SMEs are good business for Kenya’s growing banking sector

Maasai women make, sell and display their bead work in Kajiado, Kenya. 2010. Photo: © Georgina Goodwin/World Bank

Kenya’s financial sector has expanded rapidly over the last decade and lending to businesses—including small and medium size-enterprises has played a big part. As the Kenyan economy is enjoying a period of relatively high growth, the financial sector’s ongoing ability to channel credit affordably and efficiently to SMEs will be needed to underpin inclusive and sustained economic development.
 
To better understand the SME finance landscape in Kenya, a World Bank-FSD Kenya team embarked on a study with the Central Bank of Kenya to explore the supply-side of SME finance. In addition to quantifying the extent of banks’ involvement with SMEs, the study shows the exposure of different types of banks to the SME market, the portfolio of services most used by SMEs, and the quality of assets. Our report also discusses the regulatory framework for SME finance, the drivers and obstacles of banks’ involvement with SMEs, and their specific business models. 

We found that involvement of Kenyan banks in the SME segment has grown remarkably between 2009 and 2013 and that the growth has been driven mainly by domestic banks. The total SME lending portfolio in December 2013 was estimated at KSh332 billion, representing 23.4% of the banks’ total loan portfolios. (The USD equivalent is USD 3.84 billion, based on the exchange rate on December 31, 2013. ) Furthermore, in the context of general growth of the financial sector, SME financing represents a growing share of the commercial banks’ lending portfolios: in 2009 and 2011 the total SME portfolio represented 19.5% and 20.9% of overall lending, respectively. 



Although banks are increasingly interested in the SME segment, measuring this interest precisely is somewhat challenging as there is no common definition of what constitutes an “SME.” The government proposed adopting a unified definition of the SME segment, but the banks still use definitions that differ significantly. Banks also have varied levels of interest in engaging in the SME sector: there are market leaders devoted to innovation in SME financing and other banks for which SMEs are not a target client group. 

We identify three main types of business model that banks use: the corporate oriented business model, the supply-chain oriented business model, and the microenterprise-oriented business model. Banks that were identified as having a “microenterprise-oriented business model” were the most prominent players in this space. These banks tend to have extensive outreach networks due to their move from the mass retail/microfinance market into the SME space, and they have a large network of bank branches equipped with loan officers who are in a position to assess SME loans. Additionally, these institutions have embraced alternative outreach models such as agency banking and mobile banking.
 
Despite positive developments over the last few years, the cost of credit for Kenyan SMEs remains high, and there is still considerable room for product innovation in the SME finance space. The large majority of SME loans are overdrafts. While overdrafts can be useful in getting money quickly, they expose SMEs to interest rate and liquidity risks, particularly if overdrafts are used to finance longer term investments. Agricultural SME lending remains very limited as well, representing a small percentage of the total portfolio, even though the sector is the backbone of the Kenyan economy.
 
As is the case in many emerging economies, the high cost of credit is largely driven by underlying structural issues. These include the limited use of positive information sharing about borrowers in the market, inefficiencies in the collateral registration process, the cost of the judicial process, and high overhead costs. The collateral registry could be made more efficient in terms of the speed and the range of items accepted as collateral. Resolving the legal and regulatory challenges, especially regarding the contractual environment, will require significant reforms over a period of several years. Innovation in the SME financing space could also be driven by the development of factoring and financial leasing.
 
Our report offers a number of recommendations that could support the growth of the SME finance market in Kenya. These include:
 

• Harmonizing the definition of SMEs to better understand how the SME finance market is developing over time
• Increasing the scope of credit information sharing
• Creating a more conducive environment for factoring and leasing
• Improving the enabling environment for SMEs through introducing digitized movable and immovable collateral registries and improving rules and procedures to create, recognize, and enforce security over movable assets as well as introducing Alternative Dispute Resolution or other out-of-court enforcement mechanism.