There is more than one side to every story. Bank lending to small and medium enterprises (SMEs) is not an exception. On one side are SMEs, their expansion plans, and their needs for financing. On the other side are banks and their policies. Empirical analyses of financing to SMEs typically focus on the firms’ side of the story. Surveys gather information from firms and try to understand their sources of financing, if they are credit-constrained, or even if they rule themselves out from applying for bank loans because they believe they will be turned down by banks. Those surveys also collect detailed information on firm characteristics, e.g. the date the firm started operations, the owner’s gender, and the reason why the business was started. In other words, surveys on SME financing focus on consumers with great detail. Surveys rarely—if ever—focus on suppliers.
In 2011 the United Nations’ Economic Commission for Latin America and the Caribbean (ECLAC) and Mexico’s National Banking and Securities Commission (CNBV) completed a project with a different approach. The two organizations joined efforts to carry out a survey of banks focused on their practices in lending to SMEs. Two economists were in charge of the effort: Rodrigo Fenton from CNBV, and Ramón Padilla from ECLAC.
As the overseer of banks in Mexico, the position of the CNBV was crucial in gaining the support of Mexico’s Bank Association (ABM) for the project. ABM members voluntarily agreed to participate in the survey, under the condition that no individual information be revealed, even if anonymously. Fifteen commercial banks that account for 97% of the amount loaned by banks to SMEs in Mexico participated in the survey—development banks are second-tier and therefore were not part of the study.
The survey had two parts: a questionnaire and an in-depth interview. The questionnaire included 77 quantitative and qualitative questions on three topics regarding credit to SMEs: strategy to serve SMEs, business model, and operative information. The in-depth interview was conducted after the questionnaire was completed. The interviewees were the bank officials responsible for credit to SMEs. The interviews took between 90 and 120 minutes and focused on bank policies and perceptions, among other issues.
Although the survey contains a wealth of data, it cannot be analyzed in a conventional way. First, 15 observations (one per bank) are not enough for any proper statistical inference. Second, the results should be interpreted as a census rather than as a sample, given that it covered 97% of the amount loaned by banks to SMEs. The approach of the study was qualitative.
Some interesting findings
Banks differ. That is perhaps one of the most interesting findings. Banks’ approaches to SMEs are diverse: while some are very active in the segment and pursue new customers with aggressive campaigns, others are rather passive. In fact, 11 of the 15 surveyed banks have specialized areas to serve SMEs and four do not. Based on the survey instruments, three business models were detected. The first model is based on scale and is followed by large banks. Their strategy is to serve the largest number of customers possible through their network of branches or through specialized sales representatives. The second model is based on relationship-lending, and it is applied by regional banks and some niche banks. They use informal information and the record of the relationship with the bank as an important element in the decision-making process. The third model could be called “strategic.” Some niche banks give loans to SMEs only as an extension of their core services “to keep their customers happy.” Based on the three different models, it would be a mistake to paint all banks with broad strokes when it comes to lending to SMEs.
Tax records matter to banks. Although being a registered taxpayer is not required by law to get a bank loan, banks rarely give loans to SMEs lacking tax records. Bank officials argue that tax returns are used as a signal of the quality and seriousness of the firm.
Banks do not lend to new firms. Another screening mechanism is whether the firm is new. Since according to banks the probability of surviving the first two years are slim for SMEs (around 20%), they only give loans to SMEs that have been operating for at least two years.
Banks focus on the ability to pay, not the project. Bank officials do not analyze the project that will be financed. When it comes to SMEs, they focus solely on the ability to pay based on the cash flows the business already generates. Unsurprisingly, loans typically finance working capital.
The lack of collateral is not perceived by banks as an obstacle. Consistent with the “ability to pay” approach, lacking collateral is not seen as an obstacle to lending to SMEs. Bank officials stated that limitations on appropriating the collateral after a default are not particularly bad in the case of SMEs—they also leave a lot to be desired in the case of large businesses.
Last but not least, banks do not find an obstacle in the regulatory framework. After specific questions about whether regulation was preventing banks from lending more to SMEs, the answer given by bank officials was “no.”
A Spanish version of the full report of the results can be found at this link. The report includes a detailed review of the obstacles to bank lending to SMEs found in the economic literature. The authors interpret the results of the survey in light of those obstacles. The survey results and analysis constitute a valuable exercise that debunks some myths about banking policies in Mexico. Researchers interested in understanding bank lending to SMEs in emerging economies should take note of the lessons derived from the glimpse of the supply side offered by Rodrigo Fenton and Ramón Padilla.