The Role of Credit in Enabling Growth for SMEs in East Africa

The Role of Credit in Enabling Growth for SMEs in East Africa

SMEs are not merely a component of the East African economy; they are its very heartbeat. From the vibrant markets of Nairobi and Kampala to the agricultural lands of rural Rwanda and Tanzania, these businesses are the primary drivers of economic expansion and employment.

They are the bedrock of livelihoods, contributing substantially to GDP and employment throughout the region. Nevertheless, a major hurdle obstructs their progress: a persistent and significant lack of access to credit.

According to the African Development Bank (AfDB), a staggering 80% of SMEs in sub-Saharan Africa lack a credit line from a financial institution.

This is not merely a business challenge; it’s a systemic issue that cripples these enterprises’ ability to invest, scale, and generate jobs. For East Africa, where SMEs are the main employers of young people and women, this credit gap is a direct threat to equitable growth and poverty alleviation.

Promising initiatives are emerging to address this gap.In Kenya, the Hustler Fund has been established to provide affordable credit to micro and small enterprises, directly targeting those historically excluded from formal banking. Similarly, the STAWI Mashinani program, also in Kenya, leverages technology to provide digital financial services to rural communities, including small business loans.

Tanzania has seen the rise of platforms like NMB Pesa, which offer mobile banking services and credit facilities tailored for SMEs. By understanding the unique obstacles SMEs face and implementing targeted strategies like these, policymakers and financial institutions can unleash their enormous potential, propelling prosperity for the entire region.

Understanding the SME Landscape: The East African Context

To effectively support SMEs in East Africa, we must first understand how they operate and are defined.

While definitions can vary by country, the framework used by institutions like the Central Bank of Kenya (CBK) provides a useful regional reference.

This framework categorizes enterprises by turnover and employee count:

Microenterprise:Turnover up to Ksh. 500,000, 1-9 employees.

Small Enterprise:Turnover of Ksh. 500,000 to Ksh. 5 million, 10-49 employees.

Medium Enterprise:Turnover of Ksh. 5 million to Ksh. 100 million, 50-250 employees.

This classification helps us understand the vast scope of businesses, from a small tailoring shop in Tanzania to a growing tech startup in Rwanda.

The Massive Financing Gap for East African SMEs

Despite their crucial role, East African SMEs face a massive financing gap. A report from the African Development Bank (AfDB) indicates that while Kenyan banks have a significant loan exposure to SMEs (50%), this figure can be misleading. It often masks a huge unmet demand, as a majority of funding goes to larger, more established businesses, leaving smaller enterprises with limited options.

In Uganda, a similar pattern exists, where many small businesses, like a food processing venture in Kampala, struggle to secure capital for expansion.

This problem is particularly acute for the agricultural sector, which is the backbone of many East African economies. The Commercial Agriculture for Smallholders and Agribusiness (CASA) program estimates a staggering $74.5 billion financing gap for agricultural SMEs in sub-Saharan Africa.

Job Creation and Community Development

SMEs are the region’s largest employers and a key engine for community development. In Kenya, they account for approximately 80% of all businesses and contribute up to 40% of the national GDP. Similarly, in Uganda, SMEs constitute about 90% of all private sector firms and provide over 60% of total employment.

A small-scale coffee farmer’s cooperative in Rwanda or a crafts business in Tanzania exemplifies this impact, creating employment for both skilled and unskilled labor, especially for youth and women. By empowering these businesses,East African countries are not only fostering economic growth but also driving social inclusion and reducing poverty at the grassroots level.

Actionable Strategies to Enhance Credit Accessibility

To bridge the credit gap, a multi-pronged approach is necessary, involving policymakers, financial institutions, and the SMEs themselves.

Limited Access to Capital:Despite a growing number of government initiatives, a significant funding gap persists. As of late 2024, the SME finance gap in sub-Saharan Africa was estimated at $331 billion. The gap is driven by a number of factors including firm size, perceived risk, and a general lack of knowledge about available financial products.
Lack of Collateral:Most traditional financial institutions require tangible assets like real estate as collateral. For new or smaller SMEs, this is often a non-starter, effectively locking them out of the formal credit market. A 2018 study on credit bureaus in Kenya found that even with the introduction of credit reporting, collateral requirements remain a major obstacle.
High Interest Rates:High borrowing costs are a significant barrier.While commercial banks in Kenya have charged average interest rates of around 15.5% in the past, microfinance banks have been known to charge up to 32% to SMEs. In Uganda and Tanzania, rates typically range between 18% and 21%, making debt unsustainable for many businesses with thin profit margins.
High Mortality Rate:The business environment can be unforgiving. A report by the Kenya National Bureau of Statistics (KNBS) highlighted that approximately 2.2 million MSMEs closed down in the last five years, with 46% failing within their first year. In Uganda, research suggests that as many as one-third of new businesses do not survive past their first year of operation.

When SMEs gain access to appropriate credit, the impact is immediate and transformative. It’s the catalyst they need to expand, innovate, and contribute more meaningfully to the economy.

Increased Investment and Market Reach:Credit empowers SMEs to invest in new equipment, technology, and marketing strategies, allowing them to expand operations and tap into new markets. For a country like Kenya, where SMEs generate 30% of annual jobs, improved credit access is crucial to amplifying this impact and boosting the nation’s GDP contribution beyond its current level.

Job Creation and Economic Development:Empowering SMEs is a powerful strategy for a region with a young, rapidly growing population. By providing credit, these businesses can drive job creation and foster a virtuous cycle of economic progress. The Uganda Investment Authority (UIA) reports that SMEs employ over 2.5 million people and are responsible for 90% of the private sector’s output, underscoring their immense potential when properly supported.

To bridge the credit gap, a multi-pronged approach is necessary, involving policymakers, financial institutions, and the SMEs themselves.

Improving Credit Reporting: The rise of credit bureaus in East Africa is a game-changer. By collecting and maintaining credit information, they provide lenders with a clearer picture of a borrower’s credit history. Recent regulations in Kenya, for example, have made it mandatory for financial institutions to report non-performing loans, which helps to identify serial defaulters and allows banks to offer more competitive rates to good borrowers. This builds trust and facilitates access to finance for small businesses.
Strengthening Financial Institutions:Banks and other lenders must innovate to serve the SME market better. Initiatives like Pesapal’s credit product are a great example.By leveraging their extensive network of merchants, they can provide fast, flexible financing that addresses traditional pain points like high interest rates and cumbersome collateral requirements.
Promoting Financial Literacy:Knowledge is power. Financial literacy training for entrepreneurs enables them to make informed decisions about debt, investment, and cash flow management. A study in Kenya on a soapstone business found a positive correlation between financial literacy training and improved business performance. Equipping SME owners with these skills reduces their administrative costs and enhances their ability to secure and manage credit responsibly.

The Future is Tech-Enabled: Mobile Money and Super-Apps

The digital revolution is changing how small businesses in East Africa get financing. Mobile money has already transformed the region, allowing people to get loans, save money, and make payments without a traditional bank. This makes it easier for SMEs to access funds quickly, without a lot of paperwork. This is a big step toward including everyone in the financial system.

Looking ahead, super-apps—all-in-one apps that combine many services into one platform will further close this gap. These apps can connect SMEs with more customers and use different kinds of information to decide who is a good risk for a loan.

Instead of just looking at bank records, they can check things like mobile phone usage, social media activity, and online sales.

This digital shift is a fundamental change that will be essential for helping East Africa’s SMEs reach their full potential. Learn more: https://www.pesapal.com/business/credit