The Ethiopian economy has enjoyed rapid and sustained growth – at higher rates, for the last decade, barring recent shocks. But, it faces a chronic capital shortage where state-owned or affiliated enterprises crowd out private sector financing.
Micro, Small, and medium-sized enterprises (MSMEs) can play pivotal roles in this economic development but are often overlooked, and their needs, particularly financing, are neglected.
Digitalization, a relatively new development for the financial industry in frontier markets, can be a key enabler to address this issue.
This is why the Center For International Private Enterprise partnered with Shega Media and Technology PLC and Swaye Ventures to study how digital financial services (DFS) can bridge the financing gap MSMEs face in Ethiopia and policies conducive to such adoption.
This study and follow-up deliverables are part of a project that CIPE is implementing with the aim of promoting issue-based dialogue on the inclusion of micro, small and medium-sized businesses in national policy dialogues on the digital economy and building the capacity of public, private, and civic leaders to support private sector participation in policy development around economic transformation.
The production of a research study, a policy brief, and a follow-up MSME toolkit which took more than a year included more than 1200 MSMEs across five major cities and engaged more than 40 stakeholders was launched officially at Sky Light Hotel on September 1, 2022, with a presence of High government officials including State Minister for Innovation and Technology, H.E Huria Ali as well as policymakers, entrepreneurs, Financiers, and ecosystem players.
The launch event held with a theme of Inclusion of MSMEs in the Digital Economy: Providing Access to Capital through Digital Channels provided an overview of the research study and process taken, facilitated discussion between participants and representatives from National Bank, MINT, and Shega and Swaye Ventures.
The objective of the Research
The study aimed to understand the debt financing ecosystem and identify opportunities for digital finance vehicles to unlock capital for Ethiopian MSMEs, both through structural and policy initiatives. Specifically :
- Explore how digitization can improve access to capital for Ethiopian MSMEs through an assessment of the current financing alternatives and the current digital financing environment in Ethiopia;
- Identify key barriers to MSMEs’ inclusion in the digital economy and advance potential solutions.
- Discuss the challenges Ethiopian MSMEs currently face in accessing finance and the opportunities and challenges of digital advances for MSME financing in Ethiopia through a survey of MSMEs in five major Ethiopian cities;
- Understand and recommend the types of frameworks, policies, and ecosystem support needed in Ethiopia to increase access to finance for MSMEs digitally.
The research used a survey, desk research, and key stakeholder inputs to identify the critical barriers and possible opportunities for digital financing in Ethiopia. The research employed a clustered random sampling strategy that encompassed 5 cities for the survey and used purposive sampling for the key stakeholders we interviewed. We synthesized information acquired from primary data sources, desk research, and the experience of other countries to identify the critical challenges and develop recommendations.
1. MSMEs are quite underserved by formal financial institutions to the point where some don’t even bother to apply for financing for fear of being rejected.
Only 36% of the respondents ever successfully acquired loans, while the rest either didn’t apply or were denied, predominantly because they didn’t have enough collateral to pledge. Most businesses surveyed started their business with personal savings and support/loans from family and friends while only 14% got an injection from formal financial institutions, and the rest started with retained earnings from previous businesses. Banks are mostly inaccessible for MSMEs, 69% of MSMEs for Micro Finance Institutions to apply for a loan while 15 of them go to Bank.
2. MSMEs are denied financing because of challenges that can mostly be addressed using digital financing such as collateral
Collateral requirements, high-interest rates, and long approval processes are hindering MSMEs from accessing finance. An overwhelming majority ( 75% ) of the rejected MSMEs indicated they were denied loans because they didn’t have collateral. High-interest rates were identified as a critical challenge that impacts access to credit by a fourth of surveyed MSMEs. In addition, some commercial banks can take up to a year to approve a loan for MSMEs, which has caused 23% of our respondents to not seek commercial loans.
3. MSMEs aren’t even aware of the possibility of getting financing via digital channels
The research finds our that digital skillset, awareness, and digital infrastructure are key issues that should be addressed. The majority of MSMEs noted that they did not use an email (96%) nor have a website (99%), which indicts their digital literacy levels. However, this does not entirely paint the full picture regarding since cell numbers have evolved to become an access point to digital solutions in emerging markets like Ethiopia. Digital platforms have to be easily manageable and understandable by MSMEs to be adopted well since 66% of the MSMEs surveyed noted they would use it more if it were easier to use. Lack of interoperability, which came from 41% of the businesses, followed by lack of trust in its security were also highlighted as reasons why MSMEs wouldn’t use digital financing tools.
Most MSMEs don’t consider accessing finance using a digital platform as a possibility with receiving payment, paying salary, and saving being considered as the top three use-cases of digital platforms.
Digitalization promises great advances for financial inclusion both for unserved and underserved firms, in particular MSMEs, as well as households. Small businesses need to be more open to embracing technology and adopting (further) digitalization. Covid-19 has led to dramatic shifts in consumer behavior and preferences. Integrating technology in all critical business functions and innovating is now a critical need.
Hence the government needs to both establish clear policies and invest in such capabilities. To spur such action, stakeholders need to intervene and support the sector by using policy advocacy and direct programmatic actions. The key policy recommendation the research and follow-up policy brief emphasized are the following :
1. Develop a Digital Lending Strategy and Framework to encourage banks, MFIs, and potentially non-banking financial institutions to provide digital financial services for MSMEs
Across the policy frameworks, there is currently a lack of clarity regarding digital lending policy and how financial and non-financial institutions can give digital loans to MSMEs
. In addition, there is a need for a roadmap to inform potential financial sector players about how they can integrate digitization into their traditional banking business models. Hence, the Digital Lending Framework by the National Bank of Ethiopia could Incentivize digital lenders to enter the market if enacted into regulations encourage and boost MSME-focused digital lending services to emerge and scale. It would also enhance consumer confidence.
2. Scale up credit rating by tying up the Digital-ID initiative with the Credit-Reference Bureau (CRB) and taking specific data integration policy actions
The research recommends integrating various non-financial data points into the overall data management system and integrating National Identification (National ID system data points) into the CRB database and the creation and operation of private credit reference bureaus (CRBs) in Ethiopia. Doing this will in providing credit data symmetry, thus increasing the creditworthiness of MSMEs and making them eligible for loans where there will be less need for collateral requirements and approval lead times are reduced.