The African Microfinance Week 2017 took place from 9 – 11 October 2017 in Addis Ababa under the theme of “Creating value for SMEs: A new frontier for inclusive finance”. During the event microfinance practitioners shared their experiences in serving SMEs and some lessons learned:
What do we mean by SMEs?
One important aspect of the focus on SMEs is that the term can mean a lot of different things to different actors. Microfinance institutions tend to refer to an SME segment if the loan sizes pass a certain threshold, in Africa around 10,000 – 20,000 Euros. Yet clients can be vastly different depending on whether the loan size is 10,000 or 100,000 Euros (which may be the difference between S and M). It also matters very much which segment the SME operates in since markets in agriculture, services or different forms of industry can vary very much and need to be analyzed differently.
Real entrepreneurship and its ugly cousins
A manager of a SME focused microfinance institution referred to three types of African SMEs he encounters: (1) The ones driven by real entrepreneurs: This usually means that the person driving the company has experience and knows about 70% of the business well while 30% need to be learned along the way. (2) The adventurer: Is the reverse of an entrepreneur because he or she knows about 30% of the business and needs to learn 70% along the way. This is often bound to failure. (3) The fraudster: In the absence of efficient credit bureaus some individuals pretending to be entrepreneurs have figured out the credit processes and shop around for credit they never repay.
Focus, focus, focus and risks…
Analysing credit risks of SMEs is more complex than analyzing credit risk of micro-entrepreneurs. This is often reflected in the levels of portfolio at risk (PaR). Even specialized microfinance institutions acknowledge that the SME loan portfolio performs worse than the micro loan portfolio with PaR often twice as high. This implies that you need to develop expertise in the relationship management and credit analysis which differs from what MFIs have done traditionally.
Textbook organization and reality
Often the organization needs to specifically focus on getting it right. In the past, the textbooks often prescribed the creation of dedicated SME units with specialized managers hired externally. MFIs have shared that this often does not work. It creates internal competition, particularly with regards to the transition of micro clients into the SME segment. The credit analysis loan officers is complemented by a team of specialists checking quality and pertinence. In some cases hiring externally, which often meant hiring from banks, had limited success and MFIs prefer to train their best staff for this new responsibility. On the other hand one specialized SME lender relies on a mix of three types of staff: bankers, microfinance loan officers and sector specialists.
MFIs openly stated that they had significantly overestimated the size of the SME market. The numbers commonly referred to as the missing middle (only 10% of SMEs are adequately served, they contribute 50% – 60% of GDP etc) suggest that the market is enormous. Yet when MFIs venture out to acquire new clients they find that the potential is limited. This may partly be influenced by the first point on definitions since MFIs often focus on the S rather than the M in this segment and limited geographic outreach in urban markets which may already be well served.
Competition and products
Competition in this market segment is fierce since MFIs not only compete with other MFIs but also with banks. So the idea that the larger loan sizes of SMEs lead to a golden land of lower operating costs, good margins, acceptable risks and hence big profits often proves futile. This also means that MFIs need to think about product differentiation. If the MFI copies banking products while being a less prestigious financial partner it is likely to end up with the SMEs the banks have rejected as (loan) clients. So product innovation and better service is needed to capture the best clients.
Finally a word on gender: Whereas more women than men are micro entrepreneurs, this does not seem to hold true for the SME segment (although some claim it does). Surprisingly a debate about gender considerations in SME lending was largely absent.
Author: Kaspar Wansleben, Executive Director Luxembourg Microfinance and Development Fund