Bank Financing for SMEs – Lessons from the Literature

Abstract

This is the accepted version of the paper.This version of the publication may differ from the final published version. Abstract: This paper surveys the recent literature on the relationship between SMEs, financial deepening and economic development. While a large SME sector is not associated with faster economic growth or poverty alleviation, financial deepening can have a progrowth and pro-poor impact by disproportionally alleviating SMEs' financing constraints, enabling new entry of firms and entrepreneurs, and better resource allocation. It is important to differentiate between different segments of the SME population, most critically between subsistence micro entrepreneurs and transformational entrepreneurs. There is strong evidence that long-term institution building, including contractual and information frameworks, contribute to easing SMEs' financing constraints, with supportive evidence for specific policy interventions. There is no unambiguous evidence on the relationship between market structure and SMEs' access to finance. Foreign-owned and larger banks are as likely to cater to SMEs as smaller and local banks, but using different lending techniques and where the necessary institutional framework is in place in the country. There is also evidence that SMEs are more strongly affected by banking crises and that regulatory policies have important repercussions for SME lending. Permanent repository link:

Political connectedness and formal finance in transition economies

“…This means that the number of them fluctuates with business cycles [2]. Nevertheless, a large proportion of SMEs are aspirational in the sense that they are established to pursue profitable opportunities and to grow in size; these are known as transformational SMEs.…”

“…do not provide enough information about the breadth and quality of financial depth. Moreover, they neglect certain things, such as the proportion of SMEs responsible for the utilization of available formal finance [2].…”

“…Moreover, evidence suggests that financing from formal, rather than informal, financial institutions is associated with faster firm growth, and that smaller enterprises benefit more from the improved availability of bank finance [2]. In principle, banks should finance all projects with positive net present value, independent of firm size.…”

Lending, Investments and the Financial Crisis

“…In addition, the regulations in the post-crisis period had generally a negative impact on the financing of SMEs (NIER, 2013). Financing constraints are not only higher for smaller firms, but also act as more of a growth impediment to smaller than larger enterprises (Beck, 2013). Beck et al (2011) also identify factors discriminating against small business lending.…”

“…Transaction-based lending, which relies on 'hard' information and assets, has been analyzed as an alternative lending technique for SMEs. Some recent cross-country studies show that banks may apply both methods in order to reach out to smaller firms (for example Beck, 2013).…”