Caught in the middle

THE name of the Grand Global Hotel suggests no want of ambition. But the project ran into financial problems before building work had even finished, says its owner, Emmanuel Tugume. His bank raised interest rates, and would not make allowances for delays in construction. Mr Tugume eventually got a loan from GroFin, a specialist business lender, and now his hotel is thriving. But his experience with Uganda’s banks still rankles. “They do not adjust to people like us,” he says. “They look after the big-time clients.”

Small and medium-sized enterprises (SMEs) all over the world grumble about access to finance, but the problem is worse in developing regions. Around two-thirds of SMEs in poor countries cannot borrow as much as they would like, compared with a sixth in the rich world, says the International Finance Corporation, the corporate-lending arm of the World Bank. It put the “credit gap” for small but formal businesses in developing countries at around $1 trillion in 2011. Throw in informal firms, and the shortfall is even greater.

Plenty of outfits lend to very poor people hoping to start a business. But such “micro-credit” is typically minute, fleeting and expensive. It channels funds to tiny, unproductive businesses, often with no employees. More substantial firms, with greater potential for growth, have to look elsewhere. “The poor are being stuffed with micro-credit,” says Milford Bateman, a consultant, “while SMEs are being starved.”

Banks are hardly rushing to step in. They remain the biggest source of finance for SMEs in the developing world: commercial banks supply around 58% of their funding, while state-owned ones stump up 30%. But they are often reluctant to lend more. Many small-business owners have little collateral, patchy records and non-existent credit histories. It takes time for customers to arrive or crops to grow. Far safer, many banks conclude, to lend to established clients or to the government.

That leaves a gap—the so-called “missing middle”—for newer, more specialist lenders. GroFin, which helped Mr Tugume, tries to limit defaults the old-fashioned way, by trying hard to get to know its borrowers. “Every business has records,” says Arigye Munyangabo, one of its managers in Uganda, “but sometimes they are in the customer’s head.” Regular visits and business mentoring help tease out that hidden information. GroFin charges slightly above-market rates, but has no shortage of clients: in 12 years, it has provided $260m of funding to SMEs across Africa and the Middle East.

Other firms are experimenting with different lending models. EFTA, in Tanzania, offers small businesses hire-purchase schemes for equipment. The business can use the equipment while paying off the loan, but EFTA owns it until the three-year lease period is over. This arrangement sidesteps the need for collateral: EFTA can just take back the machinery if the borrower doesn’t pay (it installs devices in tractors that can disable them remotely). Only 5-6% of its loans by value end in repossession.

These specialist lenders are nimble, and often get a leg-up from development agencies and philanthropists. But most of them are relatively small. If lending to SMEs is really to grow, banks will have to become more enthusiastic. One factor that might help is the data revolution, which is making it easier to weigh risks.

Digitisation, for example, is assisting businesses to keep better records and banks to monitor them. Commercial Bank of Africa is partnering with Strands, a fintech software company, to help businesses take their payments and records online: one advantage will be more detailed data for credit decisions. Numida, a startup in Uganda, is developing an app that allows traders to track transactions on their phones. Lenders, it hopes, will agree cheaper loans for clients that are willing to share these records.

Others are looking for new kinds of data altogether. The Entrepreneurial Finance Lab, a spin-off from a research initiative at Harvard University, is trying out psychometric testing as a way of assessing credit risk. Would-be borrowers complete a short online survey and the software quickly generates an alternative credit score, based on attributes like conscientiousness and confidence. “We want to collateralise people’s human capital,” says Asim Khwaja, a Harvard professor and co-founder of the project. Trials in Latin America suggest that this approach can help to reduce defaults, thereby paving the way for more lending.

Whizzy data are cheaper than the relationship banking of old. As smartphones spread, gathering and digesting information about a small business’s performance will vastly reduce the need for the labour-intensive approach of firms like GroFin. But algorithms can only go so far. Developing countries also need better institutions, from registries of collateral to commercial courts. Nimrod Zalk, an adviser to the South African government on industrial policy, stresses the need for big companies to nurture SME suppliers. He talks admiringly of the role played by KfW, a development bank, in financing German manufacturers. Such changes take time, however. Building a financial ecosystem is a lot harder than downloading an app.