Jua Kali is a commonly-used Swahili word that translates literally as “hot sun”. It is used to refer to the small, roadside businesses that sell everything from tires and laundry detergent to phone credit and oil changes. They include hawkers, small repair workshops, manufacturers and a host of entrepreneurial activities, including mobile money and other tech innovations.

The term is a useful one to know in Kenya, given that small and medium-sized enterprises (SMEs) in Kenya constitute an estimated 98% of all companies. Outside of the farming segment SMEs absorb half of all employment seekers each year, and their contribution to employment is growing by 12-14% a year, according to the public investment promotion agency KenInvest. They create nearly one in three jobs, but only contribute 3% to GDP as they are predominantly informal.

As is the case in emerging and frontier markets, one of the biggest obstacles SMEs face is access to finance. Addressing this is a priority both for lenders and the government, the latter which has made it a key development policy in its Vision 2030 economic strategy.

Consensus Needed

However, challenges arise as key players decide just how to implement policy. This is not only the result of the higher levels of risk and poor bookkeeping frequently encountered in smaller, informal businesses, but also the lack of data and consensual definitions. It is difficult to get a comprehensive list of active small businesses, how many are launched each year or whether they succeed, for example. In addition, most banks do not report specific lending and deposit transaction data regarding their SME customers.

Compounding the issue, a large proportion of banks have their own definitions for SMEs. The government defines SMEs according to the number of employees and the rate of turnover. Banks, however, tend to categorise them according to loan size, turnover and number of employees, in that specific order. Banks also like to manage their clients in different departments, preferring to categorise them by loan size.

Basic Outline

To help gauge the size of the sector, Financial Sector Deepening Kenya (FSDK), a World Bank initiative supported by the Central Bank of Kenya, surveyed up to 33 commercial banks as well as other financial institutions in 2013. They estimated Kenyan banks’ SME lending portfolio at KSh233bn ($2.3bn) in December 2013, or 23.4% of the total loan portfolio. This is more than Nigeria (5%), South Africa (8%), Tanzania (14%) and Rwanda (17%). A more recent estimate in mid-2016 put the number of general lending directed at SMEs between 25-30%, still higher than levels seen in regional African markets.

The competitive dynamics of serving the SME segment is a significant driver of growth and dominance for the local banks, as they are in a better position to tailor banking services to the needs of the local population. “We see quite a bit of pressure aligning to reach SMEs, and we see that portfolio growing. Banks must become more efficient by aligning their technology to reach a previously untapped market, not only by mobilising savings, but also by offering credit,” Jared Osoro, director research and policy for the Kenya Banker’s Association (KBA), told OBG.

Loan Estimates

According to the FSDK survey results, however, there is a long way to go before banks are able to effectively tap into that market. SMEs represent a small proportion of total business deposit accounts. In 2013 the average loan ranged between KSh588,849 ($5745) for micro enterprises and KSh30.9m ($301,500) for large enterprises.

The average duration of the loans was 18.8 months for a micro-enterprise, 37.1 months for small, 42.5 for medium and 48.7 months for large enterprises. The average interest rate ranged from 20.6% for micro-enterprises to 15.3% for large enterprises. Mid-size banks tend to offer the lowest interest rates to smaller enterprises, while small banks offered the lowest rates to large enterprises. Foreign banks also charge higher interest for smaller firms. SME lending was more profitable for banks than their overloan portfolios – measured by contribution to banks’ earnings compared to the proportion of the loan portfolio. A wide variety of products were offered by banks including term loans over two years, overdrafts, term loans under two years, asset financing and trade finance. Mid-size banks were the biggest lenders to SMEs by value of loans, and they focused on short-term overdrafts (35% of total value, 62% of total loans by number) while large banks are more active in small-scale, long-term loans. Henry Mbugua, managing director of Alios Finance, told OBG, “Financial literacy at the SME level is generally good, but there is a lack of awareness of the advantages of asset finance.” Mid-size banks tend to rely on overdraft facilities as their primary SME lending product, although these are more suited for providing working capital and fast access to liquidity. They are expensive to the borrower and risky if interest rates increase or if loans are withdrawn. “There is still a lot of potential for growth, but the SME sector is not easy to quantify. The major focus for us and other banks is mostly on financing working capital. Returns around SMEs are high, as they are not very price-sensitive,” Anthony Muli, economist at Co-operative Bank, told OBG.

Increasing Cost

The high cost of judicial processes, issues with registering collateral and high overheads all serve to increase the cost of credit. To address the issues posed by inadequate court resources, the KBA and the Association of Kenya Credit Providers convened to suggest an alternative dispute-resolution mechanism to help avoid high judicial costs and increase disputee satisfaction with outcomes. In mid-2016 it was estimated that some KSH10bn ($97.6m) was held up in bank-related litigation.

Credit reference bureaus (CRBs) are also helping improve access to credit by providing information about bad borrowers, and this in turn can help reduce the cost of lending. The first bureau, the Credit Reference Bureau Africa, opened in February 2010. By the end of June 2015 two more CRBs – Metropol CRB and Creditinfo CRB – had been licensed.

In addition to tracking bad borrowers, CRBs also encourage cooperation among banks, as Habil Olaka, CEO of the KBA, told OBG. “The creation of CRBs has not only increased transparency within the sector, but also facilitated greater cooperation,” he said. However, only around 35% of banks and other deposit takers contribute information. According to the 2017 World Bank “Doing Business” report, 25.8% of adults were covered by CRBs in Kenya in 2016, up from 14% in 2015. This is in comparison with an average of 7.6% in sub-Saharan Africa. While in OECD countries that number is closer to 67%, indicating room for improvement.

Slow Patch

It will be some time before SMEs are adequately covered by CRBs or can access proper dispute resolution. As a result, they will continue to represent a riskier bet for banks, who have already had to grapple with rising rates of non-performing loans over recent months (see overview).

This situation may be further compounded by the Kenya Banking (Amendment) Act 2016, passed in August and implemented the following month. The rate cap included in that legislation prevents interest rates from exceeding four percentage points above the central bank rate. Banks promised, through a KSH100m ($975,700), industry-led programme, to set aside loan funds for SMEs in order to help mitigate the effects. However, the cap is still likely to further limit banks’ interest in high-risk SME loans.

Indeed, in January 2017 it was reported in local media that the cap was edging into bank profits with most banks’ 2016 financial statements reporting a dip directly following September implementation.

Room To Grow

As is the case in so many African economies, the segment offers enormous potential and a huge customer base, which means that lending to SMEs still represents a key growth area even in the face of recent legislation, and sector challenges.