Rethinking SME finance strategies: Smarter policies for bigger impacts

Closing the financing gap for small and medium enterprises (SMEs) should be an economic priority, as they hold the key to boosting productivity, driving long-term growth, and creating more and better jobs. SMEs are vital to economic growth, making up for more than 50 percent of employment in emerging markets and developing economies (EMDEs). Yet, despite years of government backed-support programs, they still face significant financing gaps that hinder their growth, productivity, resilience, and, ultimately, a country’s economic potential. A new World Bank report, "Unleashing Productivity through Firm Financing," shows that by closing these financing gaps, middle-income economies could achieve aggregate productivity gains of up to 86 percent, with the largest potential gains in less developed countries (Figure 1A). Although a similar analysis could not be done for low-income countries due to data limitations, survey evidence suggests they may see even bigger gains. The findings also indicate that firms’ financing mix of debt and equity is important in overall productivity. This is especially true for innovative companies, as equity financing offers unique benefits that help them grow and succeed.

While the global financing landscape is evolving, thanks in part to fintech, SMEs in EMDEs still face limited financing options. Traditional banks remain the primary providers of finance for SMEs, with wide disparities in lending penetration across EMDEs. Financing from alternative lenders remain extremely limited, and private equity markets are still in their infancy. (Figures 1B, 1C, and 1D). Moreover, there are still marked gaps for specific segments of SMEs in many EMDEs, particularly women-owned and led SMEs. Fintech is making inroads, but its impact is mostly seen in larger EMDEs.

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It is time for governments in EMDEs to reevaluate their toolkit of policy interventions. A new World Bank report, “Boosting SME Finance for Growth: The Case for More Effective Support Policies,” advocates that governments should prioritize the development of a more robust enabling environment for SME debt and equity financing. This agenda carries relatively limited fiscal costs and can offer substantial returns. Reforms have begun in many countries, but efforts must be urgently deepened and expanded. The report outlines a roadmap to build the fundamental credit infrastructure, encourage fintech adoption, and establish regulatory frameworks to support the expansion of debt financing beyond traditional banks, and advance equity financing.

Although these policy reforms are necessary, most EMDEs also need targeted interventions to expand both debt and equity finance for SMEs. Most governments already use tools like public guarantee schemes and lending programs to expand debt financing. The report recommends enhancing these efforts to encourage greater penetration of alternative lenders alongside traditional banks, such as asset-based and fintech lenders, and in larger EMDEs, capital markets instruments. Governments should also consider deploying investment programs to expand equity financing, particularly for innovative firms. Overall, the range of interventions should be tailored to the country’s context, guided by a realistic assessment of necessity, feasibility and potential impact.

Given their sizable fiscal costs, countries need to greatly improve the design and implementation of these interventions to ensure they are effective, starting with the adoption of evidence-based approaches. Governments must adopt more comprehensive, rigorous, data-driven analyses of SME financing gaps and their underlying causes, complemented with robust monitoring and evaluation frameworks. Doing so would enable them to not only better target interventions—which underserved SME segments to focus on (e.g., women-owned and le SMEs and agri-SMEs) and which financial providers to engage with—but also to fine tune interventions for more impactful outcomes. Most EMDEs, however, will need to upgrade their data collection, including gender-disaggregated data, analysis, and monitoring capabilities.

There is no one-size-fits-all solution for interventions; targeting requires tailored approaches. The report calls for integrating a gender lens into the design of interventions. It also advocates for a tailored approach to SMEs in select cases, including agri-SMEs, SMEs in countries affected by fragility, conflict and violence, and to support SME access to climate finance. All these cases, including that of women-owned and led SMEs, face additional and unique challenges in accessing financing. Solutions include expanding financial provider options; leveraging fintech to reduce costs and improve accessibility; and enhancing capacity-building programs for both SMEs and financial providers, among others.

Above all, private capital mobilization should be at the heart of targeted interventions, with well-defined and quantifiable targets. In debt financing, this translates to scaling back direct lending programs, which often fail to mobilize private capital and may even crowd it out, and instead, leveraging a wide range of financial intermediaries for delivery. In equity financing, governments should favor private structures, such as funds, to instill investor confidence.

In conclusion, bridging the SME financing gap requires more than financial support; it demands a strategic overhaul. Governments in EMDEs must move beyond short-term fixes and temporary measures, and instead prioritize the development of a robust and resilient financial ecosystem that stimulates private investment. The potential benefits for EMDEs are immense: accelerated growth and productivity, more diversified and resilient economies, and the creation of more and better jobs. The time to act is now.

^{The work on the “Boosting SME Finance for Growth” report has been made possible thanks to the financial contribution from the Finance for Development (F4D) Umbrella Program.}