Finance & Investment

Lenders Focus on SMEs Playing a Giant Global Role

As the world’s focus turns to the opening of the United Nations’ 73rd session of the General Assembly, attention will turn to the state of progress on the UN’s Sustainable Development Goals (SDGs), an overarching set of aims intended to improve environmental, economic and social conditions by 2030.

By Gil Crawford | Published 6 years ago | About a 4 minute read

As the world’s focus turns to the opening of the United Nations’ 73rd session of the General Assembly, attention will turn to the state of progress on the UN’s Sustainable Development Goals (SDGs), an overarching set of aims intended to improve environmental, economic and social conditions by 2030.

There will be dramatic successes — diseases eradicated, environmental damage repaired, and the years-long efforts of dedicated professionals and striving citizens in the developing world will be justly lauded. On a less glamorous but equally vital level, progress will be measured by the global increase in access to financial products and services, the lifeblood of sustainable economic development.

While microfinance initiatives that provide small loans to support individual micro-entrepreneurs attract a great deal of attention in addressing extreme poverty, there’s a borrowing segment that development experts call the “missing middle” playing a crucial role in accelerating sustainable development. These small and medium enterprises (SMEs) — which create close to 9 out of every 10 new jobs in emerging markets and make significant contributions to national GDP — are too big to access microfinance services but remain invisible to traditional commercial lenders. Expanded credit to support their growth will make a meaningful dent in the $5.2 trillion SME funding gap that the World Bank Group has estimated exists globally. This gap must be closed before the 2030 goals can be met.

Meaningful economic development hinges on financial inclusion — access to quality financial services for all. This underpins seven of the SDGs, playing a vital role in eradicating poverty; providing decent work and economic growth; nurturing industry, innovation and infrastructure; reducing inequality; creating sustainable cities and communities; and encouraging responsible consumption and production. Supporting the SME segment is a key component of successfully achieving these goals.

Financial inclusion for the “missing middle” is gathering momentum. At the beginning of the century, for example, there was almost no investable market for SME loans in the $20,000-$50,000 range, as it was difficult for financial institutions to profitably serve this market segment. Financial sector development advances in technology, however, and a growing awareness of the crucial development role played by SMEs have vastly improved the ability of financial institutions to address SME financing needs. Impact investors play a key role in supporting these lending institutions on the ground, and the benefits of this approach are widely recognized.

The 2016 initial public offering of ProCredit Holding on the Frankfurt stock exchange marked a milestone for lending to the SME segment in emerging markets. The German company began as a microfinance lender, working primarily in Eastern Europe and South America, but the success of its borrowers meant many became small and medium-sized enterprises. At the same time, the economies in which these clients operated grew from low-income to middle-income countries. Attuned to changing demands and market needs, ProCredit altered its business model to focus exclusively on SME lending. The firm’s IPO indicates the success of this strategy, as well as investor demand to support this important business segment. This investment support allows financial institutions to offer competitive borrowing rates to SMEs that previously had little or no access to credit.

Technology plays a role in the rising support for the SME borrowing segment, too. The digitization of loan underwriting and monitoring has created huge opportunities for local financial institutions to effectively lend to the missing middle.

Kogta, a non-bank financial institution in India, provides an example of how improved technology-enabled underwriting has allowed it to further reach SMEs. By creating a web-based version of its credit assessment algorithm and formatting it for tablet use, Kogta expanded its lending efforts while keeping an effective centralized loan approval process that utilizes criteria built up over years of working with these populations.
In Latin America, Cooperativa Pacifico (CP), a Peruvian low-income financial institution, recently digitized its entire credit transaction process, enabling it to see how long a transaction lasts in each phase and identify any bottlenecks. As data accumulates, CP will gather valuable metrics that will allow them to operate more efficiently, ultimately lowering costs for end-borrowers and expanding their lending capabilities.

Greater strategic recognition of the role SMEs play in sustainable development, and impact investors’ heightened success in supporting the financial institutions that can power sustainable growth, make for an increasingly potent combination to further global financial inclusion. As the world gauges its progress in meeting Sustainable Development Goals for 2030, the missing middle will come into sharp focus, and will continue to play a highly visible role in meaningful sustainable development.