Photo: CDC

African SMEs are Starved of Finance

African SMEs are Starved of Finance

Of Africa’s 50 million SMEs, over 70% suffer from insufficient financing, leaving a funding gap of USD 140 billion. Less than a quarter of these firms have access to bank loans or lines of credit, compared to 43% in other developing regions.

To address this challenge, the African Development Bank launched the Africa SME Program in July 2013. We designed this USD 125 million program as a complement to our strategic interventions in financial sector and private sector development. What’s different about the Africa SME Program?

In our experience working with African banks and non-bank financial institutions (NBFIs), we have learned that the Continent’s smaller, local financial institutions are the key providers of financing to SMEs. Larger banks have a tendency to prioritize lending to more established (corporate) firms, and can neglect the SME segment. This is likely because larger banks view the SME segment as more risky and informal due to a lack of quality information and with insufficient collateral to meet their lending requirements.

However, while smaller banks and other financial institutions (FIs) may be better placed to reach smaller firms, they face a number of constraints which serve to limit their effectiveness.

For one, small FIs disproportionately lack access to longer term funding resourses. This means they are unable to support SMEs with appropriate term financing to undertake capital investments and upgrade their productive capacity. Larger banks could potentially raise longer term loans from capital markets and on-lend to clients at similarly long terms. However, for small FIs, this is simply not possible.

We have also seen that smaller FIs may experience capacity constraints to select and fund SME projects and to build good quality SME portfolios. This includes capacity challenges in SME credit aspects, project financing skills, SME portfolio management and customer relationship building, among others.

Of course, challenges also exist on the side of SMEs. They tend to face management and financial skills shortages and consequently may not be able to prepare adequate business plans and other information as required by FIs. Often, these SMEs either don’t have or are unwilling to offer registered collateral that banks, in particular, require. Whilst some of these issues need to be addressed through other interventions (credit bureaus, collateral registries, land registries) the capacity side can be addressed with local Business Development Services (BDS) Providers. Indeed, some FIs make use of these services or have internal mechanisms to support SMEs to prepare business plans and financial forecasts, among others. This can greatly assist in the successful loan application by SME clients.

What we have done through the Africa SME Program is to focus on the market segment where we can have the greatest impact: small local African banks. In pursuing this focus, we are currently undertaking two interlinked activities to address the challenges outlined above:

1. Providing long term lines of credit to small local FIs. We expect this to enable these FIs to on-lend to more SMEs at longer tenors and affordable terms; and

2. Offering technical assistance and capacity building to smaller FIs in order to enable them to build solid SME portfolios and support their SME clients.

To support these efforts, we have introduced a new programmatic approach for the Africa SME Program. Our fast-tracked and standardized process means that we can reach more FIs and ultimately more SMEs in a shorter period of time and with lesser costs.

What is our footprint on the continent thus far?

So far, we have reached banks in Benin, Burkina Faso, Cameroon, Mozambique, Nigeria, Tanzania and Zambia.

Figure: Access to bank lending across Africa

Source: World Bank Enterprise Data for African Countries

The initial Africa SME Program investment of USD 125 million to reach 20 to 25 FIs – and ultimately 12,000 SMEs – is only a small step towards closing the financing gap. However, we are optimistic about the transformational effects this can have. For example, research from the Continent shows that this type of investment brings additionality through mobilizing funds from third party investors. FIs that are encouraged to start lending to SMEs are found to continue to do so, taking on both repeat and new SME clients as they grow their expertise in the segment. Moreover, FIs serving predominantly SMEs are able to empower their clients to graduate to corporates, scaling up supply chains and growing their regional bases.

We will be closely tracking how our investments in local FIs reach African SMEs and look forward to sharing our results with you.

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