The diagnostic is clear: SMEs throughout Africa lack adequate access to financial services, slowing their growth and negatively impacting their ability to create employment and contribute to economic growth. In Burundi, 95% of companies in the primary, 50% in the secondary and 37% in the tertiary sector are SMEs yet only 9% have access to credit.
The reasons are complex and depend on local context, including regulation and public support programs. However, a number of common themes emerge:
- Frontier between relationship lending and transactional lending or the missing middle
Microfinance significantly innovated the provision of finance services because it reinvented the way credit is granted to very small enterprises. Instead of looking at the guarantees and formal information (audited accounts, tax declarations etc), microfinance found a way to deal with information asymmetry in the informal economy. And that is in large part attributable to relying on relationship lending models. The key to such model is that it translates unstructured information on the lender into structured information which can be used for a credit analysis. This usually happens through a credit officer sitting down with a client and going through a set of questions, verified through the experience of the officer and the contextual information (this is why in microfinance the banker comes to the client).
SMEs often have a certain amount of formal information. They might be licensed, declare taxes to be paid and be subject to certain regulations. This means they should be served by institutions relying on a mix of relationship and transactional lending models such as banks. Yet when the formal information is of weak quality, and the client too big for a lender to rely on relationship lending information only, the SME falls between the chairs.
So, the missing middle is often defined in reference to loan amounts. Loans are too big for MFIs yet too small for banks. I would argue that the nexus between relationship and transactional models poses an equally large challenge to serving SMEs. Smart combinations of both models are needed to serve SMEs well. For the moment successful examples of such combinations are scarce.
- Collateral as a hard barrier
Both MFIs and banks require collateral for loans of a certain size. SME loans mostly fall into the category of loans for which collateral is required. What is striking is that for all the innovation MFIs brought to collateral free or collateral lights loans for the informal sector, SMEs are still required to have “classical” hard collateral (real estate, physical assets). In many SME business models there is only so much physical assets to pledge (often in personal assets by the owner) and this poses a hard limit to the amount SMEs can borrow both from banks and MFIs.
What is badly needed is a fresh look at the types of collateral SMEs have and which should be allowed as security for a loan. Lending backed by receivables, factoring, leasing models and other asset based lending and integration of value chain finance all offer ideas of how the sector could innovate.
- Who serves SMEs: The risk of a loose-loose
During the discussion it became clear that there are often several actors serving the financial needs of SMEs. Credit is supplied by MFIs, banks and in some instances by public entities. In the case of Burundi 50% of financing came from MFIs and 50% from banks. But the financial needs of SMEs are larger than credit only. SMEs need cash management solutions, money transfer services, insurances…
This has led to a fragmentation of who serves which needs. MFIs often provide credit only. Banks provide accounts and liquidity management services. Insurers may provide specific solutions. The risk of the fragmentation is that the vision of the SMEs is always limited to a small window of their financial reality. MFIs only see repayments of loans. Banks only see limited amounts of deposits and cash-flows with limited meaning for their product.
The argument is that a better connection of this information may reduce risks for the financial provider and enhance access to finance for SMEs. For example, an MFI seeing the entire cash-flow of an SMEs may conclude that the credit amount may in fact be increased considerably – a vision which cannot be developed if it only monitors whether credit repayments are on time. Value chain finance is another example where a holistic vision is a requirement for an efficient product offering.
Part of the solutions for SMEs may lie in a better collaboration between banks, MFIs and other actors overcoming a status quo where everybody loses.
- The issue of costs
Microfinance lending to individuals active in the informal sector tend to charge high interest rates. The entrepreneurs can afford to pay high interest since their activity is often a high margin, low volume activity relying on their working time as the essential input.
This changes dramatically for SMEs. Their activity is often high volume, low margin. SMEs are in competition often against imports from China and elsewhere. This implies that they are unable to pay interest rates comparable to those paid by micro-entrepreneurs. Yet, traditional models relying on a branch agencies and loans officer to serving SMEs imply high costs, below but close to those incurred in microfinance.
This might be the hardest challenge to overcome. Fintech is currently considered the most promising avenue to reduce operational costs to the point of being able to serve SMEs well.
Author: Kaspar Wansleben, Executive Director, Luxembourg Microfinance and Development Fund