CHAPTER ONE

INTRODUCTION

1.1 Background of the study

 Globally, Small and Medium-Sized Enterprises (SMEs) are widely acknowledged as key contributors to global economic growth, job creation, and innovation. According to the World Bank (2023), SMEs represent approximately 90% of businesses worldwide and account for more than 70% of global employment. In both advanced and emerging economies, SMEs play a crucial role in fostering economic diversification and providing essential goods and services. The Organisation for , 2022) reports that SMEs contribute between 50% and 60% of Gross Domestic Product (GDP) in developed countries and approximately 40% in developing economies. Their ability to respond quickly to market changes and support local economic activities makes them a significant driver of sustainable economic development.

Debt financing is a common means for SMEs to acquire capital for growth and expansion. Unlike large corporations that can access equity markets, SMEs primarily rely on external debt through bank loans, trade credit, microfinance, and informal borrowing. Access to debt enables SMEs to invest in new technologies, improve operational capacity, and expand into new markets. According to Beck and Demirgüç-Kunt (2022), access to affordable credit is a key determinant of SME growth, as it facilitates innovation and increases productivity. In OECD countries, SMEs that secure external financing are more likely to experience growth in employment, turnover, and profit margins compared to those that rely solely on internal funding. However, while debt financing can support business expansion, the burden of debt can also pose serious risks to SME sustainability when poorly managed.

In addition, SMEs face significant challenges in accessing affordable and sustainable debt. The International Finance Corporation (IFC 2022) estimates that the global SME financing gap in emerging markets exceeds $5 trillion annually. This deficit reflects the unmet need for credit among small businesses, particularly in low- and middle-income countries. The World Bank Enterprise Survey (2022) indicates that more than 50% of SMEs worldwide report restricted access to credit due to high-interest rates, lack of collateral and stringent loan conditions. Such barriers prevent SMEs from securing the financing they need to scale operations and remain competitive. In many cases, financial institutions perceive SMEs as high-risk borrowers due to limited credit histories and inadequate financial reporting, further reducing their access to formal lending.

Moreover, the effects of debt on SME growth are complex and multifaceted. On one hand, debt provides SMEs with the resources necessary for expansion, enabling them to increase output, create jobs, and improve market competitiveness. For example, Cassar (2021) found that SMEs that effectively manage debt financing achieve higher revenue growth and improved operational efficiency. On the other hand, excessive debt can lead to financial distress, reduced profitability, and business failure. Siedschlag et al. (2022) argues that SMEs with high debt-to-equity ratios face increased financial vulnerability, which limits their ability to reinvest profits and stifles long-term growth. Debt overhang, where firms prioritize debt repayment over new investments, can prevent SMEs from seizing emerging market opportunities and adapting to technological advancements.

The COVID-19 pandemic further highlighted the fragile relationship between debt and SME growth. SMEs worldwide experienced significant revenue losses and operational disruptions due to lockdown measures and supply chain breakdowns. According to the OECD (2021), 60% of SMEs globally reported severe revenue declines during the pandemic, leading many to increase their reliance on debt to sustain operations. While emergency financial assistance programs and loan moratoriums offered temporary relief, they also increased SME indebtedness. A 2022 IMF report revealed that over 50% of SMEs in emerging economies faced challenges repaying loans accumulated during the pandemic, raising concerns about long-term solvency and financial resilience.

Governments and international organizations have introduced various policy interventions to address the negative effects of debt on SMEs. Credit guarantee schemes have been widely adopted to encourage banks to extend loans to SMEs while reducing lender risk. For instance, the European Commission’s SME Relief Package (2022) provided over €200 billion in loan guarantees to prevent widespread SME insolvencies. Additionally, alternative financing mechanisms, such as venture capital and equity crowd funding, are increasingly promoted as viable options to reduce SMEs’ over-reliance on traditional debt. The G20 Action Plan (2021) emphasizes the need for sustainable debt financing models and better access to affordable credit for SMEs in developing economies.

In Africa, Small and Medium Enterprises (SMEs) is a critical pillar of economic development across Africa, contributing significantly to employment, innovation, and Gross Domestic Product (GDP). According to the African Development Bank (AfDB, 2023), SMEs account for over 90% of businesses and contribute approximately 50% of employment in most African countries. They play a vital role in fostering economic diversification, reducing poverty, and driving industrialization. SMEs in Africa operate across various sectors, including agriculture, manufacturing, trade, and services, providing essential goods and services while stimulating local economies.

Debt financing remains a crucial source of capital for SMEs in Africa, enabling businesses to expand operations, invest in technological advancement, and enhance market competitiveness. Access to debt allows SMEs to overcome capital limitations and take advantage of growth opportunities. According to the International Finance Corporation (IFC, 2022), African SMEs face an estimated $330 billion financing gap, highlighting the significant unmet demand for credit. Debt financing provides SMEs with the working capital needed to sustain daily operations and explore new markets. However, the relationship between debt and SME growth is complex, as excessive or poorly managed debt can undermine business sustainability.

While debt financing can facilitate SME growth, African SMEs face significant challenges in accessing affordable credit. High-interest rates, stringent collateral requirements, and the limited reach of formal financial institutions often restrict SMEs borrowing capacity. According to a report by the African Export-Import Bank (Afreximbank, 2023), over 50% of African SMEs cite limited access to credit as the primary barrier to their growth. Additionally, the cost of borrowing across African countries remains high, with interest rates ranging from 15% to 35%, making it difficult for SMEs to finance their operations sustainably. This high cost of debt increases financial pressure on SMEs and limits their ability to reinvest profits for growth.

The COVID-19 pandemic further exacerbated the challenges of debt financing for African SMEs. According to a study by the African Union (2022), over 60% of SMEs in Africa experienced severe revenue losses due to the pandemic, forcing many to rely heavily on debt to maintain operations. While government interventions, such as loan moratoriums and emergency credit facilities, provided temporary relief, many SMEs accumulated substantial debt, increasing their financial vulnerability. In several African countries, rising debt levels among SMEs have resulted in higher default rates, limiting future access to credit and increasing the risk of business failure.

Despite these challenges, strategic debt management can have a positive impact on SME growth in Africa. Studies show that SMEs with access to well-structured financing demonstrate higher productivity, greater employment growth, and improved market competitiveness. For instance, research by the African Development Bank (2023) found that SMEs engaging in strategic partnerships and adopting financial literacy programs are better positioned to manage debt effectively and achieve long-term growth. Furthermore, regional financial initiatives, such as the African Continental Free Trade Area (AfCFTA), aim to improve financial inclusion and provide better access to cross-border financing opportunities for SMEs.

Recent studies have shown that the development of Small and Medium-Sized Enterprises (SMEs) is closely linked to economic growth, particularly in developing regions. In Cameroon, SMEs represent 99.8% of all businesses, according to the Ministry of Small and Medium-Sized Enterprises, Social Economy, and Handicrafts (MINPMEESA). Official records indicate that in 2022, the total number of registered SMEs stood at 349,722, reflecting a 7.85% increase compared to 2021(MINPMEESA, 2023)

To support the growth of SMEs, the Cameroonian government has implemented several initiatives. Notably, Business Creation Formalities Centres (CFCEs) have been established in each region to simplify the process of registering new businesses. These centers assist with administrative procedures, legal documentation, and publication of legal announcements, thereby reducing the bureaucratic barriers to business creation (Ministry of Finance, 2024). 

The Cameroonian government’s focus on SMEs aligns with its National Development Strategy (NDS) 2020–2030, which emphasizes the private sector’s role in achieving Vision 2035—transforming Cameroon into an emerging economy (MINEPAT, 2023). In 2023, the creation of 19,651 new SMEs was recorded, marking a 24% increase compared to the previous year, contributing to 137,847 new jobs (The Guardian Post, 2023). 

These figures highlight the essential role SMEs play in driving economic growth and employment in Cameroon while reflecting the government’s commitment to fostering a supportive environment for small businesses to thrive. The Cameroon National Development Strategy (NDS) 2020–2030 emphasizes private sector revitalization and structural economic transformation as crucial elements for achieving Vision 2035. SMEs play a vital role in this strategy, with the GDP growth rate needing to increase from 4.0% in 2018 to 9.3% by 2030. However, this ambitious target is unlikely to be achieved unless significant efforts are made to the growth promote and sustainability of SMEs across various sectors.

Furthermore, Small and Medium-Sized Enterprises (SMEs) are a vital component of Cameroon’s economy, contributing significantly to job creation, poverty alleviation, and economic growth. According to the Ministry of Small and Medium-Sized Enterprises, Social Economy, and Handicrafts (MINPMEESA), SMEs represent 99.8% of all businesses in Cameroon and contribute approximately 36% to the country’s Gross Domestic Product (GDP). These enterprises play a crucial role in providing employment opportunities, particularly for youth and women, and fostering economic development across both urban and rural areas. The Cameroonian government recognizes the importance of SMEs and has implemented several initiatives to support their growth, including the establishment of Business Creation Formalities Centres (CFCEs) and the SME Promotion Agency to facilitate business registration and offer financial assistance.

Debt financing is an essential tool for the growth of SMEs in Cameroon, as it provides the capital necessary for expansion, innovation, and working capital management. Access to debt allows SMEs to invest in modern equipment, increase production capacity, and enter new markets. However, despite the potential benefits, many SMEs in Cameroon face significant challenges in accessing affordable credit. A report by MINPMEESA (2023) indicates that more than 60% of SMEs struggle to obtain financing due to high-interest rates, stringent collateral requirements, and limited access to formal banking systems. This financial exclusion forces many SMEs to rely on informal lenders, where the cost of borrowing is even higher, increasing the burden of debt repayment.

The relationship between debt and SME growth in Cameroon is complex. While properly managed debt can stimulate business growth, excessive debt can lead to financial distress, reduced profitability, and business failure. According to a study by Mukete et al. (2021) on SME financing in the Mezam Division, which includes Bamenda III, SMEs that rely heavily on debt financing often face cash flow challenges and high repayment burdens, which limit their ability to reinvest in growth initiatives. The study further revealed that interest rates ranging from 15% to 30% on SME loans in Cameroon reduce profitability and increase the likelihood of default. Additionally, the World Bank (2022) highlighted that 44.6% of SMEs in Cameroon identify limited access to finance as the most significant barrier to growth, with small businesses in regions like Bamenda being particularly affected due to economic instability and underdeveloped financial infrastructure.

The COVID-19 pandemic worsened the financial pressures on SMEs in Cameroon. A 2022 report by MINEPAT (Ministry of Economy, Planning, and Regional Development) indicated that over 70% of SMEs experienced declines in revenue during the pandemic, forcing many to take on additional debt to sustain operations. Although the Cameroonian government introduced loan moratoriums and credit relief programs, many SMEs emerged from the pandemic with higher debt loads and reduced financial resilience, limiting their ability to recover and grow. The SME Promotion Agency noted in a 2023 report that SMEs in the Northwest Region were among the hardest hit, with rising debt levels threatening their long-term viability.

In response to these challenges, the Cameroonian government has taken steps to improve access to financing for SMEs. Initiatives such as the Cameroon SME Bank and credit guarantee schemes aim to bridge the financing gap and provide more favourable borrowing conditions. However, these programs remain underutilized due to limited public awareness, bureaucratic delays, and rigid eligibility criteria. To foster sustainable SME growth, experts recommend reducing interest rates, simplifying loan application processes, and enhancing financial literacy among SME owners to promote responsible debt management.

In addition, Small and Medium-Sized Enterprises (SMEs) are the backbone of the local economy in Bamenda III, contributing significantly to employment, poverty alleviation, and economic development. Located within the Mezam Division of the Northwest Region of Cameroon, Bamenda III is home to a diverse range of SMEs operating in sectors such as agriculture, retail, manufacturing, and services. According to a 2023 report from the Bamenda III Council, SMEs account for over 80% of businesses in the municipality, making them a critical driver of local economic activity. These enterprises not only provide essential goods and services but also create employment opportunities, particularly for youths and women, in a region marked by economic uncertainty and socio-political challenges.

Debt financing plays a vital role in the growth and survival of SMEs in Bamenda III by providing working capital, facilitating business expansion, and enabling investment in new technologies. Many SMEs in Bamenda III rely on bank loans, microfinance institutions (MFIs), credit unions, and informal lending sources to meet their financial needs. According to a 2022 study by Mukete and Chiefor, SMEs in Mezam Division, including Bamenda III, depend on debt financing to sustain operations, particularly in the face of rising operational costs and market competition. However, despite the potential benefits, many SMEs in the area face significant challenges in accessing affordable debt due to high-interest rates, strict collateral requirements, and bureaucratic lending processes.

One of the most pressing issues for SMEs in Bamenda III is the cost of borrowing. Interest rates from microfinance institutions (MFIs) and commercial banks range between 18% and 30% annually, making loans prohibitively expensive for many small businesses. A 2023 survey conducted by the Bamenda III Business Forum found that over 60% of SMEs in the municipality report limited access to formal credit, with many business owners citing high-interest rates and collateral demands as the primary barriers to securing loans. Additionally, the informal lending sector—which many SMEs turn to as a last resort—imposes even higher interest rates and short repayment periods, placing further strain on business sustainability.

The effects of excessive debt on SME growth in Bamenda III are profound. Many SMEs face cash flow problems as they struggle to balance loan repayments with operating expenses, limiting their ability to reinvest in business development. According to Ngwa and Asongwe (2024), SMEs with high levels of debt are more likely to experience reduced profit margins, stagnant growth, and, in some cases, business closure. This financial burden is exacerbated by the ongoing socio-political crisis in the Northwest Region, which has disrupted supply chains, reduced consumer demand, and created an unstable business environment.

The COVID-19 pandemic further intensified the debt-related challenges faced by SMEs in Bamenda III. Many businesses, already vulnerable due to limited financial reserves, were forced to take on additional debt to survive during the economic slowdown. A 2022 report by the Bamenda III Council revealed that 72% of SMEs in the municipality experienced significant revenue losses during the pandemic, with 48% relying on emergency loans to maintain operations. While some government relief programs, such as loan moratoriums and credit guarantees, offered temporary support, many SMEs emerged from the crisis burdened with increased debt levels and reduced capacity to expand.

In response to these challenges, various initiatives have been introduced to improve SME access to credit in Bamenda III. The Northwest Cooperative Credit Union and other local financial institutions have implemented reduced-interest loan programs targeting small businesses. Additionally, the Bamenda III Council has partnered with development organizations to provide financial literacy training aimed at helping SME owners better manage debt and improve creditworthiness. Despite these efforts, gaps in financial accessibility remain, particularly for micro-enterprises and informal businesses that lack the collateral required by formal lenders.

In conclusion, while debt financing is essential for the growth of SMEs in Bamenda III, high-interest rates, stringent lending criteria, and economic disruptions pose significant barriers. Unmanaged or excessive debt can lead to financial distress, reduced profitability, and business failure. This study seeks to evaluate the effects of debt on the growth of SMEs in Bamenda III, providing empirical evidence to inform policy decisions and support programs aimed at enhancing the sustainability and growth potential of local enterprises.

1.2 Statement of the problem

Small and Medium-Sized Enterprises (SMEs) serve as a critical engine for economic growth, especially in developing regions. In Cameroon, SMEs account for over 90% of the private sector and contribute significantly to employment and income generation (MINPMEESA, 2023). In Bamenda III municipality, SMEs play a pivotal role in reducing poverty and promoting local economic resilience amid ongoing conflict and market volatility.

However, despite their economic significance, SMEs in Bamenda III face persistent financial constraints, particularly in accessing debt financing. According to Mukete et al. (2021), only 2.8% of SMEs in Mezam Division successfully secure formal credit due to high collateral demands and a lack of credit history. This limited access to affordable credit forces many SMEs to rely on informal or semi-formal lenders—often under unfavourable terms with high interest rates and short repayment cycles. Cheufa et al. (2022) further reveal that such unstructured debt hampers reinvestment, innovation, and long-term competitiveness, creating a fragile foundation for business growth.

The problem is compounded by the prolonged sociopolitical crisis in the Northwest Region, which has disrupted supply chains, reduced consumer demand, and increased business operating costs. According to a 2023 Bamenda III Council report, over 60% of SMEs in the municipality experienced financial distress due to restricted credit access during the conflict. Moreover, the COVID-19 pandemic further intensified the financial burden, with many SMEs incurring more debt to survive declining revenues (Ngwa & Asongwe, 2024).

The consequence of these challenges is stagnated SME growth, reduced job creation, and in some cases, outright business failure. Government interventions such as the Cameroon SME Bank and the Business Creation Formalities Centres (CFCEs) have had minimal impact due to bureaucratic bottlenecks, limited awareness, and rigid loan conditions. This situation highlights a pressing concern: the inability of debt—especially when misaligned with SME capacity—to foster sustainable business growth.

Therefore, this study seeks to investigate the effects of formal, semi-formal, and informal debt on the growth of SMEs in Bamenda III. By understanding how different types of debt influence financial sustainability, operational expansion, and long-term viability, the research aims to provide evidence-based solutions for improving access to and the management of debt among SMEs in the municipality.

1.3 Research questions

Main Research Question

1. What are the effects of debt on the growth of SMEs in Bamenda III?

 Specific Research Questions

• How do formal debts affect the growth of SMEs in Bamenda III?
• To what extent does semi-formal debt influence the growth of SMEs in Bamenda III?
• What is the effect of informal debt on the growth of SMEs in Bamenda III?

1.4 Objectives of the Study

Main Objective:

To examine the effects of debt on the growth of Small and Medium-sized Enterprises (SMEs) in Bamenda III

Specific Objectives:

• To evaluate the effect of formal debts on the growth of SMEs in Bamenda III.
• To assess the effect of semi-formal debts on the growth of SMEs in Bamenda III.
• To investigate the effect of informal debts on the growth of SMEs in Bamenda III.