#27: On Credit & Africa's $330 Billion Credit Gap.
Hi everyone! Happy New Month and welcome to the second half of the year! I hope the second half of the year is better than the first for you.
Welcome to June's Deep Dive article. In the month of June, I spent a lot of time learning about credit systems and Africa's US $330 billion credit gap. It was so insightful that I decided to write about it and share it with you folks. This study was partly inspired by this episode of The Flip
I wrote a longer, more in-depth version, but it was around 2000 words, so I decided to create a shorter version for the newsletter. If you're interested in reading the longer piece, you can do so here ????
I’m really excited for this, so let’s get to it.
The TL;DR is: Africa's SMEs are the backbone of its economy, and they face a $330 billion credit gap due to underdeveloped credit infrastructure and traditional banking limitations.
On Credit & Africa's $330 Billion Credit Gap.
Credit in Africa is often associated with a lack of money, which is traditionally seen as a bad thing. However, in more developed economies, we see that credit has played a crucial role in reducing inequality and alleviating poverty.
First off, what is credit? Simply put, it's borrowing money or resources now with the promise to pay them back later, usually with interest. Think of it like this: you're borrowing from your future self to invest in your present self.
A great example of this is student loans. People take these loans because they can't afford tuition upfront, but they believe that education will help them earn more in the future. This investment in themselves often pays off, allowing them to repay the loans and live better lives.??
This system has been a game-changer for millions, helping them climb out of poverty and boost their family incomes. Just look at success stories like Barack and Michelle Obama, Kerry Washington, and Oprah Winfrey—they all used student loans to transform their lives.
Small business financing follows the same principle. Did you know that the founders of Starbucks, Under Armour, Airbnb, and Whole Foods all started with credit cards and bank loans? Imagine if that credit wasn't available—the world would have missed out on some revolutionary brands and products.
So we see that credit is a lifeline for life, education and businesses, especially small and medium-sized enterprises (SMEs). And this is where we run into a big problem in Africa, a problem we call the $330 billion credit gap.
The credit gap is the difference between the financing that SMEs need and what they can actually get. And in Africa, this gap is massive. In 2013, it was estimated at $140 billion. By 2018, it had ballooned to $331 billion. Today, it could be as high as $782 billion. That's a lot of businesses not getting the money they need to grow. But why does this matter?
Well, MSMEs are the backbone of Africa's economy. We're talking about more than 50 million businesses that provide over 80% of employment and generate about 40% of the GDP in African countries. These numbers represent real people, real jobs, and real opportunities.
For some context, a micro-enterprise usually has fewer than five employees and is often informal (not registered or taxed). Small and Medium Enterprises typically have at least 10 employees and are registered businesses that pay taxes. If you're African, think about your parents, uncles, and aunts. I’m sure at least half of them run their own businesses that fall into these MSME categories.?
So, why don't banks just loan these businesses the money they need? Unfortunately, banks are not in the business of doing giveaways. Before a bank gives out a loan, they look at two main things:
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Evaluating repayment capacity is relatively straightforward—banks can look at financial data. But repayment willingness is much more difficult to evaluate. The best indicator of repayment willingness is if someone has paid back a loan in the past. But how can you know that if you've never given them a loan before? It's a classic chicken-and-egg problem.
This problem is even more complicated in Africa because many countries lack proper credit infrastructure. In more developed economies, there are systems in place to track people's credit histories. These systems include:
Many African countries are still developing these systems, which makes lending riskier and more expensive for banks. For example, without a reliable credit bureau, how can a bank know if you've defaulted on loans before? Without a strong national ID system, how can they be sure you are who you say you are?
So, what happens? Banks often shy away from lending to SMEs. They see these businesses as unstable and hard to evaluate. When they do offer loans, they tend to have strict collateral requirements for the loans. Beyond that, there are also issues with verifying collateral ownership, accurate property valuation, and even liquidity [if a borrower defaults, can the bank sell the property to recover the loan?]
This is where other solutions have tried to step in. Microfinance institutions, for example, are popular in the MSME community because they provide financial services to those who don't have access to typical banking services. They offer small loans, savings accounts, insurance, and other financial products to help people build or expand small businesses.
However, recent studies show that many SMEs have outgrown micro-finance loans and are now considered "too large" for the loans. Plus, there's been a shift in the micro-finance industry towards commercialization and profitability, which has raised concerns about the ethics of their services.
More recently, we've seen a rise in digital lending and fintech companies aiming to increase credit accessibility in Africa, branding it as financial inclusion. But questions remain about their viability and impact. Have they really shifted the needle? Have they contributed to decreasing Africa's SME credit gap? There's a lot more to unpack here, but I'll have to save that for Part 2 of this article. Stay tuned to get my thoughts on these questions.
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On an unrelated note:
Here are some of my favourite reads of the week:
Signing Out:
Alright, folks! We’ve come to the end of this issue. I hope you found it valuable. If you did, share it with your friends and leave a comment.
Also, don’t hesitate to reach out to me if you have any questions, or if you just want to connect.
See you next week ???