More than 95% of registered businesses around the world are small and medium-sized enterprises (SMEs). Africa is no different. According to the World Bank, they provide for more than half of all jobs and account for more than a third of the combined GDP of emerging market economies.
Getting access to credit, however, is an uphill task for most of these SMEs. It is now widely established that lack of access to finance is the most significant constraint on the growth of small enterprises. In developing economies, the estimated annual credit gap could be as much as US$5.2trn.
Banks prefer to extend loans to large corporates. That is because their financial needs are large. Their credit history is easier to access. The business of a large corporation is often run by professionals and they have a management team that comes with some name recognition. Big corporates keep more timely and accurate business and financial information too. Bank managers are, therefore, only too ready to sanction credit for large corporates. It creates efficiency gains.
This is typically not the case with small businesses, which typically do not keep proper financial records and are often run by inexperienced managers. That often makes it difficult for banks to assess their credit-worthiness. In other words, there is an inherent cost disincentive for banks to extend credit to SMEs.
With technology, however, banks can offer the same level of service to SMEs as they do for large corporates at costs and levels of effort that make it worth their while. According to the Financial Stability Board, financial technology (FinTech) refers to “technologically enabled financial innovation that could result in new business models, applications, processes or products with an associated material effect on financial markets and institutions and the provision of financial services.” And that is in fact increasingly the case across the world, even more so in African countries.
FinTech takes away the cost disincentive of extending loans to small businesses. But are African SMEs benefitting from FinTech? This is the question I address in the article. I also look at how Singapore-based FinTech firms are beginning to facilitate the digitalization of financial services in Africa. And finally, I try to assess the outlook for FinTech in Africa.
Credit extension to African SMEs is challenging
A study conducted by the London Stock Exchange (LSE) in 2018 revealed that 40% of African SMEs identify access to finance as a primary constraint to their growth. The current funding gap is put at more than US$140bn. African banks are reluctant to make loans to SMEs for the reasons explained earlier.
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Take, for example, FinTech lender Lidya. It can disburse loans from as little as US$500 within a day. But a typical Nigerian bank would be loath to lend amounts less than US$50,000. While it would take a FinTech firm less than a day to disburse a loan, a bank can take weeks to process the transaction. Regulation is also more onerous. Because SME financing is considered riskier, banks are required to set aside more reserve capital, to account for potential default.
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According to Asoko Insight, demand-side gaps, supply-side gaps, high-interest rates, information asymmetry and macroeconomic headwinds are responsible for the SME funding shortfall in Africa. On the demand side, SMEs are generally sceptical about successfully securing loans from banks.
But this is also because small businesses tend to have shoddy business plans, poor corporate governance, and limited collateral. On the supply side, banks are constrained by competing demands on their credit risk assessment resources. And even banks that do put in the effort, usually smaller banks, are constrained by the short-term capital they attract, which weighs on their ability to make long-term loans to SMEs.
Getting accurate financial information on SMEs is another challenge. While credit bureaus should typically fill the gap, they are few and far between on the continent.
Little wonder, only about a fifth of African SMEs can lay claim to a reliable bank credit line, according to the African Development Bank (AFDB), which unsurprisingly are usually at extremely high-interest rates. To make African SME lending attractive, these myriad risks associated with small businesses must be addressed. FinTech does just that.
An edited version of this article was first published by Nanyang Business School’s NTU-SBF Centre for African Studies, Singapore. References, figures and tables are in the original article. See link viz.https://www.ntu.edu.sg/cas/news-events/news/details/can-fintech-meet-the-financing-needs-of-african-smes
