Emerging and Growth Markets | November 19, 2021

Call No. 34: How tech innovation is bridging gaps in small business financing in emerging markets

Jessica Pothering
ImpactAlpha Editor

Jessica Pothering

ImpactAlpha, November 19 – The boom in African fintech startups began before COVID-19. The economic shutdowns and financial dislocations of the pandemic supercharged the tech disruption. 

“We’re moving from digitally enabled fintech to a digitally native environment,” Lendable’s Daniel Goldfarb observed on ImpactAlpha’s Agents of Impact Call this week. “Banks, which used to offer the whole suite of financial services and were the only players in town, suddenly are getting disintermediated with specific use cases.” 

Among those use cases: data-powered lending to the continent’s informal, micro and small businesses.

Watch the replay of Agents of Impact Call No. 34

Take Pezesha in Kenya. The four-year-old fintech is becoming a go-to lending partner for companies like Twiga Foods, Jumia and MarketForce. The partners are among the growing crop of “enterprise tech” providers that are digitizing micro and small businesses through services like digital payments and inventory procurement. Pezesha collects customer data from its partners, runs it through its own credit risk-assessment algorithms, and then either makes loans itself or connects credit-worthy businesses to willing lenders. Pezesha, which operates in Kenya, Ghana and Uganda, raised a $3 million seed round in September and plans to launch in Nigeria. 

“We have built an operating system to power embedded finance,” explained Pezesha’s Hilda Moraa. “We’ve been able to democratize working capital by connecting underserved small businesses with access to affordable capital through seamless integration with partners.” 

In South Africa, The People’s Fund is filling a different small business financing gap: purchase order financing. The crowdlending platform offers underserved Black-led businesses loans to fulfill orders for government or corporate contracts. When orders are fulfilled and the businesses’ clients pay, The People’s Fund recoups its loan plus a slice of the profits. 

“What we’re doing is not new. It’s actually annoyingly not new. But the interest rates you get from banks—they’re not something that entices people,” remarked founder Luyanda Jafta. “People want to have more direct impact and participation in the economy, so the crowdfunding is just people saying, ‘Look, we want to be part of the solution.’”

The COVID-19 pandemic has been rocket fuel for such small business financing solutions. Lendable, which finances fintechs and has about 25 companies in its portfolio, has seen a 30% increase in transaction volume across its digital payments portfolio since the pandemic started, Goldfarb said, at the expense of legacy institutions, like banks, MoneyGram or Western Union.  

“Everyone that was only using digital payments, their business grew very rapidly in the first few weeks of COVID,” he added. “And lenders that lend on the back of that suddenly had more pipes to push their products through.” 

Legacy finance

Among the multiple reasons banks don’t lend to emerging market small businesses is ‘information asymmetry’ between businesses and lenders, said Moraa.

“Players in the market haven’t been able to clearly identify ways of monitoring what the capital is being used for. That is the same reason why banks are not able to come into our space—because it’s a lot of work for them to monitor where this money is going,” she explained. 

As a consequence, banks’ capital comes at exorbitant rates, or with stringent screens for potential customers, “which then means you’re excluding a lot of people,” Moraa added. 

Another reason: banks’ perception of credit risk. “Banks’ primary focus is a lens of risk not a lens of opportunity,” said Jafta. The People’s Fund’s borrowers are often rejected for bank loans because the banks fear the businesses’ clients won’t pay. 

“Government is known as the non-payer in South Africa,” explained Jafta. Lending data analyzed by The People’s Fund shows that the South African government is, in fact, one of the best payers; corporations have slower and worse track records. “But one of the reasons why banks don’t fund [purchase orders] is the perceived risk from government.” 

The new players may in fact be better able to manage such risks than banks. Goldfarb said it’s not reasonable to expect banks to fill the $5 trillion small business lending gap in emerging markets. 

“The primary role of the bank in society is to hold your deposits,” he said. “Banks are infrastructure companies, and they have a near-holy responsibility to not lose your deposits. So should banks be doing risky, new things? I don’t know if I think they should.”

Banks, agreed Daniel Kimotho of blockchain platform Celo, “are kind of maxed out on the kinds of things that they can do. That creates this new opportunity where disruption has to come from outside.” 

Celo has developed one of the first mobile-based blockchain protocols. Partners like Pezesha, Nairobi-based payment app Kotanipay and others are developing ways for people and businesses to send and receive money cheaply from anywhere in the world. 

“You may find a remittance company that was only focused on a small geography that is now able to cover a wider region and at a lower cost,” he explained.

“Cost of funds is very key,” agreed Moraa. “If the cost of funds don’t make sense to a business, the entire value chain doesn’t win—from the supplier to the retailer to Pezesha to everyone involved in that ecosystem.”

Such market imbalances are what fintechs, crypto platforms and other new financial service firms are designed to identify and fill, said Goldfarb. “What is so interesting is the disintermediation and unbundling of services has allowed for people to take risks that a bank could never take.”

Data is key

What makes the whole trend of tech-enabled financial inclusion possible is the availability of data on prospective customers and borrowers. 

Pezesha’s credit-scoring methodology, for example, is only possible because of the large volumes of customer data it receives from its e-commerce and enterprise tech partners. 

“We’ve done the hard work of integrating our rails on top of their workflows, and we are sitting in the backend, embedding and providing credit in a more productive and efficient way than ever before,” said Moraa. “We do real-time credit scoring, and then we can provide [merchants] with loan offers. So where a merchant did not have any credit history, now we can now provide that in real-time.” 

Demand for services like Pezesha soared during COVID, added Moraa. “Partners came to people like us and said, ‘This is not our core business, can you help us?’” Finding ways to extend credit services to struggling businesses became a crucial issue in e-commerce and enterprise tech ventures’ own survival.

For The People’s Fund, its tech-enabled due diligence is what allows the company to affordably extend loans as small as 10,000 South African rand ($640). “In the market we operate in, almost no one can do what we do,” said Jafta. 

Except potentially banks. “Why we’re angry that banks don’t do this is because banks have the infrastructure to offer a much lower rate,” he added.

Rebuilding the financial system

What companies like Pezesha, The People’s Fund and Celo all have in common is that they aren’t trying to make the mainstream financial system work for their clients; they’re trying to rebuild it entirely. 

In South Africa, for example, the Euro-centric financial system the country has adopted doesn’t work in an African context. The People’s Fund’s message to the Black business owners it supports is that it wants to “change the system, as it’s not designed for you,” explained Jafta. “Let’s design it so that it actually works for the objectives that we’re trying to achieve collectively as a society, instead of adopting things that look pretty but don’t functionally work in an environment where you have very high levels of poverty and very little access to opportunity.” 

Moraa explained that Pezesha’s model for financial inclusion is especially impactful for women-led businesses, which comprise a disproportionate share of Africa’s informal economy. “We are now able to offer them a credit score for the first time ever in the Pezesha ecosystem.” 

Celo launched the Alliance for Prosperity, a network of dozens of mobile, financial and research services companies committed to using crypto platforms and blockchain applications to drive responsible financial inclusion and economic opportunity. 

Goldfarb said that the financial system of the future is invisible. “None of us wake up in the morning and go, ‘I really would love to find nice financial services to integrate into my life.’ No.” 

“You want to start a business, you want to buy some food, you want to buy more inventory, you want a real world outcome,” he continued. “Financial services just enable that.”

Added Kimotho, “A financial system, at the end of the day, is supposed to enable prosperity.”

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