A credit lifeline: How banks can serve SMEs in South Africa better

Small and medium-size enterprises are crucial to the economy in South Africa, and optimal support is needed to ensure their recovery and growth into the next normal

The ongoing COVID-19 crisis has had a devastating impact on small and medium-size enterprises (SMEs) in South Africa. 1 Stringent lockdown measures imposed early on caused consumer spending to dry up and revenues to fall, almost overnight, threatening the livelihoods of an estimated 60 percent of businesses. And while conditions have since eased, many SMEs remain vulnerable.

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The government has acted swiftly to provide relief to these businesses. However, the 200 billion rand loan-guarantee scheme launched in partnership with commercial banks in May 2020 has had minimal take-up. 2 Five months after the scheme went live, only around 8 percent of the available funds had been approved for disbursement, according to an October 2020 update from the Banking Association South Africa (BASA). 3 We estimate that this equates to about 12,000 businesses, which means that less than 1 percent of the country’s 2.5 million SMEs have benefited from the scheme.

This situation has highlighted a long-standing financing challenge facing SMEs in South Africa. In this article, we look at what’s stopping the country’s SMEs from accessing the funds they need. And, using insights gained from interviews on SME lending across different stakeholder groups, we describe how banks could serve this important segment better, including by drawing inspiration from the best practices of nonbank financial institutions (NBFIs) operating locally. Although small, SMEs play an outsize role in the economy, and optimal support is needed to ensure their recovery and growth into the future.

South Africa’s SMEs struggle to access finance and those in the ‘missing middle’ are most affected

SMEs make up about 98.5 percent of all businesses in South Africa and are a critical force in the country’s economy, yet historically they have struggled to access the capital they need to grow and thrive. According to a 2018 survey, only 6 percent of SMEs reported that they received government funding and 9 percent that they received funding from private sources. 4 During the COVID-19 crisis, we’ve seen this pattern persist. Notably, the 200 billion rand COVID-19 loan guarantee scheme, which was set up to provide critical financial support to South African SMEs during the pandemic, had disbursed only about 16.7 billion rand as of October 24, 2020 (Exhibit 1).

The 200 billion rand COVID-19 loan-guarantee scheme for South African SMEs had disbursed only about 16.7 billion rand by October.
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Both demand- and supply-side factors are driving this poor performance. On the demand side, SMEs may be reluctant to take on debt or further leverage their businesses at this time because they are uncertain whether they will be able to repay the funds in the current economic climate. 5 Even before the pandemic, South African SMEs were facing headwinds, including a flagging economy, fueled by factors such as unstable electricity supply and poor economic reform. Further evidence of muted demand from SMEs for debt can be seen in the recorded utilization rates of overdraft facilities: two of the leading banks that we interviewed reported that their respective overdraft-facility utilization dropped from approximately 60 percent and between 60–70 percent prepandemic to approximately 40 percent and 50 percent, respectively, at the end of July 2020.

Commercial banks have also provided SMEs with other forms of relief, ranging from grants to payment holidays and other loan-restructuring arrangements. As of the end of the first week of August, banks had collectively provided over 30 billion rand in voluntary relief to SMEs, commercial businesses, and individuals (Exhibit 2). The book value at risk of the restructured loans is estimated at over 500 billion rand. It is also likely that smaller businesses may have been able to access other types of government relief to tide them over at this time, including the Unemployment Insurance Fund and the COVID-19 Agricultural Disaster Support Fund. 6

Commercial banks have provided more than 30 billion rand in voluntary relief to SMEs, commercial businesses, and individuals.
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On the supply side, factors limiting the uptake of the COVID-19 loan guarantee scheme include banks’ lack of distribution agility to reach SMEs at scale and slow bank lending processes—most banks have yet to migrate to digital and still follow manual processes requiring hard copy documents and in-branch applications. As of October 5, 2020, just 44,912 COVID-19 loan scheme applications had been received by commercial banks—representing only 2 percent of South Africa’s SME population—and almost 40 percent of these are still pending processing. This is partly due to the fact that, to apply for funding, some banks required SMEs to have an existing relationship of either lending or transactional banking with them, which automatically excluded unbanked businesses. Additionally, the credit-scoring models that are employed by most banks place a heavy burden on SMEs, limiting their access to finance. Traditional risk criteria such as evidence of tax status and financial statements are typically required, yet during the coronavirus crisis, delinquent tax debt has increased, and historically, over 50 percent of South African SMEs do not keep financial records. This not only limits SME's ability to access credit from banks but increases risk for both the borrower and the institution. 7 Furthermore, banks require SMEs to put down collateral, which many of these businesses are unable to provide. As a result, one banking player told us that, because of their inability to assess the risk of smaller businesses, they do not lend to SMEs with a turnover of less than 10 million rand (Exhibit 3). These same factors likely contribute to the high rejection rate of loans. Around 36 percent of COVID-19 loan guarantee scheme applications have been denied.

Current bank credit-scoring models exclude many small and medium-size enterprises.
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It is clear that in their struggle to access funds—both during the crisis and before it—not all SMEs are affected equally. Our analysis shows that larger SMEs are the most likely to receive financing. 8 According to South African Reserve Bank data on corporate and retail SMEs, businesses in this segment have significant success accessing credit from commercial banks. 9 These businesses are usually formal in nature, and they have the administrative and operational capacity to meet the credit criteria of the commercial banks. At the other end of the spectrum, while microbusinesses with turnover of less than 1 million rand that employ five or fewer people have limited access to bank lending facilities, they are able to tap into personal credit facilities, microfinance funding, grants, and other forms of government financing. 10 However, those in between, what we call the “missing middle”—very small, small, and medium-size businesses—are falling between the cracks (Exhibit 4).

Small and medium-size enterprises in the missing middle are falling between the cracks.
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Unlike their large and micro counterparts, missing-middle businesses find themselves to be neither small nor large enough. With an average turnover ranging from 1 million rand to 100 million rand and employing between five and 35 people, they do not often qualify for government grants as they are considered too well resourced, nor do they have success accessing capital from commercial banks because they don’t have the required credit criteria. SMEs in the missing middle make up a significant percentage of all South African SMEs—and include businesses such as restaurants with one or two branches, hair salons, and boutique clothing stores. Their inability to access funding has led to a credit gap, which the International Finance Corporation estimates to be approximately $30 billion (509 billion rand). According to the estimates of the National Credit Regulator, close to 780,000 formal firms and 2 million informal firms in South Africa are affected by this gap.

NBFIs step up to fill the credit gap with implications for commercial banks

Caught between a rock and a hard place, many SMEs in the missing middle have turned to NBFIs to access credit—notwithstanding the fact that these institutions generally have higher interest rates to offset their higher appetite for risk. This has especially been the case during the COVID-19 pandemic. While banks are reporting muted demand for loans at this time, interviews with nine major NBFIs operating in South Africa revealed that demand for loans from customers across the country has been rising.

Historically, SMEs have been an unattractive segment for traditional banks because of the varied credit quality of SMEs, the difficulty in managing cost-to-serve, and the relatively low return on equity, among other reasons. However, in the past decade, several NBFIs have emerged in South Africa to plug this gap (Exhibit 5).

Nonbank financial players are proliferating in the South African market.
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These nimbler, nonbank players have leveraged the rise of digitization and advanced analytics to evolve more cost-efficient credit models and have homed in on entrepreneurs’ pain points to find new ways to serve SMEs, especially those in the missing middle. The approach demonstrated by these players is aligned with banking best practices globally, as identified by McKinsey’s Global Banking Practice, and include focusing on the customer’s biggest challenges, starting with a minimum-viable product and thinking through the IT implications at the outset. Drawing on these best-practice examples both from local NBFIs and from leading banks in other markets, we have identified three key actions for South African banks to consider:

Innovate product and proposition

Banks could consider stepping away from traditional lending approaches that may no longer be well suited to the nature of businesses run by SMEs. NBFIs have developed their ability to repackage their lending products as funding solutions. Instead of restricting what borrowed funds can be used for, NBFIs allow the SMEs to determine how to use the funds and price the risk accordingly. Additionally, the majority of NBFIs offer unsecured products, thereby making it easier for businesses in the missing middle to qualify.

NBFIs are innovating their business models in other ways too. For example, an NBFI providing financing to spaza-shop owners equipped customers with a till device and takes a portion of each transaction. This collection model directly links to sales and the customer’s cash flow and the NBFI can gather valuable data on its customers, which helps inform its risk assessments.

Commercial banks could follow this example by designing new lending products with segment-specific propositions focused on personalization, enhancing client experience so that they can profitably serve very small, small, and medium-size businesses. This could include lending products with flexible terms or innovative collection models that align more closely with the nature of the businesses seeking loans.

Strengthen digital products and channels

The digitization of key SME client journeys to increase customer satisfaction offers significant potential for banks. This strengthening of digital channels is a practice that many banks in other markets have been able to adopt successfully. In South Africa, most NBFIs have already digitized their application-to-loan-disbursal process, enabling them to provide financing to SMEs efficiently and conveniently. They require little to no paperwork and have quicker turnaround times than banks, and thus offer a better customer experience. For example, one NBFI operating in South Africa has implemented a 100 percent digital model with completely automated assessment processes requiring minimal documentation.

Banks could consider deploying an omnichannel approach to engage small business customers. This segment is increasingly turning to mobile serving, and banks will better attract, serve, and retain these customers by offering mobile channels along with other digital and physical options.

Optimize coverage through leveraging nontraditional data

To better serve the SME market, banks will need to demonstrate a better understanding of SMEs and their specific financing needs. To do this, banks could leverage advanced analytics and build a digital credit assessment to better assess risk—where traditional records and credit data is not available—and price accordingly. This approach limits the risk for borrowers and financial institutions. By drawing on alternative sources of data, such as those from transactions and from social media platforms, models can be developed to automatically assess creditworthiness. Prior McKinsey analysis has shown that digital credit assessments could have substantial benefits, including prescreening of customers and ensuring a more than 90 percent approval rate, decreasing risk costs by raising the Gini score to 70 percent, and decreasing operating costs by reducing the data requirements and time needed for credit assessments. 11

NBFIs have managed to bridge the gap between what banks can see using their traditional credit metrics and the actual risk profile of SMEs by using payment data from alternative sources such as utility companies and rent. By leveraging this data they have been able to develop proprietary credit-risk algorithms that allow them to assess the risk profile of potential borrowers more accurately and price their products accordingly.

To access these advantages more quickly, banks could consider partnering with NBFIs. Partnerships have the potential to allow banks to broaden their reach and to provide the NBFIs with access to capital and broader banking products. One major South African banking player has already gone this route and now owns a percentage of a leading NBFI. The bank’s investment allowed the NBFI to introduce a new financial product and achieve higher growth, while the bank has increased its exposure to the SME market.


The COVID-19 pandemic has highlighted that there is both an opportunity and a responsibility for commercial banks to address the credit gap experienced by SMEs in South Africa. As a customer segment, SMEs represent one-fifth of global banking revenues but lending to SMEs makes up only 8 percent of the credit exposure of the South African banking sector. 12

If commercial banks are able to build on the best practices of serving SMEs globally, as ably demonstrated by local NBFIs, the implications for the banking sector and the economy as a whole could be significant. In the short term, a more agile banking sector could help SMEs—especially those in the missing middle—weather the COVID-19 pandemic and economic slowdown. In the long term, they could be a driving force in growing SMEs, creating jobs, and boosting the economy.

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