Small and Medium Scale enterprises, SMEs, are more credit-constrained than large firms in developing economies including Sub-Saharan Africa, the World Bank has said.
This situation severely affects the growth possibilities of SME’s, added the World Bank.
“Banks have an important role to play in Sub-Saharan Africa due to their dominance in the financial systems and the limitations of informal finance, especially as regards serving the higher end of the SME market,” the organisation said..
The World Bank said this was very expedient because other external financing options such as corporate bond and organized securities markets are typically only accessed by larger firms requiring longer-term funding.
The extent to which commercial banks lend to SMEs depends on a range of specific factors, the World Bank said, including the macroeconomic environment, the legal and regulatory framework, the state of the financial sector infrastructure, bank-internal limitations in terms of capacity and technology, and SME specific factors, particularly the SME landscape in terms of number, size, and focus of operation, as well as the opaqueness and sometimes unavailability of information needed before loans are granted.
The World Bank, in an August 2013 report titled ‘Bank Financing of SMEs in Five Sub-Saharan African Countries -The Role of Competition, Innovation, and the Government’ said it used new data from bank surveys for a total of 62 commercial banks in four countries to analyse the extent, drivers, and obstacles to bank involvement with SMEs adding that while cross-country evidence on the drivers of bank financing for SMEs is extensive, detailed information for Sub-Saharan Africa remains limited.
“The data collected through bank questionnaires is complemented with qualitative information obtained through interviews with bank officials and that bank-by-bank data is only available for four countries – Kenya, Nigeria, Rwanda, and South Africa,” while aggregate data was collected and bank interviews were also held in Tanzania.
It, however, added that while most banks submitted detailed information through the questionnaires, the quantitative data requested was not always readily available and had to be approximated for a few institutions hence the data may therefore not always be representative of the whole banking sector in the respective country.
Obstacles to banks financing SMEs
The most significant obstacles identified by banks across countries were macroeconomic and SME specific factors including the poor quality of financial statements and business plans, the lack of business skills, the high degree of informality and the lack of adequate collateral, which the organisation said are important obstacles throughout the region.
Given the different structures of the economy, the report stated that commercial banks in Nigeria focused their lending on the oil, gas and telecommunications sectors and the associated value chains.
“A further determinant closely related to the structure of the economy is the extent of Government borrowing, which continues to lead to crowding out of the private sector especially in Nigeria, but also in Tanzania where banks continue to hold a sizable proportion of their balance sheets in Government securities,” it said.
The report said the rise in interest rates on Government securities lowers banks’ appetite for lending to SMEs beyond the established value chains by placing an effective floor for yields that needs to be reached to make lending attractive.
“Particularly in financial systems with weaker legal and regulatory structures and capacity, there appears to be a strong interrelationship between banks’ willingness to lend to relatively risky private enterprises and the availability of “safer” investments opportunities, such as Government securities,” the report noted.
In Nigeria, according to the report, the dominance of the oil and gas sectors and the unfavourable lending environment has resulted in most banks focusing on servicing only those SMEs directly related (as suppliers or distributors) to their blue-chip larger enterprise clients. Expansion by innovators, whether domestic or foreign, has likewise not taken place and competition from the microfinance sector remains limited, though slightly increasing.
Way Forward
The report said although there may be a role for government to encourage lending to SMEs in markets where that development has not yet taken place, providing a conducive lending environment seems to be the most important aspect.
The enabling environment can in theory reduce the costs of SME lending, particularly through providing information on prospective borrowers through credit bureaus, ensuring the availability of unique IDs, facilitating the use movable collateral as security through movable collateral registries, and strengthening the enforcement of contracts through alternative dispute resolution mechanisms.
“The enabling environment lags far behind in Nigeria, Tanzania, and even in Kenya. While Nigerian credit bureaus have been building up their credit records considerably in recent years, only commercial banks submit credit information and that irregularly,” it noted.
It also clamoured for competition that would enable banks do more than just wait on Government securities.
“Competition is required to move commercial banks out of their comfort zones in countries like Nigeria where high interest rates on Government securities provide a disincentive to engage in lending to SMEs,” it said.
The report also stated that there is no movable collateral registry in Nigeria and the enforcement of contracts take time and is costly, with legal proceedings potentially taking many years to complete. Creditor information in Tanzania is weak, with no functional credit referencing system in place, no movable collateral registry, and no reliable national ID.
“Ensuring that an effective credit bureau, enabling access to comprehensive and reliable information about borrowers, is in operation, and that the securitization and realization of (movable) collateral is efficient are fundamental challenges in a number of countries.
“Governments could further support competition and innovation by introducing the legal/institutional framework for leasing and factoring, both of which offer considerable potential for SME financing,” it said.
The financing of small and medium enterprises (SMEs) has been a topic of keen interest in recent years because of the key role that SMEs play in economic development and their potentially important contribution to economic diversification and employment in various economies.
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