‘Obsession with collateral’ holding SA’s SME sector back

South African funders need to take a more innovative and empathetic approach to funding the country’s SME sector, as the traditional corporate lending approach that insists on high collateral cover for small business loans blocks many SMEs from accessing much-needed financing – and ultimately hampers the growth potential of the entire sector.

That’s the view of Kumaran Padayachee, the chief executive of SME finance specialist Spartan SME Finance, who says requesting collateral has become the proxy or replacement for a comprehensive credit assessment.

“There are three broad markets in bank financing: corporates, SMEs and individuals. At the top end, there are expensive, highly skilled resources that can be justifiably used for assessing large funding deals for corporates with substantial balance sheets and track records. At the bottom, consumers mostly require ‘vanilla’ products like mortgage bonds, car finance, personal loans and credit cards – funding decisions that are generally made efficient by a credit scoring engine. In the middle is our challenge,” said Padayachee.

“The needs of growing SMEs are specialised and bespoke, so system-generated credit scoring tools are generally inappropriate. At the same time, though, banks cannot justify allocating top-end resources and the time to assess SME funding requests, so they default to asking for collateral to make the decision easier: give me a freehold R3m house (to cover a forced-sale scenario), and I’ll give you a R2m loan. This is a major pain point for local SMEs,” he said.

Padayachee says many SMEs looking for financing have diverse needs that range from purchasing specialized equipment to capacitating for a contract, to bridging finance to smooth out cashflow gaps between projects. In these cases, traditional collateral and security models simply aren’t appropriate: an SME owner who needs R2m for working capital, often may not have a freehold house or may not own one valued at R3m.

When small businesses aren’t able to provide collateral for loans, they often end up forfeiting the specific opportunity or stalling their growth – all of which accumulatively slows growth in the SA economy and jobs. The answer lies in creating financing models that are better aligned to meet the diverse funding needs of South African SMEs.

“Financing SMEs is a challenging, risky endeavour and not for the faint-hearted. This aggravates the already difficult task of justifying deeper, comprehensive credit assessments to overcome the low/no collateral context. The problem is best solved by funders that focus on purpose and profit, as profit determination alone is insufficient to justify the investment in resources and time. It also requires funders that adopt an empathetic approach by placing SMEs at the centre of designing their processes – and that ultimately means specializing in only financing SMEs” said Padayachee.