Series: Publications

Small- and Medium-Sized Enterprise Finance in Africa

Thorsten Beck and Robert Cull

The vast majority of firms around the world fall into the
category of micro, small- or medium-sized enterprises
(SMEs). In terms of enterprises, more than 95 percent
fall into this category, but even in terms of employment
in low- and lower-middle-income countries, more than
50 percent of employees work in companies with fewer
than 100 employees. While SMEs thus constitute an
important component of the private sector in the developing
world, they report significantly higher obstacles
to their operation and growth than large enterprises. Among these obstacles, the lack
of access to appropriate financial services, especially
lending services, looms large.

Africa’s financial systems are small, shallow and costly,
with limited outreach. This is not just reflected in aggregate
financial development indicators but also in firm
and household data gauging the use of formal financial
services. However, financial systems
in Africa have also seen dramatic changes over
the past two decades in market structure and stability.
And there are enormous differences across the region,
ranging from well-developed financial systems in middle income
countries, such as Mauritius and South Africa, to
shallow banking systems offering only the most rudimentary
financial services in impoverished countries like the
Central African Republic and South Sudan.

This paper surveys the state of SME finance in sub-
Saharan Africa. We use Enterprise Survey data from
the World Bank to explore cross-country and cross-firm
variation in the use of financial services. We document
lower use of financial services by firms inside than outside
Africa and by smaller and younger firms. We use
regression analysis to relate firms’ access to finance to
an array of firm and country characteristics, and gauge
whether these relationships are different inside and
outside Africa. We also discuss several persistent and
new challenges for SME finance in Africa.

While a great amount of literature has established the
positive impact of financial deepening on economic
growth and poverty alleviation, especially and foremost
in developing countries (Levine, 2005), recent
evidence using firm-level data has pointed to SME
finance as an important channel. The literature has
identified different channels through which financial
development affects firm and, ultimately, aggregate
growth. First, the availability of external finance is positively associated with the number of start-ups—an important indicator of entrepreneurship—as well as with firm dynamism and innovation. Second, finance allows existing firms to exploit growth and investment opportunities, and to achieve larger equilibrium size. Finally, firms can safely acquire a more efficient productive asset portfolio where the infrastructure of finance is in place, and they are also able to choose more efficient organizational forms such as incorporation.

This paper also relates to a large literature on firms’ financing obstacles. Following a seminal paper by Fazzari, Hubbard and Petersen, a large body of empirical literature estimating financing constraints of firms emerged.1 A firm is typically defined to be financially constrained if a windfall increase in the supply of internal funds results in a higher level of investment spending. This literature has mostly employed balance sheet data. Beck et al., on the other hand, use firm-level survey data and find that older, larger and foreign-owned firms report fewer financing obstacles. A growing amount of literature has been using firm-level survey data to explore country covariates of access to credit and firms’ financing constraints, focusing, among others, on foreign bank entrY, legal system efficiency and regulatory frameworks.

The remainder of this paper is structured as follows. Section 2 provides descriptive evidence on firms’ access to financial services inside and outside Africa, the size gap in corporate finance, and the importance of financing constraints. Section 3 presents regression analysis to gauge firm and country covariates of access to credit and differential effects inside and outside Africa. Section 4 discusses policy challenges for SME finance in Africa, and section 5 concludes.