Banking has been in the news for the past couple of months for all the wrong reasons. This article has been in the pot for the past six months because I believe my sentiments will resonate with majority of us. I believe it’s time we took an honest look at the growth and development of banking services and products from pre-1963 to date and why the SME funding aspect has so far been nothing more than a fallacy that bankers have used to collect deposits to enrich themselves.
The early European trade in the Indian Ocean at the coast of East Africa, chiefly in Zanzibar, courtesy of the Imperial British East African Company (IBEAC) in partnership with the National Bank of India (NBI) formed a partnership courtesy of the British merchants and NBI in 1897 to form the first bank in Kenya’s history. IBEAC was disbanded in 1896 to form the EA protectorate and with that, the National Bank of India was tasked with the funding of the railway line to Kisumu.
The National Bank of India funded the railways for EA Protectorate and business was good. In 1901, the railway line arrived in Kisumu. In 1904, the National Bank of India opened its first branch in Nairobi, away from Mombasa. The first banking ordinance was set up in 1910 to coordinate the terms and conditions of engagement, deposits and loans.
This particular period has my interest. What informed the developers of the ordinance to come up with it. What terms did they refer in it? What made one qualify for a loan and what was the collateral. Despite the two World Wars, banking in Kenya kept growing and from the NBI partnership with the British colonial master, one can infer that the essence of collateral in terms of real assets that were tangible was established.
Why I say today’s banks and other financial institutions are fallacious when it comes to lending to the SME sector is because of how lending structures are set up and going back in history might help us understand this better.
The NBI funded the railway and land was the collateral among other assets and agreements on the management of the railway line. This gave rise to real estate in key areas around the line and they offered more collateral for banks that kept coming up as business picked up. Manufacturing grew. This was another hot area to fund, given the tangible assets in the sector.
Feeding people was key, as the hinterland was opened up to trade, financing agriculture was key. In 1911 Standard Bank of South Africa was set up with two branches; one in Mombasa and the other in Nairobi. Business was doing well. The British colony was growing. Key areas that these banks up to independence focused on were logistics i.e. the railway line, agriculture, manufacturing, trade (in terms of retail) and security. These sectors formed the foundation on how banks would lend. Any SME that was in this category got the support of either the bank or the government of the day. Other sectors were ignored and never given enough support to grow, if any.
Service sector is an economic piece whose success is dependent on other aspects of the economy like manufacturing and agriculture. It was ignored. It never had the requisite assets for funding. Growth was limited to the availability of assets to acquire a loan or funding.
Fast forward to today, there are many sectors of the economy. Technology has changed how Kenyans and the world in general do business, how we communicate, how we seek funding, how we seek loans and especially how we pay them back. Interesting thing is, despite the technological advancements in the banking sector, the terms and conditions for accessing financing, especially for SMES in sectors other than manufacturing, agriculture and real estate, are still archaic and more or less similar to how they were in the late 19th Century.
Banks are spending billions to tell us how they love SMEs and how 80% of the jobs created in Kenya are by virtue of them hence why they need to fund them. The banks end up getting funding from bodies like the IFC, ADB and the World Bank to finance SMEs in various sectors but what actually ends up happening is that the list of funded SMEs usually lies in the manufacturing, real estate and agricultural sectors. The rest of the SMEs in other sectors are left to fend for themselves.
The money that remains is loaned internally to insiders at really low rates. This is the hypocrisy of growth of the SME eco-system and how banks use us to get funding and enrich themselves.
Despite the advancement of technology and the advent of intellectual property rights, banks have refused to finance SMEs outside the 3 aforementioned sectors unless said SME has collateral. But in today’s world, if you run an SME in the services sector for example, without collateral, no bank will want to touch you even with a 100ft pole. And yet, we claim to have advanced in the thinking and delivery of financing to SMEs.
Question is, why isn’t intellectual property worth anything? Ghafla was recently acquired for over KES 30Mn. A website that focuses on news in the entertainment world. That’s some serious IP but no bank would bother to use that as collateral.
How can we grow to the next level if all we keep being told is to provide collateral in the form of land or houses, which most of SME owners have no access to individually or are still young to amass enough wealth to buy?
If indeed SMEs play a key role, if indeed SMEs are the best job creators in the country, accounting for over 80% of jobs created, why not support them? I dispute the data that most SMEs fail within 6 months due to mismanagement or lack of focus. Issue is simple.
90% of SMEs fail, irrespective of time in operation, not because they do not have business but because they lack the needed funding to help them grow and expand.
Cash flow is a big challenge to majority of the SMEs and despite most having clients, getting paid on time remains a major challenge.
Developed products in the market to address this challenge like discount invoicing entail so much paper work, it’s easier to get a loan instead. SMEs have been used by banks to source for funds from key strategic investors under the guise of funding them. Funds which will then be redirected to benefit other clients, leaving SMEs in the dust. This is a conversation that must be had. Intellectual Property should be used as collateral to give a fighting chance for new-age business ideas to grow and thrive. Collateral based only on tangible assets is not only archaic but has contributed to corruption and a lot of economic loss for Kenya.
This Modern SME set up will not survive unless and until the banking sector rewrites the terms and rules of lending to SMEs where the value of intellectual property (IP) is factored in. Someone once asked, “how do you measure IP?” and while I’m usually not a violent man, I almost slapped them that time. Banks have units and departments that can value and measure intellectual property value for assets like websites and the services offered on those websites. They can quantify the value and lend to respective SMEs accordingly.
Banks hold deposits and savings entrusted to them by individuals, by businesses, by governments and by central banks. They put that money to work, helping people to buy homes, for example, or lending to businesses to invest in expansion as explained by Bob Diamond. But this needs to change. How they lend it out. More value and potential for their shareholders and depositors lies with SMEs and not any other group that is seeking funding.
Vince Cable explains that Investment banking has, in recent years, resembled a casino, and the massive scale of gambling losses has dragged down traditional business and retail lending activities as banks try to rebuild their balance sheets. This was one aspect of modern financial liberalisation that had dire consequences. This is a clear indication that modern business is changing and that bank must change and adapt or close shop. Need to rethink the lending business. Relook at how to value the IP market and how to ensure that the rate at which SMEs are collapsing is truly studied and the data used to improve on lending and cash flow support for SMES.
Vince Cable explains that Banks operate like a man who either wears his trousers round his chest, stifling breathing, as now, or round his ankles, exposing his assets. We want their trousers tied round their middle: steady lending growth; particularly to productive SME, especially small scale enterprises in new emerging business trends.
Craig Ferguson captures the mind of the Kenyan SME perfectly. He says, ‘’when you need to borrow money the Mob seems like a better deal I think. ‘You don’t pay me back I break both yer legs.’ Is that all? You won’t take my house or wreck my credit rating? Fine where do I sign. Legs? Fine. You don’t even have to sign anything.” Most SMES in KE and the larger EA opt for the shylock as the lender of last resort purely because the banks have refused to adapt to the economic growth patterns and SMES are have no other options.
James Grant, author of Money of the Mind: Borrowing and Lending in America from the Civil War to Michael Milken says that Progress is cumulative in science and engineering, but cyclical in finance. This points to the error of our lending system. Based on ancient resources and values, the system refuses to grown in any direction other than circular. Majority of entrepreneurs in Kenya in the tech, service sectors have failed because of lack of funding and nothing else.
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Of notable interest is how Sidian bank, who motto is the entrepreneur, partnering with a tech firm, Uber to loan over 5B to potential Uber drivers. Now this is breaking the norm in lending and going vertical. A gesture that other banks must emulate if they are to truly be part of the financial revolution that this country needs.
Irvine Sprague, former chairman of the Federal Deposit Insurance Corporation and author of Bailout: An Insider’s Account of Bank Failures and Rescues captures the mood in the mobile banking sector as thus; Unburdened with the experience of the past, each generation of bankers believes it knows best, and each new generation produces some who have to learn the hard way. This represents what’s happening in the mobile space. It’s easier to access KES 100,000 via your mobile app connected to your bank account than if you went directly and applied for KES 10,000. I tried it. I got the KES 100,000 via mobile within minutes but when I went to branch, I was told to fill forms and produce collateral. This shows a disconnect in our lending eco-system to the SMES world.
Many would argue that lending money to SMEs is very risky and hence must be controlled by whatever means. I vehemently disagree. Irvine Sprague, former chairman of the Federal Deposit Insurance Corporation and author of ‘Bailout: An Insider’s Account of Bank Failures and Rescues‘ echoes my thoughts when he says,
’’…Banks fail in the vast majority of cases because their managements seek growth at all costs, reach for profits without due regard to risk, give privileged treatment to insiders, or gamble on the future course of interest rates. Some simply have dishonest management that loots the bank.”
Nothing to do with SMEs. It is high time the CBK, Kenya bankers and other players did the honorable thing and reviewed the terms and rules of collateral in lending to SMEs outside the major sectors of the economy.