By Holger Rothenbusch, Managing Director, Debt and Financial Institutions, CDC

It’s well known that small and medium enterprises (SMEs) have an important role to play in the economic development of developing countries. In Africa, they contribute to around 40% of GDP as well as 50% of overall employment. In some sectors, this level of job creation can be even higher – for example, informal and formal SMEs account for about three-quarters of total employment in manufacturing.[1]

However, in order to grow, SMEs need adequate levels of finance. A recent IFC jobs study confirmed that access to finance is one of the top three factors preventing businesses from growing and generating employment in developing countries.[2] Whilst it’s an important factor for all sizes of business, for SMEs it’s the most critical limitation to growth.

Financial institutions can play a crucial role in improving access to finance – they are able to channel capital to specific target markets which are underserved, including SMEs, micro clients, or customers in rural areas.

Yet, currently, banks are not able to provide SMEs in developing countries with the levels of capital they need to grow. The total unmet need for credit by formal SMEs in sub-Saharan Africa is estimated to be between US$80 – US$100 billion, the highest gap when compared with other regions of the world[3]. The top five banks serving MSMEs in non-OECD countries reach only approximately 20% of formal MSMEs and in sub-Saharan Africa, this number is even lower, at 5%.[4]

One of the main barriers faced by SMEs is the attitude of banks towards such businesses. Banks view SMEs as inherently risky for a number of reasons. Many are deterred from lending to SMEs because of the lack of adequate information they are able to provide. Other challenges include SMEs’ level of informality and their inability to provide adequate security. In other words, SMEs require more work – so even though there is potential to achieve significant impact in this sector, banks are discouraged from lending.

Nonetheless, a recent study from the African Development Bank demonstrates that banks have started to develop coping mechanisms to overcome the obstacles which discourage them from lending to SMEs.[5] For example, many banks have established separate units to be more responsive to the needs of their SME clients, in recognition of the inherent differences between SMEs and consumer and corporate clients; and some of them are allocating resources to provide training to their SME clients to improve their management skills and financial reporting. The study concludes that this is promising news for closing the ‘SME financing gap’, and that this trend should be supported and encouraged.

How is this relevant to CDC? Our mission is to support the building of businesses and job creation in Africa and South Asia, and our investments are measured by the difficulty of the geography and the propensity of the business sector in which we invest to create jobs. By focusing on local banks and financial institutions, we’re looking at new ways to get capital to businesses such as SMEs, which we may not be able to directly finance efficiently. Financial institutions have the added advantage of being significant in size and thus able to absorb capital more efficiently. This enables CDC to channel a significant amount of capital to some of the hardest countries in the geographies where we invest.

That’s why we’ve recently invested in banks with a specific remit to finance SMEs. This includes DFCU Bank in Uganda, which focuses on tackling the lack of long-term funding for SMEs in a country where SMEs contribute around 70% to GDP. It also includes a recent investment in RBL Bank in India, which is pursuing an expansion strategy of financial inclusion focused on, amongst others, agribusiness financing and lending to SMEs in a country where 65% of the population do not have access to formal financial services. In making these kinds of investments, we hope to help tackle the huge funding gap that SMEs currently face, supporting them to access the finance they need, to grow, and to create jobs.

[1] Ayyagari, M., Beck, T., and Demirgüç-Kunt, A., ‘Small and Medium Enterprises across the Globe’, Small Business Economics 29, 2007

[2] IFC Jobs Study, 2013

[3] McKinsey & Company, ‘Micro-, Small and Medium-Sized Enterprises in Emerging Markets’, 2010

[4] IFC, ‘Posing the Challenge on SME Finance’, DFI Meeting Paris, March 2011

[5] African Development Bank, Working Paper on ‘Bank Financing to Small and Medium Enterprises in Africa: Findings of a Survey in Kenya, Tanzania, Uganda and Zambia’, 2012