World Bank: Sub-Saharan African Banks Need To Lend More To SMEs

The World Bank said credit-constraint is severely affecting growth possibilities of Small and Medium Scale enterprises (SMEs) in developing economies including Sub-Saharan Africa.

“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,” a report released by the organisation said.

The Washington-based 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.

All surveys were completed between 2010 and 2012.

The analysis of the report showed that the share of SME lending in the overall loan portfolios of banks varies between 5% and 20%, with banks in Kenya, Rwanda, and Tanzania being more involved with SMEs in terms of the share of their loan book going to SMEs than banks in South Africa and Nigeria.

The research showed that SME’s share of total bank lending in Kenya represented 17.4%, while in Rwanda it was 17.0%. In Tanzania it was 14% and in South Africa it represented 8.0%. Nigeria was last out of the five countries at 5.0%.

“The evidence suggests that competition, especially as introduced by innovators, is important to encourage banks to venture into the SME space and to move them out of their comfort zone,” The World Bank said.

World Bank noted that competition in the SME market segment is strongest in Kenya where a large number of commercial banks are targeting different market segments.

“The difference between Kenya and most other Sub-Saharan African countries in that regard is that innovation started through a combination of microfinance-rooted institutions scaling up to becoming commercial banks and innovation with lending models and technology in the retail banking segment by other institutions,” it said.

The bank identified poor quality of financial statements and business plans, lack of business skills, high degree of informality and lack of adequate collateral Ts some of the most significant obstacles affecting SMEs.

The report also 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.

The report however asserts that 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.