Can fintech help to close the financing gap for small and medium size enterprises in Africa? – Fellows’ seminar by Marcus Fedder

24 May 2022

“SME financing has been described as the missing middle piece of finance. SMEs are less likely than larger corporations or microfinance borrowers to obtain financing at reasonable terms. This problem is not new yet remains unresolved. Does it matter?”

“Some 60 million SMEs form the backbone of African economies, producing about half of countries’ GDPs, accounting for 90 per cent of businesses and providing approximately 60 per cent of employment. The total financing gap is estimated to be a massive US $330 billion. What are some key factors that stop financial institutions from lending to SMEs?”

“In the last three to four years, fintech -i.e. financial technology in the form of digitalisation, mobile phone apps and background-algorithms – has led to dramatic innovation and disruption in banking and financial services in developed and developing markets. Can fintech help close this financing gap? Which problems can be addressed? Are banks utilising fintech? What about fintech companies as direct lenders to SMEs?” These are some of the questions that STIAS fellow Marcus Fedder of Channel Capital is probing in an intensive project involving a literature review (“although not much exists and it’s also quickly out of date”), digital data collection, in-depth stakeholder interviews and participant observation “as an insider in the finance arena”.

His seminar focused on some of the existing and solvable problems, and how fintech is starting to make an impact in SME lending.

STIAS Fellow Marcus Fedder during his seminar on 19 May 2022

He explained that financial technology or fintech is about the programmes – some using machine learning and AI – that run behind the walls of banks and banking apps. It’s an emerging industry that uses technology and innovation to compete with traditional methods and improve the delivery of financial services. AI-driven analysis and digital credit scoring can be used for loan-approval processes including the KYC (know your client) process, credit assessment, environmental, social and corporate social governance, company registration checks and for trade-finance documentation processes. Fintech also makes it possible to use data from sources other than official balance sheets which not all SMEs have – like mobile phone statements. This can all be digitalised, thereby shrinking loan-approval processes from weeks to hours.

He pointed out that SMEs are defined in South Africa as companies with between 2 and 200 employees. Of the 60 million registered companies in Africa some 50 million are SMEs with 17 million in Nigeria alone. They account for 40% of GDP – in Ghana it’s as much as 70%, and in Nigeria 50%.

“So if they are not financed, economies will stop functioning,” said Fedder.

“Big companies get money and microenterprises get money,” he said, “but SMEs don’t. About 40% of African SMEs have difficulty accessing financing.” With reasons including lack of financial statements, limited corporate governance, weak management, poor business plans and no collateral.

Most SMEs describe tax, electricity and access to finance as the key factors preventing their growth. 83% of developing-country SMEs have no loans and 73% have not applied – because the processes are too hard, interest rates too high, there is bribery, and they anticipate it wouldn’t be approved.

Are the banks interested?

“Banking is generally not in good shape in Africa,” said Fedder. “The banking system is weak. South Africa and North Africa dominate on the list of the Top-10 banks in Africa with South Africa being the most developed banking market.”

He reported that his mini survey of SMEs in Stellenbosch revealed little interest by banks to provide loans and when banks do lend, it is usually short term at rates of prime plus 7%, so about 15%.  The general reluctance of banks to lend small amounts can be found in the  cost and length of the processes involved with the same amount of work required for a loan of R100 000 or one of R1 million, which means that smaller loans are just not profitable for banks. But there are signs of change – he highlighted two African banks that have adopted fintech to improve the processes.

“The Bank of Kigali, the biggest in Rwanda, is privately owned and has 6000 SME clients. It has been using Q-Lana software since 2018 which cuts the loan-application and credit-scoring process by 72 work hours. Time saved means it can reduce the interest rate and widen its reach.”

“Access Bank in Nigeria is very advanced. It has 1 million SME clients and hopes to cover half of Nigerian SMEs by 2027. All processes are digitised with fast decision making and dynamic loan pricing. Non-performing loans are below 5%.”

Fedder explained that banks are advantaged when it comes to financing loans due to their huge funding base because of depositors. They basically need to lend. Digitisation substantially reduces the process which could lead to expansion as return on investment improves. “Banks open to digitisation will probably profit the most.”

New kids on the block

Turning to fintech companies, Fedder said there were 716 companies in Africa in 2021 of which 85 were lenders and the rest provide software, infrastructure and payment services. Most are in Nigeria, Kenya, South Africa and Egypt.

He provided information on Q-Lana; Wiserfunding; M-Pesa in Kenya, a mobile payments provider and the oldest fintech, launched in 2007; Pezesha; PayHippo in Nigeria which focuses on SMEs and has made 10 000 loans; and, LulaLend in South Africa which he described as innovative, with good customer service and aggressive marketing.

But all of them are expensive with loans charged at up to 80% interest.

“Fintechs are classical disrupters,” he said. “They have no legacy systems, are modern and fast, with low overheads. But the proof of the algorithm pudding is in the eating. They haven’t been round long enough to prove the algorithm really works.”

He also described COVID as having “provided a credit cycle on steroids. It was a good learning process, hopefully they learnt and the algorithms were adjusted”.

“Fintechs struggle with their own funding though – with no depositors they need to get their own financing first.”

Turning to trade finance (the financial instruments and products used by companies to facilitate international trade), he pointed out that African imports amounted to $570 billion and exports to $462 billion with intra-African trade only standing at 17% in 2019. The trade-financing gap is about $90 billion.

The challenge is also time-consuming documentation processes. “There are an estimated 4 billion pages of documentation in circulation,” he said. “An automated process would be hugely time saving. One company tackling this is London-based Traydstream which uses a machine-learning algorithm, as well as automated approval systems and reporting. The time saved is enormous meaning that banks are more likely to provide finance and allow trade to happen.”

“Fintech has the potential of improving the processes of SME financing in Africa.  Faster KYC, big data driven credit scoring and improved documentation processes should make financing less costly and thus more profitable.  This should help increase volumes and allow also smaller and currently unbanked SMEs to receive funding. But there’s a long way to go.  At this juncture, fintech companies probably contribute only about 1% to the closing of the total African SME financing gap.  ”

In discussion he pointed out that knowledge in this area is very fluid. “The SME financing gap is a global phenomenon. People are working on solutions everywhere.”

“Other options like credit unions, private and state banks all have advantages and disadvantages. It’s not easy to solve. It’s also not one size fits all – differing by country and culture, institution and industry.”

“And, of course, machine-learning is only as good as those who programme it.”

He also pointed out that African development and government-owned banks should play a bigger role in SME financing. “They do too little, which is sad. But people also don’t want conditions attached or government interference.”

“A longer track record for fintech will mean better data and more predictable outcomes. Better decisions and returns means more available finance and therefore more competitive lending with lower interest rates (80% is not sustainable). This can lead to a closing of the gaps.”

Michelle Galloway: Part-time media officer at STIAS
Photograph: Noloyiso Mtembu



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