Deconstructing involuntary financial exclusion for African SMEs

Background

Small to medium enterprises (SMEs) in Africa are often at the mercy of stringent bank credit assessment criteria. Empirical observations on 13,783 SMEs in 41 African countries reveal the scale of the problem of involuntary financial exclusion happening across the continent (Simba et al., 2024). This research evidence illustrates how a conventional borrower/lender relationship model has limited application across many African countries and is continuously used in a way that involuntarily excludes SMEs from accessing crucial credit lines. A major problem is that this model has become universal and is rigidly utilized by bank managers to assess the creditworthiness of the owners of these SMEs. Its deployment in contexts where there are high information asymmetries and patchy credit records discounts SMEs from benefiting through this rigid one–size–fits–all assessment criteria. The strictness of the application process, which requires one to have collateral security, a strong bank credit history, and a guarantor with a healthy bank balance, is a bar too far for most of these SMEs in Africa. Consequently, they are discouraged from applying for bank credit. Yet in their resource-constrained business environment (Simba et al., 2021), any financial support provides them with a lifeline for their continued survival and growth in often chaotic market scenarios. The insensitivity to the context of Africa, its institutions, and the general landscape must drastically change, especially if financial institutions, among other institutions, are to meaningfully support small businesses known to sustain livelihoods, reduce poverty, and support gainful employment across many African economies (Simba & Tajeddin, 2023). Indeed, it is about time financial lending services consider incorporating other mechanisms, such as social bonds for assessing the creditworthiness of the owners of SMEs in Africa.

Making financing systems work for African SMEs

For a start, formal financial services must incorporate aspects of social engagements that define the landscape in which Africa’s economic transactions are performed, particularly when they assess the credit applications of African SMEs. Given the complex tapestry of economic and social interactions in an African business environment, it means that the continent's formal financial services industry must reconsider their rigid credit assessment instruments, as they evidently have limited application in such a business scenario. They must pay close attention to the localized African systems embedded in culture, social norms, and values. Recognizing and tapping into Africa’s traditional systems, including informal credit history derived from observations of how prospective borrowers relate to others in their community, can positively influence how bank managers assess the creditworthiness of the owners of SMEs in Africa.

Likewise, exploiting long–standing social order mechanisms that involve local elders, traditional/church leaders, and chiefs as entrusted custodians should be used as an avenue for acquiring knowledge about potential borrowers’ credit worthiness. Being a largely collective society, Africa has systems in which trust naturally develops through chains of pro-social acts, kinship, camaraderie, reciprocity, belonging and togetherness, making their connectivity ready-made fountains of knowledge to dip into when assessing the riskiness or worthiness of a borrower be it an individual or a business. Thus, discounting the value of such sources in assessing credit applications made by African SMEs is an opportunity formal financing institutions are missing to make their services more inclusive and sensitive to the African context.

An integrated model for assessing African SMEs’ credit application    

Africa has powerful institutions that draw their strength from the community. Though informal, these institutions can be effectively blended into a taxonomy of formal credit application measures in such a way that alleviates issues of financial exclusion in Africa. Indeed, there is growing recognition in research that informal financing mechanisms, including community-based schemes (the so–called rotating saving groups), are powerful financial lending institutions transforming women's entrepreneurship (see Aliber, 2015; Ogundana et al., 2021; Simba et al., 2023). Similar to traditional formal financial services, community financing schemes have robust community–centered checks and balances designed to monitor borrowers and potential opportunistic behaviours. In societal systems built on collectivism, every member’s obligation to society is far–greater than engaging in opportunistic behaviour. That can alleviate bank fears of risky borrowers. Taken together, the cultural and social systems at the core of most African communities can be essential for unlocking crucial financial resources SMEs need not only for their survival, but for growing their ventures as well. Rather than perceiving financial systems that fall outside of the formal financial services as archaic and a remnant of past behaviour that will come to pass with modernization, there has to be some realization by banks that the African philosophy of business financing embedded in localized systems provide a cocktail with some of the answers that can go some way towards addressing issues of involuntary financial exclusion affecting large portions of African SMEs. To bring the African philosophy of business financing back onto the agenda, policy institutions that govern the financial services in Africa must establish policy reforms aimed at reconciling the formal financing and informal financing systems to build a continuum rather than seeing them as incompatible. 

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References:

Aliber, M. (2015). The importance of informal finance in promoting decent work among informal operators: A comparative study of Uganda and India. International Labour Office, Social Finance Programme–Geneva: ILO (Social Finance Working Paper, 66).

Ogundana, O. M., Simba, A., Dana, L. P., & Liguori, E. (2021). Women entrepreneurship in developing economies: A gender-based growth model. Journal of Small Business Management, 59(sup1), S42-S72.

Simba, A., Ojong, N., & Kuk, G. (2021). Bricolage and MSEs in emerging economies. The International Journal of Entrepreneurship and Innovation, 22(2), 112-123.

Simba, A., Tajeddin, M., Dana, L. P., & Ribeiro Soriano, D. E. (2024). Deconstructing involuntary financial exclusion: a focus on African SMEs. Small Business Economics, 62(1), 285–305.

Simba, A., & Tajeddin, M. (2023). Enabling economic and social change in sub–Saharan Africa: An informal economy perspective. Journal of Developmental Entrepreneurship, 28(03), 2350022.

Simba, A., Ogundana, O. M., Braune, E., & Dana, L. P. (2023). Community financing in entrepreneurship: A focus on women entrepreneurs in the developing world. Journal of Business Research, 163, 113962.

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About the authors

Prof. Dr. Amon Simba is an Associate Professor of Entrepreneurship and Innovation at Nottingham Business School (NBS) in the UK, and his expertise lies in entrepreneurship and innovation with a focus on Africa. Amon is the Director of the AfrIE Research Hub at NBS. He supervises PhD students whose studies focus on entrepreneurship & innovation. In addition to his roles at NBS, he is a Professor (Visiting) of Entrepreneurship and Innovation at HEC Montréal, Canada. Also, he is a Professor Adjunct at the Central University of Technology, Free State, Bloemfontein, South Africa. Amon is an Associate Editor for the Journal of Small Business Management (JSBM), International Journal of Entrepreneurship and Small Business (IJESB) and the Journal of Small Business & Entrepreneurship (JSBE). He is also a Research Grants Board Member of the Economic and Social Research Council (ESRC) and an Editorial Board Member at CABS. His work is published in leading journal outlets, including Small Business Economics, Technological Forecasting & Social Change, Journal of International Management, Journal of Business Research, Journal of Small Business Management, International Marketing Review and International Journal of Entrepreneurial Behavior Research.

Dr. Mahdi Tajeddin, is an Associate Professor of Strategy and Entrepreneurship at the Sobey School of Business, Saint Mary’s University. His research focuses on the complex dynamics of firms in Sub-Saharan Africa (SSA), with three primary areas of expertise: the unique internationalization challenges and strategies of SMEs in SSA, the impact of technological evolution and innovation on global firms, and the adoption of non-market strategies by companies in emerging economies. His work offers insights into SME affiliations in ethnically diverse regions, the role of technology in SME internationalization, and the intricacies of the informal economy. With a proven track record of securing significant research grants and fostering collaborations with African universities, his research has been published in leading journals such as Entrepreneurship Theory & Practice, Small Business Economics, Journal of Small Business Management, Journal of International Management, International Journal of Entrepreneurial Behaviour & Research, Technological Forecasting & Social Change, and others.

Prof Dr Léo-Paul Dana is Professor at Dalhousie University and Visiting Professor at LUT School of Business and Management, Lappeenranta University of Technology. He is also associated with the  Sorbonne Business School.  A graduate of McGill University, he has served as Marie Curie Fellow at Princeton University and Visiting Professor at INSEAD and at Kingston University. He has published extensively in a variety of journals, including: Entrepreneurship: Theory & Practice, International Business Review, International Small Business Journal, Journal of Business Research, Journal of Small Business Management, Journal of World Business, Small Business Economics, and Technological Forecasting & Social Change.

Professor Domingo Ribeiro-Soriano is a Professor of Business Administration at the Universitat de València, Spain. He is also the co-director of “Entrepreneurship: from student to entrepreneur”. As a researcher, he has published more than 140 papers in SSCI/SCI-ranked journals. Throughout his career, he has edited and contributed to books, journals, and conferences and has delivered keynote speeches at international conferences. He has also led several EU-funded projects and contracts with private companies. Before starting his career in academia, he worked as a consultant at EY (formerly Ernst & Young).