Can blended finance be the catalyst for financial inclusion in Africa?

The robustness of African ingenuity can be witnessed in the many Small and Medium Enterprises (SMEs) that dot every corner of the continent. They play a major role in driving economic growth in Africa. According to McKinsey analysis, there are over 44 million SMEs in the continent, which provide up to 80 percent of all jobs available. However, SMEs face significant barriers to financing, which can only be resolved if the continent pivots to a new form of financing called blended finance.

Running a business in Africa has become easier with time, evident through the regulatory reforms most countries have undertaken over the last two decades. Significantly, policymakers have adopted continental frameworks such as the African Continental Free Trade Agreement (AfCFTA) that eliminate barriers to trade, such as customs duties and protectionism. However, those changes alone have not been incremental in halting the most significant challenge that African SMEs face – financing. Funding is vital in the initial stage of starting a business and enabling SMEs to make investments necessary for growth.

To describe this challenge requires focusing on two main areas – accessibility and affordability. Accessibility refers to the ability of the SME to access capital for establishment or growth. Due to the licensing bottlenecks, more than 50% of businesses in Africa are not formally registered – classified as informal. It makes it difficult to access financing as credit institutions or donors only deal with registered organizations that can provide the requisite paperwork. According to the World Bank, only 30% of SMEs in sub-Saharan Africa have a bank loan or line of credit. Those who cannot access loans are also unable to access donor grants and government subsidy programs, as they all require paperwork.

Aside from accessibility, affordability is also a key challenge in the financing area. It refers to how much it costs for an SME to take out a loan or receive an investment. That cost of capital is not just the cost of the original loan, but also the interest charged and transaction costs, like legal fees for lawyers to perfect collateral, facilitation fees or bribes for local authorities to sign off required documents. Even before the COVID-19 pandemic, interest fees in African banks reached double digits, sometimes higher than 20-25 percent.

But it is not just traditional lenders like banks who are unaffordable to small businesses. Microfinance institutions and digital lenders have recently swept the capital scene due to their simplicity in offering loans. However, these groups often charge interests that could amount to more than 40% in some cases.

Blended finance offers alternative

Blended financing offers a viable pathway to mitigate these challenges. It refers to a financial structuring approach that combines public, private, and philanthropic capital to finance small and micro-investments that support sustainable development. This model has gained traction in recent years due to the failure of the current international financial architecture to address the growing inequalities in the Global South. Historically, development finance institutions (DFIs) like USAID and bilateral donors like the World Bank and IMF have focused on direct funding for projects. However, with official development assistance (ODA) representing only 6 percent of the $2.5 trillion Sustainable Development Goal (SDG) investment gap, their resources are insufficient. Thus, blended financing is crucial.

One clear example that illustrates why blended financing could be a resounding success in Africa is the case of Ethiopian Airlines. Africa’s only profit-making airline has combined public and private resources to support its growth by purchasing new aircraft. In 2020, Ethiopian Airlines took on a debt financing package that involved the Export-Import Bank of the United States (Ex-Im Bank), JP Morgan, the Emerging Africa Infrastructure Fund (part of the Private Infrastructure Development Group), and ING Group to purchase ten new Boeing 787-8 Dreamliner aircraft and support expansion to more routes across the world.

Blended finance, as in the case of Ethiopian Airlines, seeks to de-risk potential investments in such a way that encourages private actors and philanthropists to feel comfortable investing alongside or on top. Traditionally, private sector investors are hesitant to invest in Africa due to credible and sometimes perceived risks such as foreign exchange fluctuations, credit risk, and political instability. Blended finance can assist in overcoming some of the challenges faced by private investors looking to put their wealth in Africa by leveraging development funding to eliminate risk.

Moreover, blended finance can allow investments to flow in previously neglected sectors. In a 2018–2019 study, analysts found that lending to SMEs in agriculture was twice as risky as lending to other sectors. Another challenge noted was the large presence of subsistence farmers who operate at a scale that is too small to be investor-attractive. As a result, agricultural SMEs receive less than 10 percent of commercial bank lending in most African countries. Through blended finance, these previously locked-out businesses can access funding, supply chains, and markets. It also makes it viable for commercial investment and linkages with large-scale retailers and processors.

While blended finance may be a relatively new concept in Africa, outside the continent, it has helped mobilize nearly $152 billion in private capital, according to Convergence Market. To be fully adopted, African governments must create permissive policy regulatory environments, including pro-investment policies that prioritize macro stability, sensible taxation and administration, and repatriation of profits. The current financial landscape needs to be revamped to allow informal businesses to play a more significant role in the investment ecosystem. 

Citations

African Development Bank. AfDB and peers leverage Blended Finance to unlock nearly $9 billion for developing countries. Retrieved October 5^th, 2023 from

United Nations. Blended Finance Tools Can Offset Risks, Incentivize Climate Investment in Africa. Retrieved October 5^th, 2023 from

Yale School of Management. The Promise of Blended Finance for Sub-Saharan Africa. Retrieved October 5^th, 2023 from