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How impact investing can bridge the MSME funding gap

How impact investing can bridge the MSME funding gap

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Inside Oikocredit’s partner Pro Mujer branch office.

27 June | 2023

Micro, small and medium enterprises are essential to the global economy, but they can’t access financial services easily. Here we look at their importance and at how Oikocredit and other impact investors are stepping in to address the problem.

Micro, small and medium enterprises (MSME) are the backbone of the global economy. Together, they comprise 90 per cent of businesses and up to 70 per cent of the world’s employment, and they are responsible for half of global GDP, according to the United Nations. 

Their contributions are highlighted on MSME Day, which falls on June 27 each year. The day raises awareness of MSMEs’ contribution to sustainable development and the global economy, and their role in achieving the Sustainable Development Goals (SDGs). 

Despite their prominent role, MSMEs find it hard to access finance. Oikocredit has partnered for many years with inclusive finance institutions that support MSMEs, and its response now also embraces a community-focused approach.   

Let’s take a closer look. 

What are MSMEs and why are they important?  

MSMEs are small and medium sized business enterprises. The term covers a broad range of enterprises of different sizes.  

MSMEs typically range from up to 10 employees with an assets of below US$ 100,000 at the micro level to a staff strength of between 50 and 300 employees and assets of between US$ 3 million and US$ 15 million for larger SMEs, according to the World Bank’s International Finance Corporation. 

Since the mid-2010s, development agencies, multilateral banks, and microfinance and other impact investment vehicles – including Oikocredit – have focused on MSMEs’ important role in addressing economic growth, providing a decent living and fighting poverty, explains Nicolas Viedma, Investments Manager at Oikocredit. More recently, the idea of partnering with MSMEs has been recognised as even more crucial to address gender equality and to provide quality education, clean water, affordable energy and other community services. 

Together, these aims speak to a number of the SDGs, including goals 1, 4, 5, 6, 7 and 8. 

The MSME funding gap 

Despite their importance to the global economy, MSMEs face a significant funding gap, Nicolas says. 

“Differently from large corporations or informal micro entrepreneurs, MSMEs are positioned in the ‘middle gap’ of finance,” according to Nicolas. “They are largely underserved. Although they often partly comply with formal and professional financial accounting standards and with tax and labour regulations, MSMEs can't always fulfil all the conventional requirements and standards of financial institutions and capital markets, including risk-return expectations.”  

The financial sector, meanwhile, often lacks the understanding to adapt its offerings to the needs of MSMEs. 

The SME Finance Forum reports that 131 million formal MSMEs in developing countries – about 41 per cent of the total – have unmet financing needs.  

The MSME finance gap in low-income countries is estimated to be approximately US$ 5 trillion, which is 1.3 times the current level of MSME lending. Women-owned enterprises comprise 23 per cent of MSMEs and are especially affected, accounting for nearly a third of the finance gap. 

Different kinds of financing and where Oikocredit can help 

Microfinance institutions (MFIs) have developed alternative banking models to service informal micro entrepreneurs, Nicolas explains. MFI loans to such micro businesses tend to be in the range of US$ 3,000 to US$ 15,000, provided in person or though digital channels. And MFI support often continues as the client business grows and becomes more formalised. However, few MFIs invest more than a quarter of their total funds in the larger and more formal SME sector, and most remain focused on micro enterprises.  

Beyond the micro level, SME financial institutions (FIs) typically make up the bulk of financing for small and mid-size enterprises, says Nicolas. Such institutions include SME banks and non-banking financial institutions such as savings and loan cooperatives and finance companies, as well as factoring, leasing, securitisation and fintech (financial technology) companies.  

Larger than the loans MFIs provide to micro enterprises, SME FI lending can range from about US$ 20,000 to sometimes millions of dollars.And whereas microfinance often relates to the business owner’s personal finances and assets, SME finance is more usually based on business cash flow. 

Over the past decade, microfinance investment vehicles, including Oikocredit, have engaged with and supported primarily MFIs but also to an extent specialised SME FIs. 

As Nicolas observes:  “We strongly believe Oikocredit can be part of this solution. Our financing of SMEs helps them grow and create jobs, and some SMEs address issues affecting low income earners such as inadequate housing, healthcare and education.”  

Pro Mujer Argentina Carmen Bravo - Hardware Shop

Oikocredit’s community-focused approach: supporting the SDGs and responding to the “permacrisis” 

According to the UN, increasing annual investment in SMEs by US$ 1 trillion would yield exceptional dividends in terms of progress towards the SDGs. When they are well financed, SMEs directly benefit society on three fronts, Nicolas points out: 

“First, SMEs create quality jobs and provide regular employment income, sometimes above general market levels. Second, many SMEs are women owned and socially driven, with resulting benefits for women’s empowerment and other social goals. And third, SMEs often deliver products and services adapted to local needs and promote solutions that complement public provision in education, healthcare, water and sanitation, and other sectors.”  

Oikocredit’s continuing support for SME FIs is central to our commitment to promote both gender inclusion and job creation, which are key aspects of our vision of a global, just society where all people can lead lives of dignity . 

As a central theme of Oikocredit’s recently adopted 2022-2026 strategy, we are also striving to respond to what is being called the world’s permacrisis. Today’s exceptionally challenging period combines the continuing legacy of the Covid-19 pandemic, mounting climate change and biodiversity loss impacts, increasing migration flows and war. Our strategy aims to help low-income communities become more resilient in the face of increasing uncertainty. 

“Connecting to and supporting communities is key for MFIs and other FIs to identify and enhance feasible, sustainable and scalable solutions to today’s multiple crises,” Nicolas says.  

“Many low-income rural and peri-urban communities urgently need not only our long-standing support for financial inclusion, gender equity and sustainable agriculture. They also need innovative resilience-building investment and capacity building in housing, education, healthcare, water and sanitation, renewable energy and other areas of community infrastructure.”  

Oikocredit is therefore seeking out resilient SMEs that can respond to community needs at scale.   

“There are opportunities for MFIs and SME FIs to identify SMEs in these segments,” adds Nicolas, “which will likely be in greater need and socially far more worthwhile than consumer financing.” 

Pro Mujer Argentina Inside the Pro Mujer branch office of San Miguel de Tucumán, with security staff

Oikocredit at work: MSMEs for a better world 

Some examples of Oikocredit’s work in supporting MSMEs come from Latin America, where we have partnered with key MSME financiers. 

Visión Banco in Paraguay, for example, reaches 900,000 individuals and businesses across the country. Over the past 10 years, it has grown from only offering savings accounts and micro loans to providing specialised digital solutions to formalised SMEs. Around half of Visión Banco’s financing portfolio is allocated to small enterprises, most of them SMEs that borrow less than US$ 100,000 and typically employ between 5 and 15 people. 

Another example is Banco Industrial(BIND) in Argentina, which has built a successful business by focusing on the needs of smaller enterprises that operate in challenging conditions, including a volatile macroeconomy, cumbersome bureaucratic restrictions and a lack of credit. BIND is one of the first FIs in Argentina to offer digital loans to businesses and has launched a joint initiative with the country’s main mobile wallet provider to enable more than 5.5 million clients to invest their money as a way to protect it from one of the world’s highest inflation rates. In 2018 BIND won the Best SME Bank Argentina Award.

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