Small and medium enterprises (SMEs) are the backbone of the economy, being the main contributors to employment in developing and developed countries. Despite their importance, access to finance is relatively limited when comparing to large firms and is a major operating constraint for SMEs. The International Finance Corporation (IFC) estimates that to satisfy the demand by formal SMEs around the world credit had to increase between 900 and 1,100 billion U.S. dollars in 2011.
In a new policy brief (Abraham and Schmukler, 2017), we explore the obstacles to SME finance and some of the solutions that have been put in practice to try overcome them.
The limited financing to SMEs derives from their nature. SMEs tend to be informal, young, have less publicly available information, and operate in unfamiliar sectors, all of which results in higher information asymmetries and risk, discouraging bank lending. Many times, these firms also do not have enough assets that can be used as collateral. Additionally, these firms might find it too costly to list in capital markets. Even when they do list, they might fail to attract enough capital market financing, as investors in these markets prefer large companies which are less risky and more liquid.
The financing problems of SMEs have not gone unnoticed. Policy makers and market participants have implemented different initiatives to try to broaden access. One involves setting up credit information sharing mechanisms to promote bank lending to SMEs. Reforms that foster the use of movable assets as collateral (such as improving collateral laws and introducing movable collateral registries) are also well regarded. Public credit guarantees are another popular tool used to channel credit toward SMEs. Other initiatives have tried to promote alternatives financing mechanisms beyond bank lending, by for example establishing online platforms to conduct supply-chain finance. In addition, governments have tried to sidestep banks by creating secondary exchanges targeted at SMEs.
These examples show how countries are approaching the problem of SME finance in innovative ways. This new focus requires some experimentation to understand what works and what doesn’t in different contexts. It also requires periodic and rigorous evaluations of the initiatives to determine whether they should be continued, changed, or terminated. Governments should join these efforts by collecting and using information on SME financing and by participating in the different initiatives.
Abraham F., and S. Schmukler, 2017. “Addressing the SME Finance Problem.” Research and Policy Briefs No. 9, World Bank.
- Financial Sector