Labeling: A Response to Cases of Information Asymmetry in SME Financing in Africa
When the issue of SME access to credit is addressed, often the major concern raised by stakeholders is the problem of information asymmetry that characterizes the relationship between the bank and the SME. Information asymmetry is a contractual situation in which one co-contractor has access to better quality information or more information on skills and motivations than the other. In a credit relationship, this comes in the shape of the difficulty of a credit institution in assessing the credit applicant's actual ability to generate sufficient income to repay the loan and fulfil its commitments. This problem therefore poses the dual challenge for the Bank in selecting beneficiaries with the skills and "guarantees" necessary to repay the loan (adverse selection) and in behaving appropriately to meet its commitments (moral hazard).
These difficulties highlighted in theory, especially by Michael JENSEN and William MECKLING, are often true in practice when it comes to SME financing. For example, a 2016 survey conducted by the Central Bank of West African States (BCEAO) among credit institutions in the WAEMU region showed that 97.3% of SMEs consider the poor quality of financial information to be the primary constraint to accessing finance. The perception of information asymmetry is therefore the first obstacle insofar as the credit institution prefers to withhold loans rather than commit to a customer on whom information is not sufficiently unambiguous. This is confirmed by the perceived behaviour of loan applicants since the same survey reveals that 69.1% of them are limited by the then-downgraded portfolio. The two sides of information asymmetry are, therefore, a real barrier to SME access to loans in the WAEMU area.
To tackle this barrier to accessing finance, the Government of Senegal, during the second National Consultation on Credit in 2010, focused on certification for SMEs as the main instrument to reduce the perception of risks associated with information asymmetry. Certification entails, in fact, in "a process of improving the eligibility of SMEs for bank or other financing by strengthening management and improving the readability of the company in its sector and monitoring". This system thus consists of tackling the two aspects of information asymmetry via three pillars: improving readability to mitigate the risk of adverse selection and monitoring to diminish moral hazard; strengthening company management enabling SMEs to consolidate the components of their organisation and gradually eliminate weaknesses that often characterize their governance by organizing and modernizing the company's main functions.
Improving the readability of SMEs is based on a multifaceted evaluation system that combines quantitative and qualitative analysis tools.
On the quantitative side, a scoring tool called "eRating" is used to assess each SME’s “ability to meet its financial commitments over a three-year period". This tool is based on two components: scoring and rating.
Scoring is a composite instrument that categorizes SMEs according to their size or the quality of their manager as well as according to the results of an in-depth financial analysis. This financial analysis combines criteria from three sources:
- BCEAO recommendations in the Instruction on classification agreements;
- second, sector references resulting from a long-term analysis of the ratios of all SMEs filing their financial statements with the Single Information Collection Centre (CUCI) of the National Statistics and Demography Agency (ANSD);
- and finally, banking-sector recommendations on the most relevant ratios to assess a company's performance.
The company's final rating is therefore based on a composite of financial activity and credit ratings.
Rating uses scoring techniques to determine the relative risk of the SME and provides a detailed breakdown of its main risk factors.
The score is used to complement the financial review of the file in order to optimize decision-making. It is, in effect, a study of the company’s statistics that confirms its rating based on a weighted average of economic and financial ratios which provides information in a synthetic form whose reliability exceeds that of examining each of its constituent parts. hence the importance of comparing the results of the rating with those of the scoring.
The quantitative analysis is supplemented by a qualitative assessment of the company's main functions by performing a flash diagnosis conducted via a questionnaire and a site visit. This analysis serves as a support to strengthen the company's management and helps to consolidate the dynamics of improving the SME’s readability. The combination of these two approaches provides quality information on the real capacities of the SME. It is therefore proving to be an effective mechanism that facilitates the relationship between the bank and the SME. Indeed, it makes it possible to build a relationship with the intervention of a third-party actor capable of mobilizing all relevant, objective information on the SME and make it available to the bank in a summarized form likely to facilitate its decision-making.
This analysis is supplemented by a monitoring system for the company receiving the financing. Monitoring significantly reduces the risk of misallocation and sub-optimal use of resources received by the SME, and comprises coaching, a problem-solving mechanism and seminars on the main management issues such as organization, strategy, information system, human resources and marketing. Such seminars raise awareness among company managers of the importance of taking on these functions in order to consolidate the company's achievements and enable it to take a qualitative and sustainable leap forward.
ADEPME's statistics on support for SMEs seeking financing further substantiates the importance of these services. Applications are generally submitted either to financial institutions (banks, DFSs, leasing institutions or private-equity firms) or to public funds for a category of actors (young people, women, the agricultural sector, etc.). In 2015 and 2016, the financing rate for applications submitted by SMEs was 46% and 50% respectively. For the specific case of 2016, out of 104 applications sent to financial institutions, 88 obtained a loan, i.e. 68%. All these cases are monitored by ADEPME’s services.
ADEPME has also concluded a series of agreements with the financial sector to improve their relations with the SME sector. One of the latest initiatives concerns the partnership with ECOBANK SENEGAL. Certification is now the main framework for collaboration with financial institutions.
In the specific case of ECOBANK SENEGAL, significant changes have been made to its loan procedures to include certification in the appraisal process. Therefore, companies wishing to benefit from the Bank's support in accessing and carrying out public procurement contracts are asked to submit, in advance, to the certification process. The rating assigned to the SME by the ADEPME Certification Unit is therefore fundamental in the SME's loan application, and the Agency's participation in the monitoring of the SME financed, one of the major pillars of the Bank's policy on securing loans granted to SMEs.
 Jensen M., Meckling W., , Theory of the firm: Managerial Behavior, Agency Costs and Capital Structure, Journal of Financial Economics, 3, n°4
About the author
Soyibou NDAO is the Head of the SME Labeling Program within the Development Agency for the Supervision of Small and Medium Enterprises (ADEPME - SENEGAL). He is an Expert in the Private Sector, Financing and Development of SMEs.