High cost of credit slowing growth of Kenya’s SMEs, says World Bank

Mark Nyongesa started his business four years ago, a marketing firm that focuses on viral strategies in online marketing. His company landed a big client last year as the elections were approaching.

“To execute this project we needed to buy video equipment, and at least six computers capable of live streaming. But when we approached a bank for a Ksh500,000 ($5,800) loan, they said it was a ‘high risk’ venture and turned us down,” he said.

“They also asked us for surety in the form of title deeds, physical assets and the like. But my firm only needed ideas, computers and people to run it. All the computers, our major physical assets, are worth much less than Ksh500,000 ($5,800). So we didn’t have any surety to give them.”

Nyongesa had to borrow from friends to execute the contract. Like many small and medium-sized enterprises (SMEs) in Kenya, one of his biggest problems has been securing cash flow for day-to-day operations.

“The problem with most SMEs is that we have very low cash reserves; we’re constantly chasing one client or another to be able to pay our bills. But even getting an overdraft facility from a bank still requires title deeds and log books. It’s much easier to approach friends, family and private investors than a bank.”

Nyongesa’s experience reflects that of many SMEs in Kenya, which are still finding it difficult to access credit. This is despite an expansion in lending to SMEs by commercial banks and dedicated SME sub-units in most banks, a new report from the World Bank shows.

The latest Kenya Economic Update — the ninth in a series of bi-annual reports on the state of the Kenyan economy — says that although financial inclusion is increasing and Kenyan banks are ahead of their counterparts in terms of the share of lending to SMEs in their portfolios, the high cost of credit is constraining the growth of SMEs.

This corroborates earlier data released by the World Economic Forum (WEF), which showed that Kenyan businesses cite access to financing as the second-most problematic factor in doing business.

“Several critical areas need to be addressed to reduce the cost of credit, including the factors that influence the pricing of bank loans, better credit information sharing, and diversifying sources of financing for SMEs,” said Smita Wagh, senior World Bank financial sector specialist for Kenya and one of the lead authors of the report.

The World Bank singles out the high interest rate spread — the difference between the interest charged by banks on loans and the interest paid by banks on deposits — as one key factor constraining credit access.

This perception of high spreads, coupled with the growing profitability of the banking sector, has “left the industry open to repeated criticism of collusive price-setting behaviour,” particularly among the larger banks.

READ: Kenyan MPs push for control over interest rates

High volatility in the pricing of government debt has pushed banks to keep interest rates high when lending to private borrowers, as they lack a reliable way of predicting the expected returns from their investment in Treasury bills, the report states.

Since the macroeconomic turbulence of late 2011, when the economy was beset by a dramatic spike in inflation and interest rates, the banks have displayed an “asymmetric response” to changes in the policy rate, “in which bank lending rates seem to track hikes in the Central Bank rate more closely than reductions,” the report noted.

But the World Bank analysts are quick to say that “no hard rules prescribe the optimal spreads,” and that there is “no definitive way to determine whether spreads are too high, too low or just right,” considering that information on credit history is often incomplete.

However, banks are not the only problem. The poor quality of financial records and high informality lock out many SMEs from accessing credit.

“It’s not all the banks’ fault, we also need to look at the strength of SMEs,” said Ravi Ruparel, senior policy advisor at Financial Sector Deepening Kenya. “They have to have audited accounts, business projections and those kinds of documents to access credit.”

Still, Mr Ruparel says, banks need to learn to speak the language of SMEs, as lending largely remains based on physical collateral, like in Mr Nyongesa’s case.

“Many banks don’t have the skills to properly assess SMEs; they are used to lending to the big companies and using a factory or godown as collateral. So when an SME doesn’t have these things, the banks are not able to engage with them.”

Despite the challenges SMEs face in accessing credit, Kenyan banks still lend more to SMEs than their counterparts in South Africa and Nigeria; SME loans account for 17.4 per cent of total loan portfolios in Kenya’s banks, compared with eight per cent of South African banks and just five per cent of Nigerian banks. SME loans account for 16 per cent of loan books in Rwanda and 14 per cent in Tanzania.

Kenyan banks have been partnering with donor agencies to expand their SME loan books. USAid operates the largest credit guarantee in Kenya, a $70 million programme.

Other development agencies such as the African Development Bank, the European Investment Bank and German agency kfW have all provided lines of credit and partial credit guarantees.

READ: Region’s SMEs to receive $101m in loans

But banks are still finding it too risky to give long-term loans, preferring to lend working capital rather than investment loans. According to the banks interviewed for the report, it takes 190 days to recover bad loans in Kenya, with a recovery rate of 80 per cent; the cost of recovery — including auctioneers, legal fees and so on — is 40 per cent of the amount of the loan.

The environment is better in Rwanda where it takes four and a half months to recover a bad loan, the rate of recovery is about 85 per cent, and the cost of recovery is 10 per cent.

Credit registry

Rwanda’s relative ease of loan recovery is buoyed by a more robust credit information bureau, so the banks are better able to make proper background checks on customers before lending.

The country’s public and private credit registries have information on a combined 15 per cent of customers, an impressive showing in East Africa, according to data from WEF.

READ: Credit fund spurs lending as banks at ease with SMEs

Kenya does not have an operational public credit registry, while its two private bureaus — Credit Reference Bureau and Metropol Credit Reference Bureau — have information on about 20,000 individuals, just five per cent of potential borrowers. Uganda’s private registry covers 4.1 per cent of customers, while Tanzania’s credit information is ranked lowest in East Africa, having neither a public nor a private registry.

The report recommends that SMEs look for alternative financing to expand operations and not only rely on bank loans. Issuing shares on the stockmarket is one way to achieve this.

About 28 per cent of firms surveyed in this year’s Top 100 Mid-Sized Companies survey conducted by the Business Daily, and KPMG, a consultancy firm, said they were considering listing on the Nairobi Stock Exchange, which now has a special segment — the Growth Enterprise Market Segment — for SMEs.

Some 49 per cent of the firms, mostly in the manufacturing, ICT, transport and construction sectors, plan to list at the bourse in the next two to three years.

So far, only one company has listed on the Growth Enterprise Market Segment since its launch last year — real estate firm Home Afrika. The cost of meeting the requirements for listing has been prohibitive, discouraging many firms.