Small and medium-sized enterprises (SMEs) are the backbone of the Kenyan economy — they provide work to nearly 15 million Kenyans and account for 24% of the country’s gross domestic product (GDP). Despite their financial contribution, SMEs face considerable challenges primarily due to their informality.
According to the Kenya SME market, only 13% of SMEs can qualify for financing. There’s a considerable gap in funding between microloans and larger commercial lending. The main form of financing accessible to African SMEs is usually debt finance, in the form of collateralised bank loans. These are often unsuitable for many small businesses as they lack collateral, don’t generate enough income or leverage new innovative business models.
Other factors such as; inadequate credit information, low financial literacy, physical remoteness and gender discrimination, also contribute to SMEs’ lack of access to financing.
Governments, non-governmental organisations (NGOs) and the private sector in Kenya are trying to fund this gap but are still only catering to a small part of the market. There’s a need for more efforts and targeting beyond high-growth companies in this space. Funding options need to be redesigned to meet the needs of evolving SME markets in Kenya.
Needless to say, the COVID-19 pandemic has only widened the financing gap. SMEs were among the hardest hit businesses in the height of the pandemic — with studies showing that nearly half of SMEs recorded a decline in performance between September and October 2020 as a result of the measures taken to contain the spread of the pandemic.
Bridging the gap of SME financing through FinTech
Financial technology (FinTech) came into use during this time with many digital lending platforms responding quickly to the surge of loan applications triggered by business shutdowns and layoffs.
FinTech is playing a critical role in financial inclusion, bringing the ‘unbanked’ into formal finance. This has been key in providing financial products and services to traditionally risky segments.
Additionally, FinTech is improving access to finance for SMEs through new business models or using technology to adapt existing ones. Technology can be the answer in enabling new and old forms of finance to reach these businesses. Some of the ways FinTech firms facilitate SMEs’ access to funding are:
- Alternative credit scoring: Using alternative data such as social media networks or mobile phone contacts to expand credit access to those who might not have a good (or any) credit score.
- Factoring: A business sells its accounts receivable — a historically cumbersome and expensive form of finance made simpler and cheaper through technology.
- Equity crowdfunding: Small investors take a share of the equity of the business in exchange for funding — this is similar to the public issuance of stock but without the high barriers to entry.
- Rewards-based crowdfunding: Funding is provided in exchange for a reward, opening funding to businesses that may not be able to offer a financial return or investment. Some examples of rewards include a first run of products or film credits.
- Marketplace and peer-to-peer lending: Loans are pooled or made directly using an online platform offering a new source of funding.
- Digital versions of existing tools: Expanding the reach of traditional tools such as rotating savings and credit associations and microfinance through technology.
Other FinTech business offerings include:
- Providing tools that provide financial and business education alongside transactional services to support SMEs in developing business plans and financial statements that assist with getting loans.
- Basic lending through digital channels.
- Connecting angel investors with SMEs digitally.
SMEs see the value of FinTech first-hand as digital lenders offer business models that are easier, faster, more cost-effective and transparent. In addition, the use of advanced analytics and artificial intelligence to process transactional and alternative data have enabled SMEs to use data to improve access to financing.
Despite all these benefits of FinTech in increasing financial access to the underserved, the use of these innovative technologies remains relatively limited compared to traditional debt finance. One of the reasons for this is that these options are mostly accessible to SMEs with financial and digital literacy, and those with access to reliable information and infrastructure.
Moreover, alternative financing such as equity crowdfunding comes with inherent risks — investors risk losing their money, there’s also fraud risk, information leak risks and cyberattack concerns. The design of regulatory bodies is vital but incomplete and inconsistent.
FinTech could be the bridge in narrowing the SME funding gap, but it will need to be strengthened through wider financial literacy, access to digital information and tools and the development of policies and standards in the space.