The continually growing credit funds provide financing formulas likely to widen the range of possibilities offered to SMEs on the continent. It is a flexible and tailor-made approach which, far from competing with traditional bank financing, could on the contrary complement it, argues financier Sidoine Viagbo.
By Sidoine Viagbo, Deputy Managing Director of Enko Capital West Africa
Access to credit remains a real problem for small and medium-sized enterprises (SMEs) on the continent. Local banks have a preference for financing mature companies with a certain level of collateral as well as for financing public debt. As a result, this creates very difficult access to credit for SMEs, with very high rates and equally stringent conditions. These companies, therefore, start out with a significant handicap, which can potentially hinder their growth. This phenomenon is even more perceptible in the agricultural commodities sector, with local SMEs struggling to find financing, even though they are able to close deals with international end-buyers, but lack the capital to procure the commodity and secure working capital.
“36% of requests for financing in the agricultural sector are rejected by local banking institutions because of the solvency of their promoter”
As an investment fund, Enko Capital’s strategy is an alternative to traditional bank financing, which is often perceived as “rigid” by many small entrepreneurial structures that are still not very formalized. This probably explains why in Africa and according to data from the African Development, 36% of requests for financing in the agricultural sector are rejected by local banking institutions because of the solvency of their promoter; 30% for lack of sufficient guarantees; 11% because of capital constraints; 9% because of their inability to provide foreign currency; 8% because of a lack of banking credibility and 6% because of the size of the balance sheet. In the case of trade finance, for example, the financing gap in sub-Saharan Africa is estimated by the World Bank at $20 billion.
Tailor-made financing
Banks are unable to fill this gap, for the reasons outlined above. Yet 36% of the transactions rejected by banks could be financed by alternative financial institutions and closing this financing gap would unlock the trade potential of thousands of SMEs. There is a perception that trade finance is high risk, yet the results show that the risk of default is low. In comparison, the financing packages offered by credit funds when financing commodities are often more tailored to SMEs on a purely transactional basis. The same is true for time horizons, where, once again, the key word is flexibility, with financing pledged against existing or future raw material stocks.
“A synergy could be put in place with the funds during this crisis, in order to put this new « business model » for financing VSE/SMEs in the agricultural sector on a permanent footing”
However, these two sources of funding (banks and credit funds) should not be seen as competing with each other. Structured differently, they are first and foremost complementary. The current period, made up of uncertainties born in the wake of the COVID-19 crisis, is in this respect a particularly opportune moment to recall that banks and credit funds would be well advised to work hand in hand, capitalizing on their respective strengths. Unlike banks, credit funds do not have the possibility of obtaining refinancing from central banks. This has limited their room for manoeuvre in difficult times, such as the COVID-19 crisis. The ideal solution would therefore be for traditional credit institutions to make up for this relative « withdrawal » of hedge funds by making good use of the liquidity made available to them by central banks to lend more vigorously to VSE/SMEs, which are in dire need of financing today.Failing that, domestic savings should play a full role and allow credit funds to mobilize capital within Africa itself.
Synergy between banks and credit funds
The continent has the advantage of a rapidly growing population with the emergence of a middle class, seeking financial products and concerned about building up savings for the long term, enabling the financing of African economies through the growth of SMEs and the private sector, thereby creating an increase in household income.
A synergy could be put in place with the funds during this crisis, in order to put this new « business model » for financing VSE/SMEs in the agricultural sector on a permanent footing. Banks would de facto benefit from the funds’ experience with this type of clientele (customer knowledge, origination and transaction structuring), which would lead to better risk sharing, with substantial bank participation in transactions. In addition, partnering with well-known local and international banks to provide senior debt/cofinancing on selected transactions can be beneficial for both parties (banks and funds). As for funds, by investing in partnership with the banks, they would benefit from the banks’ origination capabilities as well as their investment, operational and financial control expertise.
