While we have a number of institutions that are earmarked to help drive growth in the SMEs sector, the major challenge cited by SMEs is access to finance. According to the FinScope MSME Survey of 2012, SMEs in Zimbabwe employ approximately 5.7 million people (2.8 million business owners and 2.9 million employees), representing 73% of the total workforce of 7.8 million. Meanwhile, it is paradoxical that while the SMEs are a key source of economic growth and employment in Zimbabwe, the level of financial inclusion for this sector remains very low.
The same Finscope Survey revealed the following statistics: a) Only 14% of SMEs were banked; 3 b) Only 18% were served by formal financial institutions; c) 39% were served by informal financial service providers; and d) 43% did not have access to financial services. According to the data maintained by the central bank, as at 31 March 2017, a total of $135.83 million credit was extended to the sector constituting a mere 3.78% of the entire banking sector loans and advances.
While a number of barriers affect the SMEs ability to access finances such as inadequate business and financial management skills, lack of acceptable collateral, poor corporate governance structures and lack of critical economic size – there is need to develop innovative ways to finance the SMEs sector.
Local Banks have gone a long way to include SMEs in their services portfolio while the central bank has developed the financial inclusion strategy. A lot needs to be done and lessons can be borrowed from the developed nations. Recently, the Empower Bank was launched with the youth in mind. The bank’s major purpose is to provide ‘social and financial solution’ to the excluded populace and this mainly includes the small businesses. It should not be left to banks alone to finance SMEs activities.
Bank lending remain the most common source of external finance for many SMEs and entrepreneurs, which are often heavily reliant on traditional debt to fulfill their start-up, cash flow and investment needs. While it is commonly used by small businesses, however, traditional bank finance poses challenges to SMEs, in particular to newer, innovative and fast growing companies, with a higher risk-return profile.
While bank financing will continue to be crucial for the SME sector, there is a broad concern worldwide that credit constraints will simply become “the new normal” for SMEs and entrepreneurs. It is therefore necessary to broaden the range of financing instruments available to SMEs and entrepreneurs, in order to enable them to continue to play their role in investment, growth, innovation and employment
One form of such financing could be asset based financing. Through asset-based finance, firms obtain funding based on the value of specific assets, including accounts receivables, inventory, machinery, equipment and real estate, rather than on their own credit standing. In this way, it can serve the needs of young and small firms that have difficulties in accessing traditional lending. Asset-based lending, which provides more flexible terms than collateralised traditional lending, has also been expanding in recent years, in countries with sophisticated and efficient legal systems and advanced financial expertise and services. In particular, factoring (where a business sells its accounts receivable to a third party) has been supported as a means to ease SMEs’ access to trade finance and promote their inclusion in value chains.
Another form of financing which should be explored is alternative forms of debt. Alternative debt differs from traditional lending in that investors in the capital market, rather than banks, provide the financing for SMEs. This will require transparency and protection rules for investors to allow for greater participation and liquidity. Innovative ways could include creation of SME trading venues and participation by unlisted and smaller companies. In some countries, public entities participate with private investors to funds that target the SME bond market, with the aim of stimulating its development. However lack of information on issuers and of standardised documentation, illiquid secondary markets and differences in insolvency laws across industry players and jurisdictions limit the development of these markets.
Crowdfunding is another method of financing that can be considered for SMEs financing. While this form of funding has grown in other countries, it still represents a very minor share of financing for businesses. One specificity of this instrument is that it serves to finance specific projects rather than an enterprise. It has been used in particular by non-profit organisations and the entertainment industry, where non-monetary benefits or an enhanced community experience represent important motivations for donors and investors. Nevertheless, over time, crowdfunding has become an alternative source of funding across many other sectors, and it is increasingly used to support a wide range of for-profit activities and businesses.
Debt securitisation and covered bonds, which also rely on capital markets, had increased at high rates before the global crisis in OECD countries, as an instrument for refinancing of banks and for their portfolio risk management.
There are other financing mechanisms such as hybrid instruments, which combine debt and equity features into a single financing vehicle. These techniques represent an appealing form of finance for firms that are approaching a turning point in their life cycle, when the risks and opportunities of the business are increasing, a capital injection is needed, but they have limited or no access to debt financing or equity, or the owners do not want the dilution of control that would accompany equity finance. This can be the case of young high-growth companies, established firms with emerging growth opportunities, companies undergoing transitions or restructuring, as well as companies seeking to strengthen their capital structures. At the same time, these techniques are not well-suited for many SMEs, as they require a well-established and stable earning power and market position, and demand a certain level of financial skills.
Hybrid instruments and equity financing is usually turned down by SMEs as they fear losing control of the business. However these methods are critical for the growth of the business.
Limited awareness and understanding about alternative instruments on the part of start-ups and SMEs has slowed the development of these financing alternatives and there is need for market information on alternative funding.
It is also necessary to improve the quality of start-up business plans and SME investment projects, especially for the development of the riskier segment of the market. In many countries, a major impediment to the development of equity finance for young and small businesses is the lack of “investor-ready” companies. Furthermore, SMEs are generally ill-equipped to deal with investor due diligence requirements. Indeed, in some countries, an increasing concern about the lack of entrepreneurial skills and capabilities and low quality of investment projects is driving more attention to the demand side, such as training and mentoring.
The regulatory framework is a key enabler for the development of instruments that imply a greater risk for investors than traditional debt finance. However, designing and implementing effective regulation, which balances financial stability, investors’ protection and the opening of new financing channels for SMEs, represents a challenge for policy makers and regulatory authorities. This is especially the case in light of the rapid evolution in the market, resulting from technological changes as well as the engineering of products that, in a low interest environment, respond to the appetite for high yields by financiers.
Information infrastructures for credit risk assessment, such as credit bureaus or registries or data warehouses with loan-level granularity, can reduce the risk perceived by investors when approaching SME finance and help them identify investment opportunities. Reducing the perceived risk by investors may also help reduce the financing costs which are typically higher for SMEs than for large firms.
Dephine Mazambani writes in her capacity as Chief Economist for the Bankers Association of Zimbabwe. For your valuable feedback and comments related to this article, Dephine can be contacted on dephine@baz.org.zw or on numbers 04-744686 and 0773841566