SME Finance & Leasing

a group of people in discussion

Small and Medium Enterprises (SMEs) play a vital role in economic development, by increasing competition, fostering innovation, and generating employment. In African countries, as in many other developing and transition economies, SMEs employ the largest share of workers. However, in Africa, these enterprises’ contribution to GDP is significantly lower than anywhere else in the world: while they contribute to up to 50 percent of GDP for high-income countries, the percentage in Africa remains below 10 percent.

A wide range of definitions exists for classifying small and medium enterprises (SMEs). These range from volume of loans, to ownership, turnover, and number of staff. Most commercial banks, however, define SMEs in terms of annual sales, an indicator that is more easily observable, a good proxy of an SME level of business activity, and, therefore, more useful to banks’ business and risk management purposes. The threshold of annual sales used by banks varies by country, according to the size of the economies and structure of their corporate sector.

SMEs in the continent face several challenges to growth, ranging from unfavorable macroeconomic environments to administrative barriers and red tape. Perhaps the biggest obstacle, however, remains their limited ability to access financial services.

Traditional long-term bank finance is generally inaccessible to small and medium sized enterprises because of the lack of collateral requirements, which, in most of the continent, render movable assets unusable for the purposes of accessing credit. This, associated with the high transaction costs associated with due diligence, leads to commercial banks continuing to focus on lending to large, established businesses and multi-national corporations. Venture capital is often also not an option as would-be financiers cite the lack of opportunities to take equity positions in small- and medium-sized businesses at rates of return justifying the risks involved.

Leasing financing for equipment and capital goods is an important alternative to traditional means of financing, especially for smaller businesses that lack the credit history or the required collateral to access traditional forms of financing. In leasing, the provider – or lessor - owns the equipment and allows the client – the lessee – to use it, in exchange for periodic payments. This type of financing allows the lessee to access to equipment or capital goods that might otherwise be out of reach, while guaranteeing the lessor repossession of the good in case of default. As a result, leasing generally implies lower transaction costs compared to loans and, where available, it can also be an attractive financing option for rural and agricultural small-scale operators.

With the exceptions of Egypt, Morocco, Tunisia, Nigeria and South Africa, the leasing market is in its nascent stages in Africa, with penetration rates ranging from 1 to 5 percent (against a global average of 20). As any other industry in its infancy stage, leasing is characterized by absence of favorable operating environment since the taxation, regulation and legal regimes are not yet adapted to the sector’s requirements.