Increasing SMEs access to formal financing

The role of SMEs in driving the eco¬nomic development process of their home countries is not in doubt. However, for SMEs to pay their meaningful roles, they must have access to finance under the right conditions. For example, improving business environ¬ments, boosting the capacity of SMEs, expanding the financial sector and strengthening links between firms will permanently increase SMEs' access to finance, a critical missing link in their quest to make a meaningful contribution to the development process.

IMPROVING BUSINESS ENVIRONMENT
Providing sufficient and proper information, a key to deciding whether a bank will make a loan; the chance of the bank making the loan would be enhanced by adopting clear and con¬sistent accounting standards, setting up independent, competent and reputable accounting firms and creating more credit bureaus to supply data on sol¬vency of firms.

Also, a legal system that can help settle contract disputes, commercial law reform, as well as, clarifying land titles, and making bankruptcy procedures effective are vital for the growth of the busi¬ness sector.

In addition, a country's tax laws can either coax small businesses into the formal sector of the economy or keep them away. Governments should also make sure that they pay SMEs promptly, since public contracts are vital to the financial security of these firms.

ASSISTING SMEs MEET THE MINIMUM REQUIREMENTS FOR

FORMAL FINANCING
Apart from the need to boost SME capacities, some financial instruments can help provide missing information or reduce the risk stemming from some SMEs' lack of transparency. Franchising, which is very popular in Southern and East Africa with the encouragement of South Africa, allows use of a brand name or know-how that reduces the risk of failure.

Warehouse-receipt financing (in South Africa, Kenya and Zambia) guarantees loans with agricultural stocks.

Other financial instruments, such as leas¬ing and factoring, can reduce risk effec¬tively for credit institutions but are still little used in many African countries.

Credit associations that reduce risk by sharing it are on the increase. They help financial institutions to choose who to lend, by guaranteeing the technical viability of projects, and sometimes pro¬viding guarantees. But growth of these bodies is limited by the lack of organi¬sation among SMEs in SSA and by their focus on certain sectors and geo¬graphical areas. Governments and donor sources have thus supported the creation of guarantee funds to ensure repayment in case of default.

MAKING THE FINANCIAL SYSTEM MORE ACCESSIBLE TO SMES

Most African financial systems are fragmented, making it very difficult for SMEs to access funding, lack of fund¬ing for SMEs has partly been made up for by microcredit institutions, whose growth is due to the flexible loans they offer small businesses. For example, in Angola, Novobanco provides loans free of bank charges, without a mini¬mum deposit and with informal guaran¬tees (property assets and a guarantor), as well as permanent contact with loan managers.

Though adapted to local needs, however, microcredit institutions remain fragile and modest-sized. As well as lacking trained staff, microcredit institu¬tions face limited expansion because of their limited funds. Their mainly short-term finance means they cannot easily turn the savings they collect into medium or long-term loans.

They are also up against the cost of refinancing through the formal banking sector and have no access to refinanc-ing either by the central bank or by ven¬ture capital. Microcredit institutions could be put on a firmer financial foot¬ing by developing and adapting long-term savings products that exist else¬where, such as life insurance and home-saving plans, and encouraging the set¬ting up of specialised refinance banks such as Mali's "solidarity bank" (Banque malienne de solidarity), or working more closely with the formal banking sector (Benin's SME support organization PAPME and the local Bank of Africa).

Some countries (such as Kenya) have dealt with the lack of funding by supporting growth of smaller commercial banks or (in Ghana) of rural banks, so as to bring traditional banks and SMEs closer geographically and businesswise

South Africa passed two laws in early 2005 to expand the banking sys¬tem to include savings and loan institu¬tions (second-tier banks] and coopera¬tive banks (third-tier banks) while easing banking regulations so the newcomers could still be flexible in providing loans. In many countries, commercial banks are also setting up their own microcred¬it services.

Removing the obstacles to access for SMEs to finance requires that commercial banks, microcredit institutions, com¬munity groups and business develop¬ment services SMEs, expanding the financial sector and strengthening links between firms will permanently increase SMEs' access to finance.

EPANDING THE SUPPLY OF FINANCE THROUGH THE NON-FINANCIAL PRIVATE SECTOR

Financial institutions are not the only source of money for SMEs. Apart from remittances by nationals working abroad, which are a key boost to private-sector growth, the interdependence between SMEs, large firms and sectoral "clusters' is a major potential source of finance, as shown in Asia and Latin America. Big firms can do a lot to help SMEs get finance more easi¬ly by transferring resources (money and factors of production) and guaranteeing SME solvency with financial institutions.

Links with major companies can also help SMEs get export credits, which are especially important in countries with weak institutions, since commercial part¬ners are better informed than other cred¬itors (especially financial institutions) about the ability of their customers to repay debts. Export credits have been proved useful in Zambia's agrofood industry. Subcontracting is still uncom¬mon in Africa, but has grown rapidly in South Africa since 1998, though there is increasing skepticism about it because it may confine SMEs to low-skill informal activities.

Clusters of SMEs, which are very active in Asia, enable member firms to seek finance together, provide collec¬tive guarantees or even set up their own financial body. The threat of expulsion from the cluster ensures that promises are kept, which allows the network to overcome shortcomings in the legal sys¬tem.

Frequent interaction with financial authorities, as well as the role that repu-tation plays in the cluster, can greatly increase confidence between firms and financial institutions and thus make it easier to get loans and lower rates of interest.

Working together also means firms can get supplier credits and can borrow from each other when necessary, which reduces general costs. Such clusters, however, are very little developed in Africa and are concentrated in South Africa, Kenya, Nigeria, Tanzania and Zimbabwe.

In conclusion, SMEs play important roles as growth drivers within their economies, provided the economic environment is conducive and are not limited by finance (critical link). Having access to finance means governments must find creative ways (reforming of commercial laws, creating credit bureaus, land documentation reforms, etc) of encouraging the private sector provide funding to SMEs.

Dr. Sampson Amoafo, the writer, is an economic consultant and former Assistant Professor of Finance and Economics at Alabama State University. [email protected]

Story by Dr. Sampson Amoafo / Graphic Business