Micro, small, and medium enterprises (MSMEs) are vital to the economic development of emerging economies. In Kenya, an estimated 7.4 million MSMEs employ over 15 million people.
Despite this significant contribution, Kenyan MSMEs, like those worldwide, face substantial underfunding, hindering their growth potential.
A 2024 Ipsos Kenya research estimates this funding gap at $20 billion. Several factors contribute to this challenge, including difficulties raising collateral, low financial literacy, and concerns about borrowers' willingness and ability to repay loans.
A three-pronged approach is essential to address these issues and stimulate increased funding for MSMEs.
Alternative credit scoring
Traditional financing processes, including credit appraisal, have historically catered for customers with regular, structured income, established credit histories, and existing banking relationships. Many MSMEs don't fit this profile, leaving banks unable to fully serve this segment.
Credit providers' continued reliance on conventional credit scoring is often cited as the primary obstacle to MSME funding. A shift to alternative credit scoring—evaluating creditworthiness beyond traditional credit bureau reports—is crucial to overcome this constraint.
Effective alternative credit scores must address two key factors lenders consider for any prospective borrower: willingness and capacity to repay loans. To better predict these behaviors, credit scores should rely more on third-party data sources than self-reported information.
For MSMEs, mobile money data related to income collection, combined with transaction data from suppliers, could be used to build robust predictive scores. Once an alternative credit score is determined, credit providers should move beyond simply using it for loan eligibility decisions.
The score should also be used to determine loan limits and applicable pricing, based on each MSME's individual risk profile. Because the efficacy of any credit score depends on the data used to create it, the initial score must be continually updated as new data becomes available.
More purpose lending
Capital diversion from business to personal use is a major contributor to non-performing loans (NPLs) among MSMEs in Kenya. High NPL rates discourage banks from lending to MSMEs, often leading to stringent pre-financing conditions like collateral requirements. Many MSMEs struggle to meet these requirements, creating a cycle that widens the financial inclusion gap.
Purpose lending, which involves providing loans for specific uses, offers a promising solution.
Leveraging emerging technologies like digital supply chain platforms, pioneered by Kenyan fintechs such as Solv Kenya, an SC Ventures portfolio company, could help break this cycle. Seamless implementation requires collaboration among key stakeholders: MSMEs, credit providers, and suppliers.
Consider inventory or invoice financing, a lending product designed for acquiring specific inventory for resale. MSMEs place orders with their suppliers and receive digital invoices.
These invoices are digitally routed to credit providers, who then disburse funds directly to the MSMEs' suppliers' bank accounts. This process eliminates the risk of capital diversion.
Following disbursement, suppliers play a crucial role by working closely with their MSME customers to ensure timely loan repayments.
Timely repayments enable MSMEs to secure further financing for restocking, leading to increased sales volumes for suppliers and greater working capital availability from lenders. This creates a win-win scenario for all economic actors.
More financial literacy
Financial literacy, encompassing budgeting, saving and debt management, is crucial for any society's well-being.
In Kenya, it's particularly vital. A 2012 study by the Kenya Institute for Public Policy Research and Analysis demonstrated a strong correlation between financial literacy and access to financial services.
However, a 2021 Global Financial Literacy Survey reveals that only 38 percent of Kenyans are financially literate. This necessitates intensified efforts to improve financial literacy, especially among MSMEs, given their critical role in the economy.
While several financial literacy initiatives exist in Kenya—such as The Chora Plan by the Kenya Bankers Association, Financial Knowledge for Africa by Equity Group and the MasterCard FoundaNKtions—scaling their impact on MSMEs requires strong partnerships and collaboration among government, educational institutions, non-governmental organisations and financial institutions.
Leveraging technology and expanding the curricula of financial literacy toolkits, like the recently launched Safaricom initiative, to specifically address the needs of MSMEs will also significantly enhance literacy levels.
Addressing the challenges faced by Kenyan MSMEs is a long-term endeavor.
However, by embracing alternative credit scoring models, increasing purpose-driven lending, and prioritising financial literacy, we can bridge the funding gap and create transformational impact for underserved MSMEs.
The writer leads fintech engagement in Africa for SC Ventures, the fintech, investments and ventures arm of Standard Chartered Bank. [email protected]
