Small and medium-size enterprises (SMEs) account for close to 60 percent of global manufacturing employment. So it is no surprise that financing for SMEs has been a subject of great interest to both policymakers and researchers. More important, a number of studies using firm-level survey data have shown that SMEs perceive access to finance and the cost of credit to be greater obstacles than large firms do—and that these factors really do constrain the growth of SMEs.
In recent years a debate has emerged about the nature of bank financing for SMEs: Are small domestic private banks more likely to finance SMEs because they are better suited to engage in “relationship lending,” which requires continual, personalized, direct contact with SMEs in the local community in which they operate? Or can large foreign banks with centralized organizational structures be as effective in lending to SMEs through arm’s-length approaches (such as asset-based lending, factoring, leasing, fixed-asset lending, and credit scoring)? And how well do state-owned banks—for which expanding access to finance is often among their top objectives—serve SMEs?
In a recent paper (working paper version here) Thorsten Beck, Sole Martinez, and I try to inform this debate using newly gathered data for 91 large banks from 45 countries. First, we examine whether banks of different ownership types use different lending technologies and organizational structures in lending to SMEs. In particular, we examine whether foreign banks are more likely than domestic private banks to use arm’s-length lending technologies based on “hard information” and centralized organizational structures. Second, we investigate whether arm’s-length lending technologies and centralized organizational structures are just as suitable as relationship lending for SME finance. Third, we test whether foreign banks tend to specialize less heavily in SME finance or make SME loans on less favorable terms than domestic private banks do. Finally, we analyze whether the institutional and legal environment of the country affects the extent, type, and pricing of SME lending.
We find that banks of different ownership types apply different lending technologies and organizational structures in lending to SMEs. In particular, foreign banks grant a larger share of collateralized loans, are less likely to rate “soft information” as important in evaluating loans, and are less likely to decentralize loan approval and risk management decisions. Government-owned banks appear to be more likely to decentralize decisions involving SME finance. But they do not appear to rely on relationship lending, since they seem more likely than private banks to use collateral and hard information in lending to SMEs.
However, we find few significant correlations between lending technologies and organizational structures on the one hand and the extent, type, and pricing of SME lending on the other. Most notably, we find no evidence that foreign banks tend to lend less to SMEs than other banks do. In fact, if we focus only on developing countries, we find that foreign banks are more likely to approve loans to small firms than domestic private banks are—and do so at fees and rates that do not differ significantly from those charged by domestic private banks. Compared with government-owned banks, domestic private banks seem to charge higher interest rates to both small and medium-size enterprises, while foreign banks seem to charge higher fees to small enterprises.
We find more significant differences between banks in developed countries and those in developing countries, even after controlling for bank types. In particular, banks in developing countries provide a smaller share of investment loans and charge higher fees to SMEs than those in developed countries. They also tend to charge higher interest rates on loans to small firms.
These differences appear to be driven by differences in the institutional and legal environment. For example, the smaller share of SME loans for investment observed in developing countries seems to be explained by the higher cost of registering property in those countries; once we control for this variable, the dummy variable for developing countries is no longer significant in the regressions for either small or medium-size firm financing. Similarly, the higher fees for SMEs observed in developing countries seem to be related to the higher cost of property registration and worse credit information environment in those countries. In addition, the weaker protection of property rights in developing countries seems to matter in explaining differences in lending fees for medium-size firms. Finally, the higher interest rates for small firms observed in developing countries seem to be associated with the higher costs of enforcing contracts and weaker protection of property rights prevalent in those countries.
Our results confirm the importance of strengthening the institutional environment to improve access to finance for SMEs. Differences across banks and their lending technologies and organizational structures seem to be of secondary importance. Still, our study has looked at a sample of large banks, which tend to be relatively similar regardless of differences in ownership type. Whether these results hold in larger samples that include small as well as large banks remains to be seen. Stay tuned for more.
Beck, Thorsten, Asli Demirgüç-Kunt, and Maria Soledad Martinez Peria. Forthcoming. “Bank Financing for SMEs: Evidence across Countries and Bank-Ownership Types.” Journal of Financial Services Research. (Working Paper Version)