Earlier this month during the Central Bank’s launch of the Monetary Policy and Financial Stability Statement, the Minister for Trade and Industry, Vincent Munyeshaka, challenged financial sector players to introduce innovative products for Small and Medium Enterprises (SME’s)
The minister is right to give us such a challenge, and we in the financial sector should listen well to how it was phrased – innovate to serve the needs of SMEs. He did not challenge us to extend the reach of existing products through mere financial inclusion nor to improve the efficiency of service delivery. He challenged us to provide solutions that work for the SME sector.
When thinking about innovation, established players, such as commercial banks that dominate the Rwanda’s financial sector, tend to focus on improving existing products, making incremental changes. We have seen the Rwandan financial sector do so recently, bringing online banking and mobile applications to their clients while their main corporate product remains the same –term loans with fixed repayment schedules collateralised by land titles.
Incremental innovation is not necessarily a bad place to start, but it limits our focus to what is already available on the market. However, as the Minister pointed out, it should be clear for everyone that more efficient iterations of existing products are not going to solve the structural challenges surrounding SMEs’ access to finance.
We cannot entirely blame commercial banks and Microfinance Institutions (MFIs) for their lack of capacity for disruptive innovation. Indeed, this is not an exclusively a Rwandan phenomenon. Banking business models in developed markets have scarcely changed since the 19th century, iterating only on their existing product ranges and improving the channels they use to reach clients with those products.
Given their systemic importance and potential for creating major crises, traditional banks and other deposit-taking institutions are (and should be) also heavily regulated, which further limits their ability to introduce new services or make changes to their business mod-el.
Having already saturated the large-company segment of the market for whom the existing products do work and lacking the ability to come up with disruptive innovation, Rwandan banks now focus on retail markets as their growth markets. MFIs, facing the same internal innovation capacity constraints, deploy a similar strategy, focusing on microenterprises (with 1-3 employees), whose financial needs are similar to those of retail customers. SMEs in the meantime struggle with ill-suited risk assessment technologies copy/pasted from developed countries and high transaction costs and time requirements – or they use the ubiquitous moneylenders (the Banque Lamberts), who for all their flaws, at least understand what is important for their SMEs clients – speed, low transaction costs and flexibility.
Where financial innovation comes from
So if not the incumbents, where can financial innovation for SMEs come from? It comes from start-ups, the non-bank financial institutions (NBFIs) and the fintechs. These are businesses who do not operate within the limitations of the fractional reserve banking model (attract deposits to on-lend at a higher rate), but can focus freely on the needs of the customers, asking “What is your pain point and your goals? As a business owner, what are your biggest constraints?”
The financial solution is then designed according to the stated goal: expanding business operations, paying bills and taxes on time, transfer money quickly and reliably, portray an image of reliability to new clients and suppliers and cover the cost of rebuilding in case of a fire, etc. The customer is at the centre of financial innovation, not the activity nor business model of the financial institution. Indeed, the main pain point might not be financial in nature at all, although in Rwanda access to appropriate and affordable financial services is the main constraint.
Financial innovation is different from other types of innovation in that the main concern is how to control risks. When you’re in the business of offering money, it is after all not hard to find willing clients. The challenge is rather how to ensure full recovery with a percentage fee on top.
Therefore, the additional question a financial innovator needs to ask is “Now that I know what our clients struggle with, and have an idea for how to solve it, how do I identify which clients I can trust with my money? What can I do if I am wrong or the initial business plan does not work out?
As a result, financial innovation tends to manifest itself in new ways to screen applicants, new mechanisms that encourage repayments or new ways of automating collections. The innovation that gave rise to microfinance is a classic example.
The Minister’s challenge is to come up with a similar solution for SMEs tailored to their current characteristics. The challenge is not to change the SMEs to fit existing products, but for the financial sector to change to fit the SMEs.
Implications for Rwanda’s financial institutions
Given the more sophisticated needs of SMEs compared to micro-enterprises, and their fewer internal resources compared to large corporations, the challenge is indeed complex. An SME client with a goal such as “expand my business” may need the following:
1. Investment capital for buying assets, e.g. term loans or equity investments;
2. Working capital for covering the increased operational costs, e.g. overdrafts, supply chain finance, supplier credit or buyer advances;
3. Insurance cover to protect from accidental damage or loss;
4. Payment solutions that are widely accepted within the business community, are se-cure and have low transaction costs;
5. Savings products for future investments.
It is clear that no one institution can provide all these services alone. Financial service providers specialise due to efficiency gains, as well as regulatory constraints imposed for sys-tem stability. However, the SME client cannot be expected to have the managerial band-width or time to research the regulatory nuances or different requirements, when they just need financial services for their operations. Indeed, they should not have to concern them-selves with how our plumbing works. From the perspective of the client, any time spent obtaining financial services is time wasted, since it is not spent on running operations.
SMEs tend to go to a commercial bank as their first port of call for financial services due to the trust that they have in such institutions. However, as the Minister pointed out, their needs are not met by the current offerings of banks which is the cause of much of the observed frustration.
The banks should therefore leverage other financial players to provide a holistic suite of services, tailored to the needs of the clients and fully integrated to minimise transaction costs. The benefits of such collaboration should be clear. NBFIs and fintechs can take risks and structure new business models that the fractional reserve banking model does not allow for, while leveraging technologies that legacy core banking systems cannot easily deploy. Banks, on the other hand, bring the clients’ trust and data as well as financial muscle and as a result share in the revenue streams that NBFIs and fintechs open up for them. From the client perspective, however, the service delivery is holistic and minimises time away from their core operations.
In Rwanda, the biggest advances towards holistic financial service provision has been in payments, even if the transaction costs are still far too high. Other cross-provider integrations are as of yet minimal, although at BeneFactors Ltd. we are very happy to see emerging willingness by some commercial banks to collaborate with us. We have seen in other markets how banks have initially resisted working with NBFIs or fintechs, feeling threatened by the perceived competition. Now, only 7% of global banks try to beat fintechs in their own game as their main strategy, with the vast majority actively supporting new entrants or partnering with them (83 per cent).
Indeed, banks in developed markets now compete on the basis of the integrated end-to-end solutions they can offer together with their partners, rather than on how efficiently they can deliver their core in-house products. This is an encouraging trend for innovation and one we hope to see more of in Rwanda.
We can understand the Minister’s challenge as a challenge to collaborate for innovation and thus better service the needs of our brothers and sisters working hard to run SMEs and create jobs for Rwandans up and down the country.
The writer is the CEO and Founder of BeneFactors Ltd., a Rwandan factoring company providing working capital solutions to SMEs.