Home .Finance SME financing and the crisis
SME financing and the crisis
Friday, 03 June 2011 01:13

This paper is a presentation that I made to an ADBI/ILO Conference on Employment in the Postcrisis Context, in December 2009.



As this week’s Economist newspaper says, small business has a big problem. And that is access to finance. Access to finance usually means access to bank finance, because small and medium size enterprises (SMEs) are usually too small to access bond and equity markets.


In normal times, access to finance is one of the most significant challenges for the creation, survival and growth of SMEs, especially the innovative ones. And the problem is even worse in a time of crisis like the present.


This is not only a problem in developing Asia, but also for SMEs in OECD countries:


US small business is having financing problems. Smaller banks, on which they rely, are reluctant to lend and are tightening lending standards, as they grapple with exposure to commercial real estate. And small business’s own collateral, typically real estate, has fallen in value. And what’s more, many small US banks are still going bankrupt. 


According to a survey by the European Central Bank, access to finance is a major problem for European SMEs.  And the concern is that as demand picks up more, credit constraints will begin to bite more tightly. The recovery could be stillborn.


Concern about this is so great that just the other day, President Barack Obama told bankers to increase loans to SMEs. Obama said that US banks had received extraordinary assistance and demanded they show extraordinary commitment to rebuild the US economy.


But let’s come back to the beginning. Why do SMEs matter? There are several reasons why SMEs matter to us, the participants in this conference.


First, SMEs (enterprises with less than 200 workers) account for a large share of manufacturing employment – 50%- 90% in developing Asia. The shares in the agriculture and services sectors are even higher. And within that, micro and small enterprises (those with less than 50 workers) are particularly important in countries like India, the Philippines and Indonesia. Many microenterprises operate of course in the informal sector; that means that they are not formally registered.


Second, evidence from OECD countries and some developing Asia economies suggests that SMEs, especially new ones, can be among the most innovative and dynamic. For example, Microsoft may be a software giant today, but it started off in typical SME fashion, as a dream developed by a young student with the help of family and friends.


More close to home, the Economist newspaper reports that “whereas big Japanese electronics companies such as Panasonic, Sharp and Sony have been losing market share to rivals from China, South Korea and Taiwan, smaller, less well known Japanese firms continue to dominate niches upon which the global technology industry depends …Japanese companies serve more than 70% of the worldwide market in at least 30 technology sectors worth more than $1 billion apiece, according to the Ministry of Economy, Trade and Industry (METI). They range from certain films to diffuse light used in LCD screens (where they have the whole of a market worth more than ¥270 billion, or $3 billion) to multilayer ceramic capacitors that regulate the current in electrical equipment (77% of ¥540 billion)”.


Third, with the increasing fragmentation of production and trade, many SMEs can be caught in a supply chain trap. Again, the Economist newspaper reports that 90% of the micro-motors used to adjust the rear -view mirror in every car are made by Mabuchi, a Japanese SME. But, when car sales drop, Mabuchi takes a direct hit.


Fourth, SMEs suffer many constraints that larger enterprises do not suffer – constraints like infrastructure (they cannot afford their own electricity generator), access to technology, regulatory environment and above all, access to finance.


Financing is necessary to help them set up and expand their operations, develop new products, and invest in new staff or production facilities. Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business. But if they are successful, there comes a time for all developing SMEs when they need new investment to expand or innovate further. That is where they often run into problems, because they find it much harder than larger businesses to obtain financing from banks. And when a crisis strikes, SMEs are the first to see their financing get chopped.


And regrettably, the financing problem is most important for innovative SMEs. They tend to be newcomers to the market. They may be seeking financing for a new type of product or service. Initially, they may have negative cash flows and untried business models. They represent a higher risk to banks and cannot be assessed in the same manner as traditional SMEs or large firms. Credit constraints can stop SMEs growing into larger firms.


What is the situation regarding SMEs’ access to finance is developing Asia?


First, it is estimated by CGAP that more than half the households in developing Asia and most SMEs do not have access to formal financial services. In the World Bank’s report on the ease of doing business, SMEs in most developing Asian countries report that getting credit is difficult. Of the 183 countries surveyed: interestingly, Malaysia is the world easiest country in which to get credit (it is only the world’s 23rd easiest country in which to do business overall); Singapore is the 4th easiest country to get credit and easiest country to do business overall. Then, Hong Kong – 3rd/3rd; Thailand 71st/12th; Japan 15th/15th; Korea 15th/19th; Taipei,China 71st/46th; Mongolia 71st/ 60 th; Pakistan 61st/85th; China 61 st/89th; Vietnam 30th/93rd; Bangladesh 71st/119th; Indonesia 113rd/122nd; Nepal 113th/123rd; India 30th/133rd; Philippines 127th/144th; Lao PDR 150th/167th.


In short, in many developing Asian economies, it is not easy for SMEs to do business, and one element of that is that getting credit is quite difficult in many countries.


There are many reasons why access to finance is difficult in developing Asia:


(i) Large numbers of SMEs are in the informal sector. They are not registered, they do not have all the necessary documentation. It can be difficult for potential lenders to distinguish the financial situation of the company from that of its owners. They are less able to provide collateral.


(ii) Financial markets are underdeveloped in many Asia countries. They do not offer a complete range of financial products and services. They may also suffer from regulatory rigidities.


(iii) The fixed costs of all the paperwork mean that it is easier for banks to make bigger loans to larger enterprises.


(iv) In many countries, large enterprises enjoy privileged access to finance from banks. Many of these banks are state-owned or have close links with the government which uses bank lending as an instrument of industrial policy to develop specific sectors. Banks may also have ownership and other ties to industrial interests and will tend to favor affiliated companies. This means that it is difficult for SMEs to obtain finance.


So, even in normal economic conditions governments have recognized that, to survive and grow, SMEs need specific policies and programs especially to facilitate their access to finance.


Let’s move on to the crisis. SMEs and their financing have been especially hard hit by the global crisis leading to massive job losses. For example, Lim reports that over 100,000 factories in southern China alone have closed.


This has occurred as revenues have fallen, and the credit crunch has reduced access to finance for SMEs, which are perceived as riskier, more than for large enterprises.


Let’s go through the effects. Revenues have been hit by plummeting exports. While MNEs and large enterprises are major exporters in Asia, many SMEs are caught in their supply chains, and thus seen their sales fall. And this all feeds into domestic demand, where SMEs are also taking a big hit. The crisis has now moved from exports to foreign direct investment which according to the OECD’s recent forecast will collapse by 60% this year.


SMEs are big players in the travel and tourism industry. According to the World Tourism Organization, worldwide, international tourist arrivals declined by 7% in the first 8 months of this year compared with last year. For Asia and the Pacific, the decline was 5%. The region does show the clearest signs of improvement, and is expected to show the strongest rebound in 2010.


One relatively bright spot is migrants’ remittances which everyone thought would crash. In fact, many SMEs rely on migrants’ remittance. This is particularly the case for microenterprises which do not have access to formal financial services. Interestingly, according to the World Bank, global remittances may only fall by about 6% in 2009 to $317 billion, thanks to a remittances “boom“ in South Asia and strong flows to East Asia and the Pacific. It is not clear how long this resilience in remittances can be maintained, especially if the economic recovery turns out to be jobless.


Western financial institutions withdrew finance from the region to bolster balance sheets at home. This has contributed to the reduced availability of credit. Overall, the crisis has resulted in capital depletion, risk aversion and credit contraction. A great number of SMEs have been forced to go bankrupt due to lack of finance.


It is important to stress that SMEs are generally more vulnerable in times of crisis for many reasons among which are:


-- it is more difficult for them to downsize as they are already small;

-- they are individually less diversified in their economic activities;

-- they have a weaker financial structure (i.e. lower capitalization);

-- they have a lower or no credit rating;

-- they are heavily dependent on credit and

-- they have fewer financing options.


And SMEs in global value chains are even more vulnerable as they often bear the brunt of the difficulties of the large firms.


As Lim reports, governments have undertaken a number of short term actions such as loan guarantees. Examples of specific measures are subsidizing interest rates and raising exporters’ bank limits (e.g., Pakistan), providing shipment credit for exports with interest subvention (e.g., India), simplifying lending requirements for SMEs (e.g., Indonesia), and opening special service credit outlets at banks for SMEs (e.g., China). In addition, many countries have provided enterprises with tax incentives (e.g., India, Kyrgyz Republic, Philippines, Singapore, Thailand, and China) (ADB, 2009).


But such initiatives are not always effective. And it does not seem that governments are addressing the longer term imperatives for rebalancing growth.


An important theme of this conference is the need to rebalance growth. East Asia’s export-oriented growth model can no longer be relied upon to sustain the region's economic and employment growth as US consumer spending will remain sluggish over many years to come. Developing Asian economies now need to adapt their development strategies to this more difficult environment and to take up the challenge of “rebalancing growth” towards greater reliance on domestic and regional demand. And SMEs have an important role to play in servicing regional and domestic demand.


There are many things that governments can do to rebalance growth.


(i) Further development of microfinance holds great promise. As argued by the Alliance for Financial Inclusion, microfinance can be fostered by policy measures in the following areas: agent banking; mobile phone banking;  diversification of financial service channels and providers; state bank reforms; financial identity; and consumer protection.


(ii) The financial sector can be strengthened by improving the institutional underpinnings of financial transactions by strengthening creditor rights, defining property rights so property can be used as collateral for credit, and enhancing credit registries and systems to screen borrowers.


(iii) Move to more market- based banking, where banks are accountable for achieving high returns to shareholders and maintaining high prudential standards, is gaining acceptance on a global level. This model creates a competitive market where there is more incentive for banks to lend to SMEs, but many emerging markets have been comparatively slow in implementing this model.


(iv) Development of “business angel networks” or venture capital markets.


(v) Making it easier to do business. And second, eliminating or reducing the pro-export and pro-MNE bias of export processing zones.


In the past, Asia was often criticized by the Washington consensus for not liberalizing sufficiently its financial markets. The financial crisis has highlighted the perverse effects of “financialization” of the US economy in part because insufficient regulation. Financial sector’s share of total corporate profit reached 42 per cent before the crisis, up from about 25 per cent in the early 1980s. Furthermore, financial sector’s profit as a share of total wages and salaries of all private sector workers increased from 24 per cent to 40 per cent in the period from 1990 to 2005. The sector has attracted many of the best qualified personnel, employing over 40 per cent of graduates from the most prestigious business schools. While real wages in the non-financial sector stagnated over the past 15 years or so, they grew significantly in the financial sector – driven by growing real compensation for the executives, traders and other qualified financial personnel.


This financialization has reduced the scope for development of the real economy -- all the more so given that within the non -financial sector, incentives are increasingly driven by capital markets and the imperative for quick and better financial returns. Our financial market policy makers have to be reminded that the role of the financial sector is to support sustainable development of the real economy, especially SMEs.


In the G20 Leaders Statement from the September 2009 Pittsburgh Summit, G20 Leaders said the following: “We commit to improving access to financial services for the poor. We have agreed to support the safe and sound spread of new modes of financial service delivery capable of reaching the poor and, building on the example of micro finance, will scale up the successful models of small and medium-sized enterprise (SME) financing. Working with the Consultative Group to Assist the Poor (CGAP), the International Finance Corporation (IFC) and other international organizations, we will launch a G20 Financial Inclusion Experts Group. This group will identify lessons learned on innovative approaches to providing financial services to these groups, promote successful regulatory and policy approaches and elaborate standards on financial access, financial literacy, and consumer protection. We commit to launch a G20 SME Finance Challenge, a call to the private sector to put forward its best proposals for how public finance can maximize the deployment of private finance on a sustainable and scalable basis.”


You may all have some suggestions to make to the G20 on these issues.





Alliance for Financial Inclusion


Asian Development Bank, Key Indicators for Asia and the Pacific 2009, Special Chapter on “Enterprises in Asia: Fostering Dynamism in SMEs”


Consultative Group to Assist the Poor (CGAP), Financial Access 2009: Measuring Access to Financial Services around the World


European Central Bank, “Survey on the Access to Finance of Small and Medium-Sized Enterprises in the Euro Area, September 2009

www.ecb.europa.eu  .

G20 Leaders Statement: The Pittsburgh Summit


Guha, Krishna, “Aid for US business at heart of jobs plan”.

www.FT.com , 9 December 2009.

International Institute for Labour Studies, ILO, “World of Work Report 2009”


Lim, Hank, “Nurturing SMEs as a Strategy to Rebalance Growth in Asia”. Draft paper for ADBI

OECD, “International investment collapses in 2009, says OECD”


OECD, “The Impact of the Global Crisis on SME and Entrepreneurship Financing and Policy Responses


OECD, Policy Brief, “Financing SMEs and Entrepreneurs”, November 2006


The Economist, “Invisible but indispensable”, Nov 5th 2009 --


The Economist, “Small business, big problem”, Dec 10th 2009


UN World Tourism Organization World Tourism Barometer --


World Bank, Doing Business 2010: A record in business regulation reform


World Bank, “Workers’ Remittances Fall Less Than Expected in 2009, But 2010 Recovery Likely to Be Shallow”

http://web.worldbank.org/WBSITE/EXTERNAL/NEWS/0,,contentMDK:22394180~pageP K:64257043~piPK:437376~theSitePK:4607,00.html    





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