Credit where credit is due

Looking at formal SMEs alone, the unmet need for credit in SSA is close to $100bn. An array of strategies exists to derisk Africa’s SMEs for lenders and spur private sector growth.

Small and Medium Enterprises (SMEs) are the driving force of economic development in Africa, accounting for 90% of all businesses, 50% of employment and 40% of GDP across the continent. Yet a persistent financing gap of more than $330bn a year, according to the International Finance Corporation (IFC), has challenged African SMEs to grow without access to credit – an unprecedented pathway to economic development, and not one to rely on.

What’s causing the funding shortfall?

Demand-side gaps – SMEs remain uncompetitive due to inadequate business plans and corporate governance, limited accounting expertise and a lack of collateral. Surveys consistently illustrate that SMEs do not believe they will receive financing and do not approach banks.

Supply-side gaps – Banks are operating under relatively nascent financial regulatory frameworks; they have constrained technical capacity such as credit analysis resources and technology access; and there is a short (but growing) supply of credit bureaus. Small local banks, which have more exposure to SMEs, have difficulty accessing long- term financing compared to larger commercial banks, forcing short-term arrangements with SMEs that limit adequate capital investments.

Tough interest rates – Borrowing costs in Africa’s growth markets are often high and volatile, either pricing SMEs out of the lending market or inducing non-performing loans (NPLs); the ratios of NPLs to total gross loans are higher in leading Sub-Saharan African growth markets compared to other leading emerging markets globally, such as Vietnam, Brazil, Indonesia and China.

Information asymmetry – Easy access to corporate information, including data on ownership structures, financial performance, incorporation documents, credit history and movable collateral, remains elusive, compounding the risk barrier around lending.

Macroeconomic headwinds – The above challenges are exacerbated by ballooning sovereign debt; limited foreign exchange reserves and US dollar liquidity; low commodity prices; and a slowdown in Chinese growth.

Where does that leave the SME financing market?

The result is heightened risk perception around SME financing as an asset class, scaring away large banks with long-term capital and therefore restricting credit. African bank loan books are heavily weighted towards governments, multinationals and major family-run businesses, with as little as 5% and 8% of loan portfolios – in the continent’s largest markets of Nigeria and South Africa, respectively – allocated toward SMEs (East African countries having higher allocations on average), according to the World Bank. Overall, only 20% of African SMEs have a line of credit, according to the African Development Bank. Looking only at formal SMEs, the overall unmet need for credit in sub-Saharan Africa alone is close to $100bn, the highest figure compared to other emerging market regions, according to McKinsey. As the growth engine of economic development, the gap illustrates a major priority for African policymakers, lenders and innovators.

The opportunity

To grease the wheel, SMEs require de-risking at scale, and banks require the right information technology.

Tech enablement  – Business banking units, even in many of the continent’s largest banks, rely on legacy technology and inefficient processes, making onboarding and due diligence resource-intensive. However, specialised fintech, business intelligence and workflow solutions are now available to help digitalise, organise or automate these processes, which increase efficiency around origination and compliance. As more SMEs formalise and Africa’s markets mature, the banks quickest to adapt will become market leaders. Kenya’s top 5 local banks, for example, have come together in a consortium to trial a mobile-based lending service to SMEs, starting with 3,500 businesses and at a more competitive interest rate.

Government & capacity building – African governments have indeed increased their attention to the SME financing gap. Movable collateral registries, such as in Egypt and Nigeria, are an innovative approach to formalising and de-risking SMEs. Credit Guarantee Schemes, supported by governments and multilaterals, are also on the rise, however, they typically result in short-term financing solutions, tied to particular fund lifecycles, without spurring a structural change for financial inclusion. Attention, however, is highly deficient with regard to capacity building support for SMEs. New public pilots should allocate resources to trial advisory programmes via local business associations to finance business plan formation and skills development in accountancy, management, governance and technology. This will yield long-term dividends for SMEs to become competitive and formalised.

Corporate data transparency regulations – Easy access to corporate records, at scale, particularly on accurate ownership information, is not impossible. Governments should invest in new Africa-centric data regulations that, while protecting individuals’ privacy, incentivise formal participation in the private sector. SMEs will not formalise until they are properly incentivised to do so with financial rewards, and currently the perception of a tax burden outweighs the various incentives.

SME credit ratings – One innovation repeatedly in demand from African bankers is the ability to accurately rate SMEs, along with the wider private middle market, at scale. This is a significant opportunity for banks to work with specialised fintech firms to apply data solutions that have already proven effective in the consumer retail banking space toward the SME and corporate space. n

This report was compiled by Asoko Insight, the leading market intelligence agency.