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A look at funding SMEs for inclusive growth in Africa

Inclusive economic growth is growth that leads to job creation, causing a ripple effect on the purchasing power of the majority of the populace. The private sector, and in particular small and medium enterprises (SMEs), are the drivers of an economy. SMEs are also the largest providers of direct employment and inclusive growth can be achieved through promotion of policies that would drive their development.

According to the Central Bank of Nigeria, 96% of Nigerian businesses are SMEs (US = 53%, EU = 65%). Inclusive growth can be achieved by positioning these SMEs to take advantage of the opportunities in the economy.

Financial services is crucial to SMEs

According to the Small Business Administration of the US, two of the top 10 reasons why SMEs fail are: lack of capital, and poor credit management. It is no different in Nigeria and the rest of Africa. While there are several aggregators/sources of capital including private equity (PE) funds, development finance institutions (DFIs) and insurance companies in Africa, the key players in the financial services industry that are optimally positioned to serve SMEs and therefore drive inclusive growth are banks and micro-lenders.

Government macro-economic policies impact SME financing

Lenders operate within the wider macro-economic environment, and government policies regarding inflation and infrastructure are crucial to keeping the cost of funding down. When inflation drives up the cost of funding and ultimately lending costs, it in turn drives up the cost of production, making SMEs less competitive. Standardisation of physical address systems is another area where African governments can make a meaningful contribution to SME growth. Inconsistent address systems make it difficult for SMEs to establish formal relationships and credit histories with suppliers, customers and transient clients.

What can banks do?

At the credit application and processing stage, banks need to invest in systems that allow more efficient and tailored risk profiling. Such a system rewards diligent entrepreneurs with lower lending rates and greater access to capital.

Post-disbursement, the establishment of dedicated advisory/support teams can help to minimise credit risk and improve credit management by educating and advising SMEs on day-to-day financial management, record keeping and corporate governance. The incremental cost of this will be easily offset by the increased patronage and lower default rates.

Banks also need to create systems for long-term funding by innovating longer tenured liability products. In Nigeria this sort of long-term funding would help the growth of the manufacturing and agriculture sectors, which are better positioned to create more jobs.

New and potential sources of SME funding

SMEs can now look to a wider range of funding sources including PE, DFIs and diaspora remittances.

Tapping into private equity

PE is critical to developing SMEs. PE institutions are a source of capital that remains largely untapped in Nigeria; PEs also offer a number of secondary benefits that cannot be easily quantified. PE institutions provide a diversified mix of capital, debt, equity, preferential shares, etc. They also provide capital over every stage of a SMEs growth: from startup to expansion. PE institutions are good at spotting investment opportunities – risk capital goes where it will work best. PE institutions help individual companies fulfill their potential, and the macro effect is to drive efficiency and growth across the entire economy. Their high level of commitment means they offer significant operational support to SMEs (in order to protect their investment).

Furthermore, PE institutions help instill an accounting discipline, something that is often absent from a one-person startup, or even an established family firm. They help to spot talent within an organisation and can provide access to a bigger human capital pool and to training opportunities. They are also able to attract talent, a function that SMEs find challenging as they simply don’t have the resources or skills to find suitable staff.

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