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Small Frims

Why are small firms less likely to pledge collateral for formal loans than large firms?

Ha Minh Nguyen's picture

Small firms are commonly believed to have weak access to finance. Previous studies have shown that small firms report larger financing obstacles and use less external finance than large firms do.

It is then a surprise to find in the new research we just published that small firms are significantly less likely to pledge collateral. Using the World Bank Enterprise Survey (WBES) covering 6800 firms across 43 developing countries, we find that all else being equal, the odds of small firms-- those with less than 20 workers-- pledging collateral for formal loans from financial institutions are about 35-37% lower than those of larger firms. Yet when loans are collateralized, the ratio of collateral value to loan value for small firms is not statistically different from that for larger firms. These results are robust across countries, or within a particular country. Given that small firms have weak  access to finance, this is a counter-intuitive, yet interesting finding.