A financial sector that does not fund enterprise

Lesotho’s financial sector has grown. It has deepened on the metrics that regulators tend to watch. And yet, by the measure that matters most for a developing economy, its ability to move money from where it sits to where it can work, the system remains structurally limited.

Understanding why requires looking at what the sector does, who it serves, and what it was built to do in the first place.

Financial inclusion in Lesotho has expanded substantially over the past decade. Overall financial inclusion rose from 81 percent in 2011 to 91 percent by 2021, according to the Financial Sector Development Strategy II (2025-2030). Formal financial inclusion moved more dramatically, from 60 percent to 87 percent over the same period. These are real gains, driven largely by mobile money, which has extended the reach of transactional services to populations that commercial banks never seriously tried to reach.

But one figure sits unchanged across that entire decade: banking access. In both 2011 and 2021, it stood at 39 percent. A system that widened its reach did not deepen its core function. More people were financially included; no more people were banked.

That table captures the problem in miniature. Access broadened. Banking depth did not.

If there is one fault line that most clearly reveals the inadequacy of Lesotho’s financial system, it is the treatment of small and medium enterprises.

SMEs sit in a financing vacuum. They are too risky for commercial banks, which require collateral, audited accounts, and predictable cash flows that most small businesses cannot provide. They are too small for capital markets, which in any case barely function in Lesotho. They are too informal for structured finance, which demands legal clarity and financial documentation that SMEs often lack.

The missing middle, the financing gap between microfinance and commercial banking, afflicts developing economies across Africa. But in Lesotho, the problem is particularly acute. The IMF’s 2025 Selected Issues paper says two-thirds of firms cite insufficient operational cash flow as a key challenge. It also says only 17 percent of MSMEs had a formal bank account in 2023, and only 10 percent received credit from a formal financial institution. Most MSMEs instead relied on mobile money for transactions, while only 22 percent reliably kept financial records and only 18 percent were formally registered.

Despite years of policy discussion and successive development strategies, the structure of lending has barely shifted. Banks still prefer the certainty of payroll deductions over the uncertainty of enterprise growth. Credit scoring systems are built around salaried employment, not business performance. Collateral requirements exclude the majority of potential borrowers. Loan tenors are too short for meaningful investment.

The practical implications are severe. Lesotho’s textile sector, dominated by East Asian-owned firms, grew not through domestic banking but through direct foreign investment and trade preferences. The handful of domestically-owned businesses that have achieved scale did so through retained earnings, diaspora capital, or personal relationships, not through the formal credit system. The banking sector has not been a significant driver of industrial development, because it was never structured to be.

There is a certain irony in Lesotho’s financial data. The sector is now one of the larger contributors to the country’s GDP. The FSDS II says the financial sector reached 13.9 percent of GDP by end-2023, up from 7.6 percent in 2014, making it the third-largest contributor to GDP after public administration and manufacturing.

By the headline numbers, the financial sector looks significant. But its depth remains profoundly limited.

Capital markets are underdeveloped. The Maseru Securities Market exists, but activity is minimal. The FSDS II states that the MSM is very small, with one listed equity as of 2021, nine listed government bonds, and very limited trading and liquidity. Equity financing, the mechanism by which growing companies in developed economies raise expansion capital, is almost nonexistent for domestic businesses. Long-term debt finance, the kind that would fund a factory, a hotel, or a large-scale agricultural operation, is scarce.

Insurance penetration is shallow, and what penetration exists is heavily concentrated in funeral insurance. Credit guarantee schemes remain nascent. Pension fund assets, potentially a source of long-term domestic investment, are large enough to matter but are not yet fully mobilised into domestic capital formation. The FSDS II puts pension sector assets at about M17 billion, equivalent to 41 percent of GDP.

The system has size, but not breadth. It occupies space in the economy without transforming it.

The Financial Sector Development Strategy II (2025-2030) signals that policymakers are aware of the problem. The strategy identifies low financial intermediation as one of the major gaps and says there is an urgent need to scale up access to finance for productive sectors and broaden lending opportunities for small businesses. It also places agricultural finance, housing finance, investment funds for SMEs, capital-market development, and improvement of the partial credit guarantee regime among its priorities.

These are not trivial commitments. A coherent strategy, backed by political will and adequate implementation capacity, could meaningfully shift the trajectory of the sector over a five-year horizon.

But the history of financial sector development in Lesotho counsels realism. Previous strategies have articulated similar ambitions. The gap between policy intent and structural change has been persistent, not because policymakers are uncommitted, but because the forces sustaining the status quo are powerful and deeply embedded.

The central question is whether reform will change incentives or merely frameworks. Lesotho does not suffer from an absence of policy documents. It has strategies, reports, diagnostic assessments, and technical recommendations in considerable number. What it has lacked is the structural transformation that turns sound analysis into changed behaviour. Regulatory frameworks can be redesigned without changing how banks assess risk. Capital market rules can be modernised without generating the deal flow and investor confidence that make markets function. Inclusion targets can be met through mobile money without improving access to credit.

At its core, this is not primarily a regulatory failure. It is a risk problem.

Banks are behaving rationally. Government salaries are predictable; SMEs are volatile. Legal enforcement of creditor rights is uncertain and slow. Financial data on small businesses is weak or absent. Collateral registries are incomplete. Credit bureaus lack comprehensive coverage. In an environment of information asymmetry and institutional weakness, lending to a civil servant on payroll deduction is simply a better business proposition than extending credit to an entrepreneur with a business plan. The IMF’s 2025 paper makes this point directly, noting that weak financial records, incomplete firm registration, limited bureau coverage, and collateral constraints all make SME risk difficult to assess.

Until these fundamentals change, credit will continue to flow toward safety rather than growth, not because banks are failing in their fiduciary duty, but because they are performing it.

This means the reform agenda must go deeper than banking regulation. It requires strengthening the legal infrastructure of credit: land titling, collateral registration, contract enforcement. It requires building the information infrastructure, including credit bureaus, business registration systems, and accounting standards for SMEs. It requires risk-sharing mechanisms that change the payoff structure for banks, through partial credit guarantees, development finance institutions, and blended finance instruments. Some of these require capital. Most require institutional reform. All of them take time.

The implications of a financial system that does not fund enterprise are profound, and in Lesotho’s case, compounded by the country’s specific economic vulnerabilities. A financial system that cannot drive industrialisation, support job creation, or enable export growth does not simply leave growth on the table. It reinforces the structural conditions that make growth difficult: dependency on wages, remittances from South African mines, and government spending sustained by SACU transfers that are themselves declining.

Lesotho’s fiscal position has become increasingly precarious as SACU revenues come under pressure, while the IMF notes that public expenditure remains exceptionally high relative to GDP and that the public sector-led model has failed to deliver stronger living standards. The textile sector, the country’s primary source of formal private employment, is exposed to trade policy shifts largely beyond Lesotho’s control. The agricultural sector is constrained by climate vulnerability and underinvestment.

In this context, a financial sector that does not mobilise domestic capital for productive investment is not a peripheral concern. It is a structural vulnerability at the centre of the country’s development challenge. The capacity to grow the economy from within, through domestically financed enterprise, through credit-supported agricultural intensification, through capital-market-funded infrastructure, is exactly what is missing.

Lesotho now faces a choice about what its financial sector is for. The current model is safe. Banks are profitable. Regulators are competent. Stability is maintained. But from the perspective of national development, job creation, industrial diversification, poverty reduction, and economic resilience, the system is falling short. And the gap between financial sector performance and development outcomes is not a rounding error. It is the central economic challenge of the country’s next decade.

The choice involves trade-offs between stability and dynamism, between investor returns and development imperatives, between the interests of institutions embedded in the South African financial system and the needs of a small landlocked economy trying to build productive capacity of its own.

What is clear is that the current equilibrium, stable, profitable, conservative, and disconnected from the productive economy, cannot be the end point of reform. The question is whether Lesotho’s policymakers, regulators, and financial institutions have the appetite to move beyond it.

Because perhaps the most uncomfortable truth is this: Lesotho’s financial sector was not designed to transform the economy. It was designed to survive within it. And until that design changes, the most important economic question in the country will continue to go unanswered, not for want of analysis, but for want of structural ambition.