SMEs are the backbone of economic activity in East Africa, even more so than in other regions. Can we leverage technology to fill the financing gap?

According to the 2020 report titled - Banking in Africa: financing transformation amid uncertainty by European Investment Bank, we draw the following conclusions about the performance of the banking sector in East Africa (E.A):

1. In recent years the performance of the banking sector in East Africa has been underpinned by largely
2. The profitability of the banking industry in East Africa is mixed
3. Interest rate margins have largely remained within the upper single digit range
4. The recovery of private sector credit growth was accompanied by a decline in non-performing loans (NPLs) across the region.

However, as with many other regions across the globe (Africa included), there are clear challenges that are affecting the sector. In my last newsletter, I wrote about the journey of banks partnering with fintechs (side eye to you if you did not reach out for a partnership). In my opinion, these partnerships between both banks and fintechs are a great step not just for the shareholders but mainly for the people (whom I believe we all should aim to serve).

That said, there is one particular sector that largely pushes the East African economy, and that is the SME (or MSME) sector.

Because East Africa is less resource-dependent than other parts of the continent, the private sector plays a larger role, accounting for over 40% of total economic output and roughly the same share of average gross value added. This sector's contribution to employment is far greater, as it is expected to account for more than 80% of overall employment.

Table shows characteristics of East African firms, %

Now the question we need to ask is how many of these SMEs are being well served today?

According to the World Bank MSME Finance Gap report of 2017, it is clear that for a region which is largely is dependant on the SME sector due to the absence of large deposits or variety of natural resources, the East African region could do more to close the financing gap that exist in the SME sector.

Image shows - Access to finance by micro, small and medium-sized enterprises across some East African countries

Why the Credit Gap Exists

Providing financial services to SMEs generally involves greater costs and higher risks compared with serving other types of enterprises. Small businesses have fewer assets to use for collateral, less stable sources of revenue, and limited liquidity—factors that increase credit risk. From a cost perspective, providing a commercial loan involves significant operational costs prior to loan origination, such as customer acquisition, due diligence, regulatory compliance, credit risk analysis, and document processing. Loan servicing, particularly for higher-risk customers like SMEs, brings additional costs. Because SMEs typically borrow small amounts of money, lenders may find such loans less profitable, even if they charge higher interest to account for greater credit risk. Instead, banks and other financial institutions generally rely on economies of scale to lend efficiently, directing credit to larger customers.

East Africa's Digital Economy: Can Leveraging technology Fill the Gap?

Emerging financial technology and innovations in traditional business models can take advantage of East Africa’s rising digital economy to expand SMEs’ access to credit in E.A through several complementary improvements. The use of alternative data can enhance credit analysis of small businesses previously disadvantaged by limited credit history, a problem in most African countries without comprehensive credit bureau coverage. Technology-driven changes to business models can also expand access to financial services with growth potential for East Africa’s SMEs: trade finance, by modernizing inefficient processes and reducing the role of costly intermediaries, and invoice financing, by leveraging the digitization of commerce to make accounts receivables more easily priced and traded.

Even in a conservative scenario, innovation in SME financing can unlock liquidity and working capital that allows SMEs to survive the volatile early stages of growth and development. Having greater access to finance might also create a benevolent cycle as access helps build credit history that financial institutions can use to better price SME loans, amplifying the benefits and supporting long-term economic growth. Some of these improvements would undoubtedly be disruptive to incumbents. Still, while new SME-focused fintech firms might take some market share from traditional firms, they are most likely to serve many borrowers that traditional firms currently reject. Market share lost to newcomers will likely be offset by an increase in the overall size of the market.

Existing Market Players Across Africa

• Formerly Swipe, Float is an 18-month-old Lagos and San Francisco-based company aiming to close the $300 billion liquidity gap for Africa’s small and medium businesses (copied from TechCrunch).
• Founded in August 2019, Payhippo, Nigeria (AI driven on demand financing). Their mission is to serve the 40 million SMEs unable to gain access to the funds necessary to grow their business for a more financially equitable Africa.

The question for me after writing and doing some research about this, are:

1. What East African technology companies are there solving these problems? (I have a couple in mind but will like to get your thoughts)
2. What ways can banks partner to enable this to happen on a digital and technological scale?
3. What else could be done to better serve SMEs in your country?

Do kindly share your thoughts in the comment section.

Thank you for reading.

About East Africa Fintech Corner: This is a newsletter that is focused on telling the story of payment, remittance, e-commerce, in East Africa with a personal touch from Seye Obadeyi.

About Seye Obadeyi: I currently serve at Equity Bank as the Group Manager for Fintech & E-Commerce (focusing on Strategic Partnerships). I have worked all my life in East Africa (totally love the region), as a chief of staff at Cellulant Kenya, Commercial Manager at Glovo Uganda, and remote consultant for business across Tanzania, Uganda, and Rwanda. Serving as a Nigerian in the East African community has taught me a lot about communication, cultures, and serving others in peculiar ways. Also, I am a big fan of the continent and its people! Probably the biggest :)