SURVEY REPORT ON ALTERNATIVE FINANCE FOR MSMEs
SURVEY REPORT ON ALTERNATIVEFINANCE FOR MSMEsSURVEY REPORT
2SCOPINGREPORTSURVEYAND ASSESSMENTON ALTERNATIVEREPORT – MSMEFINANCETOACCESSFORFINANCEMSMEs ECOSYSTEM IN AFRICACONTENTSEXECUTIVE SUMMARY3INTRODUCTION4SME FINANCE WORKING GROUP SURVEY11PRINCIPLES FOR ALTERNATIVE MSME FINANCE14Principle 1: Establish clear and comprehensiveregulations governing all forms of access to financeavailable to MSMEs15Principle 2: Establish a sound, comprehensive,enforceable and fair legal framework17Principle 3: Market conduct/client protection18Principle 4: Credit infrastructure19Principle 5: Outreach and market engagement19Principle 6: Data Protection and Cybersecurity Risks20Principle 7: Coordination with other regulators andministries20Principle 8: Authorities should ensure that grants(from governments and other sources) are managed in amanner that is beneficial to the target market21Principle 9: Development of the capital market in aMSME-friendly manner21COUNTRY EXAMPLES OF ALTERNATIVE MSME FINANCEREGULATIONS AND INTERVENTIONS22CONCLUSION27ANNEXURE A: DETAILED RESPONSES TO THE SURVEY28ANNEXURE B: DEFINITIONS OF ALTERNATIVEMECHANISMS AND TERMS35BIBLIOGRAPHY37 2020 (December), Alliance for Financial Inclusion. All rights reserved.ACKNOWLEDGMENTSThis survey report is a product of the SME Finance Working Group(SMEFWG) and its members.Authors:Group members: Peter Owira (Subgroup Leader) SASRA, Kenya,Jason Barrantes (SUGEF, Costa Rica), Gul Badshah (Da AfghanistanBank, Afghanistan), Olga IIyukevich (National Bank of the Republicof Belarus, Belarus), Ugyen Choden (Royal Monetary Authorityof Bhutan, Bhutan), Marie Thérèse (Banque de la République duBurundi, Burundi), Ismail Adam (Bank of Ghana, Ghana), ElijahOsha/Sale Lukman A. (Central Bank of Nigeria, Nigeria), KalubiKayembe/Kikata Kiowe Cynthia (Banque Centrale du Congo,Democratic Republic of the Congo).Contributors:Peter Owira (Subgroup Leader, SASRA, Kenya) and Jason Barrantes(SUGEF, Costa Rica). From the AFI Management Unit: Nik Kamarun(Senior Policy Manager, SME Finance) and Taty Azman (PolicyAnalyst). Roelof Goosen (Independent Consultant).We would like to thank AFI member institutions, partners anddonors for generously contributing to development of thispublication.Tailor in a clothing production room. (Photo by Odua Images/Shutterstock)
3SURVEY REPORT ON ALTERNATIVEFINANCE FOR MSMEsEXECUTIVE SUMMARYThe objective of this report is twofold: To share the insights from an AFI SME Finance Working Groupsurvey undertaken in 2019 on the state of alternative MSMEfinance in the AFI network. To provide guidelines and country examples to regulators andother authorities on the issues to consider when developingalternative MSME finance.The report reflects on the economic and social importanceof the MSME sector in emerging economies. It explores thesignificance of available research on the MSME finance gap, i.e.the difference between what access to finance is available toMSMEs and the level of financing that they actually require. Thereport analyzes the reasons for this and the growing role thatalternative MSME finance mechanisms play to overcome theproblem and to increase efficiencies in the market.The survey results are summarized, largely reflecting theresearch insights. The survey identified three primary challengesexperienced in the AFI network with MSME alternative financing,namely the lack of market awareness, lack of trust and theconsequent low take-up of these mechanisms. Leasing, factoringand grants are identified as the three most commonly availableand used alternative financing mechanisms.The insights from the research and from the survey are thencombined to identify principles that regulators and otherauthorities should consider and to guide them when planning tostrengthen and develop alternative MSME finance market. Theseprinciples address regulatory and legal frameworks, marketprotection and the supporting environment that is necessary totake alternative financing forward.The report concludes with examples from a few countries tofurther illustrate what can be achieved and provides a highlevel roadmap of the steps necessary for countries to usealternative financing to improve the growth prospects of MSMEs.
4SURVEY REPORT ON ALTERNATIVEFINANCE FOR MSMEsINTRODUCTIONMicro, small and medium enterprises(MSMEs) play a major role in mosteconomies, particularly in thedeveloping world. The sector is rightlyviewed as the engine of economicgrowth in many countries. It provides,particularly at the micro enterpriselevel, an on-ramp to economicparticipation that is often the onlypathway out of poverty available todisadvantaged households.MSMEs constitute 90 percent of all businesses andmore than 50 percent of employment globally.1 Inemerging economies formal MSMEs contribute up to 40percent of national income (GDP). In these countries,informal MSMEs form a sizable portion of enterprises,for a variety of reasons. If the contribution of suchenterprises is also taken into account, then the MSMEsector’s contribution to GDP is significantly higher than40 percent. In the next few decades, a large numberof new jobs will be required to absorb the growingworkforce – an estimated 600 million new jobs arerequired by 2030, with most of these in the emergingworld. As MSMEs have been creating most of the formaljobs (7 out of 10) in emerging markets, the burdento provide additional employment will fall heavilyon this sector. Consequently, MSME development hasbecome a high priority for many governments, witha variety of supporting structures in place. However,MSME development is still hampered by a relativelyconstrained access to finance, which inhibits growthand job creation in the sector. It is the second mostcited obstacle in growing an MSME business. Althoughtraditional sources of access to finance, typically banksand similar institutions, have been growing over thelast decade, this growth has been insufficient to meetthe increase in demand from the sector in emergingeconomies.MSMEs are not only an engine that drives economicgrowth, it is also a major conduit for reducing genderinequality. Women entrepreneurs play a critical rolein the MSME sector, contributing to economic growthand job creation.2 Women-owned businesses constitute23 percent of MSMEs and account for 32 percent ofthe SME finance gap (see below). Women own aboutone-third of micro and small enterprises (less than 50employees) and one-fifth of medium-size enterprises inemerging countries (50–250 employees). Women-ownedenterprises are more likely to be informal than maleowned enterprises. The majority of the women-ownedMSME finance gap is in the low-income and lowermiddle income countries, where it represents morethan 50 percent of the total finance gap on average.Based on the World Bank studies, the higher the accessto bank accounts and lending to women, the higherthe share of female-led businesses.3 These marketrealities point to the fact that women-led MSMEs aremore credit-constrained than male-owned enterprises,although women are able to directly convert access tofinance into sustainable enterprises.Women-owned MSMEs and MSMEs from vulnerable andunderserved groups also face significant non-financialbarriers that exacerbate the challenge to obtaincredit and other financial services. Such MSMEs tendto have disproportionately lower access to collateraland they are often overlooked as viable businesses byfinancial service professionals. Non-financial barriersinclude social and cultural norms manifesting in genderbiases, where women are traditionally not associatedwith running an enterprise. Other barriers includegaps in legal frameworks and property rights that mayconstrain women from entering into contracts. Limitedaccess to business education opportunities and limitednetworks that enable access to business opportunitiesare frequently experienced by women. Biases anddiscrimination can also affect other underserved groupsand can be a factor in the financial exclusion of smallbusinesses.470 %Some 70 percent of formal women-ownedMSMEs in emerging economies are eitherexcluded by financial institutions or areunable to receive financial services toadequately meet their needs.This results in a growing credit deficit for women-ownedMSMEs. The challenge requires a holistic public andprivate sector approach, which should aim to providesustainable and beneficial support that will result intailored financial services, and financial infrastructuresthat will directly and uniquely benefit women-ownedMSMEs and MSMEs owned by vulnerable and underservedgroups.1 https://www.worldbank.org/en/topic/smefinance2WBG (2017), Women’s Entrepreneurship Facility3GPFI (2020), Promoting Digital And Innovative SME Financing4GPFI (2020), Promoting Digital And Innovative SME Financing
5SURVEY REPORT ON ALTERNATIVEFINANCE FOR MSMEsTABLE 1. DISTRIBUTION OF MSMEs BY FINANCIAL CONSTRAINT LEVEL, %MIDDLE EASTAND NORTH AFRICAEUROPE ANDCENTRAL ASIAUnconstrained66,1Unconstrained72,6Partly Constrained14,3Partly Constrained12,9Fully constrained19,6Fully constrained14,5SOUTH ASIAUnconstrained46,4Partly Constrained17,9Fully constrained35,7LATIN AMERICA ANDTHE CARIBBEANUnconstrained78,6Partly Constrained11,6Fully constrained9,8EAST ASIAAND THE ly Constrained18,2Fully constrained22,2Source: IFC (2017) SME Finance GapUnconstrained47,9Unconstrained58,3Partly Constrained39,3Partly Constrained7,8Fully constrained12,9Fully constrained33,9
6SURVEY REPORT ON ALTERNATIVEFINANCE FOR MSMEsThe difference between the estimated demand oraccess to finance and the extent to which this demandhas been met is termed the MSME finance gap. TheInternational Finance Corporation undertook a numberof studies to determine this gap, with the latest studydone in 2017.5 This study is based on multiple datasources and covers 128 countries. According to thestudy, the potential demand for MSME finance in theemerging economies is estimated at US 8.9 trillion,compared to the credit supply of 3.7 trillion. The MSMEformal finance gap from formal MSMEs in these emergingeconomies is therefore estimated at 5.2 trillion. Thegap is equivalent to 19 percent of the gross domesticproduct (GDP) of the countries covered in the study. Thisis 1.4 times the current level of MSME lending in theseeconomies, or more than double the current lendingtotal. In addition, there is an estimated 2.9 trillionpotential demand for finance from informal enterprisesin these countries, equivalent to 10 percent of the GDP.40%The study estimates that 40 percentof all enterprises in the 128 reviewedcountries face significant constraints inobtaining finance.The percentage of enterprises with fully-met financingneeds (unconstrained), with financing needs onlypartially met (partially constrained) and with financingneeds not met at all (fully constrained) are shown inTable 1 above.There are many reasons for the large gap in MSMEfinancing.6,7 The cost to reach and serve MSMEs relativeto the revenue potential that banks can achievefrom them as customers; information asymmetriesor the absence of traditional data used by banks toassess creditworthiness; lack of collateral; onerousdocumentation and application requirements andweak creditor protection. These factors may makeit more difficult for financial institutions to assessthe credit risk of MSMEs, to monitor MSMEs and toenforce repayment. Information asymmetry stemsfrom the reality that MSMEs often have less availableinformation, such as regular and complete financialstatements, as compared to larger enterprises. Thismakes it difficult for banks to appropriately evaluateand monitor the credit risk posed by MSMEs. A relatedissue is the lack of available (shared) credit informationfor MSMEs in many emerging markets. From a MSMEperspective, the high cost and limited availability ofsuitable financial products make it difficult for theseenterprises to obtain financing. The lack of acceptablecollateral is also a major barrier to access finance;in emerging markets, many banks would only lend toMSMEs that have available collateral. In most emergingmarkets, informality represents a major barrier tofinancial access for MSMEs in general and particularlyfor access to finance.Further evidence is available in many of the researchstudies that have been undertaken in the MSME financespace. The European Investment Bank’s survey of thebanking industry in Africa provides a perspective onhow banks perceive the issues around MSME accessto finance.8 The 2019 survey amongst African banksrevealed that banks are planning to expand their loanbooks, with particular emphasis on MSMEs, as thatis perceived as a growth area. However, banks alsoidentify some specific constraints to MSME lending:a shortage of bankable projects, a lack of effectivecollateral, a lack of managerial capacity, informalityand a high default rate amongst MSMEs. The results ofthe survey response are shown in Graph 1 below. Banksidentify credit guarantee schemes as an importantmechanism to mitigate some of the risk but are of theopinion that the available schemes typically do notmeet their requirements.The COVID-19 pandemic has and will continue to havea negative effect on MSMEs in the developing world.In some countries, the severity of the pandemic led tolockdowns and a severe dampening of economic activityin countries. This puts additional strain on alreadychallenged MSMEs to cope in a situation of decreasedor no revenue, resulting in a weakening of the sectorfinancially. Even in countries where the local impactof the pandemic was less severe, the reduction ininternational trade is having a disproportionate effecton MSMEs. This reality is highlighted in the findingsin the SME Competitiveness Outlook.9 This study findsthat the lockdowns in China, the European Union andthe United States that have had the greatest impacton trade. Together, these three economies account for63 percent of the worlds’ supply-chain imports and 64percent of supply-chain exports.The report estimates that the disruption of thesemanufacturing hubs will amount to a reduction of 126billion in global trade volume in 2020. This disruptionis having a negative knock-on effect on emerging5IFC (2017), MSME Finance Gap6 GPFI (2020), Promoting Digital And Innovative SME Financing7 European Investment Bank (2020), Banking in Africa - financingtransformation amid uncertainty8 European Investment Bank (2020), Banking in Africa - financingtransformation amid uncertainty9 International Trade Centre (2020), SME Competitiveness Outlook 2020 –The Great Lockdown And its Impact on Small Business
7SURVEY REPORT ON ALTERNATIVEFINANCE FOR MSMEseconomies. For example, the study predicts thatAfrican exporters are set to lose more than 2.4 billionin global industrial supply-chain exports as a resultof the global disruption in manufacturing and relatedindustries. The survey supporting the study was carriedout in the first few months of the pandemic. More than55 percent of businesses globally had been significantlyaffected by the pandemic and the responses to thepandemic in that period. However, the effects weremore severe for smaller businesses. Two-thirds of microand small firms said that the crisis had affected theirbusiness operations, compared with 40 percent of largercompanies. One-fifth of SMEs said that they were at riskof shutting down permanently within three months atthe time of the survey.The current situation regarding MSME access to financerequires the addition of different approaches to meetthe growing demand for MSME finance. Traditionalfinance (from banks and similar sources) has beengrowing steadily but have been unable to reduce theMSME finance gap, have not adequately addressed theaccess to finance problems faced by women and othervulnerable groups, and is unlikely to deal with theanticipated increased demand from MSMEs as a result ofthe COVID-19 pandemic. Authorities in many countrieshave established a variety of measures to supportthe economy, including direct support to MSMEs, butthis is generally insufficient to deal with the impactof the pandemic and will not deal with the structuralshortcomings in the market with regards to MSMEs’need for finance. This will leave MSMEs in the currentsituation where the bulk of required funding has tocome from own resources. This is illustrated in Graphs2 and 3, showing the sources of funding used by MSMEsglobally, split by investment or initial funding andworking capital or operational funding.GRAPH 1: MAIN OBSTACLE TO SME LENDING, %44 238Lack of collateralLack of managerial capacity of SME7Lack of information (financial or ID)High default rate11Lack of credit reference bureausRegulatory / legal barriersQuality of asset portfolio17High competition17Source: EIB (2019), Banking in Africa financing transformation amid uncertaintyGRAPH 2: FINANCING OF INVESTMENTS, %45GRAPH 3: FINANCING OF WORKING CAPITAL, %724511Internal fundsInternal fundsBanks1474Supplier creditEquityOther sourcesSource: World Bank Ghana Office (2016), Access to Finance for SMEs11BanksSupplier creditOther sources
8SURVEY REPORT ON ALTERNATIVEFINANCE FOR MSMEsThe relatively low level of external funding indicatesthat there is a need to strengthen and expandalternative finance mechanisms for MSMEs. Giventhe expectations from the sector in terms of economicgrowth and job creation, improving access to finance forMSMEs is crucial for countries in emerging economies.As traditional finance has not been able to reduce thefinance gap to a meaningful extent, alternative financemechanisms are required. This approach is necessary toaddress some of the constraints that currently exists inthe MSME finance ecosystem. Some of the alternativemechanisms can be used to reduce the impact of thoseconstraints, thereby improving the levels of finance thatare accessible to MSMEs.The types of alternative finance mechanisms consideredin this guideline note are the following: Digital finance- Equity-base crowdfunding, debt-basedcrowdfunding, rewards-based crowdfunding- P2P lending The use of the capital market- Equity finance- Angel capital- Venture capital- Mezzanine capital- Initial coin offering (ICO) Finance mechanisms from banks and finance housesother than secured loans- Leasing & Factoring (asset-based financing)- Non-secured loans, supply-chain financing GrantsThe mechanisms and terms mentioned above aredefined in Annexure C below (to follow).Traditional debt finance generates moderate returnsfor lenders and is therefore, appropriate for lowto-moderate risk profiles.10 It typically sustains theordinary activity and planned short-term needs ofMSMEs, generally characterized by stable cash flow,modest growth, tested business models and accessto collateral or guarantees when needed. Financinginstruments that is an alternative to straight debt,changes this traditional risk-sharing mechanism andcould therefore be more appropriate during periodsin the growth cycle of MSMEs, where traditional debtis not suitable. The mechanisms differ in terms ofthe associated risk, with the risk increasing fromasset-based lending, to alternative debt, to hybridinstruments and then to equity-based finance andplatforms for public listings of MSMEs.10 OECD (2015), New Approaches to SME and Entrepreneurship Financing:Broadening the Range of InstrumentsTABLE 2: GROWTH CYCLES OF MSMEs AND CREDIT PROVIDERSLIFE CYCLE OF MSMESTART-UPEXPANSIONSTEADILY GROWINGINVESTORSINVESTORSINVESTORSFounders, friends & family,MFIs, asset-based financingAngel investorsBanksVenture capitalInstitutional investorsBanksListed large firms withsufficient investmentexperienceAngel investorsVenture capitalSource: The table is based on United Nations ESCAP (2017), Small and Medium Enterprise Financing
9SURVEY REPORT ON ALTERNATIVEFINANCE FOR MSMEsOne view of how different types of debt match onto lifecycles of MSMEs is given in Table 2 below. It should
financial access for MSMEs in general and particularly for access to finance. Further evidence is available in many of the research studies that have been undertaken in the MSME finance space. The European Investment Bank’s survey of the banking industry in Africa provides a perspective on how banks perceive the issues around MSME access to finance.8 The 2019 survey amongst African banks .
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