Africa: A look at SMEs
Africa has tremendous scope to become one of the most attractive investment destinations in the world. The current level of investment – 23.5% of Africa’s gross domestic product – is insufficient to meet spending needs for growth factors such as infrastructure, education and technology. Foreign and domestic investment will be critical in closing the development gap, lifting incomes and creating jobs.
Developing an inclusive trade ecosystem, that promotes small and medium-sized enterprises (SMEs), promises to transform the plight of nearly half of the world’s poor – who coincidentally live in Africa. SMEs are the cornerstone of most economies. They account for about half of global gross domestic product (GDP) and 60 %–70 % of employment. In developing countries, SMEs tend to employ the poorer, more vulnerable segments of society, such as youth and women. They make up the lion’s share of enterprises in Africa and hire a large portion of the workforce. Investing in SMEs is a long-term and smart strategy, with sustainable returns that multiply across societies, regions and countries.
Aligning SMEs in the context of the African Continental Free Trade Area (AfCFTA) poses significant upside potential in achieving sustainable development goals. Trade and investment represent a massive unfulfilled business opportunity for African SMEs and those that choose to invest in them. Africa invests just 23.5 % of its GDP today, and this must rise to 37 % to meet the continent’s development targets. That implies a gap of $11.4 trillion by 2040. Africa’s private sector will struggle to finance this gap alone, which means foreign investors have a role to play and an opportunity to seize.
Policy reform, development of the trade support ecosystem and capacity building at the enterprise level can help African SMEs become more competitive globally and achieve investment-grade ratings. To bring about effective change and give reliable signals to investors, however, information is needed about the strengths of SMEs and the constraints they face.
Finance is the backbone of any business. It is crucial to start a company and important for scale-up and growth. However, SMEs in Africa face a large financing gap, estimated at more than $136 billion annually. Many SMEs report finance as their biggest constraint to growth, due to high-interest rates, large collateral requirements and a burdensome application process. It is especially difficult for women to obtain financing, as fewer African women have bank accounts, compared to men, and the legal rights of family capital and collateral can be restrictive, given local laws and customs about land ownership:
(i) Financial Institutions(FI) approach to SMEs in Kenya:
Growing enterprises continue to find it extremely difficult to access financial services appropriate to their needs. This situation is mirrored in Kenya despite interventions aimed at improving the situation by government, donors, industry associations and financial institutions (FIs).
Despite having over 40 banks, it is the case that 6 institutions control 80% of the market. This oligopoly manifests itself in the lack of an incentive to differentiate an offer for the small and growing business market. Making profits without taking on unfamiliar risks by financial institutions have kept SMEs on the periphery appropriate solutions.
There is a need for a mind-shift in the approach to SME financing. An SME centric approach in financial services is the FIs complete understanding of their SME clients and their needs and then tailoring the financial offer to meet those needs. It requires a sustained effort to achieve an institutional SME focus, developing and implementing a strategy with specific, measurable, attainable, realistic and time-bound (S.M.A.R.T.) objectives, optimizing the institutional structure and operations to serve target customers, developing or acquiring SME focussed human resources to fill defined competencies, and all the while reorienting credit and risk systems to ensure that timely and consistent services can be delivered.
(ii) Interest Rate Cap Legislation in Kenya
The authorities capped loan interest rates in September 2016 at 400bp above the prevailing central bank policy rate (currently 9%) in response to social and political opposition to high-interest rates being charged to borrowers. The cap has hit banks' earnings, with the spread between loan and deposit rates more than halving, although customer fees and other non-interest income continue to underpin profitability.
Restricting the interest charged on lending has helped some borrowers, but it has also had unintended side-effects, including dampening loan growth, despite its aim to make credit more accessible and affordable. This is counterproductive to SMEs, who cite financing as a huge constraint.
The rate cap has caused banks to shy away from lending to perceived riskier sectors as it has limited their ability to price risk correctly. This has contributed to a slowdown in lending to the private sector, particularly to SMEs, which are the bulk of Kenya's economy.
Banks have also shifted their asset mix in favour of government securities, which offer attractive yields relative to their lower risk, and carry a capital benefit. Gross loans grew by only 5% on average for Kenya's eight largest banks in 2018, compared with 6% in 2017, 7% in 2016 and 17% in 2015.
About the author
Moses Macharia is in commercial banking practice with 9 years of experience covering a number of African countries. His experience transitions through a series of departments culminating in the current treasury department, where he drives SMEs and corporate clients’ foreign exchange business. This entails structuring solutions that facilitate bilateral and multilateral trade. He holds MSc in Financial Economics from University of Leicester (UK), and BA in Economics from Kenyatta University. Professionally he is an Associate Professional Risk Manager and a Certified Financial Markets dealer. His passion is in trade, an important ingredient in re-defining intra-African commerce.