SME growth key to Africa’s future, says African Guarantee Fund

Enabling access to investment finance for micro, small and medium-sized enterprises is essential for economic growth to continue in Africa

 
Author: Felix Adahi Bikpo, CEO, African Guarantee Fund
November 18, 2014

Small and medium-sized enterprises (SMEs) are widely recognised as big drivers of economic growth, innovation, regional development and job creation. A strong and vibrant SME sector provides a strong foundation to increase standards of living and to reduce poverty. Indeed, Africa’s small enterprises, from trading to farming, contribute more than 80 percent of output and jobs in most African nations. They also offer the best opportunities for growth, diversification and job creation. But SMEs are constrained by limited access to stable energy services, business management, skilled labour and especially finance for investment.

Successful developing countries have seen their SMEs flourish, moving from informal to formal production and becoming the backbone of growth in production and employment. Such processes of development support the creation of a strong middle class and also tend to strengthen democratisation and the rule of law.

80%

of output and jobs from SMEs in Africa

Despite the internationally recognised importance of SMEs, African small businesses often have difficulties accessing financing from the formal financial sector. Almost 50 percent of African companies identify lack of access to finance as a major constraint to doing business. The cost of finance, including investment finance, is higher in Africa than any other part of the world, and the access for SMEs is particularly limited. Very few commercial banks do small-enterprise banking in Africa. Furthermore, SME financing is often considered by many financial sector players in Africa to be a risky activity as promoters quite more often than not, fail to come up with the collateral levels required to secure bank facilities.

Low-level financing
Studies done by the World Bank and other organisations have revealed very low levels of bank financing to SMEs in Africa when compared to other developing countries. It is also often noted that SMEs represent a ‘missing middle’ in African private sectors as these are dominated on the one hand, by (mostly informal) very small (micro) enterprises, and by large companies on the other.

The missing middle is particularly pronounced in sub-Saharan Africa, where the unmet need for credit by all micro, small, and medium-size enterprises (MSMES – enterprises that typically have fewer than 250 employees) is in the range of $140-170bn, approximately 70 percent do not use external financing from financial institutions, although they are in need for it.

These studies have attributed low levels of bank financing to SMEs in Africa to both supply and demand. While the lack of effective business plans and adequate skills within SMEs are a problem on the demand side, the supply is constrained by lack of capacity in the financial sector to do business with smaller companies; inadequate information resulting in high-risk assessments; lack of collateral and collateral registries; poor protection of creditors; and lack of availability of longer term funds.

Rising to the challenge
It is in response to these challenges, the African Guarantee Fund for Small and Medium-sized Enterprises (AGF) was created in by the African Development Bank (AfDB), the Government of Denmark through the Danish International Development Agency (Danida), and the Government of Spain through the Spanish Agency for International Development Cooperation (AECID). AGF was imagined and designed primarily as a response to a development challenge as the need to foster innovation, growth companies and provide employment opportunities in all economies is essential to long-term and sustained growth.

Today, Africa is enjoying unprecedented growth and the world is awakening to the opportunities that the continent offers. AGF’s job is to be part of the effort to ensure that the benefits of that growth are fairly shared at all levels of the society.

Through its guarantee facility, AGF assists financial institutions partially cover the risks associated with SME financing and thus enable them increase their portfolio in that asset class. Its guarantee business also enables financial institutions to raise long-term resources for SMEs long-term needs. AGF also offers capacity development facility enable partners financial institutions enhance their SME financing capabilities and thus to execute their growth strategies in that sector with ease. A combination of AGF’s guarantee and capacity development facilities, allows partner financial institutions to bring their SME financing business to the required scale that would not only enable them bring down transaction costs significantly, but also increase returns on investment. AGF is the missing link that enables partner financial institutions execute their SME financing strategies effectively, while enabling SMEs to play their expected role in fostering African economic development.

Since its official launch in 2012, AGF has gained over $300m of financing to more than 300 SMEs in Africa. Through its partner financial institutions the company operates in more than 20 countries in Africa.

AGF anticipates in its strategic plan that it will guarantee approximately $2bn of new lending in the medium term and enable over 10,000 African SMEs to have access to finance. This would help to secure and create millions of productive and better jobs for the youth across the continent.