Ghana: Increasing The Effectiveness Of SME Financing Schemes

Ghana's economy comprises of different types of businesses that function both collectively and in diverse ways as a medium through which the country's economic activities are undertaken. SMEs and multinational companies (MNCs) alike have their specific roles they play in ensuring that the country's goal of attaining 'economic freedom' is attained. But in a country where according to the Registrar General's Department, about 92 percent of all businesses are SMEs – like almost all other countries – it becomes more evident that much attention must be given to the growth and performance of these SMEs if any good improvements is expected in the economic growth and development of the country.

Indeed, there are various points of view as to what, exactly, a Small to Medium-Sized Enterprise (SME) is, and what size a business needs to be in order for it to be considered an SME. However, it must be noted that SME classification across the world in their differences, are all defined in terms of the number of employees, annual turnover, industry of enterprise, ownership of enterprise, and value of fixed assets.

But whatever the definition or classification is, the fact remains that these businesses are invaluable to any economy. They function as a strong catalyst for the economic growth and prosperity of developing and developed countries alike – as they are a major source of income and employment.

For instance, here in Ghana, SMEs provide about 85% of employment in the manufacturing sector and were noted to contribute about 75% to the country's GDP until the commencement of the country's oil production.

In light of the above, it is no debate then that all efforts geared towards enhancing the development, growth and productivity of these businesses will go a long way to reduce the country's economic woes and improve the living standards of Ghanaians.

It is however unfortunate that SME's are still enormously challenged by myriad factors and so are not able to perform as they should – with one of the main challenges being access to finance – which this piece attempts to examine.

Given their low level of capitalization and technological support – owing to the fact that they are often unable to finance technological resources and other innovative business projects, SMEs are often not able to expand or take advantage of the opportunities around them to increase their output and productivity – which also translate into minimal sales and profits.

As a result, most of these businesses stay in the valley of consistent financial crisis struggling to survive and are never able to climb up the business development ladder to the hill of business growth. They are left in a vicious cycle of financial constraint – hence, the need for external capital injection to boost their performance.

It is against this backdrop that the governments over the world have SME financing schemes to support these businesses.

In Ghana, the focus of policy interventions for the promotion of SMEs have generally been on supporting entrepreneurial training and labour skills development; promoting the transfer and use of appropriate technology within the SME sector; establishing linkages between small industries and large industries; and also increasing SME access to sources of funds, decreasing the strong dependence on collaterals in credit disbursements, as well as providing safeguards for the credit delivery system.

It can therefore be seen that SME financing remains but just a single component of the country's SME policy.

THE SME FINANCING GAP
In spite of their grand contribution to the state, access to finance remains a major challenge for many SMEs in Ghana. Small businesses are often being denied credit due to insufficient guarantee or perceived risks.

Although it should be acknowledged that lack of credit and inaccessibility to funds are not the only challenges of these businesses, it should be noted that the availability of funds could improve SMEs' access to all other resources such as human, information and physical resources.

As part of efforts to bridge this SME financing gap, there have been several attempts by governments (both previous and existing) and other private institutions (both financial and non-financial) to fuel the flow of funds to these businesses.

SME financing in Ghana over the years have taken place in two forms; either as an official scheme (that through which finance is provided to SMEs by government and or other international agencies); or financing provided by financial institutions.

In the case of the official schemes, the motive for their establishment has been to increase the flow of finance and credit to the Small and Medium sized Enterprises to help them gain enough 'strength' to increase their operational capacities; increase productivity; and to improve both their local and international competitiveness. These have been schemes introduced by government, either alone, or with the support of donor agencies to support SMEs. Some of the funds under these schemes include the Business Assistance Fund, EDIF, Ghana Investment Fund, Ghana SME fund and other guarantee facilities.

The other channel through which money flows to the SME sector in Ghana is the private financial sector – particularly in reference to lending by the banks and non-bank financial institutions as well as private equity to SMEs.

Contrary to the expectation of seeing an improvement in SME financing – in the presence of the different sources of finance – SMEs still do not get the required support they need because of factors such as inadequate institutional frameworks to regulate financing in the SME sector, inadequate legal and regulatory systems, SME managerial capacity issues and lack of training, inappropriate risk management, moral hazard and adverse selections.

CURRENT FINANCING SCHEMES
As banks and other financial institutions have sought to broaden their loan portfolios, SMEs have become an increasingly attractive customer group. However, financial institutions in Ghana have been cautious with lending to SME groups because of high default rates and risks associated with the sector.

Issues of moral hazard – the possibility of borrowers (SME owners) using the funds that they access from financial institutions for purposes other than the ones stated to be the basis for accessing the facilities; and cases of adverse selection – which relates to the paucity or inadequacy of information requirements of a lending contract, often make it difficult for lenders to extend funds to SMEs.

It is not as though there are insufficient funds to finance SMEs in the country, but client unfaithfulness and in some cases mismanagement of funds by business owners seem to make SME financing an albatross around the necks of financial institutions. As a result, only a few banks have an explicit policy for SME target groups taking their particular requirements and needs into consideration. More so, although there is so much talk about SME financing, only few banks have SME specific loan products for SMEs, and many of these are donor funded. Few banking institutions have departments for SMEs, and for others, lending to micro and small businesses is simply transacted by credit officers from corporate finance departments of the bank who generally apply the same stringent appraisal and lending principles of large corporate financing to SMEs.

In order to mitigate their risks, financial institutions still dwell much on provision of collateral as a requirement for lending to SMEs and also charge higher interest rates on loans as a safeguard for the lots of funds they are likely to lose through default.

Now in regard to the effectiveness of government financial schemes, they happen to have been failing or not being effective for reasons such as client defaults (inability or unwillingness of SME clients to pay back the funds they accessed as scheduled) – in order to help perpetuate the functioning of the schemes ; and politicizing of the disbursement of the funds. Business owners who access funds from the government financial support schemes often do not fulfill their obligations of paying back in due time or even in certain instances do not or are not able to repay the loans at all. This leaves the schemes consistently in short supply of funds to support other businesses and sooner or later runs into extinction. Complaints of the disbursement of funds from these schemes characterized by nepotism and cronyism are also rampant. There have not been enough fairness and clarity in the disbursement and administration of these funds to businesses and this has left many SMEs which really need financial support out of the circle of support.

Private equity is another source of funding for SMEs in countries that have reaped great dividends from the productivity in the SME sector. But here in Ghana, long term financing in terms of equity capital which is mostly needed by growth-oriented businesses, is virtually non-existent for SMEs – due to the high uncertainty in the returns rate of SMEs, the risks and costs involved in managing shareholding in SMEs and the length of time required to realize attractive dividends from SME investments. Also, lack of proper management skills and inappropriate management systems create much higher business failure risks for SMEs than for large companies, and so tend to contribute to venture capitalists disinterest in SMEs.

THE WAY FORWARD
Training of the SME entrepreneurs appears critical in our quest to bridge the SME financing gap.

It appears one of the main reasons why SMEs struggle in accessing finance has to do with borrowers' lack of confidence in their ability to manage their operations effectively so as to be able to repay the loans they access – which in most cases is genuine, looking at the way some businesses operate in secrecy and the default history of SMEs in financial institutions. Some coordination and rigor should be brought into SME training. Efforts towards centralization of the many disparate training programs, perhaps under the NBSSI and other training agencies would ensure the design and implementation of effective training programs for SMEs. Training programs with accounting, business management, preparation of business plans, financial statement analysis, personnel management, marketing and other subjects as well as one-on-one counseling sessions for business owners inclusive will greatly help in the proper management of SMEs and the funds extended to them. SMEs should be encouraged to keep good accounting records.

Whiles improving the management and accounting ability of SME entrepreneurs to reduce the risk of them mismanaging funds, issues of collateral and loan security can also be managed collectively by both government and financial institutions to encourage financial institutions to lend to SMEs. The availability of loan guarantees for SME lending, computerized registration systems for pledges, mortgages, leases as well as centralized databases of information on businesses will greatly increase the confidence in the SME credit market. It is worth noting that a necessary condition for an efficient financial system is the existence of readily accessible information about participants in the system. The absence of such information is what creates moral hazards and adverse selection costs that have the potential of causing credit markets to fail. Having systems of information on the operations of businesses, their assets among other details will increase credibility in the SME credit market.

While maintaining sound government finances will contribute to the availability of finance for development purposes, SME access to finance may also be enhanced by ensuring that contracts are easily enforceable through functioning of secured transactions and bankruptcy regulations and institution. There should be proper registration and structuring of all SME ventures to facilitate their access to credit and also meet regulatory requirements.

In respect of government SME funds and SME financing schemes, funds should be well managed by bodies which have no political affiliations (in other words, managed by qualified independent fund managers who are not into politics) and will administer the funds to businesses solely on the basis of merit and not on grounds of bigotry or any other criteria. SMEs that access funds from such state funds should also be closely monitored and directed and guided so that they pay back into the funds to ensure the continuity of the schemes in supporting other businesses.

Given the significant contribution of SMEs to the country, there is the need to facilitate the availability of and access to loan and equity finance, particularly medium to long-term opportunities to improve trade and investment capacity of SMEs. The actions and inactions that have led to creation of the SME financing gap are ones that can be tackled and reverted and so prompt measures should be taken to address the situation.

Without access to medium and long-term finance within the economy, SMEs would not be able to make the necessary investments in innovations and technologies to improve their trade capacity and act as partners to foreign direct investors (FDI).

If strategies are devised to solve SMEs' problems, they could contribute more to the development of the society. Increasing SME financing and streamlining the credit market will help businesses to expand, grow, increase profitability and employment capacity, and will also ensure the birth of many new businesses which have not been set into operation as a result of the lack of sufficient startup capitals.

At a time when the country is battling with rising imports and increasing balance of payment deficits, efforts towards increasing the capacity of local businesses to expand and increase local production in order to cut down imports is nothing but an urgent economic imperative. Indeed, improving the investment climate for SMEs, and strengthening their capacities to respond to trade and investment opportunities, does strengthen the economic performance of the country.

Charles Yeboah Frimpong
Africa Business Analyst
Tel: +233 -246 542 642
Email: [email protected]