As with most developing countries, micro, small, and medium Enterprises (MSMEs) are the backbone of economies in West Africa. They account for the majority of businesses, are important contributors to job creation and have evolved to become key suppliers and service providers.
Despite their importance, access to capital is a key constraint to SMEs realising their full potential. SMEs are less likely to be able to obtain bank loans compared to large firms. Their sources of financing mostly include internal funds, or cash from friends and family, to launch and initially run their enterprises. This limits their potential to grow and more effectively contribute to economic development, job creation and tax contributions. In fact, the International Finance Corporation (IFC) estimates that 65 million firms, or 40% of formal micro, small, and medium enterprises (MSMEs) in developing countries, have an unmet financing need of $5.2 trillion every year, which is equivalent to 1.4 times the current level of global MSME lending.
A review of domestic credit as a percentage of GDP, for instance, helps put this issue of the SME lending gap into perspective. The World Bank estimates that in Nigeria, domestic credit as a percentage of GDP was 12.5% in 2017, 10.2% in 2018, and 11.2% in 2019, with similar figures for Côte d’Ivoire and Ghana. This, compared to Sweden (on average 131%) and the United States of America (on average 190%) for the same period, shows the extent of the gap.
Demand and supply theory helps explain the SME financing gap in West Africa and by extension the globe.
Since financial infrastructure is primarily designed for corporates and high net worth individuals, SMEs are not able to send strong demand signals to commercial capital. “Poor record keeping, inadequate KYC (know your customer) details, and proximity to financial institutions are common challenges for SMEs in West Africa. This increases the perception of them being at a high risk for NPLs (non-performing loans),” says Arnold Kavaarpuo, Country Manager for market leading financial services technology platform, JUMO in Ghana.
On the supply side, it is often argued that even with the best of intentions, the needs of a large proportion of the market remain unmet by modern economic function. That is, there is a price point in any market where marginal propensity to produce reduces, as cost exceeds any marginal revenues. Some have referred to this as the Pareto principle or market equilibrium. Attempts to move this curve outward through social impact funding and corporate social investment has improved market development, but hasn’t solved the core problem of legacy thinking that is holding back access for a whole new market.
IFC’s global SME Banking Survey in 2019, identified the three biggest challenges accounting for the SME lending gap as: credit risk, external environmental risk, and technology adoption. “JUMO has introduced a great potential solution to these problems by utilising mobile money infrastructure. We have developed bespoke digital credit products for both SMEs and individuals. The success is evident: JUMO has served 18.3 million customers across Africa and Asia. In Ghana alone, we have 4.4 million unique customers and 6 out of 10 are MSMEs that are now able to access credit through JUMO’s platform,” says Kavaarpuo.
Through the use of advanced data science and artificial intelligence, JUMO’s information processing engine is able to more accurately predict the risk profiles of SMEs in order to match them to affordable bank capital. “This predictive capability is constantly improving through an increase in the quantity and variety of data available. It also shows SMEs to be a viable market segment for the allocation of bank capital,” he continues.
The SME funding gap requires a multifactor approach from the private sector as well as policy makers. Governments tend to subsidise cash providers but penalise digital financial service distribution and products, which is not tenable for a healthy financial system in the long run. We need to invest in distribution infrastructure to reduce unit economics or cost to serve. Responsibility for development should be shared between government interventions and private sector initiatives. There is also a need to invest in citizen identity and address systems to improve KYC, as well as credit reference bureaus to improve confidence in lending to SMEs.
The artefacts built for notes and coinage financial services need to be revamped for a modern digital financial services architecture. “There should also be a conscious effort to incentivise new players that are taking on unpopular financing segments and trying to bridge the SME funding gap. With conscious and collaborative design, the SME funding gap can be reduced,” concludes Kavaarpuo.