Interest in Kenya’s small and medium enterprises (smes) has increased in recent years. banks that were generally averse to the sector not long ago have now dedi-
cated billions to it. Discussions of how to strengthen the sector have also become more frequent and robust. even the Commonwealth secretariat has chimed in, initiating deliberations on how smes can access trade finance in order to tap into the more lucrative export markets. smes contribute about 45 per cent
of Kenya’s GDp and employ up to 85 per cent of the workforce. Accordingly, Kenya Vision 2030 contends that smes
will be a major driver of social develop-
ment and youth employment, as well as a key enhancer of the country’s global competitiveness.
the opportunity in the sme sec- tor is therefore immense, explaining why a growing number of banks are modelling themselves as “sme banks.” even brands such as barclays bank Kenya, long known for its sharp focus on corporate banking, has substantial- ly increased its activities in the sme sector.
Banks close in
barclays is now one of the banks closing in on opportunities in the sme segment, having commited sh30 billion to the sector in August last year. One of the pillars of its sme strategy is enhancing financial literacy for smes through a financial literacy program targeted at uplifting smes in the counties.
barclays launched the financial lit- eracy program with the aim of training 10,000 sme owners in 11 counties. “the sector (sme) currently contrib- utes more than half of Kenya’s Gross Domestic product and creates more than three-quarters of all new jobs,” said barclays head of retail and busi- ness banking Humphrey muturi, add- ing that: “there is therefore a significant multiplier effect on our economy if this sector is adequately resourced.”
Different banks are using different strategies to reach out to smes. this
notwithstanding, the common thread that runs through all of their unique strategies is the selling point they choose to emphasize—affordability of loans.
banks are using the phrase “affordable loans” to reel in smes in pretty much the same way a fish- erman uses bait to catch his supper. but smes have learnt through expe- rience that most commercial bank loans are anything but affordable, despite marketing material emphat- ically suggesting they are.
even when the headline rate for an sme loan product is compar- atively low, other charges such as legal—and other fees occasioned by the infamous ‘terms and conditions apply’ addendum—usually end up inflating the final cost of finance for smes.
moreover, there are some struc- tural issues that make it difficult for smaller banks, which happen to be the ones most involved in sme lending, to lower rates.
smaller banks generally rely on the interbank market—that is, lend- ing from one commercial bank to another—for a sizeable amount of their capital. How this interbank market works is that the bigger banks lend their excess liquidity to
smaller banks, which use the funds for onward lending.
but the interbank market is now very stagnant, as big banks are increasingly careful about lending to small banks following the well documented mishaps at Dubai bank, Imperial bank and Chase bank (three small lenders).
Industry insiders, however, opine that the primary reason why big banks are not lending to the small ones is to deliberately starve them of liquidity and drive down their busi- ness in order to coax them into sell- ing off majority shareholding on the cheap. Whether or not this hypoth- esis is true is anyone’s guess. What is clear is that the vast majority of small banks are currently suffering from tight liquidity and have to look for finance from other sources— often expensive.
the ripple effect is obvious: small banks get their capital expen- sively, and therefore sell it expen- sively. this hurts smes, majority of whom depend on these small banks. In light of these structural issues, lowering interest rates for smes is not as straight forward as it may sound. but parliamentarians think it is.
parliament in July 2016
unanimously signed off on the banking Amendment bill 2015, which seeks to cap interest rates at not more than 4 per cent higher than the Central bank base lending rate. At the time of writing, president Uhuru Kenyatta had not signed the bill into Law and was still engag- ing stakeholders in consultations in light of treasury’s, CbK’s and the Kenya bankers Association’s (KbA) opposition to the bill.
On paper, controlling interest rates by means of legislation seems like a good idea. but in practice, it could harm the very smes it is meant to uplift. this is because capping interest rates throws risk profiling—a critical tool in pricing credit—out of the window.
this basically means that banks will not be able to price loans on the basis of risk, leading them to avoid smes (which have higher risk profiles) altogether and focus almost exclusively on government paper, high net worth individuals and blue chips. this could encourage the development of a parallel lending market for smes, leading to illicit flows and possibly safe havens for terrorists and money launders.
“If the interest rate is capped then only borrowers whose risk pro- files fall within the stated range will access loans,” KbA chief executive Habil Olaka said, adding that those with higher risk profiles would be pushed out to unregulated lenders such as shylocks.
the best long-term solution to high cost of credit for smes is to make them less risky. this means building the capacity of smes by, for instance, making it easier for them to adhere to reporting stan- dards through affordable training of staff; or improving the ease of secur- ing business by clamping down on cartels and rooting out corruption. this is an undertaking that requires resolve and patience, two qualities that very few dare cultivate.
Lowering interest rates—or better yet, reducing the risk profiles of smes—is just one way of uplift- ing the sector. the other, and it is equally important, is ensuring that the financial products targeting smes respond to the unique needs of smes. there is a poor product-mar- ket fit in the sme sector as most products don’t respond to the real needs of smes.
“Kenya’s high sme failure rate persists despite banks’ increasingly pronounced exposure to the sec- tor, illustrating that their efforts are not reaping the kind of results they want,” says tim Gitonga, the managing Director of spire bank. “part of the reason for this is that most of the currently proposed solu- tions to the problems bedeviling the sme sector are too generic,” he adds. spire bank, which rebranded from equatorial Commercial bank in July this year, will increase smes’ share of its total loans portfolio from 45 per cent to 65 per cent over the next two years, underscoring the
growing relevance of the sector.
the bank’s mD, mr. Gitonga, has consistently said that their sme focus is informed by the need to develop products that are respon- sive to the real needs of smes. this means going beyond giving loan facilities to offer much needed advi- sory services.
70 per cent of smes fail within the first three years of existence, according to a 2016 study commis- sioned by Invest in Africa (IIA) and strathmore business school. part of the reason for this high failure rate is that most smes don’t get good business advice, especially with regard to handling cash flow or on the importance of ethics in business. “there are a number of smes that would come to banks today and we review their business plans and are impressed. However, when the bank takes the risk to partner with that business and offer funds, they divert the funds for personal use,” observes mr. Gitonga.“this needs to change and banks need to lead this change by offering advisory services
to smes,” he further submits.
Uplifting the sme sector there- fore has to be a conversation that not only touches on financing, but also capacity building. Consequently, there is only so much that banks can do. Government has to step in. Development agencies also have to offer support where they can.
the main route to prosperity for smes is accessing the export mar- kets. exporters are generally deemed to have achieved a certain level of quality and reliability. the big prob- lem, however, for most smes which produce export-quality goods is accessing trade finance, notes the Commonwealth secretariat.
trade finance refers to finan- cial assistance extended by banks and other financial institutions to businesses for the export of prod- ucts (good/services) outside of a country or a region, says Commonwealth. It enables micro, small and medium enterprises to expand their reach to a global audi- ence, adds Commonwealth, which hosted a media breakfast on July 16th 2016 to sensitize the media on the topic of trade financing.
According to the WtO, over 80 per cent of the world trade relies on trade finance. Yet in many countries, particularly in sub sahara Africa, there is lack of capacity in the finan- cial sector to support trade and also a lack of access to the internation- al financial system. trade financing, especially for smes, therefore has to pick up.
One key challenge that smes face when accessing trade finance for exports is the perception of risk. Following the global financial crisis in 2008, regulators tightened rules for banks, introducing what would later be known as basel III.
basel III basically established tougher capital standards through more restrictive capital definitions, higher risk Weighted Assets, addi- tional capital buffers, and higher requirements for minimum capital ratios. this has led many banks to move away from clients who are per- ceived as “high risk,” such as smes.
rather than manage these risky clients, financial institutions opt to end the relationship altogether, con- sequently minimizing their own risk exposure while leaving clients bank- less. the implications on smes which would like to access export markets is immense.
the irony is that banks under- stand that there is great demand for trade finance from smes; they under- stand that there is huge potential for business and that most of the risks are perceived and not real. the only challenge is empirically proving to regulators that smes are not as risky as imagined.
most smes have some element of informality. this is often out of
necessity as the cost of formalizing some aspects of business operations can erase the margins of smes. the effect of this is that it becomes chal- lenging for financial institutions to use standard risk assessment procedures for smes, making it difficult to empir- ically prove that smes are not as risky as imagined.
It is instructive to note that while only 7 per cent of multinationals’ trade finance needs are not met, a staggering
50 per cent of smes’ trade finance needs are not met. this is according to professor Yuefen Li, special Advisor on economics and Development Finance of the Geneva based south Center.
professor Li, who was speaking at the Commonwealth secretariat media breakfast, further submitted that current regulations have conditioned banks to favor less risky multinationals over smes. “there is a glut of liquidity in big companies. these monies idle on big companies’ balance sheets,” she added, underscoring the fact that money is not the problem, but rather the flow of this money to smes.
the only obstacle to smes access- ing finance is risk perception. this is what needs to change—the perception of risk. either smes need to improve their risk profiles or banks need to develop unique risk assessment tools for smes, or both. this calls for a lot of collabora- tion between smes and banks, but also a lot of government intervention. Functions such as improving the ease of doing business and lowering indi- vidual tax rates by widening the tax base properly fall within the jurisdiction of the government.
the blame for smes’ challenges cannot be heaped entirely on banks’ supposed reluctance to reduce interest rates. Government has a big role to play as well. It is the only one which and help reduce the risks for smes, leading to lower cost of finance for them