Small and Medium Enterprises (SMEs) in Uganda and most Sub-Saharan Africa countries continue to lead as the growth engine for economic development, innovation, and wealth creation.

In Uganda, SMEs are spread across various sectors, with 49 percent in the service sector, 33 percent in commerce and trade, 10 percent in manufacturing, and 8 percent in other sectors (Source: Uganda Investment Authority, 2016).

In addition, over 2.5 million people are employed by SMEs, accounting for approximately 90% of the entire private sector and generating over 80% of manufactured output (equivalent to 20% of GDP).

The challenges facing SMEs in Uganda

However, despite the enormous contribution of SMEs to Uganda’s economy, they continue to face several challenges.

These include inadequate corporate governance structures, poor access to working capital (in the form of debt or equity), and limited entrepreneurial skills, to mention but a few.

Among these, lack of access to working capital has been identified as the most profound challenge.

The loan profile of SMEs on the rise

Over the years, SMEs’ need for financing solutions has led to an influx of many commercial banks and microfinance institutions.

It’s not surprising that as of November 2020, the loan portfolio for all financial institutions regulated by the Central Bank (Commercial Banks and Non-Bank Financial Institutions) added up to $4.7Bn (source: Bank of Uganda Statistics).

Approximately 30% of the figure is accounted for by SMEs. That is to say, the SME Lending space is a $1.4Bn market.

Commercial Banks’ Definition of SMEs and the implications

For most commercial banks, the term “SME” has been defined to encompass companies/businesses with an annual turnover of approximately $1M and below (for Small Businesses) and $1-5M for Medium Businesses.

Businesses with turnover above $5M belong to the Large Enterprises or Local Corporates category.

Thus, while the positive impacts of commercial banks on the growth of SMEs are properly acknowledged, the definitions above have manifested as barriers hindering other relatively “smaller” businesses from accessing financing opportunities.

In other words, many low revenue businesses continue to be left out among the target clientele of these banks.

The reason is that most of these businesses do not meet criteria such as collateral, sufficient cash flow, business records, and more which are prerequisites to gaining loan approval in a standard commercial bank.

Microlenders to the rescue for small income businesses

The financing gap faced by small businesses has led to the emergence of micro-lending institutions spread across the following categories:

• Non-deposit-taking microfinance institutions – regulated by the Uganda Microfinance Regulatory Authority and created under the Tier 4 Microfinance Institutions and Moneylenders Act, 2016, commenced in July 2017.
• Moneylenders – regulated by the Uganda Microfinance Regulatory Authority, created under the Tier 4 Microfinance Institutions and Moneylenders Act, 2016, that commenced in July 2017.
• SACCOs (Savings and Credit Cooperative Societies) – regulated by the Ministry of Trade.

There are hardly any distinctions in the regulatory policies between a non-deposit-taking microfinance institution and a moneylender.

The licensure of both has similar requirements but with slightly more regulatory oversight for the former.

Perhaps, this tiny line of difference explains why both are sometimes collectively referred to as micro-lenders.

What makes micro-lenders attractive to small businesses

In comparison to their much bigger counterparts (the Central Bank regulated Financial Institutions), micro-lenders are more flexible with their requirements. Hence, the preference of micro-lenders by small businesses.

In addition, they have a faster turnaround time of processing a loan and offer smaller ticket sizes.

These advantages have made them more attractive to Small Businesses, thereby leading to the growth of the microlending sector.

In the context of the Ugandan market, microloans range anywhere from $150 to $10,000, granted over a period ranging from 1 week to 2 years, depending on the purpose and institution (lender).

However, the interest rates can be as high as 60% per annum (charged 2%-5% per month depending on the client’s risk profile and cost of funds)

Understanding how micro-lenders work

Different types of micro-lenders use different models to reach Small Businesses. These models can be classified into Individual lending and Group Lending.

These models of lending have so many variations, but they all revolve around the cash flow. That is, looking at business inflows and outflows and determining the monthly surplus that can be put aside for loan repayments.

Group Lending

The group lending model involves lending money to between 5 and sometimes up to 50 members. These members act as guarantors for any individual within the group seeking to access credit from an institution.

The collateral in such a case is the group itself, through solidarity and peer pressure. Therefore, in the event of a default or delayed payment, the creditworthiness of all members within the group gets affected.

Also, microlenders will assess the cash flow of each business as the basis to determine the maximum amount approvable for a loan. In most cases, the final amount does not exceed $2,000 for a 12 months loan period.

The model has worked very well among retail vendors who deal in agricultural products such as fruits, vegetables, beef, legumes, fish, and similar products.

Individual Lending

The individual lending model applies to small business owners that trade in personal names and hence borrow as individuals.

The problem is when lending to small businesses. It must be noted that most small businesses (up to 80%) have either poor records or none at all. As a result, it becomes difficult to lend to them based on their books of accounts alone.

The other drawback with small businesses is that they tend to be family-run. Thus one must consider the household expenses to arrive at the total loan repayment fund, which is sometimes the safest measure of the enterprise’s monthly surplus.

Processes involved in microlending

These are simple. First, it begins with a formal loan application letter by a business owner.

The application forms vary from one micro-lender to another, but they all capture the same information.

In cases where the applicant is illiterate, they are assisted by a representative from the lender’s office, usually a credit sales officer.

The followings are usually the list of requirements:

• National Identification Card.
• Letter of Introduction from the Local Council Authority.
• Proof of Business Registration and current Trading License. The lender usually runs checks with Uganda Registration Services Bureau, where the business is a registered entity.

However, the majority of the retailers, such as market vendors, trade-in their names and are hence not formally registered.

In such cases, the lender’s prerogative is to go the extra mile to do further due diligence on the individual’s background and request further documents such as proof of payment of members fees to the local city council authorities.

• Bank statements or savings records.
• Guarantor(s) of good repute.
• Spousal consent to borrow, especially where land, which is the commonest asset, is as collateral. The same is required for cases where a marital house is used as collateral.
• Proof of ownership of the collateral/security.
• Credit rating checks with the Credit Reference Bureau.

Once all application requirements are met, and the loan request form is completed, the approval process commences immediately.

It is common for most microlenders to favor the manual method of doing things. However, with more and more software developed for these processes, the turnaround time has significantly improved.

In all, the process from request to the final disbursement of loans in most micro-lending institutions takes about seven days for first-time borrowers and three days for repeat customers.

A new wave on the horizon: online based micro-lending

As the world advances in technology, micro-lending looks closely on the brink of transitioning into an online hosted business service.

The fact is that it is already becoming a growing trend.

Many advantages accrue to digital lending, such as the reduced risk of holding cash, faster turnaround time, easy KYC verification through synchronization with mobile handsets, etc.

In the recent past, most traditional microlenders have begun to invest resources in developing technology-based solutions for micro-lending.

There are very few players, if any at all, from the traditional micro-lending space that are yet to deploy tools that allow clients to make online applications and receive funds on their mobile devices upon approval.

Meanwhile, several Fintech companies such as Mobile Money aggregators or innovative companies such as Monetix with their local partner continue to play an important role in enabling the digital lending space for traditional microlenders.