Tag: banking

Africanising credit – Financing SME’s

Agriculture and SME’s (small and medium enterprises) are the backbone of Africa’s economy and societies. SME’s make up to 90% of all businesses in sub-Saharan Africa[1]. In Ghana approximately 92% of all local businesses are SME’s, providing up to 85% of manufacturing jobs in the country and contributing about 70% to the country’s GDP. In Nigeria, 37 million SMEs employ about 60 million people and account for about 48% of the country’s GDP. In South Africa, there are more than 2.2 million SMEs, about 1.5 million of them in the informal sector. As much as governments around the continent are looking to industrialise through attracting investment in large scale manufacturing, we cannot develop without our SME’s. SME’s provide the livelihoods for a significant number African’s and if they succeed, African economies and development will succeed.

However, SME’s also face an incredibly tough time. In South Africa, the Department of Small Business Development estimates that between 70%-80% of SME’s do not make it past their first year. In Kenya, the National Bureau of statistics found that at least 46% of Micro Small and Medium enterprises do not make it past their first year. What is preventing them from succeeding? Among the multitude of factors (some covered previously on this blog), one of the biggest is credit. The London Stock Exchange estimates that African SME’s face a funding gap of at least $140 billion African businesses find it incredibly hard to access credit, and credit is the fuel of the modern economy. Without credit, there is no safety net for businesses and farmers when things get a little tough. Without credit, it’s hard to fund growth and innovation. Without credit most businesses and farmers are limited to subsistence, to just surviving, because to develop we need those businesses to thrive.

Thus, the policy question becomes what can be done to ensure more credit gets to the SME’s. If the financial sector is not fit for purpose, how do we move beyond traditional definitions of collateral and banking to kickstart credit to these key sectors? The answer for many governments around the continent and development finance institutions (DFI’s) has been to try some sort of SME financing scheme such as giving banks money or guarantees to lend money to SME’s. However, this hasn’t worked, thus what’s needed is a new approach, based on evidence that takes advantage of new trends and technologies and thinks beyond banks. If so, the continent may be able to turbocharge their economies by enabling businesses that actually exist rather than those they hope will be created.

Understanding SME’s financing needs

Knowing that there is a problem and understanding the nature of that problem are two different things. Judging by their rhetoric, African governments understand the importance of SME’s to their economies and are more than willing to make commitments to improve their lot. However, before making promises to SME’s and formulating policies on the basis of those promises it is necessary to understand SME’s needs.

Thus, the first thing that African governments must do as they attempt to unlock the financing problem that SME’s face is to talk to SME’s. Understand whether the majority SME’s need financing to fund their day to day operations (working capital financing), credit to invest and grow their businesses, or trade financing to help fulfil orders or ensure that they have sufficient levels of stock. Secondly, governments need to understand how much money different types of SME’s actually require. Understanding the financing needs of SME’s will enable governments to design or enable solutions that SME’s actually need. Third, is for governments to understand the participants in the SME sector. Such as the nature of formal and informal player, the challenges facing SME’s in different sectors such as manufacturing, agriculture or the arts, the region of the country they are in etc. If the rhetoric of African governments is to become reality and SME’s are really going to be empowered African governments would do well to make a good faith effort to understand them properly first.

Beyond banking

As stated earlier many of the efforts to jumpstart SME financing have involved banks, with governments and DFI’s providing lines of credit or guarantees specifically earmarked for onward lending to SME’s. Around the continent there exist a plethora of government-owned development banks, private banks, and funds whose sole purpose is to lend to SME’s and start-ups. What’s clear is that traditional funding models (a bank loan) are not necessarily meeting the needs of African SME’s a report by the London Stock Exchange Group has placed the funding gap for African SMEs at more than $140bn. The report goes on to point out that among the key hurdles to SME’s accessing finance are:

  • Onerous credit checks from banks (especially foreign banks) restrict SME participation as SMEs often lack the track record and meaningful data inputs required.
  • Credit Bureaus (where defaulters are blacklisted) have, rather than de-risking credit, turned into a negative reinforcement tool as smaller companies run the risk of being ‘blacklisted’ if a single loan repayment is delayed.
  • Prohibitive collateral requirements: lenders seek high levels of collateral to mitigate the high risk associated with lending to SMEs

It may be time to think beyond bank loans when we ask how we can provide African SME’s with viable sustainable credit options. Across the continent, digital and mobile-based lenders are helping to fill the credit gap with innovative and ever-changing credit risk models allows them to better understand credit risk. Allowing them to lend to small business owners, traders and farmers to access short term credit. Often referred to as short term credit, this type of lending allows businesses to meet short-term funding gaps. For example, if an agricultural produce trader wants to stock for the day or week, they are limited to buying only what they can afford at that particular moment in time. However, with access to short term credit they can borrow, buy more produce, sell more produce and at the end of the day after paying the loan back they have made more money. This is not an abstract example it happens every day, especially in Kenya where mobile lending is now common. If banks are not willing to fill this gap, what policymakers and regulatory bodies such as central banks need to do is think about how we can we enable digital lenders to better meet the needs of SME’s. What regulations, consumer protections and standards do we need to put in place that will allow this industry to grow sustainably? Not just lending small traders but also possibly to larger SME’s enabling them to meet their own short-term finance needs.

Secondly, governments should start thinking about investing rather than trying to push banks to give out loans. In a previous post urging a rethink of industrialisation policy on the continent, I talked about the U.S. Governments Small Business Investment Company (SBIC) program to facilitate the flow of long-term capital to America’s small businesses. The SBIC either directly invests or facilitates private capital investment into Small businesses. Crucially these investments are long term giving small business the opportunity, capital and time to grow. Though it has lost money on some investments its investments in companies like Apple, FedEx, and Whole foods outweigh any losses made through the profits, jobs, Intellectual property and innovation that have brought trillions of dollars’ worth of wealth to the US economy. African governments must show the same willingness to invest in African businesses as the private sector (banks and investors) have not done so yet and we cannot sit around hoping it will. Public agencies with a clear mandate to invest or encourage investment in SME’s which show potential for growth will have hits and misses, not every investment is a success. But every investment like this is a positive bet in the future of your country and its citizens, it’s a sign to others that there is a path for them too, but most of all it puts public money where it could do real good not locked in a bank vault.

Making things just a little easier

Teddy Roosevelt once said that “Nothing in the world is worth having or worth doing unless it means effort, pain, difficulty.” The same applies to running an SME in Africa. Business is not for the faint-hearted, nor should it be, but neither should it be filled with potentially moveable obstacles that make It nearly impossible to succeed. Africa’s SME sector is astounding. It has survived natural disasters and the disaster that has been government policy and ignorance of small businesses. If SME’s are to not just survive but thrive it will require governments to adopt policies that make things just a little easier for them outside of the easing of access to credit.

The first of those policies is a tax. Africa’s tax systems tend to be overly complex and burdensome. With businesses often having to pay multiple taxes, that they can ill afford. Simplifying tax systems to be coherent and so simple, so that they can be understood and paid easily should be a priority. If not, many SME’s will either avoid paying taxes or struggle under the burden of being law abiding citizens.

Second, trust. A public register where key information about companies is available to banks, lenders, governments, investors, customers, etc. to have some trust in the credibility and trustworthiness of these companies.

Third would by altering our laws, specifically our employment laws to fit the reality of SME’s and labour in Africa rather than acting as if all employers were large corporations. I have written more extensively on that here.

Finally, is training and networking. Facilitating the training around financing, marketing and tax/regulatory compliance could equip SME’s with tools they need to succeed and enable them to make better use of the funds they do manage to get. Networking is simple, merely using the government’s power to bring people together, to bring SME’s, investors, financiers and potential customers together, and letting them do their thing.

Creating the right environment need not be complex, a few concrete policy actions from the government would act as a stimulus to SME’s and those that may provide credit to them, making things just a little bit easier.

Conclusion

SME’s are the lifeblood of African economies. They provide livelihoods to hundreds of millions around the continent, and alongside agriculture, they are the key that will unlock Africa’s economic potential. To do that they will need access to credit. Thus far efforts to improve credit provision to SME’s on the continent have not been as successful as hoped. This calls for some new thinking; thinking based on a deeper understanding of the challenges facing SME’s. New thinking about how we can move beyond the limitations of banks to harness new technologies and approaches to provide credit to Africa’s SME’s. And to Identify and implement the key policy interventions that governments can make to provide the right environment in which SME’s can thrive.

If we get this right, if we can get SME’s to thrive, then Africa Rising won’t be an old meme but a future reality.

[1] https://www.ifc.org/wps/wcm/connect/REGION__EXT_Content/Regions/Sub-Saharan+Africa/Advisory+Services/SustainableBusiness/SME_Initiatives/

Interest rate caps could work and be a good thing

Despite what the IMF, World Bank, Kenya Bankers Association and various private sector organisations say (as well as free market logic), interest caps can be a good thing, if done right they could actually give people access to affordable credit, but that can only happen if governments around Africa stop borrowing as much as they have been.

In August 2016 president Uhuru Kenyatta signed into law legislation that capped the interest rates charged by Kenyan banks to 4% above the Central Bank of Kenya’s (CBK) benchmark rate. This means that if you were to go to a bank in Kenya to apply for a loan today the interest rate charged would not be more than 14%, which is 4% above the CBK’s benchmark rate of 10%.

While it was a drastic step, it was a long one coming. Kenyans had long been frustrated by banks charging exorbitant interest rates often 10 or more percentage points above the CBK benchmark rate. The Donde Bill of 2000 similarly capped interest rates but was neutered by the courts, and another similar law was stopped in 2013 because of heavy lobbying by the banks in parliament. In 2016 the public had, had enough and MPs (with an election around the corner) were listening and the bill was passed, somewhat unexpectedly the president signed the law.

The consequences of the rate cap

The consequences of the law have been significant. First and most significant is that banks have severely cut lending to the private sector, with credit growth falling ominously (Figure 1) meaning that borrowers particularly small businesses have been unable to access credit, meaning that not only can they not invest in further growth they also cannot use credit to supplement working capital [1],  while ordinary households have been unable to get mortgages and car loans. This effect has been cited by people like the IMF, World Bank and the Kenya National Chamber of Commerce and industry as a cause of Kenya’s recent economic slowdown.

Figure 1 – growth of private sector growth in Kenya

Secondly, in response to falling profits from interest rates banks have cut costs, significantly. In 2016 banks in Kenya retrenched over 1000 workers (approx. 1.6% of the financial services workforce in the country), and aggressively pushed digital platforms in order to cut down on more expensive physical infrastructure (bank branches, ATM’s etc)

The third and most important thing is how banks have been making their profits. Instead of lending to people and businesses they have been lending to the government. Banks have shifted their money to buying treasury bills, which are short term loans the government takes to cover its expenses on an ongoing basis, and they are making a lot of money while doing it. The logic is simple, why lend to individuals and private businesses, where you have to spend time and money assessing each applicant for their risk and run the risk that they might not pay you back. Its much easier to lend money to the government and though the interest rates may be lower, the volumes are very large and the government will not default, essentially guaranteeing profit. This is all enabled by a government with a never-ending appetite for more and more money, the Kenya governments debts have soared over the last year and here lies the problem.  The rate cap will never achieve the goals it was meant to – making loans cheaper for ordinary Kenyan business and people – if banks can simply lend to the government and still make huge profits. On the back of this there are increasing calls on the government to repeal the rate capping laws to ‘restore’ private sector credit and boost the economy.

This would, in my view, be the wrong approach, it would simply take Kenya back to the position it was in before. Banks would be charging people and businesses blatantly usurious interest rates for loans while continuing to lend to a government with the financial appetite of a black hole, in the process making enormous profits.

Making rate caps work

Repealing the laws would be a step backwards. The focus should be on making the laws do what they were supposed to do, to which the key is stopping government borrowing so much money. The rate capping law has been a godsend for a government borrowing from every willing lender, the law made the banks much more willing to lend to the government and avoid the effects of the law.

If government appetites for borrowing money could be curbed, then the interest rate caps could work. Eventually the banks will run out of costs to cut, without treasury bills as a source of endless profits, they would have to do what banks are supposed to do, lend. Rather than caving to pressure from banks and international financial institutions (again) the top policy makers at the Kenyan treasury need to start thinking about the people the laws were meant to serve and not the accounting books in front of them.

Rate caps around the continent

Kenya is not the only country on the continent facing the problem of how to improve and increase private sector lending. Across the continent, access to credit is a major hurdle faced by businesses (figure 2)

Figure 2 Percentage of Firms Identifying Access to Finance as a Major Constraint[2]

Without credit small businesses are stuck as they cannot get the funds to operate and grow, Africa may talk glowingly about its entrepreneurial spirit but without a finance industry willing to lend to them the reality will never meet the high hopes. If rate caps can be made to work it would stand as a model that other African countries can follow, it will show that with a simple law you can fundamentally change the dynamic in the financial sector that will force banks to serve their customers, something that free market economics has been unable to do. Giving African households, businesses and entrepreneurs access to affordable could be truly game changing and contribute to solving a range of problems from housing shortages to unemployment to the high rate of failures among SME’s. However, for affordable credit to become available lawmakers and policy makers need to be bold and force the financial industry to serve Africans and that will require policy, regulation and law. For these types of laws to work it will require the government to curb its appetite to spend and borrow as much as it can get away with, something we haven’t yet quite figured out how to do.

 

[1] For many businesses flows of income do not exactly match their spending (e.g. salary must be paid monthly but clients have 60 days to pay you)

[2] https://www.afdb.org/en/news-and-events/afdb-calls-on-credit-providers-to-increase-lending-to-meet-demand-by-african-msmes-17138/