All projects require start-up capital to make establishment investments and cover operational expenses of the first months. However, it is no secret that the lack of or insufficient funding is one of the main causes of project failures in the world and in Cameroon in particular. Many players in the economy hold the banks accountable for such flaws due to their role of financiers. On this article, we show that conventional banks do not generally finance the projects of entrepreneurs because they are not meant for it.
Before further ado, we define projects as the creation of new economic activities that are unobstructed by previous work (Greenfield). Also we consider as banks all financial institutions providing loans except investment banks.
Projects are inherently risky because they involve the possibility of bringing a product or service that will fulfill a given market demand in a profitable way in the long run. Identifying and demonstrating an untapped market requires a mix of intuition, experience and insight not possessed by average people. Even when the market is exploited, you have to prove that it is not sufficiently exploited and/or could be better served.
Even if one manages to clear market concerns, it should be justified by the supply of products/services that meet the requirements of the market in terms of quality and price which can be difficult to accomplish in the absence of its effective commercialization or prototypes. Finally, there is all the strategy related to distribution, marketing, working capital and human resources that must be proven as well as the performance pledges, notably through the establishment of a competent management team.
Although entrepreneurs, not always having the all the necessary expertise, hire professional strategy and financial advisory services to prevent managerial pitfalls, there will always be residual risks associated with projects.
Banks in general have the duty to preserve the money of their customers, facilitate their transactions and grant loans upon which they are paid in compensation for the credit risks undertaken. Banks cannot fully endorse the level of risk embedded on projects because it draws money from its custodians to lend to others. In the case of excessive and uncontrolled exposure to credit defaults risks, it is not only the bank that bears the loss but also those savers who collectively influence the economy. Moreover, under the authority of COBAC[1], banks are obliged to maintain some level of deposits, accounts payables, and even off-balance sheet commitments to avoid systemic financial crises such as that encountered in the West in 2009.
Furthermore, loans have low risk tolerance since unlike the equity financing, the repayments schedules are fixed for predetermined amounts regardless of the profitability of the business. These structural characteristics make loans more suitable for activities whose profitability are stable and predictable which cannot be the case for entrepreneurial projects. The less a project has stable and predictable profitability, the higher the credit default risk; especially if the promoter does not contribute (enough) liquid assets in collateral to the project; consequently it is unlikely that your project be financed by banks. Even if the bank grants a loan, the interest rate will be prohibitive because of the project’s residual risk.
All of these factors force banks to take many precautions before granting loans when it comes to entrepreneurial projects. These precautions translate into the overwhelming amount of administrative documentation to provide and the multiplicity of short-term credits offered on the market (discounts, cash facilities, spot credit, etc…). The shorter duration of credit, the less risk it is exposed to. The famous saying that "banks only lend to the rich" does not stem from snobbery, but rather banking regulations to preserve the economy and the way loans are structured. In the second part, we explore the appropriate financing routes for projects according to their development cycles.
[1] Banking Commission of Central Africa
By Arnold A. KAMANKE