Micro-lending: Lending Financial Leverages to SMEs

Small and Medium Enterprises (SMEs) in Uganda and for most of Sub-Saharan Africa, continue to lead as the engine of growth 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).

Despite the significant contribution of SMEs to Uganda’s economy, they continue to face several challenges such as inadequate corporate governance structures, limited access to working capital either in form or debt or equity, limited entrepreneurial and management skills, to mention but a few. Limited access to working capital is the most profound challenge.

That said, the need for financing solutions by SMEs has led to an influx of many commercial banks and microfinance institutions over the years. The total loan portfolio for all lending institutions (Commercial Banks and Private Lenders) was at USD 4.7Bn as of November 2020. Of this, SMEs account for approximately 30 percent, hence USD 1.4Bn. Therefore, the SME Lending space is a USD 1.4Bn market. For most commercial banks in this market, the term “SME” has been defined to encompass companies/businesses with annual turnover of approximately USD 1M and below for Small Businesses and USD 1-5M for Medium Businesses. Businesses with turnover above USD 5M default to Large Enterprises or Local Corporates.

Whereas Commercial Banks have greatly contributed to the growth of SMEs in the country, many Small Businesses continue to be left out among the target clientele of these banks. The reason is that most small businesses do not meet the requirements for financing by Commercial Banks such as collateral, sufficient cash flows, business records/bookkeeping to mention but a few. This financing gap by small businesses has led to the influx of micro-lenders in the following broad categories:


Deposit taking microfinance institutions

·         Regulated by the Central bank -Bank of Uganda (BOU) since they are deposit taking.

Non-deposit taking microfinance institutions:

·         Regulated by the Uganda Microfinance Regulatory Authority, created under the Tier 4 Microfinance Institutions and Moneylenders Act, 2016 that commenced in July 2017.


·         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)

·         Mobile Telephone Companies MTN and Airtel have used new entities or partnership for digital lending.

There is hardly any distinctive difference with the law and regulation between a non-deposit taking microfinance institution and a money lender. Both licenses have similar requirements legally, but with slightly more regulatory oversight for non-deposit taking microfinance institutions. However, these are collectively referred to as micro-lenders.

Micro-lenders have been seen to be more flexible with their requirements. 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 this financing sector. Micro lending in the context of the Ugandan market ranges from anywhere from $150 to$10,000granted over a period ranging from 1 week to 2 years dependant on the purpose and institution (lender) and with interest rates of up to 60% per annum (charged 2%-5% per month depending on client’s risk profile and cost of funds)


Different types of micro-lenders use different models to reach Small Businesses. These Models can be classified under categories of Individual Lending and Group Lending. The group lending model involves lending money to a group of between 5 and sometimes up to 50members. 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. The practice is such that any default or delayed payments from any of group members affects the credit worthiness of all members within the group. In addition, micro lenders further assess the specific borrowers’ cash flows before arriving at an optimal amount to lend. These businesses tend to be small and will most probably access no more than US $ 2,000 maximum for a loan period not exceeding 12 months. This model has worked very well among market vendors who deal in agricultural products such as fruits and vegetables, beef, legumes such as ground nuts and beans, fish and related fish products etc.


The individual lending model applies to small businesses that trade in their personal names and hence borrow as individuals. This model of lending has so many variations, but they all revolve around cash flow lending i.e., looking at business inflows and outflows and thus arriving at a monthly business surplus. This monthly business surplus will determine how much of it can be put aside for loan repayments. To arrive at a maximum loan amount for purposes of decision making by the lending, the business surplus is multiplied by the loan period. It must be noted that most small businesses (up to 80%) have either poor records or no records at all. As a result, most small businesses will not keep books of accounts and thus it is difficult to lend to them based solely on their books of accounts. The other drawback with small businesses is that they tend to be family businesses and thus one must consider the family expenses so as to arrive at the total household surplus which is sometimes the safest measure of the surplus of the enterprise on a monthly basis.


The micro lending process is simple and straightforward. First and foremost, the process begins with a formal loan application by a small 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, he/she is assisted by a representative from the lender’s office, usually a credit sales officer. The following is the list of requirements:  


a.     National Identification Card.

b.    Letter of Introduction from the Local Council Authority.

c.     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, majority of the small business owners such as market vendors trade in their individual names and are hence not formally registered. In such cases, the Lender goes an extra mile to do further due diligence on the ground, and requests for further documents such as proof of payment of dues to the local city council authorities.

d.    Bank statements or savings records.

e.     Proof of business. Here, field/sales officers of the lenders visit business owners and take photographs of actual business premises.

f.     Guarantor(s) of good repute.

g.    Spousal consent to borrow especially whereland, which is the commonest asset, is as collateral. The same is required for cases where a marital house is used as collateral.

h.     Proof of ownership of the collateral/security. This may be moveable or non-moveable items (Pictures taken of security together with Loans Officer). Both do have a Central Registry where they can be registered.

i.      Credit rating checks with the Credit Reference Bureau.


As soon as all application requirements and the loan application form are complete, the appraisal process of the applications follows. For most micro-lenders, this has majorly been a manual process; however, this continues to change as different players continue to offer software to reduce the manual interventions. The appraisal process for most micro lenders usually takes about seven days for first time borrowers, and three days for repeat borrowers.


There has been a growing trend of technology based micro-lending. There are many advantages that accrue to digital lending such as reduced risk of holding cash, faster turnaround time, easy verification of KYC through synchronization with mobile handsets etc. In fact, telecommunication companies have taken the lead on this, at least in Uganda. These companies have in the recent past aggressively been engaging in financial services – of course starting with Mobile money services where people are able to send and receive money on their mobile phones. These firms recently integrated a service of micro lending, powered by an algorithm that analyses one’s credit worthiness and eligibility through the volumes and frequency of transactions via the mobile number. This has been a huge success and has left regulators wondering how best to regulate Telecom companies to incorporate the growing demand and push for financial services. That said, most traditional micro lenders have in the recent past, began to invest resources in developing technology-based solutions for micro lending. In fact, there are few players, if any, from the traditional micro lending space that have successfully deployed tools that allow clients to make online applications, and upon approval receive funds on their mobile devices. That said, a number of Fintech companies in Africa such as Mobile Money aggregators continue to play an important role in enabling the digital lending space for traditional micro-lenders.