What are the main reasons for micro-business and SME loan default in Sub-Saharan Africa?

In Sub-Saharan Africa – just like in the rest of the world – domestic economies are generally reliant on huge numbers of micro- and small- and medium-sized businesses (micro-businesses and SMEs) for the bulk of their employment. However, the faster economic growth witnessed by many Sub-Saharan African countries over the past decade has not resulted in a proportionate increase in jobs or in a more equal distribution of wealth. Consequently, African governments are currently rethinking the best way of stimulating inclusive economic growth and meeting the needs of communities experiencing rapid urbanisation and an increasing proportion of young people within the population as a whole. Creating and developing SMEs is a key focus of this strategy given their fundamental importance to the economic fabric, however this approach is being severely hampered in particular by poor access to funding.

Removing the obstacle of poor access to funding

Indeed, poor access to financing is the No. 1 impediment to the development of small businesses in Sub-Saharan Africa, ahead of poor governance, insufficient infrastructure or abusive taxation practices.  SMEs are often faced with restricted access to the capital that they need to grow and develop. The supply of such capital – in the form of debt or equity – is inadequate and SMEs are perceived in a negative manner by financial backers. However, it is the risk that SMEs represent and not their legal form that constitutes an obstacle for banks. For many businesses, their ability to access funding is closely tied to movements in interest rates. For the past 15 years, Agence Française de Développement (AFD) has been working in developing countries to improve access to funding for SMEs through a guarantee mechanism known as ARIZ. With diverse data on nearly 7,400 lines of guaranteed credit in the regions in which it does business, AFD aimed to produce a pioneering analysis of the causes of SME loan default in Sub-Saharan Africa. The study was completed in 2019 and highlighted a number of findings. One study, several findings The most important finding reveals that in 50% of all cases, default is due to a single cause while it is due to multiple combined factors (between two and ten factors cited) in the other 50% of cases. The 10 most frequently cited causes of loan default — i.e., applicable in at least 10% of cases — are as follows:

1. Problems with the business’s suppliers, sub-contractors or customers (36% of cases);
2. Poor managerial choices that have a negative impact on the business’s management, organisation, efficiency or profits (29% of cases);
3. Changes in market fundamentals in the course of a project – change in potential market outlets: competition, consumers, shocks to demand, drop in sales, etc. (23% of cases);
4. Financial choices and financing systems (18% of cases);
5. The financial environment;
6. Insufficient expertise of the business manager;
7. Problems related to the local infrastructure or difficulties experienced with the local ecosystem;
8. Awareness by the end beneficiary of the existence of a guarantee mechanism;
9. The bank’s risk appetite;
10. The political and social environment.

First and foremost, SMEs are vulnerable to problems arising from late payment by customers (which include the government) and they suffer from structural shortcomings and a lack of managerial skills, leading to poor management choices (excessive diversification for example) or poor financial decision-making (excessively large loans or cost of debt). They are also sensitive to problems related to local infrastructure (especially roads and energy grids that may be periodically or chronically deficient) as well as to political crises. Environmental crises were not cited very often in the study. Policies to support SMEs (from fast-track procedures for incorporating companies to setting up registries of guarantees) are key to the smooth day-to-day running of a business but they are sorely lacking in most of the countries covered by the study. Similarly, government communication with SMEs concerning support initiatives undertaken is frequently insufficient. For loans taken as a whole, the first payment incident for defaulting companies takes place when 40% of the total loan term has expired. Neither the percentage of the loan guaranteed nor the ratio of collateral/loan amount is a key factor. “Small” loans (i.e., less than €300,000) and larger loans (greater than €300,000) are affected in a very distinct manner. The largest loans are more sensitive to changes in market conditions.   The risk that the guarantee will have to be enforced is very high among businesses that are not already customers of the bank – as high as 64% – however, it is substantially lower when the loan term is between 12 and 24 months. When a business is already a customer of the lender bank, company size has a major bearing on the risk that a guarantee will have to be enforced: companies with less than five employees (9% of the overall sample) have a higher default rate (27%) than those with more than five employees (88% of the overall sample with a default rate of 5%). To a lesser extent, knowledge by the client of the ARIZ guarantee mechanism and the bank’s risk appetite are two recurring factors in default. Lastly, a certain number of factors have no impact on a business’s default risk, namely, the loan amount in euros, nature of the loan, type of interest rate, percentage of loan guaranteed, type of investment, age of the company or the amount of its turnover. It is also worth noting that a disparity was recorded between what our interviewees actually said and the results of the statistical study: if we take the total population of the businesses covered by the ARIZ guarantee, statistically speaking, there was no greater risk of default in any particular sector across the four countries studied. This study provided AFD Group with a better understanding of the causes of SME default in Sub-Saharan Africa, thus enabling it to continually adapt its product offering to boost access to funding for small- and medium-sized businesses.