By Rodrigo Deiana, Junior Policy Analyst, and Arthur Minsat, Head of Unit for Europe, Middle East and Africa (acting), OECD Development Centre
The topic discussed here builds on the success of the 2017 Africa Forum
African firms don’t have it easy. Among the many constraints faced by formal companies, access to finance consistently ranks as a top issue. Almost 20% of formal African companies cite access to finance as a constraint to their business.1 Overall, African micro, small and medium enterprises (SMEs) face a financing shortfall of about USD 190 billion from the traditional banking sector.2 African firms are 19% less likely to have a bank loan, compared to other regions of the world. Within Africa, small enterprises are 30% less likely to obtain bank loans than large ones and medium-sized enterprises are 13% less likely.3
To bridge this gap, governments and market players need to strengthen existing credit channels as well as expand new financing mechanisms.
Various innovative financing instruments are currently expanding or present strong growth potential across Africa. Private equity funds invested a total of USD 22.7 billion in Africa across 919 deals between 2011 and 2016, although less transactions took place in the last months.4 Impact investment significantly targets Africa, with 22% of global commitments going to Africa in 2014.5 Asset-based lending can ease the stringent conditions associated with traditional credit. Many entrepreneurs can directly harness new financing mechanisms such as crowdfunding or venture capital. Nigeria’s online movie entrepreneur Jason Njoku, for one, raised USD 8 million in venture capital from African and global investors. Among other financing instruments, microfinance for SMEs, direct support from development partners and philanthropic finance can help fill SMEs’ financing gap.
However, these innovative financing solutions are out of reach for the majority of small businesses operating in the informal economy. To bridge the financing gap, we must also improve traditional credit channels by expanding best practices in the financial sector.
Some emphasise the role of traditional instruments, such as credit guarantee schemes (CGSs). CGSs are guarantees by third parties — governments or development partners — that can cover a portion of the lenders’ losses from loans to SMEs, significantly reducing default risk for banks. CGSs can benefit small businesses that have little collateral, no credit history or are perceived as too risky. Policy experiences outside Africa (from Turkey and Malaysia) have shown that CGSs can avoid creating market distortions.6 A set of key principles can guide the design of effective guarantee schemes without incentivising lending to high-risk borrowers. They can also contribute to reducing poverty. In Tanzania, for instance, several of these guarantees effectively channelled funds to the more vulnerable groups otherwise unable to access credit, such as smallholder farmers as well as micro and small entrepreneurs.7 CGSs can also work on a larger scale, as shown by the African Guarantee Fund’s experience. Commercial banks leveraged the Fund’s USD 230 million in guarantees to lend out double that amount to 1 300 SMEs, generating 11 000 jobs. The Fund reached break-even point and started turning profits in just three years, quadrupling its revenue.8
Many solutions exist to bridge the financing gap faced by Africa’s SMEs. Finding a balance between traditional and innovative financing depends on each country’s context. While the 54 African countries are very diverse, three main issues stand out: developing regulations and policies that are flexible enough for innovation by African entrepreneurs, broadening and widening financial solutions that are accessible to the most vulnerable groups, and ensuring macro-economic stability by avoiding market distortions and excessive risk taking. To achieve these and increase the financial sources available to small African businesses, expanded co-operation between governments, development partners and the private sector will remain vital.
1.↩ AfDB/OECD/UNDP (2017) African Economic Outlook 2017: Entrepreneurship and Industrialisation: 210, calculations based on The World Bank Enterprise Surveys. World Bank Enterprise Surveys cover firms in the formal sector with at least 5 employees.
2.↩ Based on data from IFC’s Enterprise Finance Gap Database
3.↩ AfDB/OECD/UNDP (2017): 225, based on Beck and Cull (2014), “SME finance in Africa”, Journal of African Economies, Vol. 23 (5), pp. 583-613
4.↩ AVCA (2017), 2016 Annual African Private Equity Data Tracker
5.↩ AfDB/OECD/UNDP (2017): 227, based on: DfID (2015), Survey of Impact Investment Markets 2014
6.↩[vi] IFC (2010), Scaling-Up SME Access to Financial Services in the Developing World
8.↩ AfDB/OECD/UNDP (2017): 226, based on African Guarantee Fund, 2015 Annual Report