Ravi Chandran
Financial access is still a major limiting factor for small and medium-sized enterprises (SMEs)
By: Nesa Rahmat
In general, banks refuse credit to SMEs because they are perceived as risky and unprofitable. However, experience in the field shows that SME lending can be profitable and does not necessarily involve more risk for the bank than lending to large enterprises or the public sector.
All too often, banks see any risk as dangerous. Yet, any type of transaction which provides credit involves a chance of failure. Rather than categorically turning down requests from SMEs and denying them financial access, banks can learn how to calculate the risks.
By developing an entrepreneurial attitude, they can start generating profits from this client segment, too. To do so, banks may wish to improve their risk-evaluation skills. One study revealed that this was one of the major shortcomings that successful entrepreneurs noted in bankers.
Banks can also adopt specific tools such as credit scoring which enables bankers to calculate and compare risks against an average benchmark. It introduces a degree of objectivity in the analysis and it can assist credit officers with limited experience.
Why loans do not perform
Non-performing loans are sometimes the result of lack of knowledge about business reality. In order to minimise their number, it is advisable to offer SMEs business support, and development services, in addition to financial access. Officers in charge of lending to SMEs have to know the customers, the market and the financial counterparts involved. Financing has to be adapted to regional customs, laws and regulations. Support services are not meant to be entirely free, but can be part of a package deal alongside the credit.
Micro-enterprises are a long-neglected segment. But a new breed of financial institution is designing specifically-targeted products to bring them into the mainstream. However, it is understandable that banks should not be expected to deliver all types of services to all clients. Specialized banks will tailor products for the SME market, and will look at existing donor or government programmes to provide efficiency and complementarities. These programmes will also require the banks to train staff. Naturally, this is only possible if the bank’s top management is fully committed and if loan officers receive incentives linked to their portfolio success.
Other financing methods for financial access
Venture capital is an alternative way to finance SMEs when banks cannot intervene, and particularly when stringent collateral requirements cannot be met. It is also the only source of alternative finance when firms have outgrown their start-up phase, but have not yet reached full development. Private-equity financing for SMEs is still an underdeveloped market.
Successful venture funds are extremely selective in their choice of projects, and export-oriented enterprises are usually preferred. In these cases, deals are carefully chosen after a field analysis because documentary evidence is not enough in itself. Finally, returns must exceed average market return.
Tutoring and mentor programmes
Sometimes, venture funds will provide non-financial assistance and close tutoring for talented entrepreneurs. Non-financial credit support services can be offered via banks, government-backed initiatives or through private business support services. Support can also be provided in the form of mentor programmes.
E-finance a reality to financial access
Government and private sector have an important role to play in making e-finance a accessible for SME owners. Attention must be paid to SME capacity building for the new economy. The challenge for governments may be to improve information-sharing rather than to become involved in direct investment in SMEs.
Another important step for governments is to introduce rules that establish a competitive operational framework. There are different networks through which e-finance can function such as Internet portals, specialised apps, etc. Government’s role is to ensure that competition works properly.
E-banking can also facilitate financial access for SMEs. It has the advantage of lowering the bank’s costs, so they can obtain greater gains without necessarily increasing interest rates. Banks are slowly evolving to Internet-based, and app-based payment systems.
Adverse selection and moral hazard may have a sizeable effect when firms are young or small, which may explain why they find it hard to raise money in the public markets. However, through close and continued interaction, a firm may provide a lender with sufficient information about, and a voice in, the firm’s affairs so as to lower the cost and increase the availability of credit.
An important dimension of a relationship is its duration. The longer a borrower has been servicing its loans, the more likely the business is viable and its owner trustworthy. Conditional on its past experience with the borrower, the lender now expects loans to be less risky.
This should reduce its expected cost of lending and increase its willingness to provide funds. It is possible that the lender could obtain sufficient information on the firm’s ability to service debt‐like claims by observing its past interactions with other fixed claim holders like employees or prior creditors.
If so, the age of the firm rather than the length of the financial relationship should determine the lender’s cost and the availability of funds. Alternatively, the information generated within a financial relationship may not be observable (or transferable) to outsiders. If so, the length of the relationship should exert an independent influence.
In addition to interaction over time, relationships can be built through interaction over multiple products. Borrowers may obtain more than just loans from a lender, especially if the lender is a bank.
