African SMEs need credit: FinTech to the rescue? (2)
FinTech is a strategic fit for African SME financing
At the Financial Times’ “Unlocking SME Growth in Africa” webinar in September 2021, digitisation and technology adoption were identified as the keys to bridging the credit gap, strengthening the value chains, and boosting the productivity of SMEs. Kenya pioneered mobile money services.
While mobile money adoption varies across African countries, the continent remains the exemplar of how technology can engender rapid financial development. In fact, there are now more mobile money accounts than traditional bank deposit accounts in Africa.
Technological innovations are emerging that increasingly make financing SMEs cost-effective.
According to the International Monetary Fund (IMF), mobile internet (financial inclusion and deepening); big data and artificial intelligence (cross-border payments); distributed ledger technology (fiscal and monetary sectors); and cryptography (promoting transparency and reducing corruption) are the emerging technologies that address some of the challenges of financing small businesses.
There are well-tested FinTech solutions for almost all facets of small business financing. FinTech-enabled P2P lending and equity crowdfunding are proving effective for the long-term financing needs of SMEs.
Several e-platforms have emerged that can finance trade, merchants, invoices, and supply chains. According to World Economic Forum (2015), data availability, regulatory support, investor capital, and financial literacy are key enabling factors, whereas unmitigated retail investor exposure, bad credit misses, and limited regulations remain the top risks.
Transaction banking services like invoice financing, supply-chain financing and trade finance are now increasingly within reach of SMEs beyond a certain size threshold owing to FinTech
According to the World Economic Forum (WEF), there are currently five key FinTech products addressing the various financing needs of SMEs. These are Marketplace (peer-to-peer) lending; merchant and e-commerce finance; invoice finance; supply chain finance; and trade finance.
Marketplace or P2P lending, which is underpinned by uninsured capital from retail and institutional investors, is unsecured.
To extend credit, P2P lenders rely on the SME’s cash flow data. Big data and Artificial Intelligence (AI) are put to use for credit risk assessment, allowing P2P operations to run lean and optimise their cost-to-income ratios. While P2P lending is growing across the African continent, it is still relatively limited.
As e-commerce platforms tend to have a better view of the cashflows of their SME customers, whose payments they process as they facilitate transactions, it makes sense that they extend their range of services to include the provision of credit.
African SMEs which rely on global e-commerce platforms like PayPal, eBay, Alibaba, and so on already leverage such financing opportunities. But there are increasingly homegrown alternatives too.
Kenya’s Safaricom of M-Pesa fame facilitates credit extension to SMEs within its reach, for instance. Besides, banks are increasingly adopting FinTech solutions to cater to the hitherto sub-optimal SME segment.
Thus, transaction banking services like invoice financing, supply-chain financing, and trade finance are now increasingly within reach of SMEs beyond a certain size threshold owing to FinTech.
(We highlight the global efforts toward digitizing the disproportionately paper-based trade finance process using blockchain-based solutions in our “Blockchain and cryptocurrencies: Prospects for African trade” publication.)
FSD Africa has identified six key FinTech credit innovations in Africa viz. Scoretechs (Credit scoring platforms that allow for easier credit risk assessment of African SMEs), Invoicetechs (Digital invoice trading platforms for African SME working capital needs), Lending aggregators (FinTech platforms that allow customers to compare loans across banks), Telco-based lenders (FinTech platforms that rely on data from mobile money transactions to make loans to African SMEs), Pay as you go (FinTech platforms that leverage on the assets being financed as collateral), and Peer-to-peer platforms (FinTech platforms that match African SMEs with lenders).
Challenges related to infrastructure and regulation, however, remain. More than half of the continent’s people still do not have access to a reliable power supply and mobile internet. FinTech firms face unfair competition from traditional financial institutions. Unlike banks, they often work in a kind of regulatory ‘grey-zone’.
Regulation has been slow to catch up with emerging FinTech innovations on the African continent. In more than a few instances, African FinTech firms have had their bank accounts frozen or have had to struggle with onerous capital reserve requirements imposed on them by central banks.
While there is clearly a need for regulation, rigid rules can stifle innovations that FinTech offers.
There is a case to be made for efficiency-safety trade-offs here – especially in the African case where legal enforcement is weak and customers have poor financial literacy. FinTech can facilitate financial inclusion like no other. It has the potential to help SMEs grow and become resilient.
A number of approaches have been suggested. For example, the introduction of experimental ‘sandboxes’ in special designated economic zones that allow FinTech to operate with light-touch monitoring and supervision is a viable proposition.
Many African FinTech firms are SMEs themselves and are increasingly spoilt for choice on financing options – largely in the payments and remittances categories. A few have gone on to become ‘unicorns’ recently (Unicorns are start-ups that cross valuations of US$1bn).
Scaling up is not the norm yet, however. In fact, only 5% of the more than 700 FinTech companies on the African continent have managed to expand significantly, according to a July 2021 study by the London Business School.
Decentralised finance (DeFi) is another emerging trend with huge potential for African SME financing. According to the WEF, DeFi are blockchain-based forms of finance that do not rely on intermediaries such as banks. DeFi is ideally suited for addressing some of the most peculiar financing challenges faced by small businesses in Africa.
Still, it is early stages yet. While DeFi can help resolve complex requirements around portable digital ID and track records of transactions safely and securely, it lacks two crucial elements – a one-to-one exchange with fiat currency; and interoperability between different blockchains so that counterparties could freely interact with one another (WEF, 2021).”
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