The micro, small, and medium enterprises ecosystem plays a critical role in driving economic growth in many countries worldwide. While there is adequate evidence of the potential of SMEs, most of them struggle to finance their expansion due to factors such as asymmetry of information and credit rationing, in both emerging and developed economies.
Limited finance to SMEs has been identified as the most severe obstacle impeding their growth. As a result, many do not live past their third anniversary.
Among the reasons highlighted are the high cost of credit, limited access, complicated application procedures, and inordinate collateral requirements.
For most SMEs, their growth stage is characterised by on one hand, their resources not meeting their needs and on the other, being unable to mobilise adequate collateral to attract external financing. This reality puts them at a disadvantageous position thus locking them out of the mainstream business expansion realm.
To alleviate this, financial institutions have adopted credit guarantee schemes where appointed lenders use it as a hedge against credit risk for the loans advanced to the SME sector.
In essence, it is a promise from a third party to make good on payments to the fund provider when the borrower defaults, thus reassuring the lender that they will recover at least some of their investment in the event of losses.
In the range of instruments available to promote financing of SMEs, guarantee schemes present an interesting profile in that they fit into the existing financial fabric, without generating competition with institutions on the ground. In turn, this enables SMEs to invest in growth opportunities, improve their competitiveness, and contribute more effectively to the economy.
Benefits of credit guarantee schemes extend far beyond the individual businesses they support. These schemes stimulate broader economic activity by enabling more SMEs to access financing.
This, in turn, fuels innovation, job creation, and economic diversification, leading to sustained economic growth. The success stories of SMEs that have benefited from such schemes are a testament to their effectiveness and potential as catalysts for change.
Moreover, credit guarantee schemes can be crucial in financial inclusion, especially in regions where SMEs represent the only viable economic opportunity for entrepreneurs in underserved or rural areas.
By facilitating access to credit, they can also help ensure that these businesses grow, thereby supporting local economies and reducing income inequality.
While benefits of credit guarantee schemes are clear, it is crucial to acknowledge challenges and considerations involved in their implementation.
Designing an effective scheme requires careful calibration to ensure that guarantees are sufficient to encourage lending without encouraging reckless borrowing.
There is also a need for transparency, proper risk assessment, and efficient administration to prevent misuse of funds and ensure that the benefits of the scheme reach the intended beneficiaries.
To maximise the impact of credit guarantee schemes, banks should focus on developing products that align with the needs of SMEs.
This could include creating loan products with flexible repayment terms, reduced interest rates, and simplified application processes that consider the realities of small business operations.
By offering products that are specifically designed for SMEs and backed by credit guarantees, banks can significantly enhance the accessibility of finance for these businesses.
As the SME sector continue to show promise, the partnership between banks and Credit Guarantee Schemes will be essential in ensuring that the continent’s SMEs can access the finance they need to thrive.
It is a win-win situation that promises significant returns for businesses, financial institutions, and the economies in which they operate.
The writer is the KCB Group CEO
