work with. That is the reason you will want to think about the things mentioned in these guidelines. You will want these policies to include the very people you most want to assist.
The third grouping is of "Credit Programme Procedures". These outline the steps in the process of assisting the people from initial contact through success of the activity beyond the repayment of the loan. When thinking about these steps, you will be thinking about how you will go about providing loans and other services and how you will keep track of what you are doing so that you can learn from your experience and improve your assistance based on it and the changing needs of, the people and their enterprises.
In planning your project, you will have to decide who it is you wish to assist and in what sorts of economic activities you wish to assist them. You will want to define a client profile strategy which will indicate what you would like your overall client group to be. You might indicate the proportions of female and male clients, the proportion of group enterprises, client groups or individual enterprises, the proportions of clients of different income levels, and other possible characteristics of the people and their enterprises. This strategy will reflect the aims and goals of your organization as well as the resources you have to work with. In this section, as Well as sections II and III, it is suggested that you review the following policy areas, first one at a time and then as a whole, drawing upon your knowledge of the people, their needs, and realistic opportunities available to them for improving their lives. Then draw up your policies related to client characteristics.
A. Age and Sex - The guidelines you will have with regard to the ages and Sex of client, i.e., maximum and/or minimum age and women and/or men. To consider:
· how age of persons involved might effect the viability of the economic activity or the learning process;
· what are the legal implications in defining age limits, e.g., lending to minors;
· possibly others.
B. Location - Where the enterprises are located. Where the clients are located. To consider:
· in what geographic areas do you plan to focus your lending;
· do you plan to work In rural or urban areas or both;
· what areas can you realistically reach with your staff and resources;
· does the activity have to have a fixed locale, and, if so, what is the basis for determining a fixed locale. This is particularly relevant for very small enterprises.
C. Type of Business - The sorts of economic activities that will be financed; commerce (vendors, traders, wholesalers, retailers), services (repair, construction, transport, clinics, food, storage, mechanics, etc.), manufacturing (milling, furniture making, etc,), and agribusiness (grain millers, food processors, resources extractors, woodcutters, and possibly others). Another criteria for type of business could be those that meet unmet demands for key products in rural markets. To consider:
· what will be the implications of your policy regarding types of business to be financed on local economic development;
· what types of business can your program adequately serve with the Technical and Management assistance resources you have.
D. Status of Business - The legal and operational conditions clients must meet. To consider:
· must client have all necessary licences/registration;
· must enterprise be functioning before loan can be made; if so, for how long;
· if client will be a new business, then under what conditions can a loan be made;
· must business be for profit, not for profit, or can it be either.
E. Group and/or Individual Enterprises - A group enterprise is one in which all participants have ownership in common. Individual enterprises are those in which ownership and management tends to be concentrated in one or two persons. Groups of individual small enterprises are not considered group enterprises in this context. To consider:
· what restrictions will you have as to whether group enterprises, individual enterprises, and/or groups of individual enterprises will receive loans.
F. Size of Enterprise - How big or small will enterprises be that you will assist. To consider:
· what limits will you have which define the size of the enterprises which can receive loans. These limits might be defined by amount of total assets, total fixed assets, (with or without land and building), number of employees, total sales, net income, and possibly others.
G. Experience/Training of Business Persons - The background clients will have in the enterprises you will support. To consider:
· what will be the requirements for technical and/or managerial experience or training of the borrower(s). These, could be defined in terms of certain training courses, years experience in a technical or management capacity, or combinations thereof, before they receive the loan or while they are using the loan.
H. Reputation - Generally, this is an unwritten criteria which would be looking for references on the client. To consider:
· honesty and integrity = do they honor their commitments;
· capacity - are they seen as being able to do things generally;
· industriousness - are they consistently hardworking;
· possibly other indicators of credit worthiness.
I. Involvement of borrower in the enterprise being financed. To consider:
· what are the requirements for day-to-day involvement of the borrower in the decision making and management of business, such as a certain number of hours per day, days per week, certain portion of the activities of the enterprise and possibly others.
J. Lack of Access to Other Credit. To consider:
· what limits will be placed oh lending to persons who could borrow or have borrowed from sources other than the project (i.e. banks and financial institutions) including supplier credit.
You will want to think of what your loan portfolio strategy will be - what sorts of loans you will want to make to the clients you have described above. You will want to consider what will be the proportions of different size loans, proportions of short, medium and long term loans, proportions of loans to different types and sizes of enterprise, and for different uses in those enterprises. The definition of the following policy areas will be based on what you have determined (i) will respond to the needs of your clients, (ii) will prudently allow them access to loans their present condition, and (iii) will enable you to extend your loan funds to as many of them as possible. Follow the same procedure as suggested under Client Characteristics (page 3) for drawing up these policies.
A. Purpose/use - For what the loans are to be used. To consider:
· for what can your loan funds be used; to finance working capital (day-to-day operating costs), equipment, building or land purchases, and/or refinancing other debt (if so, under what conditions would you lend for this purpose).
B. Amount - How much you will lend to any group and/or individual. To consider:
· what are limits in the number of shillings that will be lent; maximum and minimum. This alternatively could be defined as a percentage of the revolving loan fund;
· should there be a graduated series of limits for first time borrowers, and second and third time borrowers. This will, to certain extent, be affected by the people being served, their - experience with credit and the objectives of the project. For example, the minimum for a loan fund which was lending to individual micro enterpreneurs would probably be lower than for one lending only to group enterprises.
· how the minimum might be determined by the economics of administering and following up individual loans (which is why some NGOs have chosen to make one loan to a group of micro-enterprises instead of dealing with them individually).
C. Term - The length of time someone (a group) can borrow money. To consider:
· how does this vary for the type of business, the use of the loan and the size of the loan;
· is it different for clients without prior credit experience or for first-time versus second or third time borrowers.
D. Repayment Schedules - The amounts that are to be paid for each period of time (weekly, monthly, quarterly, etc.), which include interest and principal payments, To consider:
· are they fixed (an equal amount for each period) variable, or lump sum (the total amount, either principal or principal plus interest, is paid at the end of the loan period);
· is it the same for all loans or variable depending on the use of the loan and the financial ability to repay (cash flow of the enterprise);
· how will repayment amounts be determined;
· what are the limits for any grace periods (period of time before the first payment is due);
· what is the payment grace period. If a payment is received within a certain number of days after it is due, for instance 5- days on
E. Rescheduling/Renegotiation - Changing when the loan must be repaid after the loan has been made or changing other terms of the loan agreement. To consider:
· under what circumstances will the project reschedule loan repayments or otherwise renegotiate the terms of a loan such as in cases of robbery, sickness, and possibly others.
F. Interest Rate - The cost to the borrower of the money is usually expressed as a percentage of the amount of money borrowed. To consider:
· will it be the same for all loans or variable depending on the clients, the use of the loan, the amount of the loan, the cost of making the loan, or possibly other reasons;
· how the interest charges are determined; (simple interest declining balance basis, discounted in advance, collected in advance, compounded interest, and possibly others)
G. Other Fees - These could be charges for the loan application, processing, penalties for late payment, and for related services (training, management assistance, etc.,). To consider:
· will they be flat, graduated or variable fees depending on size of loan, client, services provided, location, and possibly other considerations each of which will be defined;
· what fees are necessary for program stability (economic, client seriousness and other factors).
H. Security - The tangible assets, if any, that are pledged as collateral on a loan so that in case the borrower does not repay, the proceeds from the sale of these assets can be used to pay off the debt. To consider:
· what are the assets that are acceptable for collateral;
· what legal procedures/formalities are required for registering the collateral;
· what amount of collateral is required as a percentage of the loan;
· at what percentage of market value or cost are assets valued as collateral;
· what security is needed to motivate clients to repay their loans responsibility;
· is the project willing to take the pledged assets from a client who is not repaying,(if not, any security policy will be ineffective).
I. Guarantees - Someone or some people agreeing that they will pay off the loan and interest if the borrower refuses or cannot. They can be personal (individual) or by group (each member of a group guarantees the loans for all other members of the group). To consider:
· what are criteria for acceptable guarantors;
· what are conditions for calling on guarantor to pay the loan. (Kenyan law indicates the evidence that must be submitted before a guarantor is obliged to pay).
· in what instances, will a moral guarantee be used in the absence of a legal one. (e.g., an NGO "guarantees" to a bank that its borrower will repay because the NGO is providing other necessary technical or managerial support to that enterprise).
J. Conditions of Default - when a loanee is not meeting the terms of the loan agreement. To consider:
· what indicates that the terms of the loan agreement have been broken; for example, number of days after a payment is due, sale of assets, changes in management, and possibly others.
K. Client Contribution - The portion of the activity being funded by the loan that must come from other sources. To consider:
· what must client put into enterprise to show good faith. This can be defined by a loan/equity or loan/assets measure or some other measure of such a§ hours spent developing the business, doing various tasks related to starting up the business.
You have looked at what you will do (Loan Characteristics) with whom (Client Characteristics), It is also necessary to look at how you will implement what you have decided to do in your client and loan strategies. Decisions need to be made covering each of the areas listed below. The purpose of this part of the process is to come up with effective and quick Ways to assist clients; effective in that the process does meet clients' needs, and quick in that the process is streamlined, and has the necessary steps to be effective.
A. Application - How clients come to the project and ask for assistance. To consider:
· how will potential clients find out about the project and its services;
· how will they apply for loans;
· what information will they be required to provide;
· how will they provide the information (through interviews, filling in an application form or possibly others);
· what other requirements will they need to meet before they can apply for a loan (e.g. training/orientation courses, site visits of field extension officer, be active members of a group, etc.);
· who in project will be responsible for: (1) informing potential client about the project; (2) orienting/assisting them in the application process; (3) receiving applications and reviewing pre-application qualifications; (4) packaging applications for further review;
· how are loan applications/applicants tracked so there is a record of what has been done;
· what preparation/training are borrowers given for credit.
B. Review/Approval - This process involves making the decision to lend or not to lend. To consider:
· what are the criteria upon which the decision will be based;
· once potential borrowers have met policy guidelines, then what other benchmarks will be used to judge their projects and loan applications;
· how will the project/loan applications be done (site visits, interviews, analysis of information, reference checks, investigation of previous debt, and possibly other activity);
· who/which job positions have what authority in reviewing and approving/rejecting loan applications;
· what limits are there as to the amount each individual or each level of staff and loan review committee can approve;
· what checks or controls are there to avoid misuse of lending authority;
· what records are kept of these steps in the process.
C. Disbursement - This covers the steps in actually giving loan proceeds to clients. To consider:
· what are these steps; what kind of agreement is there between the NGO and the clients; formal and legal, etc.;
· what tasks must be completed by the borrower and by project staff;
· is the loan extended in cash or in kind;
· is it extended through a bank, financial institution, the NGO, or some other agency;
· who actually delivers the loan to the borrower, and where is it done;
· what records and receipts are used/kept on disbursements, i.e. loan ledger card indicating amount of loan, repayment period and amount, date loan disbursed, plus relevant vouchers and other records.
D. Repayment - How client actually makes payments of interest or other fees and repayments of principal (the amount loaned). Consideration should be given to the steps and those involved:
· does borrower repay to the project directly, through another NGO, a bank or financial institution, through borrowing group, or through other agent. They may have more than one choice.
· is payment made at offices (of NGO, bank, etc.) or in field (at place of business, at particular place designated for repayments etc.);
· who receives the payment;
· what receipts and records are kept of repayments;
· how is loan repayment monitored by management;
· are payments in cash and/or in-kind. If they are in-kind, how is the Value of in-kind payments determined.
E. Collection - What is done when a borrower is not meeting the terms of the loan agreement (not repaying loan, not using loan for intended purpose, closing the enterprise, selling assets, change in key staff, moving out of project area, etc.). To consider:
· what steps are taken to contact borrower and serve notice of default, try to collect repayment, foreclose on collateral, notify guarantor of loan of the default, and any other necessary steps;
· who is involved in collection (field staff, headquarters staff, outside collection agent/company, community or group leaders, or other agents);
· what records are kept of collection process.
F. Renegotiation - When a borrower is having legitimate difficulty repaying a loan according to agreement, the steps the project takes to bring the loan back in line, in accordance with the rescheduling/renegotiation policy. To consider:
· what is the process for reviewing the condition of the enterprise and client;
· what is the process for deciding on a course of action;
· what is the process for approving changes in original loan agreement;
· who will be involved in each step (field staff headquarters loan committee, outside consultants, group leaders, community leaders etc.).
G. Documentation/Reporting - Documentation process required for booking loans and follow up of repayments. To consider:
· what legal formalities must be followed in. respect of loan agreements and collateral taken to secure the borrowings, i.e. guarantees, charges, liens, and others;
· what information needs to be recorded on individual loan ledgers and loan lists for monitoring purposes;
· what progress reports are to be submitted by NGOs to their management and Board and how often, i.e. progress reports on a monthly basis, quarterly reports on loan disbursement, repayment status, and possibly others;
· what progress reports are to be obtained from enterprises by NGOs for monitoring of business performance (income statements, balance sheets, cash flow, production records and possibly others).
H. Related Services - Those other services (group formation, management training or assistance, technical training or assistance information, legal and others) that are provided to clients who are potential borrowers. To consider:
· what technical assistance and/or management assistance are required by clients in preparation for loan assistance, i.e. planning assistance cost analysis, inventory control, marketing advice, identifying appropriate tools and machinery, etc.;
· when the loans are granted, what services are provided to clients to facilitate efficient utilization of credit;
· what are the steps in providing these related services and who on staff will do what to provide them;
· what are frequency and nature of contacts by staff after loans are extended;
· follow up is a key to success of the loan programme. How will the staff determine that loan funds are being well maintained by the borrower, and how often will the follow-up visits be.
I. Inter-Institutional Relations - Working with other agencies or projects. To consider:
· how are existing financial institutions within the areas of program operations used in loan disbursement, collection and/or administration;
· what agreements between the financial institution and NGOs will be required, and what Will be their terms and conditions;
· what are the terms and mechanics of services provided by training, management and/or technical assistance organizations which are linked to loans; are they formal or informal;
· what are the steps in the process for integrating/co-ordinating the provision of those services as they are needed by borrowers.
J. Use of Interest and Other Loan Income - To what will you apply these funds. To consider:
· how will interest earnings from loans and other loan income (services charges, etc.) be utilized, such as for default coverage, as inflation hedge (to maintain real value of loan fund) to coyer loan administration costs, to cover training, other assistance, and/or overhead costs, make investments, or for other purposes.
K. Write-off Bad Debts - Removing unpaid loan amounts that will not be repaid from the loan fund on the project books. To consider:
· how will you go about removing uncollectable loans from loans outstanding records;
· after how long and after what efforts of collection will loan be considered to be uncollectable and, therefore, for charge-off in project books;
· who will recommend/approve write-offs;
· what records will be maintained of charged-off loans for purposes of follow Up and by whom will they be maintained and reviewed;
· how will borrowers whose loans have been written-off on the project books be dealt with.
L. Training - The activities related to ensuring that the staff are prepared to do what is called for in your plans. To consider:
· what are steps in orienting/preparing staff in understanding and implementing the project according to the above policies and procedures.