New SME rating tool to ease small firms’ access to credit

Small and Micro Enterprises (SMEs) have lately become the “heart” of the Kenyan banking sector, surpassing the retail market which in the previous years had been a goldmine for most commercial banks.

During the peak season for the retail market, the rate of lending rose and threshold requirements for lending were lowered.

Intensive marketing strategies were also rolled out to attract more retail borrowers.

Many of the retail customers took advantage of the lowered thresholds and dropped their loan applications at numerous banks to increase their chances of success.

And due to the information asymmetry among banks, they ended up with numerous huge loans beyond their ability repay.

But when the banks sought repayments from these retail customers, the money was not forthcoming.

Debt recovery slumped and soon the global crisis set in.

Soon the retail market became exhausted and further market opportunities only pointed to debt consolidation for the already indebted retail lot.

The fate of SMEs had been left at the mercy of microfinance institutions to provide the start- up capital, a risky venture that banks dreaded and left to the MFIs.

For the few SMEs that have dared to put in their applications for loan facilities to strengthen their working capital from commercial banks, the underwriting system have became even more tighter.

Instead of the loan underwriting system of MFIs, which are only anchored on the three Cs of lending; character, capacity, and capital, they are subjected by banks to five Cs system of underwriting which includes the three , in addition to condition and collateral.

With the latest economic growth trends, many pundits have forecasted that the future of any economy, especially in the service industry in terms of market potential lies in the SMEs sub-sector that is currently growing rapidly in various industries.

The informal nature of their operation has seen a great majority of them operate without proper data and structure on their technical, managerial and financial aspects of their daily operations.

To potential lenders that anchor their credit analysis on these, the risk related to lending to these SMEs is extremely high.

SMEs are low-risk as most of them have niche markets where they have huge growth potential to exploit.

However, they face acute shortage of capital and depend heavily on other sources for funding other than MFIs to provide huge financing to exploit their growth potential.   

Nevertheless, SMEs that have managed to get their credit applications approved have had to pay thigh interest rates charged by their lenders to cater for the risk components while majority have had their applications turned down.

This current situation is similar to what characterised the Japanese financial market back in the years before Standard & Poor’s, the leading global provider of independent research and ratings launched an SME ratings concept in 2005.

The new ratings service focused on the SMEs to enhance their access to credit facilities from financial institutions.  

Today in Kenya, the concept is slowly taking shape with commercial banks eyeing the SMEs market but still scared of the perceived risk.

Local Credit Rating agencies like Metropol East Africa Ltd have developed an SME rating product in the market for the benefit of both the SMEs and the commercial banks seeking to do business.

The SME ratings will help financial institutions with benchmark to use in their credit analysis and lending to SMEs.

This will give them the leverage to explore the potential of SME lending without restricting themselves to the long-held prescribed criteria and lending norms that only suits corporate customers but lock out the SMEs market.

For SMEs, the ratings offer a chance to demonstrate their financial strength and their credit worthiness to the financial market, paving the way for their access to capital and debt market including trade credits.

Business growth

Beyond obtaining access to credit, SMEs rating experience will give the SMEs the insight on their strengths and weaknesses and provide opportunities to enhance their competitiveness in their business growth.

In addition, the rating exercise, which has a component of business evaluation, will equip the SMEs with proper understating of fundamentals of operation and marketing, besides enlarging their managerial skills and best practices in doing business.

The rating exercise exposes the overall health of SMEs in terms of how the business will face competition and what strategies to take to keep afloat in the growth trajectory.

Projected financial performance anchored on strong business fundamentals backed by cash flow statements will form the key indicators of the SMEs creditworthiness.

Soon ,with the adoption of the SME rating in the lending market, the SMEs will be able to exploit their ratings by showing their credit information that in turn will help them to negotiate with potential lenders on loan pricing.

Interested SMEs can apply to a credit rating agency to undergo the exercise where they will provide required information for evaluation and modelling for a rating score as a measure of their credit worthiness.