Rethinking Credit Systems for MSME Inclusion

The Fourth International Conference on Financing for Development (FfD4), recently held in Seville, ended with what many are calling a "compromise." The final document emphasized ambition but lacked the financial firepower that developing countries urgently need. While delegates renewed their commitments to sustainable development and multilateral cooperation, the gap between intention and implementation remains stark—particularly for the much-needed financing of Micro, Small, and Medium Enterprises (MSMEs), the lifeblood of emerging economies.

The conference’s outcome underscored the importance of mobilizing finance from both public and private sectors, with particular emphasis on supporting MSMEs through local banks, credit unions, national development banks, and innovative digital tools. Despite these well-meaning declarations, the lived experience of many MSMEs tells a different story—one where access to capital is still an uphill battle.

In places like Kenya, the credit landscape paints a revealing picture. Banks prefer to lend to government securities, payroll-backed employees, or corporate supply chains—segments perceived as low-risk. Meanwhile, the MSMEs that policy documents praise—those with 10 to 50 employees operating in agriculture, logistics, light manufacturing, and services—remain locked out.

Why? Because the financial system, shaped by decades of regulations and risk aversion, continues to treat these businesses as too uncertain to finance. Rules such as global capital requirements and International Financial Reporting Standard 9 (IFRS 9) penalize lending to businesses that lack traditional collateral. Even guarantees from development finance institutions (DFIs) don’t sufficiently offset this bias. The net effect: banks focus on safety, not productivity.

This is not about institutional failure—it’s about a system working exactly as it was designed to: for capital preservation, not economic transformation.

In Europe, similar regulatory constraints exist. Yet SME lending works, as it is supported by a robust financial infrastructure that includes tax records, credit histories, and public guarantee schemes. These tools help banks assess creditworthiness with confidence.

In many developing countries, including Kenya, such documentation is rare. Businesses operate semi-formally, driven by social networks, seasonal trends, and reputation rather than standardized paperwork. Lacking traditional credit indicators, these enterprises are filtered out by default.

This isn’t simply a matter of risk; it’s a matter of relevance. When global financial frameworks are copy-pasted onto local contexts without adaptation, they fail to serve the economy they aim to support.

Over the past decade, a wide array of instruments has been introduced to facilitate SME lending. DFIs offer first-loss guarantees and concessional capital. Donor agencies fund alternative credit scoring models and fintech pilots. Regulators have grown more receptive to innovation, while value chain financing has emerged as a strategy to manage systemic risk collaboratively.

Many financial institutions in Kenya and beyond are now well-capitalized. They have access to concessional instruments and operate under more regulatory flexibility than ever before. What they lack is the internal shift needed to match these external changes. Risk departments continue to apply outdated provisioning logic. Lending teams are assessed based on repayment ratios, not on their ability to serve underserved markets or foster economic inclusion. The real constraint today is not regulatory—it’s institutional. Banks are no longer forced to avoid risk; they choose to, because their systems haven’t evolved. Their design choices were rational in the past—but they are obsolete today.

To move forward, banks must recognize that the most pressing challenge is not lack of intention, but lack of internal reform. A paradigm shift is needed. Financial institutions must rethink what defines creditworthiness and adapt their internal systems to reflect new realities. This includes developing alternative risk models, investing in credit scoring based on behavioral or transactional data, and revising how success is measured—from default ratios to developmental outcomes.

If institutions are truly committed to supporting SMEs, their internal design must reflect this commitment, even if only partially. Rather than waiting for a complete reform, banks might establish dedicated units or pilot programs that can experiment beyond the constraints of legacy policies. With these teams having the authority to implement new credit assessment tools, harness behavioural insights, or cooperate with fintech entrepreneurs, the institution demonstrates not only intent but also action. This partial development enables the business to collect real-world facts, gain confidence in alternative models, and progressively disseminate effective ways throughout the firm. In doing so, banks can begin to align a portion of their operations with the needs of MSMEs, demonstrating to themselves and the market that significant change does not require complete agreement—only a willingness to allow innovation to take root where it is most needed.

Most banks voice a strong commitment to inclusive lending. However, the continued use of strict credit practices reveals a discrepancy between stated intentions and actual actions. Viable enterprises continue to be overlooked—not because they pose excessive risk, but because the tools to evaluate them go unused. The solution doesn’t lie in more conferences or broader commitments. It lies within institutions themselves—in how they define, measure, and reward lending activity.

As the economy evolves, so must the credit systems designed to serve it. MSMEs are not asking for handouts. They’re asking for a financial system that sees them for what they are: engines of growth, job creators, and critical partners in sustainable development.

One promising approach is to create internal sandboxes—ring-fenced portfolios with separate approval logic, alternative scoring models, and access to blended finance. These can function as live experiments, allowing institutions to test new frameworks without jeopardizing their broader balance sheets. The goal is not to lower standards but to assess whether current ones unjustly exclude viable borrowers.

The outcomes of the FfD4 conference provide a directional map—but the journey requires actual movement. Governments can enable, donors can support, and DFIs can mitigate risks. However, banks themselves must take the final step. The tools exist. The regulatory space is open. What’s needed now is institutional courage—to reassess outdated frameworks, to test new models, and to bridge the gap between intention and action. If financial systems continue to mirror the past instead of today’s economy, they will remain disconnected from the very growth they claim to support. It’s time for that to change. This change must occur immediately, not next year or after the next conference.

The article was co-authored by Liesbeth Bakker from CASBI - Centre for Applied Sciences & Business Innovation .