Small and Medium Enterprises (SME’s) have been identified as productive drivers of inclusive economic growth and development in South Africa and around the world. Some researchers have estimated that, in South Africa, small and medium-sized enterprises make up 91% of formalised businesses, provide employment to about 60% of the labour force and total economic output accounts for roughly 34% of GDP.

While contributing significantly to the economy, SMEs foster diversification through their development of new and unsaturated sectors of the economy. In addition, innovative and technology-based small and medium enterprises can provide a platform for local, regional and international growth, especially in Brazil, Russia, India, China, and South Africa (BRICS) economies.

SME’s are considered an important contributor to the economy as drivers for reducing unemployment, especially since the formal sector continues to shed jobs.
SMALL AND MEDIUM ENTERPRISES IN SOUTH AFRICA FACE A NUMBER OF CHALLENGES, SUCH AS:

• Crime and corruption
• Appropriate technology and low production capacity (includes access to electricity)
• A lack of management skills and in adequate skilled labour
• Finance and obtaining credit
• Access to markets and developing relationships with customers
• Recognition by large companies and government bureaucracy
• Knowledge and support for the role that they play in economic development
• Regulatory compliance.

The South African government is cognisant of the importance of SME’s and has built frameworks for SME development and support.
THE SME SECTOR OF THE ECONOMY IS ACTIVELY PROMOTED BY A NUMBER OF GOVERNMENT INITIATIVES, INCLUDING:

• The National Small Business Act of 1996, which defines SME’s and provides for the establishment of the National Small Business Council and the Ntsika Enterprise Promotion Agency (Ntsika).
• Khula Enterprise Finance is charged with helping small and medium sized enterprises secure finance, primarily through the provision of security on behalf of small businesses to commercial banks, retail financial institutions, specialist funds and joint ventures, as well as offering loans through partner intermediaries.

In view of the significant potential SME’s hold for the South African economy, it is essential to examine what kind of support and development SME’s receive in a bid to realise their success and potential across the African continent. The Banking Association South Africa and member banks are committed to SME development and support through stakeholder engagement, and involvement or ownership of several initiatives.
BANKING ASSOCIATION SME DEVELOPMENT INITIATIVES:

• Financial Sector Charter and BBBEE
• Finance and Investment Committee – Credit Extension to distressed SMEs (a response to the global crisis) – NEDLAC
• Financial Sector Program (FSP) – USAID
• SME Financial Literacy – BANKSETA and FSP
• Risk Capital Facility (RCF) – EU fund admin by the Industrial Development Corporation
• Stakeholder engagement – Gauteng Dept. of Economic Development, Industrial Development Corporation, Khula, Small Enterprise Development Agency, South African Micro-Finance Apex Fund, Development Finance Institutions, Department of Trade and Industry, and donors etc
• Research and Knowledge Management.

Downstream banking and Financial Inclusion – Micro-Finance, Co-ops & Co-op banks.

The National Small Business Act (102 of 1996) aims to provide for the “establishment of the Advisory Body and the Enterprise Promotion Agency; to provide guidelines for organs of state in order to promote small business in the Republic; and to provide for matters incidental thereto”. The National Small Business Act defined small business medium, small, very small and micro enterprises based on certain characteristics.

The National Small Business Amendment Act (26 of 2003) aims to update and further define business according to five categories established by the original act, namely, standard industrial sector and subsector classification, size of class, equivalent of paid employees, turnover and asset value – excluding fixed property.

Small and Medium Enterprises (SMEs) have been identified as productive drivers of inclusive economic growth and development in South Africa and around the world. Some researchers have estimated that, in South Africa, small and medium-sized enterprises make up 91% of formalised businesses, provide employment to about 60% of the labour force and total economic output accounts for roughly 34% of GDP.

While contributing significantly to the economy, SMEs foster diversification through their development of new and unsaturated sectors of the economy. In addition, innovative and technology-based small and medium enterprises can provide a platform for local, regional and international growth, especially in Brazil, Russia, India, China, South Africa (BRICS) economies.

SMEs are considered an important contributor to the economy as drivers for reducing unemployment, especially since the formal sector continues to shed jobs.
SMALL AND MEDIUM ENTERPRISES IN SOUTH AFRICA FACE A NUMBER OF CHALLENGES, SUCH AS:

• Crime and corruption
• Appropriate technology and low production capacity (includes access to electricity)
• A lack of management skills and in adequate skilled labour
• Finance and obtaining credit
• Access to markets and developing relationships with customers
• Recognition by large companies and government bureaucracy
• Knowledge and support for the role that they play in economic development
• Regulatory compliance

The South African government is cognisant of the importance of SMEs and has built frameworks for SME development and support.
THE SME SECTOR OF THE ECONOMY IS ACTIVELY PROMOTED BY A NUMBER OF GOVERNMENT INITIATIVES, INCLUDING:

• The National Small Business Act of 1996, which defines SMEs and provides for the establishment of the National Small Business Council and the Ntsika Enterprise Promotion Agency (Ntsika).
• Khula Enterprise Finance is charged with helping small and medium sized enterprises secure finance, primarily through the provision of security on behalf of small businesses to commercial banks, retail financial institutions, specialist funds and joint ventures, as well as offering loans through partner intermediaries.

In view of the significant potential SMEs hold for the South African economy, it is essential to examine what kind of support and development SMEs receive in a bid to realise their success and potential across the African continent. The Banking Association South Africa and member banks are committed to SME development and support through stakeholder engagement, and involvement or ownership of several initiatives.
BANKING ASSOCIATION SME DEVELOPMENT INITIATIVES:

• Financial Sector Charter and BBBEE
• Finance and Investment Committee – credit extension to distressed SMEs (a response to the global crisis) – NEDLAC
• Financial Sector Program (FSP) – USAID
• SME Financial Literacy – BANKSETA and FSP
• Risk Capital Facility (RCF) – EU fund admin by the Industrial Development Corporation
• Stakeholder engagement – Gauteng Dept. of Economic Development, Industrial Development Corporation, Khula, Small Enterprise Development Agency, South African Micro-Finance Apex Fund, Development Finance Institutions, Department of Trade and Industry, and donors etc
• Research and Knowledge Management
• Downstream banking and Financial Inclusion – Micro-Finance, Co-ops & Co-op banks.

The Banking Association South Africa contributes to the socio-economic growth and development by facilitating and encouraging member banks to deliver services to a broad spectrum of the population; and catalyses change and transformation. Small and Medium Enterprise (SME) Development and Financial Literacy are strategic objectives of The Banking Association.

The South African Government has prioritised SME and informal sector development for their potential social and economic growth prospects. Vehicles for entrepreneurship and employment opportunities, innovation, competition, integration with the local economy, regional development, supply chain and procurement, SME’s face challenges such as access to finance, markets, technology, skills and management. Policy tools vary and can include finance, tax, subsidies, guarantees, information or a mix. Business culture and entrepreneurship that distinguishes between business versus occupation creates a vibrant culture to promote SME development.

Currently, only 13 banks operate in the SME space in an industry that consists of 19 registered banks, 2 mutual banks, 13 foreign banks with local branches, and 41 foreign banks with approved local representative offices.

Implemented in 2004 as a voluntary sector charter in terms of the Broad-Based Black Economic Empowerment (BBBEE) Act (52 of 2003), the Financial Sector Charter (FSC) commits participants to”actively promote a transformed, vibrant, and globally competitive financial sector that reflects the demographics of South Africa, and contribute to the establishment of an equitable society by effectively providing accessible financial services to black people and by directing investment into targeted sectors of the economy”.

Black SME Financing was identified as a transformational pillar under Empowerment Financing. Five-year targets were set by the Financial Sector Charter Council, monitored, achieved and exceeded. Still, more room for “downstream” exists in areas of micro-finance, co-operatives and co-operative banking to facilitate greater outreach, access, institutionalisation of transformation and financial inclusion.

USAID’s Financial Sector Program recently completed a comprehensive online survey and study, titled: “Financial Institutions Hurdles to SME Financing”. The survey suggests SME Financial Literacy initiatives should be more targeted, strengthened and co-ordinated to have greater effectiveness and efficiency. In addition, the professionalisation and accreditation of Business Advisors or Business Development Support aims to address this market gap.
EXECUTIVE SUMMARY
The Banking Association South Africa commissioned this research to draw on literature, best practices and consultant expertise and experience on SME access to financial services issues and to maximize financial inclusion by proposing a comprehensive framework for SME Financial Literacy development in South Africa. More specifically, the study aims to propose a workable definition of SME Financial Literacy, articulate the building blocks of SME Financial Literacy, and analyse the status of SME Financial Literacy and the related demand and supply gap. The information gathered will be used to propose a national SME Financial Literacy development framework, highlight the strengths and limits of banks’ involvement in SME Financial Literacy activities and shed light on opportunities for banks, and ultimately propose a comprehensive role for The Banking Association to promote SME Financial Literacy in the country.

A financially-literate SME is one who:
(i) has an adequate level of personal entrepreneurial competencies, personal finance skills, and business management skills; has an appropriate level of understanding of functional financial management systems;
(ii) has an appropriate level of understanding of SME life-cycle funding and other financial services needs and options and knows where and how to source and negotiate those funding and service requirements;
(iii) understands and can manage financial risks or seek relevant advice to manage such risks;
(iv) understands legal, regulatory and tax issues as they relate to financial matters;
(v) understands the range of legal recourses it can resort to when necessary, and namely, in case of bankruptcy or other situations of financial distress.
THE KEY BUILDING BLOCKS OF SME FINANCIAL LITERACY, WHICH IS A MULTI-DIMENSIONAL CONCEPT, INCLUDE:

• Entrepreneurial and basic SME management competencies
• Understanding of consumer/personal finance
• Understanding of modern accounting and financial management systems
• Understanding of financial services options, the types of funding options available to SME and access to finance requirements for SME
• Awareness of and decision-making skills on financial risk, capital investment and complex fund raising, corporate restructuring, and financial policy matters affecting SME
• Awareness and understanding of financial regulations, legal and tax issues, and related legal recourses a SME can resort to in a situation of financial distress.

SME FINANCIAL LITERACY SUPPLY-DEMAND GAPS REMAIN SIGNIFICANT BECAUSE EXISTING FINANCIAL LITERACY PROGRAMMES AND SERVICES:

• do not have clearly stated or defined objectives, and lack SME profile based contents and important Financial Literacy components
• tend to be provided by professionals with limited background and exposure
• tend to be limited in number and capacity to provide comprehensive training and advisory modules outside major cities such as Johannesburg, Cape Town, Pretoria and Durban
• have mechanisms (web-based portals, proprietary training sessions) with limited ability to maximise reach, especially, to historically disadvantaged SME’s and SME owners.

SME FINANCIAL LITERACY PROGRAMMES CAN YIELD DIFFERENT LEVELS OF BENEFITS TO BANKS SUCH AS:
Providing vehicles for marketing and customer acquisition, providing opportunity to mitigate credit risk and learn more about the SME market segment, building long-term customer relationships, and providing opportunities for cross-selling and retail service.

Broad-based Financial Literacy services with little customisation for the SME market result in lost opportunity to capitalise on business relationships in an environment where the SME segment represents 30% of South African businesses. This is indicative of South African and global banks that lack integrated “good practice” SME banking strategies, programmes and solutions. Although not the focus of this study, a comprehensive SME access to finance promotion programme for any developing or emerging economy happens on four fronts, namely; the policy framework, the institutional infrastructure, information infrastructure and SME development/SME Financial Literacy.

Based on this background, a comprehensive national SME Financial Literacy Strategy for South Africa should focus on this framework:

• Co-ordinated definition and profiling of SME per homogenous groups
• Assessment of identified SME groups’ Financial Literacy demand or needs
• Co-ordinated definition of SME Financial Literacy
• Articulation of a national SME Financial Literacy Development Strategy as well as its key implementation programme
• Definition of the objectives and intended outputs, outcomes and impact of the respective SME Financial Literacy programme and services per category of SME
• Core curriculum development and standardisation
• Trainers’ and participants manuals development
• Champion implementation and watchdog agencies
• Training of trainers and trainers’ certification
• Outreach strategy and delivery mechanisms
• Monitoring and evaluation framework
• Strategy and programme improvement framework.

The study suggests Government plays a leading role in the championing and actual implementation of the national SME Financial Literacy Strategy, while The Banking Association South Africa facilitates banking industry involvement. The proposed role of The Banking Association would include:

• Championing and driving the banking industry SME Financial Literacy Strategy along with key partners such as the dti, SEDA, Khula and BANKSETA and other financial sector players
• Advocating for banks on SME Financial Literacy and SME access to finance matters; and
• Driving the knowledge management process (research, best practice documentation, expert and consultant database, curriculum development and maintenance), and facilitate its transfer (training of trainers, training bank staff) and sharing (through a comprehensive SME Financial Literacy web-based portal) on SME Financial Literacy and SME access to finance in South Africa.

FINANCIAL INSTITUTIONS’ HURDLES TO SME FINANCING
In the last quarter of 2009, USAID’s Financial Sector Program, in partnership with The Banking Association South Africa, undertook a survey to identify what hurdles finance providers face when financing SME’s and to propose solutions or interventions, if needed, to facilitate provision of business development services to SME’s.

This report documents the rationale, methodology and results of the survey. Twenty-seven financial institutions (FI’s) including banks, private funds and DFI’s were approached, of which, 18 participated. Two thousand, nine hundred and seventy-seven (2977) senior executives, credit managers and loan officers involved in SME financing from participating institutions were included in a database from which a random sample of 683 candidates were drawn to participate in an online questionnaire. One hundred and seventy-nine (179) participants completed the survey, a response rate of 26%.
THE SURVEY FOCUSED ON:

• Overall success rate of SME finance applications
• SME financing evaluation criteria
• Reasons for declining finance
• Services offered to assist access to SME finance or promote bankability of SMEs
• Interventions required to improve or promote access to SME finance.

Survey questions related to specific categories of SME’s defined in terms of annual turnover based on the definition used by The Banking Association. The categories used were start-ups, micro enterprises with an annual turnover less than R500k per annum, very small enterprises between R500k and R2,5 million per annum, small enterprises between R2,5 million and R10 million per annum, and medium enterprises between R10 million and R20 million per annum.
HURDLES SME FINANCE – SURVEY RESULTS
The survey results show that the majority of institutions fund all categories of SME’s. However, unlike lower end SMEs, SME’s with higher turnover required less ancillary support prior to becoming a candidate for finance and enjoyed higher approval rates.

The SME’s financial status or ability to repay the loan (cash flow) and contribution to the deal were the most important financing evaluation criteria. In addition, finance institutions require solid financial records and statements, a winning sales pitch, good business skills and plans (that SMEs understand) and expert knowledge.

Age and educational qualifications are less important for FIs, who are also tolerant of issues that can be addressed or fixed, such as FICA compliance, correct paperwork submissions, and accurate costing and pricing.

To ensure more successful applications and increase market share, FIs felt more appropriate evaluation criteria is required, particularly in the case of collateral. In addition, more lenient application assessments, willingness to take more risk, provision of advice and support, and offering innovative, more appropriate and inclusive products that provide improved cost and value for SMEs would provide more scope for successful finance.

The majority of FIs provide support such as information, advisory services and referral services to third party business support and coaching/consulting/mentoring. However successful, a need for grading would provide more confidence in a referral system.

FIs felt SMEs could ensure successful financing by conducting thorough research in target markets or fields, focusing on viable business plan submissions, and if appropriate to clean up credit records, develop financial statements and business skills. This result suggests greater potential for influence by consultants/coaches and mentors.
CONCLUSION
Interventions to help SMEs overcome financing hurdles should include assistance to evaluate their own financial status and conduct risk assessments before approaching FIs. Pre-finance application services that focus on one-on-one assistance as well as mentoring and training to help; reduce risk status, prepare and understand financial statements, draft proposals and business plans, and develop business skills, particularly in finance management, understanding cash-flow and the market.

To make SMEs more bankable, FIs are already offering these services in one form or another, either in-house or outsourced to a third party. However, if the quality of third party services – or providers – were assured through grading it would go a long way to assist SMEs to become more bankable. Still, it is equally important that some form of facilitation in the market match SME needs to mentors and experts. Therefore, the opportunity exists to link graded consultants to FIs, who in turn, will facilitate referrals to clients.

These services should be provided on a case basis to help SMEs understand their own businesses and the needs of the FIs. Facilitating access to finance is a huge need, which could significantly help FIs overcome financing hurdles if relevant to both SME and FI.

FI comments made it clear that the financing model is inappropriate for this market dominated by previously disadvantaged entrepreneurs. Even though they could be qualified and potentially successful, these entrepreneurs have limited resources and are not business or financially savvy. The survey suggests significant need for FIs to develop different and more appropriate models for evaluating risk and individuals, as well as more suitable products.

The banking sector can continue to play a catalytic role in the financing and investment of SME’s through continuing and expanding traditional banking financing and non-financing instruments (e.g. loans, overdraft facilities, credit and business development support). However, we must align these more closely with the kinds of high growth potential, high-value enterprise types and industries contemplated in the NDP to place the country on a higher, more developmental and sustainable growth trajectory. This does not suggest that traditional enterprises that have been, and continue to, be funded by banks are ignored, but that there is orientation to a critical mass of enterprise types that help reposition the economy as contemplated by the NDP.

The existing bank-led credit guarantee scheme can be enhanced through being more innovative. Banks can provide credit, finance and loans to bankable and viable enterprises tendering for state procurement contracts for the delivery of goods, services and infrastructure in key state-led development programmes and projects with catalytic economic impacts as contemplated in the NDP. This will enable these enterprises to effectively and efficiently deliver to the state. The state should in turn provide guarantees to banks on two fronts, namely:

• 30-day payment turnaround time to SME’s for goods and services delivered
• Financial guarantees to repay banks where the actions of the state or the enterprise, results in the enterprise being unable to meet repayment commitments to banks
• While South Africa possesses a number of venture capital organisations in both the private and public sectors and a number of lesser-known venture capital citizens, this represents a largely untapped but potentially significant SME resource sector. There is very little data and information on these funds, in both the public and private sectors. We must collaborate to develop this sector, and communicate more effectively about it, so that SME’s have access to a blend of venture capital and debt finance. Some of these venture capital funds already work in close collaboration with banks and public sector development finance institutions. Recently, the notion of venture capital funding has been receiving more attention from government, especially within the context of the Industrial Policy Action Plan (IPAP).

Banks could also participate meaningfully in the design and operation of one or more state backed national venture capital fund, possibly segmented and diversified for various SME types and sizes in line with the NDP, The New Growth Path (NGP) and IPAP sector priorities.

The banking sector should intensify on-going efforts to influence the regulatory environment for SME development. The sector’s experience in lending to SME’s and engaging with owners and managers of businesses gives it the necessary information to lobby and advocate for facilitating regulations. We must promulgate regulations that make it easier for SME’s to establish their businesses, including registration of companies, tax matters, payments for services and others. Such a regulatory environment also helps to address particular risks banks experience in the SME sector.

The NDP advocates for stronger public and private sector resourcing and investments in the country’s SME backbone, including public procurement, improved access to debt and equity finance and a simplified regulatory environment. The NDP also acknowledges and affirms the NGP as government’s key programme to take the country into a higher growth trajectory, repeatedly emphasising and clarifying the complimentary roles between the NDP and NGP.