By: Olivia Zank, CEO

Recently I was reading an article by the excellent Jeff Schnurr from Jaza Energy about how we shouldn’t listen to what your clients are saying, but instead hear what they are telling us. Jaza, a rural electrification startup, found real product-market fit when they paid attention to what the market revealed to them, rather than what its participants were saying. That got me thinking about what the market is revealing to us and why I believe so strongly in what we do. We too have to be careful not to listen to what our clients say, and focus on hearing what the market is telling us. 

Ask any SME and they will likely tell you that they need financing but that they don’t take a bank loan to finance their business due to the cost of credit. At 16-18% annual interest rate plus fees and charges, only the most profitable companies can afford credit, right? However, with low and stable inflation, stable exchange rates and a low central bank policy rate in Rwanda, the market must have ended up with such high interest rates due to the risks present. After all, Rwanda has 16 banks for 12m people, so we can assume there is enough competition to remove excess profits and drive loan providers to focus on efficiency. 

If you speak to the banks, they will tell you that SMEs are not “bankable”. The risks are too high and it’s not feasible to lower their interest rates and get a commercial return. Banks end up highly liquid, and struggle to hit their own targets for SME lending. If the market-based interest rates are the problem, then maybe bringing in subsidised capital is the answer? Globally, the last 10 years has seen a literal explosion in the amount of money available for so-called impact investing, exceeding $500bn in 2019 according to GIIN, which isn’t (at least on paper) looking for market returns. Speak to a few of the funds that manage this money, however, and they will also lament how thin their pipelines are and how hard it is to find “investment-ready” companies. Instead, they end up chasing the same few companies and it is not uncommon to see one darling SME having received capital from a long list of providers, while the masses don’t get financed. 

Why does the market not clear, even with subsidised, risk-loving capital? 

It doesn’t clear because the market for credit is not governed by normal supply and demand. This market is characterised by large information asymmetries between lender (investor) and borrower (investee); the borrower knows more about their own risk than does the lender and has an incentive to withhold that information, making their business look less risky than it actually is. Unless the lender is able to independently verify the project’s true risk to an acceptable level of certainty, they will reject the deal despite the potential for high returns. The high interest rate is not a symptom of low supply of capital but of financial intermediation that sucks. 

We’re not dealing with risk; we’re dealing with uncertainty. Banks and investors may talk about risk, and SMEs might talk about high prices, but really what the market is telling us is that the commonly used tools in SME financial intermediation don’t work for this market. They fail, because they don’t allow us to accurately assess risk. 

What is financial intermediation? 

Financial intermediation is just a fancy name for the process of moving money from people who have it and want to earn a return to those who need it and can earn profits through some sort of business activity, and then sharing the profits according to risk and effort. It is a market-driven process of allocating resources the most efficiently and sharing profits and risk between the owners of capital and the owners of projects. 

Historically, societies have come up with two ways of intermediating capital that works at scale: Institutional investors such as banks and funds, and stock markets. If you look back at how banking emerged in 15th century Europe you will find rich business owners who started lending their profits to fellow businessmen (usually always men) and who were so good at lending out their money that others started giving them their money too for investing and they stopped doing their initial business to specialise in moving money from the its owners to those those who could put it to good use. The service was, of course, not available for the masses, but only for fellow elites. 

Stock markets on the other hand rely on the wisdom of the crowds. Companies wanting to access finance this way must open themselves up to public scrutiny and the individual investor can trust that if there were a problem, with so many eyes looking, someone would already have exposed it. Hence, no company with anything to hide would go to the stock market. This model thus offers a way for people without connections to access finance, as long as you have the capacity to present yourself well and completely. Stock markets however only work when you have thousands of analyst eyes (and nowadays computers) pouring over financial statements verified by auditors and rating agencies. The transaction costs of listing are high and it does not tend to work well in markets with fewer players like Rwanda. 

However, there is no natural law stating stock markets and banks are the only options for intermediating capital at scale. It may have worked for financing companies in developed markets (and we can debate if it really has worked), but there is no reason why a place like Rwanda can’t find a third solution that works in this market. Instead, we could focus on developing financial intermediaries that are able to assess the risk of the market where it is today, meeting SMEs where they are now, and grow with them. 

A new type of intermediary 

BeneFactors was founded on this premise. We generate return from investors by investing in a way that actually services a current need, using tools that are developed specifically to be efficient and relevant. In Rwanda the biggest need is working capital and we found that factoring is one way to provide working capital that works well in this market where it is now. 

In that sense we are similar in spirit to 15th Century Italian and French banks, even if what we actually do is completely different. Same as the early bankers, we’re business people ourselves, identifying the needs and possibilities of fellow entrepreneurs and channelling capital to them in a way that generates a return for ourselves. When we do that well, people with money want us to manage their investments too, doing more of the same. How we do it, though, couldn’t be more different. Because although the product (factoring) may be old, our tools for assessing risk (underwriting), aren’t. 

While 15th century banks relied on social ties and connections to assess risk, we rely on data, and not only about the clients themselves, but also about the supply chains they exist in. While our clients rarely would be able to present their books well, their buyers can. By leveraging the collective creditworthiness of a supply chain at scale, we can underwrite the risk of the individual player in it, even without knowing much about that player. We’re collecting and compiling large datasets on economic activity, behaviour and risk and using that to sharpen our tools for underwriting in this market. The difference is that where it took 500 years for the first generation of finance-intermediating institutions to reach scale and efficiency, we will do it in 5 years. That is the scale we work on with data and machines learning about risk instead of humans. 

In the meantime, we finance our clients where they are, as unbankable as they are, and we charge them twice as much as the banks, yet continue to have a waiting list. That is what happens when you focus on hearing what the market is telling you, rather than what the players are saying.