The underbanked and the limitations of microcredit
MSMEs make up over 90% of all businesses in Africa. Despite being vital to the continent’s economy, they often struggle to access credit from financial services providers. Although small businesses provide over 80 percent of Nigeria’s jobs, a recent World Bank survey found only 15 percent of SMEs reported having a bank loan or line of credit. Historically, this lack of access has been due to MSMEs typically not having a bank account, resorting instead to cash and physical bookkeeping. Without a bank account and a verifiable financial history, obtaining loans from banks is almost impossible. The risks are simply too high with such limited data to assess credit worthiness. The fact that MSMEs’ revenues are usually low and often irregular adds to their high-risk profile.
So SMEs are essentially locked out of the formal financial system, forcing them to turn to informal mechanisms such as family, friends, money lenders, or to microcredit organisations. All of these come with significant drawbacks. If a business owner manages to get a loan from friends or relatives, a failure to repay can create tension within their social network. High-interest rates imposed by informal lenders are even worse, trapping businesses into an endless cycle of debt they often can’t escape.
That leaves microcredit organisations. These have long been the primary access point to credit for Africa’s unbanked MSMEs and some of them like Baobab, who boasts more than a million customers, have developed a pan-African footprint and a digital offering in partnership with MNOs. Still, many MSME businesses fall outside their reach. They are also relatively expensive for MSMEs and can still require cumbersome onboarding processes. Additionally, such organisations typically only provide one-time loans designed to fund a specific purchase or investment. These “one-off” loans do not cater to the ongoing needs of SMEs for recurring credit facilities to finance inventory.
These and other limitations have led to increasing scrutiny of the effectiveness of microcredit. A recent study by the UN Office of the Special Adviser on Africa even suggests that now is an excellent time to reassess the whole role of microfinance in Africa’s development. The study concludes that microfinance is not a magic bullet for financial inclusion and cannot fundamentally transform African businesses and economies.
From micro-credit to embedded finance
The rise of tech-enabled businesses and innovative embedded finance models have begun to transform this problem. For instance, SMEs can now source their products from suppliers they order from regularly and with whom they interact digitally from product ordering to payment, sharing their data in the process. This data provides valuable business and financial information that allows suppliers to offer merchants innovative embedded financing solutions at competitive prices, such as credit lines and loans. Suppliers, in turn, can sell more and increase their margins by adding interest income.
TradeDepot, for example, is a Nigerian B2B marketplace connecting micro-retailers with distributors and manufacturers of fast-moving consumer goods (FMCGs). The company created a proprietary risk scoring engine that uses retailers’ purchase history, repayment performance, and other data to predict their creditworthiness. This innovative and cost-effective financing model, combined with the company’s industry-leading technology that supports logistics operations, has led to a sharp increase in volumes for retail store owners.
In Egypt, MaxAB, an e-commerce platform connecting grocery retailers to suppliers in underserved regions, leverages its merchant database to predict their financial status and offer credit facilities in partnership with banking and non-banking partners. Others in the FMCG category like Wasoko and MarketForce have taken similar approaches. While strategies and models differ, in nearly every instance, a digitised order-history enables these platforms to offer some kind of financing, often where it would be impossible to get financing otherwise.
Similar developments are playing out in a variety of other sectors as well. mPharma, a Ghanaian health tech startup, specialises in financing and managing prescription drug inventory for pharmacies and their suppliers. The company’s Vendor Management Inventory (VMI) system is already being used in hundreds of pharmacies across the continent. QualityRx, one of mPharma’s core programs, provides an innovative and affordable financing solution for smaller pharmacies with a history of strong performance. The program offers funding for refurbishment, inventory, customer management, and technology costs.
Similarly, in Nigeria, e-health pharmaceutical distribution startup, DrugStoc is building partnerships with financial institutions to increase access to sustainable supply chain financing for healthcare providers. Drugstoc operates a B2B model that services registered hospitals, clinics, pharmacies, and healthcare providers and links them to over 400 manufacturers. The company provides intelligent payment solutions & inventory financing for these providers so that they can focus on delivering efficient healthcare.
On the B2C side, pay-as-you-go, off-grid solar companies have been the pioneers of embedded credit solutions. For several years, companies like M-Kopa have provided financing for solar home systems, TVs, and smartphones. However, today, the buy-now-pay-later (BNPL) craze is gaining popularity among tech-enabled businesses across industries, though unlike in developed markets BNPL in Africa is typically for essential purchases which are fundamental to the wellbeing of consumers and SME’s, rather than discretionary purchases (e.g., Peloton bikes, fashion) in Europe and the US.
Companies like CredPal, which recently closed a $15 million funding round, allow consumers to buy anything from online and offline merchants and pay for it in installments. Kenya-based Lipa Later has built an innovative Buy Now Pay Later option API that integrates into e-commerce platforms enabling merchants to sell products directly to consumers who can pay for them in affordable monthly installments. The company’s proprietary credit scoring and machine learning system allow consumers to sign up and get a credit limit in real-time without complicated documentation and a lengthy credit approval process.
Africa’s next great leapfrogging is here
In the developed world, the evolution of financial services has been slow but remarkable. We’ve seen a shift from bank tellers to ATMs, from ATMs to online banking, and now to embedded finance. This story will not be repeated in Africa, where today, the purchase of a mobile phone now means a bank account and credit history are no longer required.
With high smartphone penetration, increasing digital adoption, and a largely unbanked population, we see Africa uniquely positioned to create a modern and inclusive financial sector built on embedded finance.
As we look ahead, it’s becoming increasingly clear that embedded finance represents the next leapfrog opportunity in Africa, and its impact there will be nothing short of transformational, providing huge stimulus to both supply (merchants) and demand (consumers).
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