Prime
Designing credit that supports MSE growth
Andrew Tugume
What you need to know:
- Increased access to credit for MSEs ... has led to a rise in loan products...
Access to credit for Micro and Small Enterprises (MSEs) is a critical driver of economic development. According to the World Bank, approximately 53 percent of adults globally have access to credit, with the share varying significantly between income levels.
In high-income economies, around 65 percent of adults obtain new credit. In developing economies, this figure averages about 50 percent. In Uganda, the 2023 FinScope survey highlighted that the proportion of Ugandans accessing credit dropped from 46 percent in 2018 to 36 percent in 2023. This is despite overall improvement in financial inclusion from 77 percent in 2018 to 81 percent in 2023, a clear indication that MSEs face challenges in obtaining affordable credit.
Increased access to credit for MSEs in Uganda and East Africa has led to a rise in loan products designed primarily to expand borrower numbers, prioritising access over long-term business growth. These products are short-term, characterised by quick disbursement and high interest rates and challenging to repay.
The quick access to such loan products attracts MSEs despite the high risk of falling into a debt trap. The International Finance Corporation (IFC) confirms that 70 percent of African MSEs that face a financing gap rely on such costly loans to sustain operations.
The MSE Recovery Fund, a project implemented as a consortium led by Financial Sector Deepening (FSD) Uganda in partnership with the Mastercard Foundation, also shows that most MSEs only have access to short-term loans not exceeding Shs1 million for loan tenures not exceeding 12 months. This suggests that the majority of MSEs are receiving credit only sufficient for short-term needs like working capital.
These loans are not large enough to fund business expansion, technology upgrades, or workforce development, an indication that the products are affordable in the short run. MSEs are drawn to these products because they lack collateral. Additionally, many lack financial records and account balances, which would guarantee them for larger loans with lower interest rates and longer repayment terms. Consequently, financial service providers (FSPs) design products tailored to this market segment, balancing affordability with reduced risk to meet the needs and constraints of borrowers. While this may be profitable to the FSPs, the approach fails to solve borrowers' problems.
They often resort to more borrowing, limiting returns for repayment and growth, creating a vicious debt cycle (debt trap). How can we turn the situation around? Financial institutions must shift their focus from merely providing access to credit to designing loan products that genuinely support MSE growth. This requires a mindset shift from access to impact and these strategies can help. First, formalising MSEs is essential.
The legal requirements for formalised businesses encourage better financial management and record-keeping, helping MSEs avoid over-borrowing and manage cash flows effectively. This improves the creditworthiness of the businesses, enabling them to secure loans with lower interest rates and longer repayment terms. Second, financial products should be tailored.
Loan products must align with the cash flow patterns of MSEs. Flexible terms and interest rates that reflect their financial realities are key to preventing over-indebtedness. For example, revenue-based financing models, where repayments are tied to a percentage of the borrower’s revenue, could relieve the pressure of fixed monthly payments.
Third, FSPs should offer larger loan amounts and longer tenures to businesses demonstrating growth potential. Instead of focusing solely on immediate repayment, they could implement performance-based metrics to evaluate a borrower’s ability to grow and repay over time. This approach might involve tiered lending products, where enterprises that demonstrate good repayment behaviour and growth are eligible for larger, more flexible loans in future cycles.
Finally, access to credit should be combined with capacity-building initiatives. This includes not only funds but also training in financial management and business development. Programmes that include financial literacy, mindset change, and mentorship can empower MSEs to manage their resources effectively and navigate market challenges.
The author, Andrew Tugume, is a Monitoring and Results Measurement Specialist, FSD Uganda
