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Natural Disaster Risk Pooling to Enhance Financial Access

08.01.2018Johannes Wissel, Financial Consultant

This blog is a summary of Johannes Wissel's Master's thesis on "International Economics and Development".

Limited financial access in times of natural disasters

In her blog of 5 June 2017 Sonja Kelly ascertains the low success of weather-indexed insurance and depicts the reasons why it is not working. She regrets that although these problems are not new, the industry has not managed to solve them.

In addition to insurance, Elodie Gouillat, Rodrigo Deiana and Arthur Minsat and Bella Bird in their blogs of 29 June 2017, 24 October 2017 and 19 December 2017 point out the limited access to finance particularly for low-income households and small enterprises.

Microfinance institutions (MFIs) fail to meet the demand of their clients, especially in times of a natural disaster. Despite the debate on the advantages and disadvantages of microfinance, financial access helps to strengthen the natural disaster resiliency of affected communities. MFIs are constrained in providing their services because in times of natural disasters they themselves lack financial access. They are generally not well diversified around the globe. A natural disaster leads to a widespread defaulting on credits in one region and consequently many credits of one MFI have to be written off. Without the access to external financial resources, this will hamper the MFI's capital ratio which is a key indicator of an MFI's solvency and subject to financial supervision. To avoid further risks, MFIs restrict their lending activities.

To improve an MFI's financial access, its natural disaster-related high unsystemic risks need to be transferred out of the region it mainly operates in. Financial investors follow the same principle by diversifying their wealth. However, the only existing opportunity for microfinancial actors to transfer their disaster risks, is looking for reinsurance or reinsurance-like solutions individually. The comparatively unknown market and a non-perfect competition in reinsurance induce an inefficient and costly risk transfer. MFIs usually do not make use of these possibilities.

Introducing a risk transfer innovation

Alternatively, MFIs can mitigate the unsystemic disaster risks by bearing them collectively. A certain extent of risks can be transferred out of a region by pooling the risks among microfinancial actors. Only a minimised remaining risk of the pool itself needs to be transferred to the global capital market, which is expected to save costs. Two decisive prerequisites are fulfilled that allow for a pooling of these risks among microfinancial actors. Firstly, natural disasters do not occur in every region of the world simultaneously. For example, the risk of El Niño floods in Peru is high between January and March and Vietnam might be affected in June and July. Secondly, the distribution of microfinancial actors among the world regions is relatively balanced.

GlobalAgRisk, a U.S.-based research and development company with linkages to the University of Kentucky, intends to implement such a risk pool in 2018. In one hypothetical example, they envisioned a 31%-reduction in funding needs to cover the risks of two microfinance networks by pooling their risks. The impact of a natural disaster on an MFI's portfolio has been modelled for different disaster types and severities based on historic data, in order to determine the extent of contributions that a pool-participating-MFI has to make and the required payouts it potentially receives. This facilitates an index-based risk pooling which enables a quick disaster response and eliminates potential mistrust problems between different participants. In GlobalAgRisk's concept, an affected MFI is projected to receive a credit payout in order to meet the rising demand for credit of its clients and a capital payout that the respective regulatory authorities classify as equity in order to restore the MFI's capital ratio.

In my thesis titled, “Natural Disaster Risk Management in Microfinance”, I evaluated GlobalAgRisk's concept and portrayed potential improvements to increase the concept's likelihood in achieving its aims and depicted certain constraints for the implementation of potential improvements. The full thesis can be found here.

Recommendations: Inclusion of insurance risks in the concept

One potential improvement is the inclusion of insurance risks in the concept. High costs are a common explanation why weather-indexed insurance does not reach scale (see e.g. Sonja Kelly's blog). Microinsurers make use of the outlined costly reinsurance possibilities. Thus, weather-indexed insurance can benefit from the cost advantages risk pooling offers.

If the risk pool contains both credit and insurance risks, its size and diversification are expected to grow and therefore realize additional cost advantages; for example, through lower fixed costs per participant and better prices for reinsuring the pool's remaining risk externally. Moreover, a higher market penetration of weather-indexed insurance improves credit access, because insured clients benefit from a higher creditworthiness.

Even reinsurers can benefit from pooling both risk types among microfinancial actors, by covering the remaining risks that the pool cannot bear by itself. As such, the extent of covered insurance risks decreases for the reinsurers in comparison to insuring full risks. However, the total reinsurance business might grow because reinsurers can incorporate credit risks in addition to insurance risks.

The consolidation of both risk types appears feasible because the pool's payout patterns are similar to those of microinsurers reinsurance. The contribution payment into the pool is equivalent to a reinsurance premium and a payout is triggered if an insurance taker suffers from a damage. The modelled impact of a natural disaster on an MFI's credit portfolio fits in the already prevalent weather-indexed insurance.

Further success factors

For a successful risk pooling, the basis risk that comes along with an index-based risk pooling should be minimised as much as possible. To achieve this, a compartmentalised model that considers the pivotal risk types (e.g. floods, storms, drought, earthquakes) is crucial.

If the risk pool operates as a for-profit company, the benefits of the concept might be endangered. In order to be attractive, the pool only needs to be slightly cheaper than the existing risk transfer possibilities and could charge much higher contributions from the participants than the payouts amount. Establishing the pool as a mutual or cooperative company eliminates these potential profit extractions. In case of profits, they can be returned to the participants. Insuring the pool's remaining risks minimises the danger of suffering from losses as a co-owner. If certain microfinancial actors are restricted because of their co-ownership possibilities, they can participate in the performance of the pool without being a formal co-owner.

Finally, some countries' legal frameworks might require that the pool acquires insurance licences in order to provide the capital payouts. To avoid the acquisition of numerous licences, fronting might be a way out. Insurance companies that already possess licences in the respective countries can insure the participants and pass the risks on to the pool.

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About the Author

Johannes Wissel recently graduated from Hochschule für Technik und Wirtschaft Berlin - University of Applied Sciences, with a Master's in International and Development Economics. He worked in sales management for Hannoversche Volksbank, a German Cooperative Bank. Prior to this, he worked with two international Christian organisations; Forum Wiedenest in Germany and Diguna in Kenya. Johannes is a licenced Corporate Bank Customer Consultant.

Four Challenges for Shifting from MFI to SME Finance

19.12.2017Elodie Gouillat, Project Manager, GRET

This blog was originally published on the Microfinance Gateway website.

As microfinance institutions (MFIs) have grown over the years and become more professional, some have begun to move into the small and medium enterprise (SME) segment. Many see this gradual transition to SME finance as a natural shift, as the MFIs follow their customers’ development/journey.

In fact, this shift has been driven mainly by concerns to keep the best customers in a fiercely competitive market, expand business and lower operational costs. Although portfolio growth improved the financial performance of some MFIs in the short term, profitability fell in the medium term (owing to lower margins and a higher risk of default). In hindsight, these institutions realized they overestimated their capacities to serve the SME segment.

Microcred, a digital finance company founded in 2005, has developed MFIs in Africa and China and currently has operations in nine African countries. Its current outstanding loan portfolio totals EUR 400 million for 600,000 customers with a 30-day portfolio at risk of 2% and an annual growth rate of 50%. During African Microfinance Week, Ruben Dieudonné, Chief Executive Officer of Microcred Africa, talked about the transition to SME finance, “We waited for the MFIs to establish themselves before launching SME products. But our mature subsidiaries – Madagascar, Senegal and Côte d’Ivoire – naturally moved into SME finance after just a few years of operations.” Finance for this segment represents over 40% of the total portfolio in volume and 4% in number of loans.

At the same time, the inclusive finance sector is seeing the emergence of new SME finance institutions targeting the “missing middle” SMEs. While African economies have experienced steady growth for some 15 years, powered by the private sector and SMEs in particular, access to finance for SMEs is still a real problem. A World Bank study reveals that just 10% of SMEs have access to finance, whereas they account for over 90% of private business in Africa. 

COFINA, a network of financial institutions working to finance SMEs, was set up in 2014 to address this situation. The institution operates in Senegal, Guinea, Mali, Gabon, Côte d’Ivoire and Congo, serving over 75,000 customers for an outstanding loan balance of EUR 100 million and a 30-day portfolio at risk of approximately 3%.

With their launch into the SME segment, both COFINA and MicroCred have faced a number of challenges which have prompted them to adjust their organizational and operational set-ups.

Challenge #1: Analyze the risk

Information asymmetry between entrepreneurs and financial institutions is often a problem. Analysis of the credit application is complicated by lack of knowledge of the business, its market and its cost structure. As Jean-Luc Konan, Director of the COFINA network, put it, “You need to have as accurate an idea as possible of the client’s solvency, and for that you need to be in a position to understand the market and the business perfectly. You have to be able to combine local knowledge with accounting knowledge.”

Microcred already knew most of their SME customers, as they had previously borrowed smaller sums. However, Ruben Dieudonné of Microcred also highlighted the importance of truly understanding the client’s business and its environment from the very beginning of the relationship. What often happens, he pointed out, is that in the first six to twelve months of a new SME loan, financial institutions have the impression of understanding their clients’ market well enough, and since portfolio risk rates remain low, they don’t put much effort into developing a deeper understanding. But then after about a year, that honeymoon period ends, defaults rise and the institutions start to feel the effects of not having paid enough attention to getting to know their customers. Ruben Dieudonné warned that institutions must get "to know their clients well" from the beginning because afterwards it is usually too late.

To overcome this issue, some institutions work in partnership with business support organizations that help entrepreneurs draw up their business plan and gain access to finance.

Challenge #2: Adjust the model to the environment

Unlike microcredit, where cash flow is the main consideration when evaluating loan applications, SME loans call for an analysis of balance sheet and debt capacity. They require a skilled, dedicated operational team conversant in the requirements of “Know Your Customer and “Know Your Colleagues,” as SME finance calls for sound knowledge of the customer. MFIs often do not have this type of risk analysis expertise, so the current tendency is to advise institutions to set up SME units operating separately from traditional microfinance activities.

This is precisely what Microcred set out to do with its MFIs that moved into SME finance. However, the institution had to reconsider this approach when it realized that clients were unhappy about their loans being transferred away from the microfinance loan officers that they already knew, to be handled by the new SME unit. The institution now tends to incorporate the SME line into the microfinance business with integrated risk management: “As our 250 microfinance loan officers were unable to process this type of finance, we asked their supervisors to appraise the SME credit applications. This meant the agents could retain their portfolios and attend to customer support,” explained Ruben Dieudonné.

So there is no one-size-fits-all approach, other than adjusting to the environment and adopting a decentralized model where needed.

Challenge #3: Customize methodology and guarantees

According to Jean-Luc Konan, an estimated 65% of financial institutions that move into SME finance adopt inappropriate methodologies. One of the pitfalls to avoid is offering classic banking or microfinance products. Unlike microfinance, where products can be more standardized, SME finance calls for a more nuanced product design with suitable guarantees, due to its higher loan amounts and greater credit risk. Over a certain threshold, microfinance moves into the realm of finance, meaning that institutions can no longer rely on classic solidarity group guarantees or social collateral, as these types of security are generally too low or impossible to enforce in the event of a dispute. Instead, they must develop more formalized guarantees and security for their loans.

Challenge #4: Customer support

The other point to bear in mind is ongoing support for the financed SMEs. Both MFIs and classic banks, ill-equipped for customer support, often do without. The MFIs have too many small loans outstanding to be able to provide full customer support. And the larger banks consider it outside their remit, preferring to rely on substantial collateral. Microcred and COFINA have both adopted a strong client-centric approach to their business. This position has paid off to date, with both institutions reporting a highly satisfactory customer retention rate.

A financial institution that promotes long-term customer/loan officer relations, regular visits, loan management advisory services and building borrower proficiency manages its own default risk better and bolsters the financed SME’s longevity.

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About the Author

Elodie Gouillat is an expert in inclusive finance. She is currently Project Manager for the French NGO GRET. Elodie started her career abroad very early on. She worked for several years in Senegal and Mexico for MicroCred Senegal and MicroCred Mexico, as a technical assistant in support of operations. At GRET, Elodie works to develop innovative financing mechanisms in order to capitalize and disseminate its results at the level of national public policies.

Distributed Ledger Technology: a South African financial services perspective

22.11.2017Langelihle Mnyandu, Associate in Banking & Fin. Services Regulatory, Bowmans

This post was originally published on the Bowmans website.

The advent of Distributed Ledger Technology (DLT) has caught the attention of the global financial services industry, with many labelling it a technological revolution that is set to disrupt the financial services infrastructure. DLT is a type of digital ledger or database that is used for the recording, safe keeping and decentralised sharing of data relating to the ownership and possession of a wide range of assets. It uses consensus-based cryptographic methods to record and distribute information among participants of that ledger without the need for a middleman to facilitate this. Blockchain is an example of a very popular and well-known form of DLT.

There is no doubting that DLT, and generally financial technology (fintech), has huge potential to challenge and impact conventional ways of rendering financial services and possibly even extending services to new consumers. However, very limited actual ‘use cases’ have been introduced to demonstrate how DLT can help expedite financial inclusion. At present, most use cases pertain to how DLT can improve the efficiency of existing methods in order to make them more cost-effective and secure. These use cases have been, for example, on how blockchain can help reduce costs and improve payment settlement times in the deposit and peer-to-peer payment environments, and how it can help enhance data protection and data sharing between consumers, regulated institutions and regulators. Yet use cases are still lacking on how blockchain can be more effective than existing methods in expediting economic participation and use of financial services by unbanked people.

Obvious challenges

Perhaps one of the biggest challenges in achieving financial inclusion through DLT is that current DLT (blockchain) based products and services are aimed at improving existing methods of rendering financial services. In other words, the current use cases do not seem to introduce any new services that would be useful in the daily transactions that unbanked people ordinarily undertake.

It may be argued, however, that DLT is not meant to expedite financial inclusion directly by developing new products or services but rather indirectly through the introduction of cheaper and more efficient methods of rendering existing financial services and products, which in turn makes it easier for service providers to extend these services to new markets.

Another challenge is consumer education and awareness. Regulators will always want to be comfortable that the most vulnerable members of society know about and understand new products and services well enough to use them for basic transactions without their protection as consumers being compromised. The difficulty is determining who is better placed to lead this initiative - the service providers or regulators - while also ensuring that consumers do not bear the costs.

Despite these challenges, there is general industry consensus that with appropriate regulatory supervision, DLT-based products and services hold huge potential to improve financial inclusion - whether directly by developing new use cases or indirectly by making conventional methods cheaper and more efficient and thus more accessible to underbanked people.

Regulatory buy-in and the way forward

Financial services industry participants have also taken comfort from the fact that South African regulators are actively engaged in the conversation and creative process around fintech. This eases some concerns about a potential disjoint between fintech innovation and regulation.

In most cases there may not even be a need to drastically reform legislation to cater for new product innovations such as DLT. South African financial services legislation is largely sufficient to regulate DLT-based services and products, albeit in a fragmented manner. Consider the insurance landscape, for example. The insurance Acts already have broad deeming provisions that allow the regulator to deem a person’s conduct as insurance business conducted in South Africa and therefore requiring licensing by the insurance registrars.

The same can also be said for legislation regulating the credit lending environment. As with the insurance Acts, the National Credit Act 34 of 2005 (NCA) applies to credit transactions having an effect within South Africa. Because the NCA is activities-based and not entity-based, it means that provided a credit transaction has an effect within South Africa, it may be regulated by the NCA regardless of the medium used to provide that credit. However, this does not mean that the need for some level of regulatory reform is completely negated in other areas.

Regulatory reform will likely be required if, for example, we are to realise the potential of DLT to satisfy other types of regulatory requirements. For example, DLT-based products, such as cryptocurrencies (like bitcoin, ethereum and corda based currencies), may potentially be used by regulated institutions to satisfy their prudential capital requirements. In particular, certain cryptocurrencies have qualities of a ‘tier 1’ type asset for purposes of meeting minimum and solvency capital requirements under the Solvency Assessment and Management (SAM) framework. Cryptocurrencies such as bitcoin have been lauded as being immune to inflation and highly liquid, thus making them readily available to absorb losses as required for tier 1 assets under SAM.

However, cryptocurrencies are currently not recognised as securities in South Africa, let alone as securities that can be used for purposes of meeting the capital requirements of regulated institutions. Also, the current insurance framework (including the Insurance Bill) does not provide a clear position on whether such instruments can be regarded as eligible assets for purposes of meeting capital requirements. This is just one of the areas that may benefit from regulatory reform or clarification.

Although regulation may not be moving as fast as innovation, it is positive to see that the Financial Services Board, in particular, is adopting a more hands-on approach in keeping up with fintech innovations and has indicated that it will establish a regulatory sandbox to test new product developments. This will also allow it to leverage off the strides made by the UK’s Financial Conduct Authority in regulating fintech-based products, as our financial services regulatory framework is largely similar to that of the UK.

There are clearly a number of moving parts with regards to DLT and fintech innovations. Whether it is from the perspective of expediting financial inclusion, developing regulatory sandboxes to test new DLT use cases or grappling with whether or not these innovations will necessitate significant regulatory reforms, it is reassuring to see DLT, and generally fintech, receiving buy-in from South African regulators.

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About the Author

Langelihle Mnyandu is an associate in Bowmans' Johannesburg office, more precisely in Banking and Financial Services Regulatory practice area. He holds an LLB degree from the University of Kwa-Zulu Natal. He has expertise in banking regulation, financial services, financial technology regulation, securities, insurance, financial markets regulation, investment funds structuring and investment management.

Innovation doesn't have to be disruptive

21.11.2017H. Miller, Associate Consultant, Nathan Associates & G. Njoroge, Advisor, KPMG

In the previous blog, we looked at what technology meant in the context of innovation and problem-solving for rural customers. In this second of three blogs, we dig deeper into the idea of innovation and what it means for the Mastercard Foundation Fund for Rural Prosperity.

                     

It is clear that technology is changing the landscape of financial services in rural Africa. From the largest banks to the smallest fintechs, financial service providers are gearing up for a world in which finance is digital first and in which anyone with access to a mobile phone can also derive benefits from formal financial services.

The rapid uptake of mobile money in many countries has sowed the seed for a thousand new innovations that could further extend inclusive financial services. An outcome of this success has been that everybody in digital finance is looking for "the new M-Pesa", in the same way that elsewhere, entrepreneurs want to be "the Uber of..." An underlying assumption here is that change is generally linear until a special company comes along with an idea that creates non-linear change, which we often call disruption.

But when you map this idea on to the landscape of unbundling that financial services are currently going through, it is not so clear that disruption is what's needed. It used to be that a bank, or a microfinance institution, or an insurance company, would aim to provide a vertically integrated service to the customer, from initial acquisition to all aspects of relationship management and back end services. This is changing. Technology, and in particular the ability for different platforms to link with each other, opens up new opportunities for collaboration. Not everyone needs to develop the next big product or service - there may be much more value and impact for a fintech company to build a business- to-business solution that works at a specific pain point for a financial institution.

For example, the Fund is supporting a partnership between Juhudi Kilimo, an asset financing company, and the Entrepreneurial Finance Lab to develop a psychometric credit scoring tool for smallholder farmer borrowers with no or limited verifiable credit information. This is a tech-enabled solution for a specific challenge - how to estimate likelihood of repayment in a data-light environment - that could reduce costs and improve efficiency of Juhudi Kilimo's credit processes.

A similar partnership in the Fund portfolio is between First Access, a fintech company, and Esoko, an agricultural information and communications company. The two will develop a rural agricultural credit-scoring platform for lending institutions from disparate data sets, from soil and weather data to mobile phone usage and farmer profiles. The solution has the potential to impact a large number of farmers who do not have traditionally accepted banking histories.

These are great innovations, that could have a real impact on micro and small business finance, but they probably won't be putting other lenders out of business. And that's fine. Innovation can be highly effective without being disruptive.

There's nothing wrong with ambition, and there is certainly scope for massive changes in Africa's rural finance markets. But if you focus too hard on the next disruption you can lose sight of the great ideas that represent an evolution, not necessarily a revolution. At the Mastercard Foundation Fund for Rural Prosperity, we love big ideas. But the most important aspect of the big idea is the impact it has on the livelihoods of rural communities in Africa, not necessarily on how it disrupts the structure of the financial system.

So if you want to apply for support from the Fund, we're not so fussed about if you're the next big disruption to African financial markets. We want a credible plan that overcomes some of the many challenges of financing rural populations, and can have a real impact on the lives of people living in or close to poverty. We want ideas that work from the bottom up, which solve real problems. Maybe you'll be disruptive. If you're not, that's fine too.

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About the Authors

Howard Miller is a Senior Consultant with Nathan Associates London, and Principal, Nathan Associates India. He specializes in financial inclusion, challenge funds and the market systems approach to development. A trained economist, Howard has extensive experience in consultancy, public policy, and investment banking. Since joining Nathan Associates in 2011, he has worked on DFID financial sector development programs in Uganda, Mozambique, Bangladesh, and Rwanda, and on the FSD Africa Program. Before joining Nathan, Howard was a fellow at the Overseas Development Institute working on macroeconomic and financial sector policy for the Government of Uganda.

8 years ago, Grace Njoroge ventured into the corporate world under a graduate trainee program with one of the top regional banks in East Africa. She expected to be a classic banker but this according to her did not happen, at least not all of it. Her typical day involved riding a motorcycle to help micro-traders and assist small-holder farmers open savings account. In a surprising twist, she fell in love with the power simple financial products had to drastically change life and businesses potential for low-income clients. At KPMG IDAS, she works with donors and funders to support financial and non-financial institutions, to better serve the unbanked and under banked segments.

Financing African SMEs: can more of the same help bridge the gap?

24.10.2017Rodrigo Deiana, Junior Policy Analyst & Arthur Minsat, Head of Unit, OCDE

This post was originally published on the OECD Development Matters website.

African firms don’t have it easy. Among the many constraints faced by formal companies, access to finance consistently ranks as a top issue. Almost 20% of formal African companies cite access to finance as a constraint to their business.[i] Overall, African micro, small and medium enterprises (SMEs) face a financing shortfall of about USD 190 billion from the traditional banking sector.[ii] African firms are 19% less likely to have a bank loan, compared to other regions of the world. Within Africa, small enterprises are 30% less likely to obtain bank loans than large ones and medium-sized enterprises are 13% less likely.[iii]

To bridge this gap, governments and market players need to strengthen existing credit channels as well as expand new financing mechanisms.

Various innovative financing instruments are currently expanding or present strong growth potential across Africa. Private equity funds invested a total of USD 22.7 billion in Africa across 919 deals between 2011 and 2016, although less transactions took place in the last months. Most took place in capital-intensive sectors such as telecommunications and energy.[iv] Asset-based lending can ease some stringent conditions associated with traditional credit. Experiences in Burkina Faso (with Burkina Bail) and South Africa suggest that commercial banks and other financial operators can engage in factoring and leasing services, without the need for additional legislation.[v]

At the same time, many entrepreneurs can directly harness new financing mechanisms such as crowd-funding or venture capital within and outside Africa. Togolese entrepreneur Afate Gnikou successfully used crowdfunding to raise the capital for a prototype 3D printer from recycled electronic waste selling at an affordable price of less than USD 100. Nigeria’s online movie entrepreneur Jason Njoku, for one, raised USD 8 million in venture capital from African and global investors. Andela, a pan-African start-up launched in 2014 that pairs coders with global companies, recently obtained USD 40 million in funding from an African venture capital fund.[vi] This opens the door for African entrepreneurs to look for funding within the continent rather than in Europe or North America. Return migrants are using remittances, expatriate savings or loans to fund their businesses. More international equity funds are providing seed or venture capital to African SMEs, often by specialising in African markets with a mix of private and public funds.[vii]

Many other instruments can help fill SMEs’ financing gap: microfinance for SMEs, direct support from development partners (e.g. the African Development Bank’s Souk At-Tanmia initiative, providing financing and mentoring services to entrepreneurs), and philanthropic finance (the Tony Elumelu Foundation’s support to start-ups in Africa regularly makes the headlines; other initiatives are also growing such as the think tank Land of African Business).

However, these innovative financing solutions are out of reach for the majority of small businesses operating in the informal economy. To bridge the financing gap, we must also improve traditional credit channels by expanding best practices in the financial sector.

Some emphasise the role of traditional instruments, such as credit guarantee schemes (CGSs). CGSs are guarantees by third parties -- governments or development partners -- that can cover a portion of the lenders’ losses from loans to SMEs, significantly reducing default risk for banks. CGSs can benefit small businesses that have little collateral, no credit history or are perceived as too risky. Policy experiences outside Africa (from Turkey and Malaysia) have shown that CGSs can avoid creating market distortions.[viii] A set of key principles can guide the design of effective guarantee schemes without incentivising lending to high-risk borrowers. They can also contribute to reducing poverty. In Tanzania, for instance, several of these guarantees effectively channelled funds to the more vulnerable groups otherwise unable to access credit, such as smallholder farmers as well as micro and small entrepreneurs.[ix] CGSs can also work on a larger scale, as shown by the African Guarantee Fund’s experience. Commercial banks leveraged the Fund’s USD 230 million in guarantees to lend out double that amount to 1 300 SMEs, generating 11 000 jobs. The Fund reached break-even point and started turning profits in just three years, quadrupling its revenue.[x] 

Many solutions exist to bridge the financing gap faced by Africa’s SMEs. Finding a balance between traditional and innovative financing depends on each country’s context. While the 54 African countries are very diverse, three main issues stand out. First: developing regulations and policies (e.g. on tax compliance, contract enforcement) that are flexible enough for innovation by African entrepreneurs. Second, broadening and widening financial solutions that are accessible to the most vulnerable groups. For example, Rwanda’s financial sector has been able to diversify despite its small size, with banks, savings cooperatives, microfinance institutions all tailoring their products to different target social groups. Finally, governments must aim to ensure macro-economic stability by avoiding market distortions and excessive risk taking. In this sense, the establishment of SME Authorities may help reduce information asymmetries and reduce lending risks. To achieve these objectives and increase the financial sources available to small African businesses expanded co-operation between governments, development partners and the private sector will remain vital.


[i] AfDB/OECD/UNDP (2017) African Economic Outlook 2017: Entrepreneurship and Industrialisation: 210, calculations based on The World Bank Enterprise Surveys. World Bank Enterprise Surveys cover firms in the formal sector with at least 5 employees.

[ii] Based on data from IFC’s Enterprise Finance Gap Database

[iii] AfDB/OECD/UNDP (2017): 225, based on Beck and Cull (2014), “SME finance in Africa”, Journal of African Economies, Vol. 23 (5), pp. 583-613

[iv] AVCA (2017), 2016 Annual African Private Equity Data Tracker

[v] Based on evidence from factoring and leasing services in Burkina Faso (through the financial company Burkina Bail) and South Africa (through the commercial banking sector), the Bank of Namibia argued for the possibility of successfully replicating such services in Namibia. See AfDB/OECD/UNDP (2017): 226 for further information.

[vii] Severino, J.-M. and J. Hajdenberg (2016), Entreprenante Afrique, Odile Jacob, Paris.

[viii] IFC (2010), Scaling-Up SME Access to Financial Services in the Developing World

[x] AfDB/OECD/UNDP (2017): 226, based on African Guarantee Fund, 2015 Annual Report

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About the Authors

Rodrigo Deiana is a Junior Policy Analyst in the OECD Development Centre's Africa Unit as part of the UN's JPO Programme financed by Italy. He contributed to the 2017 edition of the African Economic Outlook (AEO), and among other topics works on policy aspects of international trade and financial sector development in Africa. Before joining the OECD, Rodrigo was an economist in the Government of Rwanda as part of the ODI Fellowship, advising on regional integration, trade policy, and private sector development. He also worked as consultant to the World Bank Group in Kigali on matters of agricultural policy. Prior to that, he worked at the European Central bank in Frankfurt and at the World Trade Organization in Geneva. Rodrigo holds a Master's degree from the Barcelona Graduate School of Economics and a BA in International Economics from the University of Nottingham.

Arthur Minsat leads the OECD Development Centre's Africa Unit. He is responsible for the African Economic Outlook (AEO), a partnership with the African Development Bank and UNDP, and the Revenue Statistics in Africa, a joint publication by OECD, the African Union Commission and the African Tax Administration Forum. As lead economist, Arthur drafted the thematic chapters of the AEO 2017 on Entrepreneurship and Industrialisation, AEO 2016 on Sustainable Cities, AEO 2015 on Regional Development. Before joining the OECD, Arthur contributed to the UNDP's flagship Human Development Reports. He worked in Abidjan during the electoral crisis in 2010 and 2011, monitoring West Africa's economic outlook for the United Nations Operations in Côte d'Ivoire (ONUCI). Prior to that, he taught economics and international relations in several British universities and gained private sector experience with Wolters Kluwer Transport Services. Arthur holds a PhD from the London School of Economics (LSE) and a Franco-German double diploma from Sciences-Po Lille and the University of Münster.

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