Can FinTech meet the financing needs of African SMEs?

By Rafiq Raji

1. Introduction

More than 95% of registered businesses around the world are small and medium sized enterprises (SMEs). Africa is no different.^[1] According to the World Bank they provide for more than half of all jobs and account for more than a third of the combined GDP of emerging market economies. Getting access to credit, however, is an uphill task for most of these SMEs. It is now widely established that lack of access to finance is the most significant constraint on the growth of small enterprises. In developing economies, the estimated annual credit gap could be as much as US$5.2trn.^[2]

Banks prefer to extend loans to large corporates. That is because their financial needs are large. Their credit history is easier to access. The business of a large corporation is often run by professionals and they have a management team that comes with some name recognition. Big corporates keep more timely and accurate business and financial information too. Bank managers are, therefore, only too ready to sanction credit for large corporates. It creates efficiency gains. This is typically not the case with small businesses, which typically do not keep proper financial records and are often run by inexperienced managers. That often makes it difficult for banks to assess their credit-worthiness. In other words, there is an inherent cost disincentive for banks to extend credit to SMEs.

With technology, however, banks can offer the same level of service to SMEs as they do for large corporates at costs and level of effort that make it worth their while. According to the Financial Stability Board, financial technology (FinTech) refers to “technologically enabled financial innovation that could result in new business models, applications, processes or products with an associated material effect on financial markets and institutions and the provision of financial services.” ^[3] And that is in fact increasingly the case across the world, even more so in African countries.

FinTech takes away the cost disincentive of extending loans to small businesses. But are African SMEs benefitting from FinTech? This is the question I address in the article. I also look at how Singapore-based FinTech firms are beginning to facilitate digitalization of financial services in Africa. And finally, I try and assess the outlook for FinTech in Africa.

2. Credit extension to African SMEs is challenging

A study conducted by the London Stock Exchange (LSE) in 2018 revealed that 40% of African SMEs identify access to finance as a primary constraint to their growth. The current funding gap is put at more than US$140bn.^[4] African banks are reluctant to make loans to SMEs for the reasons explained earlier.^[5] Take for example, FinTech lender Lidya. It can disburse loans from as little as US$500 within a day. But a typical Nigerian bank would be loath to lend amounts less than US$50,000.  While it would take a FinTech firm less than a day to disburse a loan, a bank can take weeks to process the transaction.^[6] Regulation is also more onerous. Because SME financing is considered riskier, banks are required to set aside more reserve capital, to account for potential default.

According to Asoko Insight demand-side gaps, supply-side gaps, high interest rates, information asymmetry and macroeconomic headwinds are responsible for the SME funding shortfall in Africa.^[7] On the demand-side, SMEs are generally sceptical about successfully securing loans from banks. But this is also because small businesses tend to have shoddy business plans, poor corporate governance, and limited collateral. On the supply-side, banks are constrained by competing demands on their credit risk assessment resources. And even for banks which do put in the effort, usually smaller banks, they are constrained by the short-term capital they attract, which weighs on their ability to make long-term loans to SMEs.

Getting accurate financial information on SMEs is another challenge. While credit bureaus should typically fill the gap, they are few and far between on the continent. Little wonder, only about a fifth of African SMEs can lay claim to a reliable bank credit line, according to the African Development Bank (AFDB), which unsurprisingly are usually at extremely high interest rates.^[8] To make African SME lending attractive, these myriad risks associated with small businesses must be addressed. FinTech does just that.

3. FinTech is a strategic fit for African SME financing

At the Financial Times’ “Unlocking SME Growth in Africa” webinar in September 2021, digitisation and technology adoption were identified as the keys to bridging the credit gap, strengthening the value chains and boosting the productivity of SMEs.^[9] Kenya pioneered mobile money services. While mobile money adoption varies across African countries, the continent remains the exemplar of how technology can engender rapid financial development. In fact, there are now more mobile money accounts than traditional bank deposit accounts in Africa.

Technological innovations are emerging that increasingly make financing SMEs cost-effective. According to the International Monetary Fund (IMF), mobile internet (financial inclusion and deepening); big data and artificial intelligence (cross-border payments); distributed ledger technology (fiscal and monetary sectors); and cryptography (promoting transparency and reducing corruption) are the emerging technologies that address some of the challenges of financing small businesses.^[10]

There are well-tested FinTech solutions for almost all facets of small business financing. FinTech-enabled P2P lending and equity crowdfunding are proving effective for the long-term financing needs of SMEs. Several e-platforms have emerged that can finance trade, merchants, invoices, and supply chains. According to World Economic Forum (2015), data availability, regulatory support, investor capital and financial literacy are key enabling factors, whereas unmitigated retail investor exposure, bad credit misses, and limited regulations remain the top risks.

According to the World Economic Forum (WEF), there are currently five key FinTech products addressing the various financing needs of SMEs. These are: Marketplace (peer-to-peer) lending; merchant and e-commerce finance; invoice finance; supply chain finance; and trade finance (see Table 1).

Marketplace or P2P lending, which is underpinned by uninsured capital from retail and institutional investors, is unsecured. To extend credit, P2P lenders rely on the SME’s cashflow data. Big data and Artificial Intelligence (AI) are put to use for credit risk assessment, allowing P2P operations to run lean and optimise their cost-to-income ratios. While P2P lending is growing across the African continent, it is still relatively limited. 

As e-commerce platforms tend to have a better view of the cashflows of their SME customers, whose payments they process as they facilitate transactions, it makes sense that they extend their range of services to include the provision of credit. African SMEs which rely on global e-commerce platforms like PayPal, eBay, Alibaba, and so on already leverage on such financing opportunities. But there are increasingly homegrown alternatives too. Kenya’s Safaricom of M-Pesa fame facilitates credit extension to SMEs within its reach, for instance. Besides, banks are increasingly adopting FinTech solutions to cater for the hitherto sub-optimal SME segment. Thus, transaction banking services like invoice financing, supply-chain financing and trade finance are now increasingly within reach of SMEs beyond a certain size threshold owing to FinTech. (We highlight the global efforts toward digitizing the disproportionately paper-based trade finance process using blockchain-based solutions in our “ Blockchain and cryptocurrencies: Propects for African trade” publication.)

FSD Africa has identified six key FinTech credit innovations in Africa.^[11]

• Scoretechs: Credit scoring platforms that allow for easier credit risk assessment of African SMEs.  
• Invoicetechs: Digital invoice trading platforms for African SME working capital needs
  
• Lending aggregators: FinTech platforms that allow customers to compare loans across banks
  
• Telco-based lenders: FinTech platforms that rely on data from mobile money transactions to make loans to African SMEs. 
• Pay as you go (PAYG): FinTech platforms that leverage on the assets being financed as collateral.
  
• Peer-to-peer platforms: FinTech platforms that match African SMEs with lenders

Challenges related to infrastructure and regulation, however, remain. More than half of the continent’s peoples still do not have access to reliable power supply and mobile internet. FinTech firms face unfair competition from traditional financial institutions. Unlike banks they often work in a kind of regulatory ‘grey-zone’.

Regulation has been slow to catch up with emerging FinTech innovations. In more than a few instances African FinTech firms have had their bank accounts frozen or have had to struggle with onerous capital reserve requirements imposed on them by central banks. While there is clearly a need for regulation, rigid rules can stifle innovations that FinTech offers.

There is a case to be made for efficiency-safety trade-offs here - especially in the African case where legal enforcement is weak and customers have inadequate financial literacy. FinTech can facilitate financial inclusion like no other. It has the potential to help SMEs grow and become more resilient. A number of approaches have been suggested. For example, the introduction of experimental ‘sandboxes’ in special designated economic zones that allow FinTech to operate with light-touch monitoring and supervision is a viable proposition.

Many African FinTech firms are SMEs themselves and are increasingly spoilt for choice when it comes to financing. These startups mostly work in the payments and remittances categories (see Figure 3).^{[12], [13]} A few have even gone on to become ‘unicorns’ (Unicorns are start-ups whose valuations hit US$1bn).^[14] Scaling up is not the norm yet, however. In fact, only 5% of the more than 700 FinTech companies on the African continent have managed to expand significantly, according to a July 2021 study by the London Business School.^[15]    

Decentralised finance (DeFi) is another emerging trend with huge potential for African SME financing. According to the WEF, DeFi are blockchain-based forms of finance that do not rely on intermediaries such as banks.^[16] Read <Can Blockchain and Cryptocurrencies facilitate African trade> ^[17] DeFi is ideally suited for addressing some of the most peculiar financing challenges faced by small businesses in Africa.  

Still, these are early stages. While DeFi can help resolve complex requirements around portable digital ID and track records of transactions safely and securely, it lacks two crucial elements - a one-to-one exchange with fiat currency; and interoperability between different blockchains so that counterparties could freely interact with one another (WEF, 2021).”

4. Singapore is a leading facilitator of African FinTech

African FinTech firms have raised more than US$1.4bn in new capital. That is more than they were able to achieve in all of the past decade. Singapore’s sovereign wealth fund Temasek, for example, has put US$500m in investment firm LeapFrog for taking up exposure in African FinTech.^[18]  At the 2021 Singapore-Africa Business Forum in August 2021, the continent’s FinTech opportunities were a key highlight.^[19] The 2021 Singapore FinTech Festival (8-12 November) also featured a robust African showcase.^[20] And credibly so. Singapore’s central bank has been entering into various international partnerships to enable greater SME financing access in developing countries, for instance.^[21]

The Bank of Ghana and Monetary Authority of Singapore (MAS) are currently working to create a Financial Trust Corridor (FTC) – an ecosystem that will allow firms to create mutual ‘recognition’ and build trusted partnerships.” ^{[22], [23], [24]} In late August 2021, Rwanda and Singapore agreed to establish another FTC on similar lines.^[25] In mid-July 2019, MAS signed a FinTech cooperation agreement with the Central Bank of Kenya (CBK) for the development of basic digital infrastructure services including identity, data and Know-Your-Customer (KYC) utility in Kenya that are based on a common set of standards between the two countries.^[26]

In February 2020, Nigerian FinTech start-up and micro-loan provider Aella Credit, whose product line includes Creditcoin, a blockchain-based lending application, received US$10m in debt financing from Singapore’s HQ Financial Group (HQF). ^[27] Another example is Singapore’s Credolab, which is deploying innovative credit risk assessment tools to enable easier financing access for African SMEs, with operations already in Ghana, South Africa, Kenya and Nigeria.^[28] Kenyan FinTech startup WapiPay has a base in Singapore, and Singaporean investors are involved with South African FinTech startup Troygold, which allows gold owners to digitize their holdings for day-to-day transactions using its mobile app and gold-backed debit card.^[29]

The prospects of leveraging Singapore’s FinTech expertise and resources and strengthening Asia-Africa economic partnership has become stronger, especially since the African Continental Free Trade Area (AfCFTA) became operational in January 2021.^[30] More than half of the initiatives in 2021 thus far by Enterprise Singapore, which facilitates international business opportunities for Singaporean firms, have been related to digital technology.^[31] In FinTech Singapore is proving to be a fast emerging investor. Its firms come with rich experience working in other emerging markets in Asia that mirror African circumstances. That gives them a demonstrable competitive advantage over those in the West.

5. Conclusion and recommendations

SMEs often complain about lack of access to finance. They lack the scale, information, and credit history that traditional banks ask for. Nor can they come up with the necessary collaterals to raise loans. Small businesses across the world suffer a financing deficit of more than US$5trn yearly. In Africa, the credit gap is US$140bn. FinTech has the potential of reducing that gap and covering up for the many disadvantages. African SMEs are particularly well-suited to FinTech approaches. DeFi or blockchain-based financing approaches have huge potential for African SME credit extension as well.

Singapore is leading the charge in African FinTech adoption. MAS has been entering into linkage agreements with African countries to facilitate easier digital financial transactions, especially for SMEs. Singaporean FinTech firms have also been making significant strides on the continent; Credolab, is a case in point. Even as African FinTech firms are increasingly spoilt for choice on financing most of the investments thus far have been towards the payments and remittances category. Lending and financing, whether via P2P lending or equity crowdfunding, remain relatively untapped, an opportunity Singaporean firms would do well to seize.

While I have demonstrated how African SMEs are indeed faring better owing to FinTech, it is also clear that when it comes to long-term financing, the surface has barely been scratched. Although the outlook for FinTech-based credit extension for African SMEs looks bright, not until the infrastructural and regulatory constraints are addressed would the potential be fully realised.

I suggest the following recommendations:

• Credit bureaus: Information on African SMEs remain scarce and difficult to acquire. There are still too few credit bureaus across Africa. Ample opportunities exist for filling this gap 
• Regulatory sandboxes: African governments would need help to make this approach work. Singapore has huge expertise and through MAS, has been reaching out to African countries to facilitate exchange of knowledge and expertise.  
• Financial trust corridors: Following in Singapore’s example, other key international trade partners to African countries could similarly establish financial trust corridors that FinTech allows to be done relatively easily. 
• DeFi-friendliness: DeFi relies on blockchain and tokens. If stablecoins continue to be difficult to interoperate/exchange with fiat currencies or CBDCs, the potential advantages for dealing with the financing constraints faced by African SMEs would be lost.  
• Financial literacy campaigns: Most managers of African SMEs are not financially literate enough. FinTech adds complexity to what was already a difficult subject. Financial and FinTech literacy campaigns are therefore required to bridge the knowledge gap.  
• Government SME-focused support programmes: Without governments’ financial guarantees, tax concessions, etc., African SMEs would continue to be seen as overly risky by banks and financial institutions.  
• Mulilateral lending support: Government facilitation might still not be enough. Multilateral lending institutions, from the AfDB, IFC to the World Bank, have numerous programmes targetting African SME lending that could be scaled up for effectiveness, especially towards FinTech approaches.  
• Tech infrastructure build-up: FinTech relies on power and information and communication technology (ICT) infrastructure, which continue to underwhelm in most African countries and would require significant investments to upgrade or build.