Small and Medium Enterprises have contributed significantly to the overall GDP growth of Ghana. In fact, it is believed to be the engine of growth as far as private sector contribution is concerned. Statistics show that SME contributes about 70% of growth to Ghana’s GDP. Therefore, supporting and sustaining SMEs in business becomes a paramount task for the government as the potential of the SME sector to create job and enhance economic growth cannot be underestimated.
Despite the enormous contributions of SMEs, there has been consistent starving of the sector of finance which mostly stifles the growth of the sector. Research in 2010 among SMEs revealed that just half of SMEs that apply for bank loans are considered, whilst two-thirds of micro-enterprise loans are highly likely to be turned down. One of the major reasons for this demand-supply mismatch in SME financing is the perceived credit risk involved in financing SMEs. This is primarily due to non-availability of valid invoices, proper accounting systems and dearth of known buyers. In order to mitigate this credit risk, higher collateral is sought, which cannot be brought in by many SMEs. Further, due to their small size and local presence, the transaction costs involved in financing them are very high.
Reports also suggest that most SMEs cite the lack of credit facility and the complicated and bulky banking procedures as the constraining factors in accessing banking loans. Earlier research revealed that about 90% microenterprises and 82% of small enterprises self-financed at the initial stage of their business (start-up) with some support or borrowing coming from friends and relatives. Though the trend is consistent in favour of micro and small enterprises relying on self-financing in starting business, there is somewhat improvement when it comes to medium-size enterprises where the figure draft to 50% of self-financing. Meaning that reliance on formal financing such as bank overdraft rises with the size of the enterprises however, bank loans never featured at all. Furthermore, a similar trend was observed in financing working capital with as much as 80% of microenterprise plowing back profit to run operations and with just 15% relying on bank overdraft. Here, bank loans featured but relative to the size of the enterprise.
In this fast-moving age, another defining factor crippling SMEs’ effort to access bank loans are low skilled management and technology savviness. Thus, the inability for the SMEs to inculcate professional management practice in their operation imbibes less confidence in banks in their inability to manage the issued facility well and the lack of adopting technology also plays a negative role. It is important to note that SMEs mostly fall within the informal sector without a real management structure and good governance practice. And most importantly, government consistent borrowing on the domestic market harms the ability of SMEs to apply for loan as it pushes up interest rate forcing banks to also rise base rate making the cost of money expensive for SMEs.
Loans from banks are the most common source of external finance for many MSMEs which are often heavily dependent on traditional debt to fulfill their start-up, cash flow and investment needs. Albeit it is commonly used by small businesses, however, traditional bank finance poses challenges to MSMEs, in particular to newer, innovative and fast growing companies, with a higher risk-return profile.
Inadequate funding also exists for companies undertaking important transitions in their activities, such as ownership and control changes, as well as for SMEs seeking to reduce debt and improve their capital structures. The long-standing need to strengthen capital structures and to decrease dependence on borrowing has become more urgent, as many firms were obliged to increase leverage in order to survive the recent economic and financial crisis. Indeed, the problem of SME over-borrowing may have been worsened by policy responses to the crisis, which tended to focus on mechanisms that enabled firms to increase their debt.
While bank financing will continue to be crucial for the SME sector, there is a broad concern that credit constraints will simply become “the new normal” for SMEs and entrepreneurs especially following the recent developments around the DDEP and the effects on commercial banks. It is therefore necessary to broaden the range of financing instruments available to SMEs and entrepreneurs, in order to enable them to continue to play their role in investment, growth, innovation and employment.
In order to achieve the above-mentioned objectives, the banks can collaborate with government or government institutions in the field of technology to identify, collect and properly define the activities of SMEs with the aim of streamlining the activities of SMEs and the approach to lending to this critical sector.
Why should we increase funding to the SME sector?
Small and Medium Enterprises (SMEs) works as an impetus to boost up national income as well as to generate employment opportunities since the sector is labor-intensive and less time consuming for production with less capital expenditure and lower establishment cost. Like other developing countries, Ghana has a great potential for the development of the SME sector which will go a long way to transform Ghana into an industrialized developed country.
Access to finance by SMEs in Ghana will promote a balanced economic development. The trickle down effects of large enterprises is very limited in contrast to small industries where their contribution to economic growth are more visible. While the large enterprises seem to have had the biggest negative impact during the recent economic issues, small enterprises have succeeded in fulfilling the socialistic goals of providing equitable growth. One cannot discount the importance a strategic growth in the SME sector will have on industrialization of rural and backward areas, thereby, reducing regional imbalances, and eventually assuring more equitable distribution of national income.
In summary, the support to SMEs must be enhanced to ensure that this sector continue to play their dual socialistic roles of equality of income and balance regional development. With the meagre investment in comparison to the various large scale private and public enterprises, the SMEs are known to be more efficient in providing more employment opportunities at relatively lower cost.
Policy issues and way forward
The Government of Ghana, through the Ministry of Trade & Industry, came out with an MSME and Entrepreneurship Policy in 2019. This is composed of a myriad of carefully structured policy prescriptions aimed at reforming the MSME sector and harmonizing government interventions to create sustainable growth pillars for the sector. Underpinning this policy are 9 clear objectives which are all in sync with the 2017-2024 Coordinated Program for Social & Economic Development Policies.
To ensure full benefit of the policy objectives and implementation thereon, it is imperative to regroup the objectives into 3 main broad issues namely supportive policies and conducive environment; sustainable and effective institutions; and access to financial & business related services of destitute/underprivileged but potential entrepreneurs.
An effective implementation of the policy guidelines will be achieved if government will ensure an improved SME- friendly environment by increasing the scope of institutional funding in SME sector, development of requisite infrastructure and productive strategy, and linking SMEs with large industries.
Again, in order to make SMEs stand tall in the event of stiff competition from foreign enterprises, government should introduce reforms in credit, marketing, labour, rehabilitation and exit policy, infrastructure, technology and skill development and taxation areas. If government can ensure a double digit growth for the SMEs, it would definitely help in achieving the long cherished goals of equality of income and promoting the growth in rural hinterlands and stop the avoidable migration to the urban areas.
Financial Institutions on the other hand must innovate and improve their funding approach to the SMEs. Digital lending based on data driven decisions and risk scoring must be emphasized in lieu of collateral and strict documentary lending which is quite restrictive and costly to SMEs. Financial transaction data, provided by open banking, would make it possible to check, in real time, the presence of liquidity in a bank account and its evolution up to the present time. There is the need to collaborate with the FINTECHS to ensure financial inclusion which is very vital. Shared data can provide risk management teams with the ability to score a company on its capacity to generate revenue. A business’ liquidity and transaction data can be measured by the transactions in its bank account everywhere. It is this data that is the most relevant and important now.
Specific effort should also be devoted, by financial institutions, to improving the factual base on market trends and diffusion of non-debt financing instruments, to complement the information on SME access to finance from the Financing SMEs and Entrepreneurs.
For the country to achieve a possible double digit growth in SME contribution to the national cake in the short to medium term, both government and financial institutions must work together to achieve the following among others:
- Improving business environment and institutional frameworks;
- Increasing the scope of SME sector to receive institutional funding facility;
- Innovating around both conventional and unconventional ways of lending to SMEs;
- Expanding women entrepreneurial development programs and providing specialized services;
- Increasing the use of ICT and other technologies. The role of FINTECHS is paramount here;
- Supporting short-term, low cost SME business support services to the start-ups.
The writer is the Chief Risk Officer, UBA Ghana
