Why are SMEs important to Oikocredit?

Small and medium enterprises (SMEs) are often called the engine of the economy. More than any other, the SME sector creates jobs and contributes to economic development around the world. According to the World Bank, SMEs contribute up to 40% to the national GDP in emerging economies. These numbers are higher when if the informal SME sector is included.

The definition of an SME differs from country to country, but we all have our own understanding of a bakery, a local garage or small manufacturing company. These are the businesses that provide the services and employment for people in our local communities. SMEs are mainly focussed on local markets and have a crucial role in the development of the local economy, with the potential to boost demand for local goods and services.

The development of the SME sector is becoming more important in Africa where the population is relatively young and increasingly better educated. SMEs can play an important role in providing jobs and a decent livelihood for young people, and as such contribute to stability in the region. According to research done by the International Labour Organisation and the German Agency for International Cooperation (GIZ), around two-thirds of all formal jobs in Africa are created by SMEs.

Lack of access to credit in Africa

The list of constraints facing SMEs in Africa is long. The lack of access to credit is the most important one, as I’ve often heard from African entrepreneurs. Access to credit is necessary to achieve the full potential of SMEs. More than 40% of businesses in Africa rate the availability and cost of finance as their biggest obstacle, almost twice as many as outside Africa, according to World Bank enterprise surveys.

It is estimated that in sub-Saharan Africa more than 60% of micro, small and medium enterprises (MSME) need a loan and can’t access one through formal channels. For this reason, most of them depend on informal credit from family and friends. In some countries in Africa where Oikocredit is present, we have seen that only few SMEs can get a formal loan.

SMEs stuck in the middle

To access formal funding, business owners face many obstacles and often are not able to fully utilise their potential. Businesses led by women are particularly affected, with few having access to the financial services to develop their businesses, due to not having the collateral required by banks. It is not uncommon that longstanding successful women-led businesses, for example in Kenya, don’t have the legal title to the land where their business operates.

Investors generally perceive SMEs in Africa as high risk, weak in financial management and fragile. As a result of lack of regulations or enforcement of laws, providing credit to an SME is difficult and costly. In many cases the finance need, e.g. the loan amount, is just too large and too complicated for microfinance institutions, but too small for commercial banks to consider. The SMEs are stuck in the middle.

Supporting SMEs who make a difference

Several years ago, Oikocredit started providing financial support to financial institutions focusing specifically on this SME market. When we consider financing a partner who finances SMEs, we not only look at how many additional jobs a potential partner will create or sustain, but more importantly, we focus on what their social objectives are.

For example, we look at whether financial service providers work with registered SMEs who provide formal jobs. In Africa many companies are not formalised, which means that the employees of these companies are not protected by labour laws giving them the basic protection of a safe workplace and decent pay.

We also look at whether the potential partner focusses on businesses owned by women and we ask them if they have a strategy, specific products and training to reach this target group. We ask if they have specific products for SMEs in agriculture, and how the SME finance institution is placed to service regions with high-poverty rates.

Assessing social and environmental performance

After assessing potential SME finance partners on their social and environmental performance we engage with them and provide feedback and advice on how they can improve their social performance. In some cases we also provide support in the form of technical assistance.

One example is Family Bank, one of our SME finance partners in Kenya, where we provide capacity building to enable the bank to increase its lending to agri-businesses in rural areas. Between 2018 and 2019, after identifying the need for the bank to increase its loan portfolio to agri-businesses, we supported a survey in rural areas to identify the needs of smallholder farmers and the different value chains that the bank supports.

The project identified three profitable value chains: dairy farming, horticulture, tea, and the businesses focussing on them. Our staff worked with the bank to develop various products to address the needs for the businesses in the selected value chains.

Training is important

The capacity building project also identified the need to train the partners’ staff as an important element. Farmer representatives and selected businesses were also trained on how debt financing can help to increase income along the value chains. In early 2020, the bank decided to do a pilot focusing on the dairy value chain, which was highly successful.

The Covid-19 pandemic has slowed down the interest in horticulture value chains, while interest in dairy and tea value chains is improving. In early September 2020, the partner set aside € 10 million to support agriculture businesses along the dairy value chain, which will benefit over 100,000 smallholder farmers.

More opportunities

Oikocredit believes that there are more opportunities to support other SME lenderslikeFamily Bank,to have greater impact in rural areas where poverty levels and unemployment is high. Well thought out agriculture value chains financed through SME lenders can have a positive impact on smallholder farmers and local communities across the world.