Initiative: Access to Investment Finance for SMEs

Background

Small and medium-sized enterprises (SMEs¹), including commercially-oriented farms, have a largely unexploited capacity for growth and employment. Access to external finance for investment is very low for SMEs, as is the capacity for SME-banking in the financial sector and SMEs’ business management capacity.

There is a need to develop financial markets to help address these constraints. This initiative will set up an Africa Guarantee Fund (AGF) to provide guarantees to financial institutions for SME-investment lending and capacity development in financial institutions and SMEs.

Objective

The overall objective is:

• Access to investment finance for SMEs significantly increased within five years

The AGF will mobilise significant financial resources for SMEs. A guarantee capital of USD 500 million with a leverage of three times, and risk sharing coverage of 50 percent, would mobilise some USD 3 billion of loans and some USD 20 billion of SME investment (1. 5 percent of GDP in Africa). This will help secure and create millions of productive and better jobs in Africa. The AGF will help deepen the financial markets in African countries as banks increase the scope of business to include SMEs, which thus far have been largely “unbanked”.

Strategic approach

Guarantees to financial institutions will only be provided on the basis of assessed capacity development needs of the institutions and SMEs. Where such assessments identify needs, capacity development will be supported.

The AGF will be managed according to market principles and generate appropriate returns on its resources in order to achieve self-sustainability and attract investors. The aim is to achieve a AAA or AA+ rating.

The target group will be growth-oriented SMEs in a wide array of business activities. A special focus will be given to agricultural value chains in countries where their commercial potential has been identified.

In relation to each guarantee agreement and capacity development agreement, the AGF will mainstream gender equality. Ambitious but realistic targets will be set for female entrepreneurs and employees benefiting from the initiative. The need for gender-specific capacity development in financial institutions and SMEs will be addressed. The AGF will also set realistic targets for young entrepreneurs and young employees.

The guarantee coverage will generally be set at no more than 50 percent.

It is envisaged that the AGF will be rolled out in five to six countries in Africa within the first two years and gradually expand coverage, adding two to four new countries per year. The selection criteria will try to balance: Geography (all regions in Africa included); level of development in selected countries (ranging from the poorest, post-conflict countries to more prosperous countries); population size; and potential impact of the interventions. These criteria will need to be further developed by the partners in the initiative.

The AGF will increase aid effectiveness. It will be able to leverage funds, which will result in more guarantee agreements (compared to bilateral guarantees provided by development partners) and more lending to SMEs. Furthermore, the AGF could help rationalise aid activities to the extent that bilateral development partners will cease doing bilateral guarantees.

Activities

The initiative will provide guarantees and capacity development support to financial institutions and SMEs.

Guarantees

• Partial portfolio guarantees for financial institutions in African countries that increase lending for SME investment. Counter guarantees could also be considered
• Institutional (portable) guarantees. These could be in the form of: A credit line from a bank to a micro-finance institution; the purchase of bonds by institutional investors such as pension funds that are issued by a bank to raise longer-term finance for SME investments; or other innovative schemes such as equity funds
• A combination, e. g. institutional guarantee to help a bank raise long-term capital for SME-lending and portfolio guarantees in connection with SME-loans

Guarantees will be issued in compliance with the legal requirements of Basel II and as a first liability. The AGF will be designed and operated to (potentially) achieve a triple-A rating in order to attract a zero percent risk-weight on SME loans provided by financial institutions working with the AGF. For financial institutions the advantage is that a guarantee from a highly-rated AGF will allow an expansion of credit with limited or no need to set aside regulatory capital.

Capacity development for financial institutions

Capacity development services will be applied in connection with the guarantees but managed separately.

Support will be provided for gender-specific needs assessment and the development and implementation of capacity development action plans in financial institutions that make guarantee deals with the AGF. Financial institutions will increase their capacity to appraise and manage SME portfolios. The AGF will provide assistance grants but it is envisaged that the financial institutions will cover most of the costs.

Capacity development services for SMEs

Support will be provided to identify gender-specific needs and develop and implement action plans to help participating SMEs improve their business management skills (accounting, budgeting, planning, marketing etc. ). This would include support to develop and manage business plans but could also include other services specific to the enterprise, e. g. related to technology or occupational health. The need for SME capacity building will be assessed and determined in conjunction with the guarantee agreement. For individual enterprises the needs will be determined in conjunction with the financial institution’s appraisal of the SMEs. SMEs would bear most of the capacity development costs.

The capacity development of SMEs will be managed by an existing organisation with an Africa-wide network and experience in the area, but will be implemented through existing local service providers.

Expected output

Output will include:

• A number of SMEs receiving investment loans to increase business management capacity
• A number of financial institutions with increased and well-performing SME-portfolios, with increased capacity to appraise SMEs and strategies for further developing their SME-engagement
• More funds raised by  financial markets for SME investment

Setup (management and organisation)

The AGF will (preferably) be set up as a legally separate entity. The majority of its capital will be provided by multilateral and bilateral development partners. Other shareholders could comprise private financial institutions and development finance institutions.

The AGF will manage both the guarantees and the capacity development of financial institutions. The guarantee business will be separated from capacity development of financial institutions.

Another existing organisation will manage the capacity development of SMEs. There will be close coordination between the AGF and the organisation to ensure that capacity development of SMEs will be done in accordance with all guarantee agreements.

Overall budget

The overall budget for the AGF is estimated over a five-year period to be USD 500 million, approximately 10 percent of which will be for capacity development.

[1] An SME would typically employ 0-200 persons, have a turnover of USD 50,000 to 1 million and require loans between USD 10,000 to 500,000. However, SME definition may differ from country to country.