Formalizing Informal Borrowers Vs Formalizing Informal Lenders.
Overview
I co-own and for over nine years manage a small ICT Agency in Uganda East Africa. In 2015 we won a government contract to supply software and equipment, but didn’t have the funds to execute it. We talked to Banks but were ignored as we lacked collateral and our account activity didn’t merit a loan. We resorted to friends and family, but it was frustratingly disheartening. Someone gives you a “yes” today the next day you get “the number you have called is currently unavailable”. Another gives you a date within 2–3 weeks and when it reaches he is like “ah my wife was against it, I should have told you earlier.” Meanwhile the deadline is fast approaching. One OB even talked to his boss who gave us $5000 because he trusted him.
Nonetheless we finally managed to gather the required amount though far beyond the delivery deadline. We delivered, and after less than 2 months received payment, and gave our micro-investors their principle and agreed shares of the profit as a percentage of their investment and everyone was happy. No high interest, No collateral. We have also manually connected dozens of small companies to micro-investors in our network to fund and execute their contracts and purchase orders.
The above story profiles the business terrain across Africa and other developing economies. With banks preferring to lend government whose domestic borrowing in the 2017/18 budget increased by 175.7% for Uganda, this is getting worse. This notoriety is but a drop in the ocean of challenges of the MSME ecosystem in Africa which is manned by over 75% youth and women. This is why in Uganda despite being ranked (at entrepreneurial activity of 35.5%, compared to USA’s 13.8%) the world’s most entrepreneurial country by the Global Entrepreneurship Monitor, only a handful live to celebrate their first birthday.
Millions of especially Youth & women Micro, Small and Medium Enterprises (MSMEs) in developing economies are notoriously choking on hard-to-access, unethical and costly credit finance even for low risk opportunities yet these same economies have billions of unexploited financial assets on personal bank accounts.
These MSMEs are hard-pressed to find only US$ 2.1–2.6 trillion but on the flip-side, over US$ 19 trillion is sitting on personal bank accounts as global gross savings. A chilling less-than 7% of the 106–134 Million MSMEs in developing economies are well-served according to World Bank IFC data. And an average of 70% of MSMEs identify access to and high cost of credit as a major/severe barrier to their growth.
But being the problem solvers humans are, several initiatives from social or impact investors, governments, private sector, development partners, and regulators among others are aggressively attacking this credit problem along its value chain and from all angles but one. Using new advances in technology these innovative initiatives are slowly creating impact along three dimensions, customer acquisition for scale, data science and analytics for underwriting, and new loan funding mechanisms.
All these dimensions are essentially tailored to formalise MSME borrowers to access credit from financial institutions, but progress is rather slow. Using evidence from previously technology-disrupted sectors and technologies of ambition, I argue that focusing on formalising informal lenders to lend as opposed to formalising informal borrowers to borrow from financial institutions will skyrocket access to credit and reduce the credit gap 10 times more than the current 1.5% annual rate, but first why should we care about reigning in on the MSME credit gap.
Why closing the credit gap is Important?
There is overwhelming research and data that the world economy is founded on MSMEs, needless to say corporate companies were once SMEs. According to the World Bank, formal MSMEs contribute up to 33 percent of national income (GDP) in emerging economies, and the numbers are significantly higher when informal MSMEs are included. In emerging markets, most formal jobs are with MSMEs, which create four out of five new positions. But if an SME can’t access credit when it needs it, it will be constrained to sustain even two employees.
SME Access to credit is directly proportional to;
- The number of employees an SME can sustain; which in turn is directly proportional to the number of people (employees & their families) above the poverty-line.
- How much an SME can afford to pay employees; which in turn is directly proportional to how high above the poverty-line employees and their families are.
The depth of the MSME credit-gap manifests in how it proliferates the poverty problem and its key pain points, how these pain-points feed into bigger global problems like desperation leading to deadly immigration journeys to developed countries for greener pastures, social inequities in worse situations leading to violent extremism against perceived aggressors and many more.
I mean, If you are poor you’re limited to poor education, poor health, poor housing, poor feeding, poor anything. Addressing the credit-gap means addressing unemployment which also means addressing poverty which in turn means addressing major global problems like immigration, disenfranchisement and vulnerability to violent extremism among others.
“Many of the newly minted members of the low-income population are at the edge of the global poverty line, living on about $3 daily, perhaps only an economic shock from slipping back into poverty.” PEW Research 2015. The continued existence of a credit gap that huge, suspends over 88 Million MSMEs from sustaining 352 Million jobs which then could sustain 2.816 Billion people at least above $5 a day. This data is extrapolated from World-Bank & IFC surveys.
Income Inequality is another reason we need to close the credit-gap…
Article Continuing…
