New financing models needed for business growth

The country needs to reform the existing business financing architecture to make it possible for more businesses to access formal finance, Professor Joshua Yindenaba Abor, Dean of the University of Ghana Business School has said.

“Private enterprises are considered the engine of growth. However, in Africa, the nature of the financial market tends to restrict access to formal finance, thus hampering private enterprise growth and development. African countries need to look beyond policies aimed at promoting financial market development at a more general level.

Policies targeted at restructuring the financial system in ways that support enterprise financing should be part of the reform agenda. There is certainly an urgent call to design innovative financing models with appropriate public sector interventions to support private enterprises.

We need to thoughtfully consider a financial architecture that recognises the relevance of development finance with appropriate regulation to facilitate access to long-term finance in order to drive private enterprise growth in Africa,” Prof. Abor said.

He was speaking at his inaugural lecture held at the University of Ghana on the theme: “Financing Private Enterprise Growth in Africa: How do we drive the real economy.

Private enterprises in Africa are mainly made up of SMEs, which constitutes about 90% of businesses. The rationale for much emphasis on SMEs is based on the positive economic functions they perform.

SMEs are regarded as important contributors to the growth of most economies, contributing between 60% and 80% to employment generation in Africa.

They also support the process of economic growth through the demand channel. Their demand for industrial or consumer goods and other services tend to stimulate the business activities of their suppliers. Similarly, their activities are also stimulated by their clients’ demand

In Ghana, SMEs play an important role as the engine of growth of the economy. The Registrar General’s Department data shows that 92 percent of companies registered in Ghana are micro, small and medium enterprises (SMEs). SMEs also provide about 85 percent of manufacturing employment and contribute about 70 percent to Ghana’s GDP.

They contribute to the country’s overall export performance and foreign exchange and also support the evolution and emergence of a ‘new economy’ through their innovations.

Inspite of the important role played by SMEs, they are often confronted with a number of obstacles to their operations and growth, including limited access to finance, intense competition, stringent regulations, low managerial skills and limited access to international markets.

Prof. Abor said: “From the institutional finance perspective, SMEs mostly rely on the owners’ personal savings, and family and friends at the initial stages of the business. As they grow they may want to access financial markets to finance working capital and other financing needs.

However, they may find that financial institutions are not willing to lend to them, that funds provided do not meet their financing needs, that the term of the loans may differ from what they require, and that high interest rates may exclude them from the market for loans.

This financing gap is largely as a result of the issue of information asymmetry with the attendant problems of adverse selection and moral hazard. Information asymmetry occurs because the potential lender and the enterprise possess different amount and quality of information.

Adverse selection may occur because the limited nature of information available to the lender will lead to the acceptance of a bad credit risk or the rejection of an otherwise good applicant. Altman (1968) defined the latter as a type-I error and the former as a type-II error. Moral hazards also arise because the applicant, for example, may use the loan for a different purpose other than the purpose for which the funds were sourced.”

To solve the challenges faced by SMEs he postulated that: “Finance providers may implement contract provisions that discourage borrowers from acting against the interests of the finance provider. The economic costs incurred by the finance provider for taking these precautionary actions can also lead to credit rationing. The problem of adverse selection and moral hazard can also be reduced if the borrower can provide adequate collateral and exhibit good reputation.”