Financial Inclusion Experts Group | SME Finance Sub-Group 68734 Scaling-Up SME Access to Financial Services in the Developing World NOVEMBER 2010 S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 1 Table of Contents List of Abbreviations 3 Acknowledgement 4 Introduction 5 Executive Summary 6 CHAPTER 1 Role of SMEs in Economic Development 9 CHAPTER 2 Non-Financial Barriers to SME Development 14 CHAPTER 3 Access to Finance as a Key Constraint to SME Development 17 3.1 SME Life Cycle and Financial Needs 17 3.2 Quantifying the SME Finance Gap 21 3.3 Why SME Finance Remains a Challenge 28 3.3.1 The Legal and Regulatory Framework 28 3.3.2 Financial Infrastructure 29 3.3.3 Financial Institutions Capabilities and Delivery Models 33 3.4 Policy Interventions Designed to Expand SME Finance 36 CHAPTER 4 Exploring Various SME Finance Models 46 4.1 Stocktaking Exercise Methodology 46 4.2 Overview of the Case Collection 48 4.3 Primary Providers of Financial Services to SMEs 51 4.3.1 Commercial Bank Down-scaling 51 4.3.2 Micro�nance Institutions Up-Scaling 53 4.3.3 Community, Cooperative, and Municipal Banks 55 4.3.4 Equity Funds 56 4.3.5 Key Successess Factors for Providers of Financial Services to SMEs 58 2 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P 4.4 The Enabling Environment for Access 58 4.4.1 Legal and Regulatory Initiatives 58 4.4.2 Financial Infrastructure 63 4.5 Public Support Schemes 65 4.5.1 Funded Financing Facilities 65 4.5.2 Credit Guarantees 69 4.5.3 State Banks 71 4.6 Models Addressing Speci�c Gaps 71 4.6.1 Crisis Response 71 4.6.2 Gender Finance 74 4.6.3 Sustainable Energy Finance 74 4.6.4 Other Innovative Models 75 4.7 Development Interventions in the SME Finance Space 77 CHAPTER 5 Increasing Financial Access for SMEs: Suggested Actions and Policy Recommendations 80 5.1 Endorse a Set of Recommendations for Policymakers in the Developing World to Establish a Supportive Enabling Environment for SME Access to Financial Services 82 Developing country speci�c diagnostics and strategies 82 Developing a supportive legal and regulatory framework 82 Strengthening the �nancial infrastructure 83 Designing effective government support mechanisms 84 Building consistent and reliable data sources on SME �nance 85 Building capacity of the �nancial institutions 86 5.2 Establish a Global SME Finance Forum 86 5.3 Fund the Winners of the SME Finance Challenge and Set Up a Global Funding Platform to Build Capacity, Mitigate Risks, and Create Incentives for the Delivery of Sustainable and Scalable Financial Services to SMEs 87 5.4 Lead the Efforts to Gather Better SME Finance Data in a Coordinated Fashion and Establish a Platform to Consistently Collect the Cross-Country Data 88 ANNEX A Sample SME De�nitions 89 ANNEX B Methodology for Key Estimates on SME Financing Gap 90 ANNEX C SME Finance Stocktaking Matrix 94 Bibliography 136 S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 3 List of Abbreviations AFR Africa region IFRS International Financial Reporting Standards AMSME Africa Small and Medium Enterprise Finance IFC International Finance Corporation ATISG Access Through Innovation Sub-Group IPO Initial Public Offering BDC Business Development Bank of Canada IRR Internal Rate of Return BCBS Basel Committee for Banking JICA Japan International Cooperation Supervision Agency CCRIS Central Credit Reference LAC Latin America and Caribbean Information System LIC Low Income Countries CGAP Consultative Group to Assist the Poor LRS Legislation, Regulation, and Supervision CDC Citizens’ Development Corps MASSIF Micro and Small Enterprise Fund DFIs Development Finance Institutions MEs Medium Enterprises EAP East Asia and Paci�c MENA Middle East and North Africa EBRD European Bank for Reconstruction MFI Micro Finance Institution and Development MIC Middle Income Countries ECA Europe and Central Asia MSMEs Micro, Small, and Medium Enterprises EE Energy Efficiency NAFIN Nacional Financiera EIB European Investment Bank NGO Non Governmental Organization EU European Union OECD Organization for Economic FIBEN Fichier Bancaire des Entreprises Co-Operation and Development FIEG Financial Inclusion Experts Group PERC Policy and Economic Research Council GDP Gross Domestic Product PCGs Partial Credit Guarantees GNI Gross National Income SAR South Asia region GPFI Global Partnership for Financial Inclusion SBs Small Businesses GSM Government Support Mechanisms SMEs Small and Medium Enterprises HIC High Income Countries TA Technical Assistance IADB Inter American Development Bank USD United States Dollar IDA International Development Association VC Venture Capital IFIs International Finance Institutions 4 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P Acknowledgement The International Finance Corporation (IFC) is the lead technical advisor to the G-20 Financial Inclusion Experts Group’s (FIEG) SME Finance Sub-Group. The report “Scaling-Up SME Access to Financial Services in the Developing World� was developed under the overall guidance of Peer Stein. The working group team for the report, led by Ghada Teima, comprised Alexander Berthaud, Miriam Bruhn, Olympia De Castro, Mukta Joshi, Melina Mirmulstein and Andrea Onate. Ary Naim and Roberto Rocha provided technical expert advice to the working group. This report has been a collaborative effort with the cross-functional/cross-regional contributions from Timothy Brennen, Katia D’hulster, Youssef Saadani Hassani, Ben Helps, Leora Klapper, Minerva Adei Kotei, Asli Demirgüç-Kunt, Tracy Lloyd, Tony Lythgoe, Maria Soledad Martinez Peria, Nataliya Mylenko, Douglas Pearce, Rita Ramalho, Bikki Randhawa, Heinz Rudolph, Peter Tropper, and Mahesh Uttamchandani. The team would like to thank the World Bank-IFC internal peer reviewers: Rolf Behrndt, Massimo Cirasino, Neil Gregory, William Haworth, Patrick Luternauer, Samuel Munzele Maimbo, Ann Christine Rennie, Ritva Reinikka, and Mariloy Uy and the external reviewers: Bernd Balkenhol, Thorsten Beck, Tony Goland, Randall Kempner, and Michael Klein. Last but not the least, this work was completed under the leadership of the co-chairs of the G-20 SME �nance sub-group: Susanne Dorasil (Germany) and Omega Shelembe (South Africa). The team would also like to thank Oliver Lenze, Shepherd Muzamba, and Kim Nguyen and the FIEG peer reviewers for their insightful comments. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 5 Introduction At their September 2009 meeting in Pittsburgh, the G-20 Leaders announced the creation of the Financial Inclusion Experts Group (FIEG), tasked with: (i) supporting innovative modes of �nancial service delivery capable of reaching the poor; and (ii) scaling up models of small and medium enterprise (SME) �nancing. Two sub-groups have been formed, the Access Through Innovation Sub-Group (supported by the Consultative Group to Assist the Poor (CGAP) and co-chaired by Brazil and Australia) and the SME Finance Sub-Group (supported by IFC and co-chaired by Germany and South Africa). In the constituent meeting of the SME Finance Sub-Group on December 3rd 2009, the G-20 FIEG mem- bers agreed that the Sub-Group will follow a development agenda on SME Finance, focusing on provid- ing SME Finance solutions for developing countries in particular. A work plan was established and articulated in two tracks: (i) A stocktaking and scaling-up of best practices in SME Finance; and (ii) the SME Finance Challenge, a call to the private sector to put forward its best proposals for how public �nance can maximize the deployment of private �nance on a sustainable and scalable basis. The SME Finance Challenge was launched by the G-20 Leaders in Toronto on June 26–27, 2010; winning proposals will be announced at the November 2010 G-20 Summit in Seoul, South Korea (Korea). The Stocktaking Report aims to provide the G-20 Leaders with a summarized but comprehensive frame- work by which to understand the SME �nance gap and its challenges. The �rst part of the report is con- ceptual and primarily consists of a review of the literature on SME Finance in the developing world; the second part of the report discusses the analysis of 164 cases of SME Finance interventions compiled through a collective effort involving G-20 member countries, non-member countries, development �nance institutions, and private sector players. Finally, the report highlights key recommendations that are proposed to the G-20 Leaders in order to achieve signi�cant and sustainable scale-up of SME access to �nancial services across the developing world. 6 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P Executive Summary Small and Medium Enterprises (SMEs) play a major enterprises and non-employer �rms. According to the role in economic development, particularly in same study, close to 45 to 55 percent of the formal emerging countries. Studies indicate that formal SMEs (11-17 million) in the emerging markets do SMEs contribute up to 45 percent of employment and not have access to formal institutional loans or up to 33 percent of GDP in developing economies; overdrafts despite a need for one. The �nance gap is these numbers are signi�cantly higher when taking far bigger when considering the micro and informal into account the estimated contributions of SMEs enterprises – 65-72 percent of all MSMEs (240-315 operating in the informal sector. The informal sector million) in emerging markets lack access to credit. The presents one of the greatest challenges in the SME proportional size of the �nance gap varies widely space, with issues that go well beyond �nance. In the across regions and is particularly daunting in Asia and context of the international development agenda, and Africa. given the critical importance of job creation in the recovery cycle following the recent �nancial crisis, Closing the credit gap for formal SMEs will be less promoting SME development appears to be an impor- daunting than for informal SMEs. Close to 70–76 tant priority. percent of the formal SMEs (18-22 million) in emerg- ing markets already have a banking relationship via Access to finance remains a key constraint to SME deposit/checking accounts, while only about 30–35 development in emerging economies. Comprehensive percent of SMEs (8-10 million) have access to credit. data on the SME �nance gap is still to be more consis- Hence the key challenge is to support banks in extend- tently collected and monitored over time; however ing credit facilities to SMEs who have a deposit/check- various data sources and studies indicate that small ing account, but do not yet have access to credit. �rms rely on internal �nancing much more than Risk-sharing facilities, coupled with the introduction large �rms do, and that the likelihood of a small � rm of best practice SME lending approaches, are key inter- having access to a bank loan in low-income countries ventions that can help banks provide credit to those is about a third of what it is for a medium-sized � rm, SMEs. These interventions need to be accompanied by and less than half of what it is for a larger �rm. Other enhancements to the enabling environment for SME sources of SME �nance, such as leasing and factoring, lending, such as improved credit bureaus, and collat- are also less developed in emerging countries. eral and insolvency regimes. A recent study by the IFC and McKinsey and It will be a greater challenge to reach informal Company (McKinsey) suggests that there are close to SMEs. Informal SMEs are far less likely than formal 365-445 million micro, small, and medium enter- businesses to have existing deposit relationships with prises in emerging markets of which 25-30 million are �nancial institutions, and are also far more dif�cult formal SMEs and 55-70 million are formal micro enter- to serve, especially for commercial banks. Short of prises, while the rest (285-345 million) are informal comprehensive approaches to move informal S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 7 businesses into the formal sector, reaching informal infrastructure; (iii) public support schemes; and (iv) businesses will have to build on micro�nance private sector initiatives. approaches, including up-scaling existing micro�- nance institutions to serve small businesses. As in the The stocktaking exercise confirms the rise in various case for expanding credit to formal SMEs, this will parts of the world of specific business models aimed need to be combined with enhancements to the at providing financial services to SMEs in a cost-effec- enabling environment for SME lending, including tive manner. From micro�nance up-scaling to bank improvements to the �nancial infrastructure of credit down-scaling, including community banks, these reporting and collateral registries. models share common characteristics: they reduce cost to serve through intensive use of technology and/or the The SME finance gap is the result of a mismatch adoption of cost-effective client-relationship models; between the needs of the small firms and the supply they combine offering of savings, transactional, and of financial services, which typically are easier for credit products, with a view to increase generated larger firms to access. The SME bankable universe, income; they use advanced risk management technol- in which providers are able to meet their expected ogy to maximize the risk/reward balance; and, they return on capital while serving client needs, can be achieve strong focus on the small and/or medium enter- severely limited. This is due to SME intrinsic weak- prise segment, to help implement excellent execution nesses, flaws in provider delivery models and, most capabilities in the above areas. importantly, lingering de�ciencies in the enabling environment for �nancial services: �nancial infra- Effective SME financing models can be implemented structure (accounting and auditing standards, credit in different country and market environments, but reporting systems, and collateral and insolvency greater outreach is achieved in the most developed regimes), and the legal and regulatory framework for environments for the financial sector. In particular, �nancial institutions and instruments. �nancial information and the ability to enforce collat- eral are seen as critical by major SME banks operating Deficiencies in the enabling environment and resid- in developed markets. Weaknesses in these areas appear ual market failures have motivated government to impede more aggressive �nancial services growth in interventions to foster SME access to financing. developing markets. Government interventions can be justi�ed in many cases, but research shows that some of these interven- Although SME banking and microfinance models are tions can have mixed results. In addition, although a successfully being rolled out in an increasing number large spectrum of interventions have been imple- of countries and regions, equity financing remains a mented in various countries to support SME access to challenge in developing economies. Given that bank- �nance, little is known with respect to the actual eval- ing and lending services represent the bulk of SME uation of these interventions in terms of additionality, �nancing in the developing world, especially for small outreach, and sustainability. �rms, equity �nancing presents an opportunity for the development of a complementary �nancial product. In order to scale up the best practices in SME Finance, Interesting models that provide a select number of mid- the G-20 FIEG SME Finance Sub-Group executed a sized �rms with equity capital for growth are starting to global SME Finance stocktaking exercise with vari- be developed, with signi�cant support from govern- ous SME finance models. This exercise entailed the ments and development agencies. collection of 164 SME �nance models spanning across a broad spectrum of interventions, including: (i) legal SME finance in the developing world has typically and regulatory framework; (ii) �nancial information been an area of experiment for multiple government 8 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P support mechanisms. Although these mechanisms are a. Developing country specific diagnostics and dif�cult to assess in terms of effectiveness, leverage, and strategies; additionality, and their performance is observed to be b. Developing a supportive legal and regulatory mixed, some of these initiatives have played a catalytic framework; role by providing an incentive to innovate in the SME c. Strengthening the financial information infra- �nance space. Public support schemes (funded facilities, structure; guarantee schemes, and state banks) represent the large d. Designing effective government support majority of the collected models, a con�rmation that mechanisms; support to SME �nance is seen as necessary to address e. Building consistent and reliable data sources on weaknesses and possible market failures in this space. SME finance; and, f. Building capacity of the financial institutions. The role of International Finance Institutions (IFIs) and Development Finance Institutions (DFIs) to foster SME 2 Establish a Global SME Finance Forum as a knowledge sharing financing in the developing world has been significant and monitoring platform to further identify and promote best so far. IFIs and DFIs have supported both public and private practices across countries and institutions, establish baselines, sector initiatives in the SME �nance space, with a mix of and monitor progress. technical assistance, capacity-building, �nancing and risk mitigation instruments. The G-20 has a unique opportu- 3. Scale up previous G-20 successful development interventions in nity to leverage this experience and accumulated knowl- the SME Finance space by setting up a global funding platform edge by scaling up this effort on a more comprehensive to build capacity, provide technical assistance, mitigate risks, and strategic basis. and create incentives for the delivery of sustainable and scalable financial services to SMEs, by means of a collaborative effort Increasing access to finance can only be successful if implemented by its bilateral and multilateral development qualitative aspects are taken into account. Adhering finance institutions. to principles of responsible �nance and the G-20 prin- ciples on innovative �nancial inclusion can serve as 4. Lead the efforts to gather better SME finance data in a coordinated qualitative orientation in this regard. It should also be fashion by establishing a platform to consistently collect the cross- noted that although �nancial access is critical for SME country data. growth, expansion of �nancial access should not be achieved at the cost of �nancial stability. Appropriate prudential measures need to be exercised while offer- ing �nance to SMEs, in order to avoid the potential pitfalls stemming from excessive credit. In the light of the new understanding of the SME finance challenge that this report synthesizes, the FIEG makes four key recommendations for the G-20 leaders to implement, in order to achieve a signifi- cant and global scale-up of SME access to financial services in the developing world: 1. Endorse a set of recommendations for policymakers in the develop- ing world to establish a supportive enabling environment for SME access to financial services in their respective countries by: S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 9 CHAPTER 1 Role of SMEs in Economic Development The term “SME� typically encompasses a broad typically 95 to 99 percent.2 The de�nitional issue is fur- spectrum of definitions across countries and regions. ther complicated by the fact that individual banks in the Many countries and international organizations set same country use different de�nitions of SME for their their own guidelines for de�ning an SME, often based own strategic and risk management purposes.3 For on the number of employees, sales, or assets. For instance, among banks in the Middle East and North example, the European Union (EU) de�nes SMEs as Africa (MENA), the cut-off between small and medium �rms with 10 to 250 employees, with less than Euro �rms ranges from 5 to 50 employees, and the cut-off 50 million in turnover or less than Euro 43 million in between medium and large �rms ranges from 15 to 100 balance sheet total (Table 1.1). This de�nition explic- employees.4 Since this report relies on a broad number itly distinguishes between micro-�rms and SMEs. of data sources, it considers different de�nitions of Although the EU thresholds are very high for most SMEs, following the de�nition used in each source and developing countries, this de�nition is presented as an stating these de�nitions in the accompanying notes, example because the EU has made the greatest effort to whenever available. Box 1.1 presents the preliminary standardize the SME de�nition. Currently, at least 27 estimates from the recent IFC-McKinsey database on countries follow the EU de�nition.1 micro, small, and medium enterprises (MSMEs).5 Many countries adopt a definition of SME that SMEs account for a significant share of employment covers all firms with fewer than 250 employees, and GDP around the world, especially when taking therefore including micro-firms. Under this de�ni- into account the informal sector. In developed coun- tion, the vast majority of all businesses are SMEs, tries, SMEs employ an average of 67 percent of the TABLE 1.1 EUROPEAN UNION SME DEFINITION Firm Size Headcount Turnover or Balance Sheet Total Medium-sized < 250 ≤ € 50 million ≤ € 43 million Small < 50 ≤ € 10 million ≤ € 10 million Micro < 10 ≤ € 2 million ≤ € 2 million Source: European Commission Recommendation 96/280/EC 1 See Annex A (attached separately) for a list of different SME definitions. 2 OECD (2006) 3 Beck, Demirgüç-Kunt, and Martinez Peria (2008) 4 Rocha, Farazi, Khouri, and Pearce (2010) 5 MSMEs included in the IFC-McKinsey database do not include farmers or sole proprietorships. 10 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 1.1 ESTIMATED NUMBER OF MSMES IN THE WORLD BY REGION BOX 1.1 | FIGURE 1 ESTIMATED NUMBER OF MSMES Formal SMEs, micro and Informal MSMEs by region Percent of Total Percent of all MSMEs 100%= MSMEs East Asia 81 12 7 170–205 44–46 Latin America 71 23 6 47–57 10–12 Sub-Saharan Africa 69 21 10 36–44 8–10 Central Asia & 45 40 15 18–22 3–5 Eastern Europe South Asia 89 8 3 75–90 16–20 68 22 19–23 4–6 MENA 10 High-Income OECD 52 28 21 56–67 12–14 Total 74 17 9 420–510 100 Total (excluding high-income OECD) 78 16 7 365–445 80–95 Informal & Nonemployer �rms Micro enterprises Formal SMEs Breakdown of formal MSMEs by Segment Percent of formal MSMEs in region 100%= East Asia 72–88% 17–21% 0–1% 11–14 Mn Latin America 54–68 29–35 5–7 3–4 Sub-Saharan Africa 22–28 54–65 14–18 3–5 Central Asia & 58–72 27–33 4–6 2–4 Eastern Europe 82–99 7–9 2–3 South Asia 0 MENA 35–43 36–44 19–23 1–3 High-Income OECD 51–63 32–40 6–8 11–14 Total 54–68 28–34 5–7 36–44 Total (excluding high-income OECD) 59–73 25–31 4–5 25–30 ~65–70% of formal SMEs in the World Very Small Small Medium IFC and McKinsey recently built a detailed database on MSMEs, drawing on readily available global datasets that provide coverage to a large number of countries in terms of number of micro (1-4 employees), very small (5-9 employees), small (10-49 employees), and medium enterprises (50-250 employees). The MSMEs can be further clas- si�ed into formal and informal based on their registration status.* As seen in Box 1.1: Figure 1, there are an estimated 420 to 510 million MSMEs worldwide , of which 9 percent are formal SMEs (typically registered businesses with 5-250 employees ) and 80-95 percent are in emerging markets. The �gure also emphasizes the importance of informal sector �rms, particularly in the emerging markets. As discussed later in this chapter, the informal sector presents one of the greatest challenges in the SME space, with issues that go well beyond �nancing. *MSMEs include micro, very small, small, and medium enterprises, while SMEs include very small, small, and medium enterprises. Non- registered or informal enterprises and nonemployer firms are grouped together due to the lack of data to consistently differentiate between formal and informal nonemployer firms. Note: Please see Annex B for the methodology used to derive the estimates. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 11 formal employment in the manufacturing sector. In countries seems comparatively modest, but estimates developing countries, this number is around 45 per- suggest that the informal sector (which consists essen- cent. Similarly, SMEs contribute a sizable share to tially of SMEs) accounts for up to 48 percent of the formal GDP — 49 percent on average in high-income total labor force and 37 percent of GDP in developing countries and 29 percent on average in low-income countries. The corresponding percentages for devel- countries, respectively (Figure 1.1).6 The contribution oped countries are much lower, at 25 of the total labor of SMEs to employment and GDP in developing force and 16 percent of the GDP7 (Figure 1.2). FIGURE 1.1 SHARE OF FORMAL SMES IN FORMAL FIGURE 1.2 SHARE OF INFORMAL SMES IN MANUFACTURING EMPLOYMENT AND GDP LABOR FORCE AND GDP 80 60 70 50 60 67 40 48 50 40 49 30 37 45 30 20 25 20 29 10 16 10 0 0 Share of formal SMEs in Share of formal SMEs in GDP Share of informal sector Share of informal sector in GDP formal manufacturing employment in labor force Developing Developed Developing Developed Source: Based on Ayyagari, Beck, and Demirgüç-Kunt (2007) Source: Based on Ayyagari, Beck, and Demirgüç-Kunt (2007) Note: The share of formal SMEs in employment corresponds to Note: The informal sector includes all informal sector firms their share in formal employment in the manufacturing sector irrespective of the size and sector of operation. when 250 employees are taken as the cut-off for the definition of an SME. FIGURE 1.3 SIZE OF INFORMAL ECONOMY VS. FIGURE 1.4 SOCIAL SECURITY COVERAGE VS. GNI PER CAPITA GNI PER CAPITA 70 120 60 100 Size of shadow economy Pension Contributors 50 (% of Laborforce) 80 (% of GDP) 40 45 60 45 30 40 20 10 20 0 0 2.0 2.5 3.0 3.5 4.0 4.5 5.0 2.0 2.5 3.0 3.5 4.0 4.5 5.0 Log GNI, PCI Atlas Method Log GNI Per Capita (Atlas Methods, Current USD) Source: Size of shadow economy from Schneider and Buehn Source: WDI based on national sources, either household (2009), GNI per capita from World Development Indicators surveys or national social security administrations (WDI) 6 Numbers by income group are simple averages of all countries that fall in the income group. The data on employment and GDP comes from a large number of country specific sources and some general databases, such as OECD, Eurostat, and UNEC, implying that the definition of formal firms may vary within the data. Table II in the appendix to Ayyagari, Beck, and Demirgüç-Kunt (2007) provides the list of data sources. 7 Ayyagari, Beck, and Demirgüç-Kunt (2007). Data on SME (formal or informal) contribution to GDP and employment are scarce. Figures 1.1 and 1.2, although preliminary and illustrative, are presented to depict the importance of the informal sector (which typically comprises SMEs) in the context of developing countries. 12 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P Figures 1.3 and 1.4 illustrate further the importance to the level of economic and social development. of the informal economy for developing countries. Addressing the problem of informality requires the At low levels of per capita income, informal GDP implementation of a variety of policies, including edu- reaches as much as half of recorded GDP, implying an cation, regulation (e.g., taxation and registration), and important contribution of informal SMEs to economic regional development policies. In principle, the regu- activity. Similarly, Figure 1.4 shows that the coverage latory issues discussed in this report are relevant to of the social security system (a measure of job policy discussions about the informal sector, to the formality) is very small at low levels of per capita extent that they affect the incentives for formalization, income, implying that informal SMEs may absorb a but they are only a subset of the policies required to signi�cant share of the labor force that is not employed address the issue of informality. by the formal sector. SMEs typically create more jobs than do large firms, This report addresses primarily the financial con- which is especially the case for recently created straints of formal SMEs, as well as small firms oper- companies. Several studies have found that SMEs ating in the vicinity of formality, but does not create more jobs than large �rms do, both in devel- provide a comprehensive treatment of informality.8 oped and developing countries. SMEs also shed more Informality is a complex phenomenon, strongly related jobs than do large �rms, but job creation tends to FIGURE 1.5 FINANCIAL AND NON-FINANCIAL FIGURE 1.6 FINANCIAL AND NON-FINANCIAL BARRIERS TO SME GROWTH BY COUNTRY BARRIERS TO LARGE FIRM GROWTH BY INCOME GROUP COUNTRY INCOME GROUP Tax Rates Tax Rates Corruption Corruption Informal Informal Finance Finance Electricity Electricity Transportation Transportation Regulation Regulation 0 10 20 30 40 50 60 0 10 20 30 40 50 60 70 PERCENT (%) PERCENT (%) Low Income Middle Income High Income Low Income Middle Income High Income Source: World Bank Enterprise Surveys (2006–09) Source: World Bank Enterprise Surveys (2006–09) Note: 1. Regulation refers to licenses and permits, tax adminis- Note: 1. Regulation refers to licenses and permits, tax adminis- tration, labor regulation, and functioning of courts. tration, labor regulation, and functioning of courts. 2. Competition in the informal sector as a constraint was not 2. Competition in the informal sector as a constraint was not asked for high income countries. asked for high income countries. 8 For more information on informality, please see the materials from the Donor Committee for Enterprise Development’s conference on informality organized in South Africa in April 2010. http://www.enterprise-development.org/page/ informal-economy-conference-2010 S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 13 outweigh job destruction, so that net job creation is obstacles to business growth also shows that the small- higher in SMEs than in large � rms.9 This creative job est �rms are most adversely affected by �nancial and destruction and net job creation characterize the non-�nancial constraints, and that these constraints are innovative, competitive, and dynamic nature of SMEs. particularly severe in developing countries.12 Research has shown that business start-ups contribute greatly to overall job creation. In addition to job cre- This stocktaking report is structured as follows: ation, a vibrant SME segment can help economic Chapter Two briefly reviews non-�nancial barriers to development through other channels such as innova- SME development in emerging countries. Chapter tion and competition. In fact, when leaving out jobs Three discusses in greater detail the issues that may created by start-ups, the U.S. net employment growth affect SME access to �nancing. These issues include rate is negative on average.10 identifying the range of products that SMEs should be able to access in order to sustain growth, assessing the There is evidence that, in developing economies, magnitude of the SME �nance gap on the basis of avail- SMEs could contribute more to economic develop- able indicators, examining the possible reasons why ment than they currently do. SMEs tend to be small SME �nance remains a challenge for most countries, in developing countries, and the percentage of and providing a brief review of the main government medium-sized �rms is often low. A number of studies interventions in this area. An overview of the stocktak- show that both small and large �rms account for most ing exercise conducted January through March 2010 is of the employment in developing countries, with provided in Chapter Four. Finally, Chapter Five pres- medium-sized �rms accounting for a relatively low ents a set of policy recommendations and discusses the fraction of overall employment.11 Helping SMEs in role of the development community in scaling up their developing countries to grow would lead to income support to the SME �nance cause. growth and poverty reduction. The fact that SMEs tend to be smaller in developing countries suggests that they face greater constraints to growth, including �nancial constraints. An environment that fosters dynamism by allowing easy entry and exit of new enterprises and helps in their growth is critical. Enterprise surveys conducted by the World Bank show that SMEs face more severe financing con- straints than do large firms. SMEs face a host of non- �nancial and �nancial constraints, as shown in Figure 1.5, especially in low-income countries. Although large �rms generally face the same constraints, they seem to be much less constrained by the lack of access to �nanc- ing, at all income levels (Figure 1.6). Other research on 9 See Globalization and Economic Policy Centre (2010), Aterido, Hallward-Driemeier and Pagés (2009), Klapper and Richmond (2009), OECD (1997) and (2003a), Neumark et al. (2008) 10 Haltiwanger, Jarmin, and Miranda (2009) 11 Tybout (2000), Sleuwaegen and Goedhuys (2002), Snodgrass and Biggs (1996) 12 See Beck, Demirgüç-Kunt, and Maksimovic (2005) 14 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P CHAPTER 2 Non-Financial Barriers to SME Development Prior to exploring financial constraints to SME devel- establishing, running, and closing an enterprise. Figures opment, it is important to acknowledge the wide 2.1 and 2.2 demonstrate the differences among coun- range of non-financial barriers that disproportion- tries in terms of the time taken and costs incurred in ally affect SMEs. Often, the non-�nancial and �nancial registering property and enforcing contracts, two indi- barriers can be correlated, and this relationship may be cators that are particularly relevant for �nancial access. strong in some cases. For example, improvement in Not surprisingly, such costs are lower in high-income physical infrastructure can generate important produc- countries than in lower-income ones. These results are tivity gains and enhance the prospects of higher rates of also con�rmed by �rm-level studies, as shown below. returns, facilitating access to a wider range of �nancial services. Furthermore, some of the non-�nancial con- Specific constraints have a disproportionate effect straints are also binding on �nancial institutions and on smaller firms in developing countries compared might undermine outreach and, ultimately, access to to their counterparts in the developed markets. As �nance. For example, electricity shortages and the con- shown in Chapter 1, the �ve non-�nancial components sequent need for generators may increase the costs of of the business environment that SMEs most frequently physical outreach for banks. rate to be major obstacles are lack of electricity, heavy regulation, high tax rates, practices of competitors in There are significant differences across countries in the informal sector, and corruption. Although they terms of the quality of their business environments. complain about high tax rates and heavy regulation as This is evident from the World Bank Doing Business well, SMEs in high-income countries are less likely to indices (made up of a variety of business relevant indi- report major non-�nancial obstacles than are SMEs in cators), which rank countries based on their ease of low and middle-income countries. FIGURE 2.1 REGISTERING PROPERTY FIGURE 2.2 ENFORCING CONTRACTS 150 10 800 60 8.4 8 53.6 600 100 5.6 40 6 33.3 4.5 400 4 20.5 50 20 200 2 100 61 43 605 649 526 0 0 0 0 Low income Middle income High income Low income Middle income High income Time taken to register property (days) Time taken to enforce contract (days) Cost of registering property (% of income per capita) Cost of enforcing contract (% of income per capita) Source: World Bank, Doing Business Indicators 2010 Source: World Bank, Doing Business Indicators 2010 S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 15 In low-income countries, the factor that SMEs most promote SME growth through other policies to suc- frequently perceive to be a major obstacle is electric- ceed, especially in the long run, regulatory short- ity, with 52 percent of SMEs viewing it as a significant comings must be addressed. issue. Although this information is self-reported, addi- tional data from the Enterprise Surveys suggest that lack More than 33 percent of SMEs in low and middle-in- of electrical infrastructure could hinder SMEs’ opera- come countries report tax rates and practices of com- tions, since SMEs seldom have alternative sources of petitors in the informal sector15 as major obstacles to electricity. On average, only 22 percent of small �rms growth. These two obstacles are closely linked, since own a generator, compared to 35 percent of medium- governments in developing countries often impose sized �rms, and 51 percent of large �rms, probably due heavy taxes on the formal sector where the informal to the substantial �xed costs of owning and operating a sector is large, in order to compensate for forgone tax generator. The importance of electricity as an obstacle to revenue from informal businesses. However, the higher SMEs’ operations declines as country income increases taxes in the formal sector may result in an even larger and electricity infrastructure becomes more developed. informal sector in these countries. Typically, the prac- In high-income countries, only 6 percent of SMEs report tices of competitors in the informal sector become an electricity to be a major obstacle. obstacle for formal �rms due to the fact that informal companies do not pay taxes, allowing them to offer The second component of the business environment lower prices and thereby draw customers away from that is most frequently perceived to be a major their formal sector competitors. obstacle for SMEs is regulation, as designated by over 36 percent of SMEs. SMEs often lack the capacity of SMEs in countries with different per capita incomes larger �rms to navigate through the complexities of complain about taxes, even SMEs in developed coun- regulatory and bureaucratic procedures. Research tries. This reflects in good part the high taxes on payroll shows that countries with lower entry costs and lower in all countries. According to the World Bank’s Doing costs of registering property have a larger SME sector Business report, the median pro�t tax rates are higher in in manufacturing.13 Moreover, regulatory reform can low and middle-income countries (20 percent) relative to foster the creation of formal SMEs. For example, the median in high-income countries (14 percent). reforms in Mexico and Colombia that simpli�ed busi- Although the imposition of taxes from the �scal stand- ness registration procedures led to increases in the point is justi�ed, SMEs face a disproportionately high tax number of registered businesses.14 compliance cost burden compared to larger enterprises. Moreover, SME taxation does not contribute signi�cantly Removing regulatory obstacles could also signifi- to increased �scal revenue. Adjustments to administrative cantly increase SMEs’ access to finance. A lower cost approaches and/or policy to reduce the tax compliance of registering property may lead to an increase in col- costs for SMEs are thus called for.16 lateralizable assets. In addition, more ef�cient courts and legal procedures have the potential to reduce SMEs in low and middle-income countries fre- enforcement costs for lenders. In fact, property regis- quently cite corruption as a major obstacle. About 42 tration and legal procedures are considered to be an percent of �rms in middle-income countries perceive important part of �nancial infrastructure, as dis- corruption to be a major obstacle, a number that is cussed in Chapter Three. In order for efforts to slightly lower in low-income countries (34 percent), 13 Ayyagari, Beck, and Demirgüç-Kunt (2007) 14 Bruhn (2011) and Cardenas and Rozo (2007) 15 The Enterprise Surveys questionnaire does not define “practices of competitors in the informal sector� further. Firms are open to interpret this obstacle in their own way. 16 OECD (2009) 16 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P and much lower in high-income counties (18 percent). related to accounting, business planning, and market SMEs are somewhat more likely to pay a bribe to get research to the same extent that large �rms can. This things done than are large �rms, since SMEs have fewer may lead SMEs to under-invest in activities and services resources and less bargaining power to avoid paying that could potentially enhance their transparency and bribes. However, this could also reflect the fact that productivity. For example, data from the Enterprise SMEs may not comply with all regulations, making Surveys indicates that only 37 percent of small �rms them a more likely target for corrupt of�cials.17 have their annual �nancial statement reviewed by an external auditor, compared to 58 percent of medium- In addition, a broader set of policy environment sized �rms and 79 percent of large �rms. issues could act as non-financial barriers to SME development. An example would be the prudent �scal In several developed countries, SME management policies that avoid the crowding-out of the private training appears to have been successful in reducing sector by government borrowing. With a decline of the failure rates of small firms.19 Preliminary �nd- demand from the government and large enterprises, ings from recent research in Mexico indicate that man- this can act as a relevant driver for banks to increase agement consulting for SMEs can increase productivity, SME lending. Furthermore, policy uncertainty caused sales, and pro�ts.20 A related constraint is lack of �nan- by frequent changes in the “rules of the game� such as cial education. Recent evidence suggests that levels of through price controls, changing tax rates or export �nancial literacy are often low among small business bans may constitute barriers for investment and long- owners, which can potentially pose dif�culties for term �nancing. Weak investor protection, on the other managing a �rm’s �nances effectively.21 hand, has a negative impact on both the demand and supply of long-term �nancing for SMEs. Lack of business and management skills can magnify financial barriers for SMEs. Low levels of �nancial Specific characteristics of SMEs put them at disad- literacy can prevent SMEs from adequately assessing vantage in comparison with large firms. On top of and understanding different �nancing options, and obstacles arising from the investment climate, SMEs from navigating complex loan application procedures. face several non-�nancial barriers related to the capaci- Similarly, the fact that SMEs’ accounting and �nancial ties of SMEs themselves. The small size of these �rms statements are often not transparent makes them risky implies that managers (or owners) of SMEs often need borrowers and thus less attractive to lenders. Capacity to perform a wider range of tasks than do those in building of SMEs in terms of preparing �nancial state- larger �rms, since there is less room for specialization. ments and business plans, as well as improving their This requires diverse skills that SME managers may not �nancial literacy and management training, is shown have, particularly in developing countries where the to have positive impact on SME development.22 quality of management education tends to be lower Furthermore, strengthening the horizontal linkages than that found in developed countries.18 Moreover, with other SMEs and vertical linkages with larger �rms SMEs cannot take advantage of economies of scale would improve SMEs’ market access.23 17 Aterido, Hallward-Driemeier and Pagés (2009) suggest that in countries with low corruption and a strong rule of law, access to finance promotes employment growth among SMEs. 18 Chaudhry (2003) 19 OECD (2003b) 20 Bruhn, Karlan, and Schoar (2010) 21 Studies on the link between financial literacy and business outcomes are ongoing. For example, Bruhn and Zia conducted a survey among youth entrepreneurs in Bosnia who are microfinance clients to assess their financial knowledge through a series of questions. This survey shows low levels of financial literacy. The same project provided financial literacy training to a randomly selected group of youth entrepreneurs. A follow-up survey, to be conducted in mid-2010, will provide information on whether the training improved levels of financial literacy, as well as business outcomes. 22 European Commission (2006) 23 Hussain (2000) S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 17 CHAPTER 3 Access to Finance as a Key Constraint to SME Development This chapter describes the SME life cycle and �nancing needs, and reviews information about the SME �nanc- FIGURE 3.1 EXTERNAL FINANCING SOURCES ing gap based on the available data from the enterprise FOR WORKING CAPITAL NEEDS and �nancial institution sides. The chapter also discusses 20 the reasons why SME �nance remains a challenge, stress- ing the lingering de�ciencies in the legal/regulatory 15 frameworks and in �nancial infrastructures of many PERCENT (%) emerging countries. Finally, the chapter examines policy 10 interventions that have been introduced to alleviate the access constraint, while also identifying possible short- 5 comings of these interventions. 0 Bank Financing (%) Supplier Credit Other Financing (%) 3.1 SME Life Cycle and Financial Needs Financing (%) Small(<20) Medium(20–99) Large(100 and over) Financial access can help firms start up and expand Source: World Bank Enterprise Survey Data (2006–09) their businesses through inter alia development of new products and production processes, and invest- ment in human capital. A variety of �nancial services (credit, savings, insurance, and payment facilities) are FIGURE 3.2 EXTERNAL FINANCING SOURCES crucial for growth in the SME life cycle; however, the FOR FIXED INVESTMENT NEEDS focus of this report is on expanding access to �nance. 30 Firms often depend on informal sources of funding in 25 the very early stages of their development. External sources, however, become more important as �rms 20 PERCENT (%) start expanding, and their availability can determine 15 decisively the growth trajectory of SMEs.24 Internal 10 �nancing sources typically include an entrepreneur’s 5 own savings, retained earnings, or funding through the sale of assets. The external sources of �nance can 0 Bank Supplier Credit Equity, Sale of Other be informal (family and friends or supplier �nance) Financing (%) Financing (%) Stock (%) Financing (%) and formal (debt or equity). Figures 3.1 and 3.2 pres- Small(<20) Medium(20–99) Large(100 and over) ent the proportion of �rms’ working capital and invest- Source: World Bank Enterprise Survey Data (2006–09) ment needs funded by various external �nancing sources, for �rms of different sizes. 24 Entry and growth of small firms is facilitated in countries that provide a supporting enabling environment, including easier access to finance (Klapper, Laeven, and Rajan, 2006). 18 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P Bank financing remains by and large the most impor- high-credit quality buyers, resulting in the provision tant source of external finance to SMEs. As shown in of low-risk loans to high-risk suppliers such as SMEs. Figures 3.1 and 3.2, banks �nance a signi�cant propor- Reverse factoring is particularly useful for SMEs in tion of companies’ investment �nance needs and are countries with underdeveloped contract enforcement also the major provider of �nancing for working capital. regimes and weak credit information systems.27 SMEs typically need a variety of additional �nancial ser- vices that only commercial banks are well-positioned to Likewise, leasing appears as an important comple- provide. These include cash management, insurance, mentary source of investment finance, especially in transfers, and other transactional products. In the past countries where the collateral regime and the infor- few years, some banks have mainstreamed gender and mation infrastructure are weak. This is particularly sustainable �nance (energy �nance) under SME bank- the case for smaller �rms, as suggested in Figure 3.2 ing. For example, banks are designing special �nancing (“Other Financing�). The advantage of leasing lies in programs to increase access to business �nancing by the fact that it focuses on the �rm’s ability to generate women-owned SMEs. In some cases, such programs are cash flows from business operations to service the leas- accompanied by support such as training in business ing payment, rather than on its credit history or ability development skills. Under sustainable �nance, banks to pledge collateral. A second way-out for the leasing assist their SME clients along the road to environmen- providers in case of payment default is the repossession tally sustainable business practices by offering them and sale of the leased asset, which provide additional speci�c �nancing instruments.25 risk mitigation. Leasing is also an appropriate �nanc- ing instrument for demand-side reasons, as small Supplier credit is a common source of finance for entrepreneurs, especially those who are not incorpo- many SMEs and corporations all around the world. rated might be very reluctant to yield their personal Such transactions typically occur between two busi- property as collateral for a loan. nesses. Trade credit allows businesses to delay payment for goods and services purchased, and thus helps with Equity financing is often necessary to enable firms effective cash flow management. It may also substitute to grow, invest in fixed assets, and support increased for �nancing, such as short-term bank credit or other needs for debt. Typically, private equity investors more formal arrangements. Trade credit is usually used receive a return on their investment through an initial to meet short-term working capital needs.26 public offering (IPO), a management buy-back, or the sale of the controlled company to a larger one. Private Factoring clearly appears as an important comple- equity investment in start-ups and very young �rms is mentary source of working capital finance for SMEs, also known as venture capital �nance. Venture capital- especially in jurisdictions where the financial infra- ists inject cash into such companies and are likely to structure presents gaps (see Figure 3.1, Other provide management expertise. In some countries, Financing). Factoring entails the purchase by the business angel investors (“informal venture capital- lender of a �rm’s accounts receivables and the collec- ists�) contribute their own capital and business experi- tion of invoices from the parties that owe money. ence in order to assist fast-growing companies with Factoring addresses the problem of SME opacity by high potential.28 A few specialized private equity com- focusing on the quality of the obligor. In recent years, panies have started investing in SMEs in developing the concept of reverse factoring as a �nancial instru- markets with positive development outcomes and ment has become popular. With reverse factoring, the �nancial returns. �nancial institution purchases receivables only from 25 Jeucken (2005) 26 OECD (2006) 27 Klapper (2005) 28 OECD (2006) S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 19 BOX 3.1 SME EQUITY FUNDS central team and local management teams in each country. This structure allows the local teams to focus on invest- Private equity funds are pooled investment vehicles that ments while spreading overhead costs over as broad a base invest in unlisted equity, quasi-equity and, occasionally, as possible. The central “platform� shortens the learning debt securities. Equity funds are often structured as part- curve for the local teams and provides necessary services nerships, comprising two kinds of partners: and support in an efficient and cost effective way. 1. Limited partners are the fund’s investors. Their partnerships have �xed investment terms (e.g., 10 years). Limited Over the last decade, DFIs have expanded their participa- partners are passive investors who do not get involved tion in SME equity funds. While they are considered among in the day-to-day management and investment decision- the riskier SME �nance models and require highly skilled making of the fund, but have a role overseeing the fund’s human resources, equity funds are being recognized as a governance. pro�table asset class with signi�cant development impact, 2. General partners are the fund managers. They are allowing DFIs to connect with SMEs that they otherwise responsible for all investment decisions following a would be unable to reach directly. Moreover, SME equity pre-determined investment strategy. Fund managers funds provide an opportunity to strengthen investees’ generate growth and development in emerging markets environmental, social, and governance policies, while also by unlocking value in their investee companies. providing co-investment opportunities for DFIs’ direct investment in such companies. Market practice for successful equity funds is based on a set of parameters: Recent analysis conducted by the Dahlberg Global Funds have a �xed life of typically 10 years, often with Development Advisors suggests that there are close to annual extensions, including a �xed investment period 192 investment funds supporting small and growing busi- (4–5 years). The main challenge is that funds must exit nesses (SGB) in emerging markets, with the majority of their investments by a �xed date. funds concentrated in Asia, Africa, and Latin America. Funds usually have a 2 percent fee and 20 percent share of These funds are typically willing to make investments pro�ts in invested companies. Except for venture capital, smaller than USD 2 million. The cumulative target size of equity funds need consistent performance across their these investment funds is estimated at USD 7 billion. 29 portfolio companies and cannot afford many failures. Such funds have seen rapid growth since 2006. Performance is measured by the funds’ internal rate of return (IRR), achieved through any of four basic strategies: BOX 3.1 | FIGURE 1 PERCENTAGE OF leverage, multiple expansion, growth, and efficiency. Most IDENTIFIED SGB FUNDS INVESTING IN KEY funds use a blend of the four, although IRR in emerging REGIONS markets is primarily driven by growth and efficiency. For the majority of SMEs in emerging markets, equity investments are not available. SME equity funds in emerg- 13% ing markets face unique challenges, including: (i) Shortage of experienced fund managers with the right 8% 20% skill set and market knowledge; (ii) Volatile exit windows as IPO markets appear and disappear quickly; (iii) High 18% 58% 6% cost of technical assistance during due diligence and post-investment phase, in response to risk mitigation; (iv) Extensive fundraising efforts; (v) Low capital needs of small businesses, making the deal sizes unattractive to most private equity �rms; and (vi) Capturing and quanti- Americas Middle East Asia fying non-�nancial bene�ts generated by investees. India Africa Central & Eastern Europe In general, deal flow and exit opportunities in most of the Note: N=186, does not include 6 funds with unknown investment smaller emerging countries are too limited to support dedi- regions. Funds investing in multiple regions are counted once for cated single-country funds. Thus, successful SME fund each region. models usually cover more than one country, with a small Source: Dalberg analysis 29 Aspen Network of Development Entrepreneurs, 2009 20 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P Equity finance can be a potentially beneficial financ- Striking the right balance between debt and equity ing source for SMEs — including high-risk SMEs — financing is the key. Debt and equity � nancing play in their early lifecycle stages, when cash flow is not a complementary role in a � rm’s growth. Just piling yet regular. For these �rms, bank debt often is not more debt onto SMEs without a balanced capital available in suf�cient amounts for a variety of regula- structure may prevent them from securing or repay- tory reasons, making equity their primary source of ing the debt, and make them vulnerable to business �nance. However, even well-established and success- downturns and changes in interest rates. Carrying ful SMEs face a number of challenges when trying to little or no debt may be an indicator of risk aversion. access local or international capital markets. To begin Too much equity, on the other hand, dilutes � rms’ with, the cost of raising capital tends to be consider- ownership interest. The IFC experience suggests that ably higher for SMEs, not only because of the perceived the lack of equity � nance is a binding constraint for greater risk associated with lending to or investing in many SMEs, in particular for larger SMEs, in devel- such enterprises, but also due to the smaller relative oping countries, while extending additional debt amounts of �nancing that SMEs require in order to � nancing for undercapitalized SMEs may be coun- fund their growth at any given stage. Since many of terproductive. Unlike the large-buy-out funds in the compliance costs associated with accessing capital developed markets, typical SME funds in emerging markets are �xed (e.g., listing and rating agency markets rarely try to use leverage to increase their charges, legal fees, prospectus preparation costs, etc.), returns, focusing instead on making money by SMEs usually �nd that the all-in cost of using the capi- assisting with operational, management, and mar- tal markets is prohibitive (Box 3.1).30 keting improvements. FIGURE 3.3 SME FINANCE COVERAGE Financing Needs Capital Markets Long Term Available Private Equity Financing Options Medium Term Lease Financing Bank Financing inance Trade Financing/Factoring Micro F Short Term Micro Small Medium Large Firm Size Infromal, mostly targeted by MFIs Formal, targeted by banks Source: IFC 30 An additional challenge to equity finance with SMEs can come from the reluctance of many SME owners to engage in a process that might result in equity providers or associates interfering with the day to day running of the business. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 21 Some countries have created SME stock exchanges to FIGURE 3.4 PERCENTAGE OF FIRMS VIEWING facilitate access to public funds, although the perfor- ACCESS TO FINANCE AS A MAJOR OBSTACLE mance of these exchanges has been mixed.31 Over the BY FIRM SIZE AND COUNTRY INCOME GROUP years, many countries have sought to address the issues 45 43 faced by SMEs by establishing dedicated stock exchanges, 40 38 35 33 junior market segments, or separate trading platforms 32 30 PERCENT (%) exclusively for the SME sector, with the aim of facilitat- 27 25 23 ing access to capital markets more quickly, with less 20 17 stringent eligibility criteria and at a lower all-in cost. 15 14 11 However, the performance of many of these junior 10 exchanges, particularly in some lower-income coun- 5 tries, has been unimpressive, with only a handful of 0 Low Income Middle Income High Income SMEs electing to list in certain markets and with little or Small(<20) Medium(20–99) Large(100 and over) no new capital actually being raised. Notable exceptions Source: World Bank Enterprise Surveys (2006–09) are found in the high or middle income countries and Note: The Enterprise Surveys define small firms as having fewer include the Alternative Investment Market (AIM) in than 20 employees and medium-sized firms as having between London, the Growth Enterprises Market (GEM) in Hong 20 and 100 employees. Data are for the most recent year avail- able for each country, ranging from 2003 to 2009. Statistics by Kong, KOSDAQ in Korea, MESDAQ in Malaysia, TSX in country income group are simple averages of the countries in each group. Canada, the MOTHERS market in Japan, and the Shenzhen SE in China. In developing countries, and in developed countries to SME access to finance usually starts through the a lesser extent32, the SME finance coverage appears lim- provision of short-term credits. When banks and ited to only a few financing options. Figure 3.3 illus- other �nancial institutions start lending to SMEs, they trates the SME �nance coverage by looking at the most usually remain at the lower risk of the spectrum commonly used �nancing tools across two dimensions: (smaller loans and shorter tenures), until there is suf- �rm size and maturity of �nancing. Traditional banking �cient credit history and infrastructure available to models typically target the largest �rms. While commer- enable larger volumes of lending and longer tenures cial banks in developed countries have become better while also containing risks. Beginning the credit rela- able to serve the needs of smaller �rms, banks in most tionship based on short-term �nance enables banks to developing countries often limit their SME activities to build credit histories with borrowers, even in markets fully secured working capital facilities. Micro�nance with poor land title regimes, poor collateral registries, companies have developed speci�c skills and business and weak credit bureaus. It also allows banks to gain models to provide small loans to the informal sector and experience, reach an increasing number of new cohorts the smallest formal enterprises, but they have limited of smaller �rms over time, and graduate these enter- ability to accompany client �rms as they grow. They also prises to access medium and long-term loans as well as lack the ability to offer additional non-lending products unsecured �nancing. that are critical to their clients. Leasing and factoring vol- umes remain small in most developing economies, yet 3.2 Quantifying the SME Finance Gap these products could help address some of the �nancing needs of smaller and informal �rms. Finally, only a very SMEs in low and middle income countries perceive limited number of innovative SMEs with clear growth access to financing as a major obstacle to growth potential are able to access venture capital. and development, indicating that most of 31 OECD (2006) provides a comprehensive review of equity finance in the early stages of the life cycle. 32 OECD, 2006. “The SME Financing Gap, Vol. I: Theory and Evidence� 22 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P FIGURE 3.5 FINANCIAL ACCESS: DEVELOPED the financial instruments discussed above are not VS. DEVELOPING COUNTRIES readily available in most of these countries. The World Bank Enterprise Survey results indicate that Number of bank loans to individuals per adult SMEs in developing countries are more likely than SMEs in developed countries to report that access to 0.0 0.2 0.4 0.6 0.8 1.0 �nance is a major obstacle to their development. As Value of bank loans shown in Figure 3.4, 43 percent of small enterprises to individuals (percent of GDP) and 38 percent of medium-sized �rms in low-income Average bank loan to countries report that access to �nance is a major obsta- individuals (percent of cle to their operations. The equivalent �gures in mid- GDP per capita) 0 30 60 90 120 150 dle-income countries are 32 and 27 percent, respectively. Financial access is reported to be a relatively less sig- Developing Countries Developed Countries ni�cant constraint in high-income countries. Source: CGAP (2009) Quantifying the SME Finance Gap (where the offer of FIGURE 3.6 PERCENT FIRMS WITH A LOAN/LINE available financial services only partially meets SME OF CREDIT FROM FINANCIAL INSTITUTION needs) remains a difficult challenge, given the absence 80 of reliable and consistently monitored sources of data on both the SME segment and SME access to financial 60 services. This section provides an assessment of SME PERCENT (%) �nancing constraints based on available sources, includ- 40 ing enterprise surveys, banking surveys, and data directly provided by central banks or �nancial regulators. In 20 enterprise surveys, SMEs are interviewed in order to explore their �nancial needs, access, and constraints. The 0 World Bank Enterprise Surveys provide a starting point Small(<20) Medium(20–99) Large(100 and over) for examining obstacles that SMEs face, although these Low Income Medium Income High Income surveys cover only a small fraction of �rms in each coun- Source: World Bank Enterprise Surveys (2006–2009) try and typically represent only certain industries, in most cases the manufacturing and services (including retail) FIGURE 3.7 FINANCING SOURCES FOR FIXED sectors. On the supply side, �nancial access for SMEs can INVESTMENT IN DEVELOPING COUNTRIES be measured by collecting data through banking surveys, although very few surveys of this type have been con- Internal Finance for Investment (%) ducted. More recently, some central banks and �nancial Bank Finance for regulators have started requiring the banks to report their Investment (%) SME portfolios. This is possibly one of the most promis- Supplier Credit Financing (%) ing sources of information on SME �nance, which is Equity, Sale of Stock being compiled for several countries by the OECD and For Investment (%) the World Bank Group/CGAP. Other Financing for Investment (%) 0 10 20 30 40 50 60 70 80 In general, financial access in developing countries is PERCENT (%) observed to be much lower compared to that for devel- Small(<20) Medium(20–99) Large(100 and over) oped countries, and concentrated among top borrow- Source: World Bank Enterprise Surveys (2006–2009) ers. Figure 3.5 shows that �nancial access for individuals S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 23 (measured by the ratio of the number of loans per adult) BOX 3.2 MEASURING THE VOLUME OF SME LENDING: THE SUPPLY SIDE APPROACH in developed countries is almost four times higher than the average ratio in developing countries. Moreover, in Lack of cross-country data on the level of SME �nancing developing countries the average loan amount relative to presents major challenges, both in evaluating the needs in the sector and in assessing progress. To address this per capita income is much higher, indicating that credit is data gap, the Financial Access 2010 survey, imple- much more concentrated among fewer borrowers. The mented by the CGAP and the World Bank Group and relatively low number of loans to individuals in develop- launched in February of 2010, included a number of ing countries to some extent captures SME �nance con- questions on measurement of SME �nancing levels. The straints, as many early stage SMEs rely on personal loans survey is addressed to the main �nancial regulator and to the owner to meet their business needs. asks to identify the main sources of data on SME �nanc- ing, de�nition of SME, value and number of outstanding SME loans, and the number of SMEs with loans. The story of SME Finance is not much different, and Enterprise Surveys conducted by the World Bank in BOX 3.2 | FIGURE 1: SHARE OF SME over 120 countries show that SMEs face more severe TOTAL/BUSINESS LOANS financing constraints than large firms, especially in 70 PERCENT (%) 60 lower income environments. As shown in Figure 3.6, 50 62% only 17 and 32 percent of small �rms in low and mid- 40 30 dle-income countries, respectively, have a loan or line of 34% 20 10 19% credit. This ratio is over 50 percent in the case of high- 0 15% income countries. Medium-sized enterprises are also Low and middle income High income Share of SME loans in total (% by volume) constrained in lower-income settings, although to a Share of SME loans in total business loans (% by volume) lesser degree. Large enterprises are generally much less constrained, even in low and middle-income countries. Financial Access 2010 received responses from 142 On average, the likelihood of a small �rm having access countries, of which 50 provided information on the to a bank loan in low-income countries is less than half volume of SME �nancing. Countries were asked to pro- vide information on the de�nition of SMEs used in the of what it is for a medium-sized �rm, and about a third country and statistics based on those de�nitions. This of what it is for a larger �rm (Figure 3.6). approach limits comparability of data across countries but allows for greater coverage. Although firms of all sizes in developing countries SME loans account for 19 percent of total lending volume rely on internal sources to meet their fixed invest- in developed countries, and 15 percent in developing ment needs, SMEs have a much stronger reliance on countries. The difference in the ratio is statistically signi�- such sources.33 As shown in Figure 3.7, banks remain cant between high-income and middle and low-income the most important source of external �nance in devel- countries. Variation in the statistics is high, reflecting in oping countries. Only 14 percent of the �xed capital part the different de�nitions used. The Financial Access 2010 report discusses in detail both the challenges investment of small �rms is funded by banking sources, related to the measurement of SME �nancing volume while the proportion is signi�cantly higher — at 25 using supply side data and the need for a greater stan- percent — for large �rms. These results are in line dardization in de�nitions and measurement metrics for with other studies reflecting the positive association SME Finance. between �rm size and external �nance.34 Source: World Bank Group/CGAP Financial Access 2010 Survey 33 It should be noted, however, that in some countries firms — especially family-owned SMEs — may be reluctant for cultural reasons (fear of loss of independence) to call on external finance, and often rely on family or other informal financing sources deliberately, not because they are constrained. 34 Beck, et al. (2006) 24 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P TABLE 3.1 AVERAGE SHARE OF SME LOANS IN TOTAL BANK LOANS Developed Countries Developing Countries Source OECD World Bank World Bank World Bank/UAB (2010)36 (2008)37 (2008)38 (2010)39 Number of Countries 5 countries 7 countries 38 countries 10 non-oil Middle East countries SME Loans/Total Loans (%) 26.8 22.1 16.2 14.5 FIGURE 3.8 LEASING ASSETS (% OF GDP) FIGURE 3.9 FACTORING VOLUME (% OF GDP) 6 China (1) 0.5 Factoring volume as % of GDP 5.1 5 MENA (2) 1.1 4 LAC (7) 1.3 2.9 3 High Income OECD (23) 1.4 2.2 Central and Eastern 2 1.8 Europe-Other (4) Central and Eastern 1 0.7 0.8 3.8 0.5 Europe-EU (9) 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 0 Leasing Assets as % of GDP South Asia EAP MENA LAC ECA High Income Source: World Leasing Yearbook (2010), Data for 2008 Source: Factor Chain International (2008 data) Note: Number in parenthesis indicates the number of sample Note: High-income countries include some ECA countries. countries for that region. Supply side information (provided by bank surveys preliminary results con�rm the same pattern — as or financial regulators) portrays a similar picture shown in Box 3.2, the average share of SME lending is — SME loans as a percentage of total bank loans is smaller in the case of developing countries.35 generally smaller in developing countries, implying more restricted access to finance. Information on Leasing and factoring markets, which are particularly SME lending is available from two World Bank sur- useful for SMEs, are unevenly developed around the veys, and from central banks and �nancial regulators world. As shown in Figure 3.8, the leasing sector seems (compiled by the OECD). These studies show that to have been more developed in Central and Eastern banks generally hold smaller SME portfolios in devel- Europe, particularly among that region’s EU countries. oping countries (Table 3.1). The pattern is consistent This is possibly due to the efforts made in overcoming with the results of enterprise surveys, which show that the weaknesses in creditor rights during the period of proportionately fewer SMEs in developing countries transition, and also to the large market share of multina- have a loan or a line of credit. The CGAP is collecting tional banking groups that may have used leasing as a information on SME lending in its 2010 survey, and more secure way to provide �nancing to �rms in riskier 35 Beck, Demirgüç-Kunt and Martinez Peria (2010) show that SME lending volumes and prices are significantly affected by measures of financial infrastructure, including creditor rights and credit information. Rocha, Farazi, Khouri, and Pearce (2010) show the results of a recent survey in which Middle Eastern banks report weaknesses in the financial infrastructure that constrain their willingness to lend to SMEs. 36 Canada, France, Korea, Sweden, and the US. 37 Beck, Demirgüç-Kunt, and Martinez Peria (2008) 38 Ibid 39 Rocha, Farazi, Khouri, and Pearce (2010) S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 25 BOX 3.3 THE IMPACT OF THE GLOBAL FINANCIAL CRISIS ON SME FINANCE: FINDINGS FROM THE RECENT OECD STUDIES Assessments of the impact of the �nancial crisis on SMEs’ access to �nance have revealed that policymakers and major stakeholders (e.g., �nancial institutions) lack the hard data necessary to monitor and evaluate the situation. Thus, it was deemed necessary to develop a coherent set of core indicators that would: (i) improve the understand- ing of business �nancing needs and provide a basis for a better-informed public discussion; (ii) give the suppliers of �nance a more comprehensive understanding of their clients’ needs; and (iii) facilitate the assessment of whether �rms’ �nancing needs were being met and help with evaluating the effectiveness of government policies and pro- grams. In order to achieve these objectives, OECD is constructing a pilot Scorecard with core access indicators sat- isfying the criteria of usefulness, availability, feasibility, timeliness, and comparability.* Since the various de�nitions used in the OECD pilot Scoreboard are still not standardized, a number of challenges in data collection and harmo- nization still remain in many countries. In parallel, the OECD also conducted a study examining the impact of the global �nancial crisis on SME and entre- preneurship �nancing. The �ndings of this study suggest that SMEs and entrepreneurs have suffered two shocks that adversely affected their cash flows during the �nancial crisis: a drastic drop in �nal demand for goods and services, and a deterioration of credit conditions.** A recent survey of �rms in Eastern Europe has identi�ed the drop in demand as a more challenging constraint than the credit crunch. Most SMEs have responded to the evaporation of liquidity since 2008 by reducing operating costs, running down inventories, and cutting investment, including inno- vation spending. The reliance on trade credit as a substitute for bank �nancing is also observed during credit crunches.*** Overall levels of SME borrowing have remained steady or declined slightly, but trends have diverged between demand for investment capital, which has reduced signi�cantly almost everywhere, and demand for work- ing capital, which has risen sharply. The preliminary analysis of these on-going studies suggests that during the �nancial crisis there was a slowing down in business lending in general, and in SME lending in particular. The majority of SMEs in surveyed countries experi- enced hardening of credit terms in 2009, due to low pro�tability as a result of the recession, a decline in their cred- itworthiness, and weakened �nancial markets. With banks becoming increasingly risk averse, many �rms experienced difficulties in obtaining export �nance. In a number of countries, the percentage of �rms using bank credit fell, while the use of alternative �nancing sources such as leasing and factoring declined even faster than bank �nancing. Tight credit conditions were further exacerbated with shortened maturities, increased collateral requirements, and high lending margins on SME credit. In the face of severely tightened credit conditions, the governments of OECD countries intervened forcefully in late 2008 and early 2009. Under special crisis support/emergency measures packages, existing programs were strength- ened and new programs were introduced to enhance the access of viable SMEs to credit. Government responses (including the shortening or maintaining the payment terms by the governments) to contain the credit squeeze for SMEs appear to have been instrumental in saving a large number of �rms from bankruptcy and in preventing job losses from becoming even more serious. In order to ensure long-term gains in SME �nance, governments should emphasize strong banking systems, adequate regulation, and �nancial stability. *The Scorecard has been constructed with the cooperation of nine volunteer countries: Canada, Finland, France, Italy, Korea, New Zealand, Sweden, Thailand and the United States. Core indicators for the pilot scorecards are being developed for these nine countries. **The study included 17 OECD and 2 non-OECD countries: Australia, Austria, Belgium, Canada, Czech Republic, Finland, France, Germany, Hungary, Italy, Japan, Netherlands, New Zealand, Poland, Sweden, Turkey, United Kingdom, Israel, and Estonia. World Bank Enterprise Surveys News Release (2010). ***Love, Preve, Sartia-Allende (2007) Source: OECD (2010a) and OECD (2010b) 26 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P FIGURE 3.10 FORMAL SMES’ ACCESS TO FINANCE BY REGION Bar graphs refer to million of formal SMEs in the region (i.e., typically 5 employees and above) LEGEND % SMEs that need but have neither a High-income OECD Number of SMEs (Mn) loan nor a overdraft 11–14 11–14 Total With <20 Deposits With 20–39 Loans 5–6 40–59 Number of SMEs unserved >59 1.4–2 mn Central Asia & Eastern Europe Latin America 2.7–3.3 2.5–3.0 1.5–1.9 3.1–3.7 2.6–3.2 2.0–2.5 0.4–0.8 mn 0.3–0.7 mn East Asia 11.2–13.6 Middle East & North Africa 7.6–9.1 1.9–2.3 1.4–1.8 0.4–0.6 2.0–2.5 0.5–0.9 mn 7–10 mn Total Number of SMEs unserved: Total Number of SMEs Unserved Sub-Saharan Africa 12–19 mn Excluding High-Income OECD: South Asia 3.5–4.3 3.0–3.7 36–44 25–30 11–17 mn 29–35 18–22 2.0–2.8 1.3–1.7 13–16 8–10 1.0–1.2 0.5–0.7 1.5–2 mn 1.4–2 mn Source: IFC and McKinsey Database 2010 Note: Data for calculation from World Bank enterprise surveys, IFC MSME database, literature searches and McKinsey proprietary research. FIGURE 3.11 FORMAL SMES’ USE OF FINANCIAL INSTITUTIONS LOANS AND FINANCING CONSTRAINTS Percent of total enterprises in emerging markets (i.e., excluding high-income OECD) 16–20 100 45–55 21–24 8–10 Have a loan and/or Have a loan and/or Do not have a Do not need Total formal overdraft and no �nancing overdraft but �nancing loan overdraft a loan SMEs in emerging constraint constraint but need a loan markets Source: IFC and McKinsey Database 2010 Note: The number of SMEs unserved or underserved is calculated based on SME access to bank loans and overdrafts only (i.e., not including SMEs’ access to trade financing, leasing, factoring, and other forms of credit). Data for calculation from World Bank enter- prise surveys, IFC MSME database, literature searches, and McKinsey proprietary research. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 27 environments. In many parts of the world, the leasing In the absence of an accurate and academic approach sector remains underdeveloped. Measured as a percent- to measure the (formal) SME finance gap and track age of Fixed Capital Formation, leasing penetration in progress globally, the IFC and McKinsey have investment �nance varies from 2.2 percent in China to engaged in an effort to combine all available data 27.3 percent in Hungary.40 Likewise, factoring markets sources as of June 2010, establishing proxies to allow seem comparatively more developed in high-income cross-regional comparisons and using assumptions countries, and remain relatively weak in developing when needed to fill the data gaps. This effort repre- countries, particularly in Asia and MENA (Figure 3.9). sents one of the most comprehensive attempts to quan- tify and map the SME �nance gap globally.41 The results The global financial crisis has further constrained of this exercise are preliminary, and constitute a start- financial access for SMEs. The crisis has had a negative ing point on gathering data for mapping the global impact on SME activity in terms of employment, output, SME �nance gap. The methodology used to develop sales, and exports. Low pro�tability resulting from the these data points had to make assumptions where data crisis has adversely affected SMEs’ creditworthiness. At gaps prevailed, which are speci�ed in more detail in the same time, �nancial institutions have become increas- the annex B. Going forward, signi�cant improvements ingly risk-averse in expanding �nancial access to SMEs to data collection for SME �nance are necessary to and, in many cases, have tightened credit conditions, thus guide policy decisions and monitor progress. The G-20 further worsening SMEs’ �nancial access. (Box 3.3) SME Finance Data Working Group established in May 2010, is preparing a set of recommendations, which The quantification of the SME finance gap remains — if put into practice — should help improve data today as a major challenge, at both the global and availability and quality. national levels. While the above data show in broad terms the extent of the SME access to �nancing problem, Approximately 45–55 percent of formal SMEs42 (11–17 there is limited capacity to assess the potential areas for million) in emerging markets are unserved (i.e., they improvement and track progress over time. Due in large need credit but do not have access), 21–24 percent (5–7 part to the enterprise surveys, the availability of data on million) are underserved (i.e., they have access to some formal SMEs is somewhat better, while data acquisition credit but identify �nancing as a constraint), and 16–20 and assessment is more severely problematic for the percent (4–6 million) do not need credit.43 The magni- micro and informal sectors. Moreover, little is known tude of the credit gap varies by size of enterprises: 18–22 about speci�c demand-side constraints that may hamper percent of formal medium enterprises in emerging mar- a sustainable increase in access to �nance for SMEs. kets are unserved compared to 49–59 percent of very small formal enterprises.44 Moreover, there are signi�cant This makes policy design particularly challenging. regional differences in terms of �nancial access. Access to Intensifying efforts in data collection should therefore credit for SMEs is particularly daunting in Asia and Africa be a key area of focus for the FIEG. A Working Group on (Figure 3.10 and 3.11). SME Finance Data has been set-up by the FIEG, with the mandates to design a possible approach to SME Finance data collection and aggregation, assess the possibility of setting targets for SME Financing, and recommend a global mechanism to ensure monitoring of progress. 40 World Leasing Yearbook, Euromoney, 2010 41 Please see Annex B for the methodology used to derive the estimates. 42 Segmentation of SMEs as per the Box 1.1. 43 Estimates as a proportion of total SMEs in emerging markets. 44 Estimates as a proportion of formal SMEs in the respective segment. 28 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P The credit challenge for formal SMEs is easier to 3.3.1 THE LEGAL AND REGULATORY tackle, given that close to 18–22 million formal SMEs FRAMEWORK in emerging markets (70–76 percent of total SMEs in emerging markets), already have a banking relation- The legal and regulatory framework is defined here ship via deposit/checking accounts; hence the need is to include the collection of laws and regulations that to incentivize banks to lend to their existing clients. define the scope and depth of all the financial insti- Interestingly, close to 9.5–11.5 million formal SMEs in tutions, instruments, and markets operating in a emerging markets (75–80 percent of all unserved SMEs given country. This includes, for example, banking, in emerging markets) do not have loans or overdrafts insurance, leasing, factoring, and security laws, as well but have deposit accounts. Hence the key challenge is the respective bodies of secondary regulations and not only to support banks in opening accounts for the guidelines. Effective legal and regulatory frameworks 25 to 30 percent of formal SMEs (6–8 million) with no promote access to �nance while preserving �nancial access to banks, but also to extend credit facilities to stability. This is achieved by expanding the range of those SMEs that have a deposit/checking account, are �nancial institutions and instruments and promoting credit worthy, but do not have access to credit. Such pre- market development and competition, while subject- existing clients could be the �rst/ most straightforward ing �nancial institutions and agents to sound pruden- targets for the banks in expanding outreach to other tial rules, as well as rules of conduct. �nancial services, particularly to credit. The legal and regulatory framework plays a critical 3.3 Why SME Finance Remains role in improving the SME Finance landscape. For a Challenge example, banking regulations that allow entry of sound and ef�cient banks and promote market compe- Lingering deficiencies in the enabling environment tition may reduce margins in traditional business lines help explain the constrained access of SMEs to and induce banks to develop SME banking. This is a finance. The enabling environment is defined here driver of SME lending typically reported in SME sur- to include both financial infrastructure and the veys conducted by the World Bank.45 Legislation that overall legal and regulatory framework for finan- promotes leasing and factoring also promotes access to cial institutions and instruments. Financial infra- �nance by SMEs, especially in environments where structure includes the informational, contractual, and �nancial infrastructure remains de�cient. The lower transactional frameworks that provide the basis for �nan- development of leasing and factoring in most develop- cial intermediation. The legal and regulatory framework ing countries (shown above) may reflect gaps in the for �nance is the collection of laws and secondary regula- legal and regulatory environment of these countries. tions on �nancial institutions and instruments that pro- Legislation that facilitates bond and equity �nance for vide the foundations for market development and the large �rms may promote competition to bank lending, overall degree of market competition. reducing bank margins on traditional business lines and inducing banks to diversify lending to SMEs. Financial regulation can also constitute a hindering factor, however, as in the case of interest rate ceilings that do not allow banks to cover lending risks and dis- courage lending to the SME segment.46 45 See De la Torre, Martinez Peria and Schmukler (2010), Beck, Demirgüç-Kunt and Martinez Peria (2008), and Rocha, Farazi, Khouri, and Pearce (2010). 46 IFC (2009) S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 29 One regulatory framework widely discussed in the improves the reliability of �nancial statements, the EU context of SME Finance is the Basel II framework, exempts �rms with fewer than 50 employees from which seeks to align banks’ capital allocations with obligatory audits, a rule that also attempts to strike a the risk characteristics of their loan portfolio. After balance between the objectives of improving transpar- considerable initial debate, the effects of Basel II ency and reducing the regulatory burden for small on SME Finance are now considered to be neutral or �rms. Some studies have found that effective account- positive (Box 3.4). ing standards are positively associated with measures of access50, but research in this area has been limited by 3.3.2 FINANCIAL INFRASTRUCTURE the lack of good quantitative indicators of the quality of �nancial reporting, and are not focused on SMEs. Financial infrastructure as defined here includes accounting and auditing standards, credit reporting Public credit registries and private credit bureaus systems (credit registries and bureaus), collateral can play a fundamental role in SME Finance by pro- and insolvency regimes, and payments and settle- viding information on borrower creditworthiness.51 ment system.47 Financial infrastructure reduces the Well-functioning credit information systems reduce information asymmetries and legal uncertainties that adverse selection and moral hazard, and can contribute increase risk to lenders and constrain the supply of to both an expansion of credit and a reduction in lend- �nance. Financial infrastructure development improves ing costs. Considerable variation across countries is �nancial access for all �rms, but SMEs bene�t propor- observed in the depth of credit information and the tionately more, as the problems of opacity and infor- coverage of credit registries and bureaus. A credit reg- mation asymmetry are more severe in the case of istry or bureau will be more effective to the extent that smaller �rms. it obtains both positive and negative information from regulated and unregulated institutions (e.g., utilities, Strong accounting and auditing standards improve retailers), builds credit histories for a large number of SME access to finance by reducing informational potential borrowers, and processes comprehensive opacities and encouraging lending based on finan- credit reports timely. Credit bureau information also cial statements, but countries have had to strike a facilitates the adoption of lending technologies based balance between improving transparency and on credit scoring models. The World Bank Group is reducing the regulatory burden for SMEs. leading an international effort to de�ne standards for International Financial Reporting Standards (IFRS) credit reporting systems. The new standards are have been adapted to SMEs, and about 60 countries intended to bene�t SMEs. seem to have adopted the SME version of IFRS.48 Other countries have concluded that the SME version of IFRS The development of credit registries and bureaus is still too costly for SMEs, and have adopted a simpler improves access to finance. A study of 5,000 �rms in set of obligatory standards. This includes Germany and 51 countries suggests that SMEs �nd it relatively easy to other EU countries.49 There are similar concerns obtain a bank loan in countries where credit informa- regarding obligatory auditing. Although auditing tion is available through credit bureaus/registries 47 See World Bank (2009). Although the payment/settlement systems are also part of the financial infrastructure, due to their limited relevance for SME finance, they are not discussed in this report. 48 International Accounting Standards Board (2009). See iasb.org. 49 See the European Commission’s consultations on the adoption of IFRS for SMEs (European Commission 2010). 50 La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1998), Rajan and Zingales (1998), and Beck, Levine, and Loayza (2000). 51 For more research on the respective roles and relative importance of public credit registries and private credit bureaus, please refer to: Love and Mylenko (2003), Djankov et al. (2007), Jappelli and Pagano (2005), World Bank Doing Business Indicators (2010) and OECD discussion paper on Credit Information Sharing which can be accessed at http://www.oecd.org/dataoecd/37/1/45370071.pdf 30 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 3.4 BASEL II AND SME FINANCE The release of the �nal version of Basel II in June 2004 was preceded by several years of intense discussions and studies about its potential impact on the economy, particularly on SMEs. Some empirical studies supported claims that the risk-sensitive nature of Basel II would reduce the availability and increase the cost of �nance for SMEs, in particular unrated SMEs, as banks would be required to hold relatively more capital for SME exposures. In response, the Basel Committee made some speci�c changes to accommodate SME Finance. These changes included: (i) calibration of risk-weight functions in a way that, at a given probability of default, exposures to SMEs require relatively less capital than larger �rms; (ii) introduction of a speci�c risk weight curve for SME exposures clas- si�ed as retail; (iii) reduction of the risk weight for non-mortgage retail exposures under the standardized approach; and (iv) better recognition of credit risk mitigants, particularly collateral and guarantees. The design of speci�c risk weighting formulas for SMEs was justi�ed on the basis that SME and retail portfolios exhibit lower asset correlations compared to large �rms, reflecting the importance of idiosyncratic factors in driving the default risk of small borrowers. Thus, the Committee believed that unexpected losses for SME and retail portfolios would be relatively lower, warranting lower risk weights. However, some studies have rejected the assumption that asset correla- tions consistently fall with �rm size, classifying the special treatment of SMEs as excessive. This lack of strong empirical evidence supporting lower capital charges on SME exposures has been referred to as the main reason for the enact- ment of national Basel II versions that do not confer preferential treatment to SMEs (e.g., the United States). The debate on the impact of Basel II on SME Finance has abated since the release of the �nal version of the Basel II Framework. The changes largely succeeded in addressing the main concerns about the potential impact of Basel II on SME Finance. Indeed, the impact studies of the Basel Committee have suggested that broadly speaking capital requirements for SMEs would not be signi�cantly higher than those under Basel I. The impact of Basel II on SME �nance will however ultimately depend, among other things, on the particular mix of obligors for any given bank in any given country. The results of the Basel impact studies were supported by other studies, which have also stressed that Basel II would provide incentives for banks to implement advanced risk management techniques that would possibly make SME lending easier, cheaper, and pro�table. Moreover, a study commissioned by the European Commission to assess the consequences of Basel II on the European economy, with particular attention to SMEs, did not anticipate an overall reduction in the availability of, and access to, credit. It concluded that the overall impact of Basel II would be positive for Europe’s SMEs, despite possible varia- tions across sectors, segments of SMEs, regions, and other dimensions. Nevertheless, the impact of ongoing �nancial reform on SME lending remains to be seen. Renewed attention to the risks that banking regulation may pose for SME access to �nance may be required. Source: Jacobson, et al. (2004), Dietsch and Petey (2004), Saurina and Trucharte (2003), Altman and Sabato (2005), PricewaterhouseCoopers (2004) S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 31 (Figure 3.12). Moreover, in countries where �nancial bureaus, effective collateral regimes improve access to information is available through credit bureaus, smaller �nance for all �rms, but can prove particularly effec- �rms report relatively lower �nancing constraints.52 tive in improving access to SMEs. In countries with The existence of credit registries and bureaus seems to strong secured transactions regimes, asset-based lend- matter more in developing countries, suggesting a ing technologies are facilitated.56 Typically, SMEs have more important role for the government in promoting limited immovable assets but possess a wider range of information sharing in these countries.53 In transitional movable assets. An effective secured transactions economies, the adoption of a credit reference bureau regime facilitates lending by using the available mov- reduced obstacles in access to and cost of �nance and able assets as collateral in loan contracts.57 increased use of external �nance.54 The development of credit registries and bureaus is particularly important Credit information and creditor rights remain rela- for smaller �rms, given the more severe problems of tively weak in developing countries, constraining information opacity and asymmetry in these cases. access to finance in these countries. As indicated in Table 3.2, private bureau coverage has increased in all Effective collateral regimes contribute to SME regions and is wider than public registry coverage. In finance by reducing the risks and losses of lenders. A general, however, credit bureau coverage in developing well-functioning collateral regime entails a wide range regions is much lower than the average of the OECD. of allowable collaterals (especially movable collateral), Credit bureau coverage in Sub-Saharan Africa and in the establishment of clear priority rankings (clarifying South Asia seems particularly weak. Lingering de�cien- the rights of secured creditors), ef�cient collateral reg- cies in credit information are con�rmed by the relatively istries (making priority interests publicly known), and low credit information index score for many emerging effective enforcement of collateral in the case of default regions. Finally, creditor rights (measuring the strength (both seizure and disposition). Ef�cient collateral of the collateral and insolvency regimes) are relatively regimes encourage lending by reducing the probability strong in the OECD and ECA regions but weaker in the of default (by reducing adverse selection and moral other regions, especially in MENA, Africa, and South hazard) and reducing losses of lenders given default. Asia. In these regions, policy interventions that strengthen the �nancial information infrastructure have Stronger creditor rights improve access to finance. the potential to expand SME �nancial access by reducing As shown in Figures 3.13 and 3.14, countries with information asymmetries between SMEs and �nancial stronger creditor rights tend to have a higher number institutions and by facilitating the use of various lending of loan accounts per adult population and also higher technologies. (Box 3.5) rates of private credit to GDP.55 As in the case of credit 52 Love and Mylenko (2003) 53 Djankov, McLiesh and Shleifer (2007). 54 Brown, Jappelli, and Pagano (2009) 55 Also see Chong, Galindo, and Micco (2004) 56 Berger and Udell (2006) 57 World Bank (2007) 32 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P FIGURE 3.12 EXISTENCE OF CREDIT BUREAUS FIGURE 3.13 CREDITOR RIGHTS AND NUMBER AND SMALL FIRMS’ LIQUIDITY CONSTRAINTS OF LOANS AND ACCESS TO FINANCE High Loan accounts per 1,000 adults % of Small Firms Reporting Probability of Obtaining a High Financing Constraints Bank Loan for a Small Firm 49% 40% 27% 28% Without With credit Without With credit Low credit bureau bureau credit bureau bureau Low Strength of Legal Rights Index (0–10) High Source: Love and Mylenko (2003) Source: World Bank Doing Business Indicators (2009) and CGAP Financial Access Database (2009) FIGURE 3.14 CREDITOR RIGHTS AND PRIVATE CREDIT/GDP Source: Djankov, McLiesh and Shleifer (2007) S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 33 3.3.3 FINANCIAL INSTITUTIONS credit only but on the cross-selling of a mix of �nan- CAPABILITIES AND DELIVERY MODELS cial services beyond credit (Box 3.6).58 To a certain extent, weaknesses in the enabling Relationship lending still entails high internal trans- environment for financial services can be mitigated action costs, limiting financial institutions’ ability to through internal lending technologies that reduce outreach to SMEs at acceptable rates. A weak enabling information asymmetries, such as the traditional environment will ultimately limit the extent to which relationship lending model. Relationship lending still institutions may be able to expand �nance to SMEs. plays an important role in SME �nance in many coun- For example, credit scoring technology can support tries. Banks can reorganize themselves internally so as the implementation of cost-effective delivery models to develop the SME business and optimize the balance that can mitigate risks, such as automation of credit between risk, reward, and cost to serve, even in weak underwriting, but the accuracy of these models enabling environments. For instance, more effective depends to a large extent on a solid �nancial informa- business models for SME banking can be developed tion infrastructure (Box 3.7). through a clear strategy, dedicated SME units with spe- cialized staff, a standardized set of products to reduce On the revenue side, risk-based pricing models cost to serve, internal credit scoring models, and a have allowed financial institutions to profitably client relationship approach that does not focus on serve SMEs by incorporating the associated risks TABLE 3.2 CREDIT INFORMATION INFRASTRUCTURE AND STRENGTH OF LEGAL RIGHTS BY REGION Region Strength of Depth of Credit Public Registry Private Bureau Legal Rights Information Coverage Coverage Index (0–10) Index (0–6) (% of adults) (% of adults) Sub-Saharan Africa 4.6 1.5 2.4 4.5 South Asia 5.3 2.1 0.8 3.3 OECD 6.8 4.9 8.8 59.6 Middle East and North Africa 3.3 3.3 5.0 10.9 Latin America and Caribbean 5.5 3.3 10.0 33.2 Eastern Europe and Central Asia 6.6 4.0 9.7 19.4 East Asia and Paci�c 5.7 1.9 7.2 14.4 Source: World Bank-Doing Business Database (2010). 58 De la Torre A., M. S. Martinez Peria, and S. Schmukler, 2009 34 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 3.5 INSOLVENCY REGIME FOR SMES Extensive literature addresses the so-called “�nance-growth nexus�59, whereby a good �nancial system comprising fac- tors such as an efficient and predictable bankruptcy system, positively correlates with economic growth and a reduction in inequalities between �rms of different sizes.60 Bankruptcy regimes feed into such an effective �nancial system, insofar as they regulate the efficient exiting of the market, and make the resolution of multiple creditors’ conflicting claims more orderly, resulting in more extensive opportunities for recovery by both the bankrupt entity and its creditors. Many countries have signi�cant legal gaps such that insolvency frameworks are unable to deal with SMEs effectively. SMEs can be divided into two broad categories: corporates and non-corporates. Under most legal systems, corporates effectively limit the liability of shareholders to the amounts of their capital contributions to the business and, absent fraud or other mitigating circumstances61, do not extend that liability to the ordinary debts of the business. Non- corporates, by contrast, do not possess a distinct legal identity from their shareholders and, as such, the debts of the business are the debts of the individual shareholders. Although the trend in insolvency reform has been towards the creation of a single, uni�ed insolvency act that deals with all legal forms, most countries have not undertaken such reforms. In many common law countries that inherited the English legal framework, insolvency provisions are contained in the companies acts. The cumulative effect is that most legal systems either have severely outdated insolvency law provisions or have modern insolvency frameworks contained in companies acts that either do not apply to non-corpo- rates and or contain outdated or nonexistent personal insolvency provisions. 62 For non-corporate SMEs, the absence of a personal or “merchant� insolvency framework leaves the SME exposed on at least three critical fronts. First, SMEs that are fundamentally viable but �nd themselves in short-term liquidity crises have no safety valve for business distress. Where the legal framework is absent, the SME cannot seek temporary pro- tection from its creditors, cannot propose a plan of reorganization, and cannot compromise debts in order to achieve greater returns to all creditors. Admittedly, the reorganization of an SME might be a rare event in most developed economies. However, this underscores the second problem, which is the absence of an efficient, orderly, and transpar- ent liquidation process to repay creditors and return productive assets into the economy as quickly as possible. Third, and perhaps more importantly, where the legal framework is absent, individual owners of SMEs cannot obtain discharge from the SMEs’ debt. It is impossible to overstate the importance of this element. When an SME fails, its outstanding obligations will be the obligations of the individual entrepreneur, in perpetuity, unless speci�cally for- given by creditors. This has created innumerable social problems in countries that have seen a dramatic increase in credit to individuals.63 The absence of these effective exit mechanisms inhibits entrepreneurship, limits the entry of SMEs into the market, and imperils the ability of creditors to be repaid. Not only are productive SME assets locked in a legal limbo for a longer period of time, delaying creditor repayment, but the absence of a debt discharge effectively inhibits the entrepreneur from re-entering the marketplace. Studies have tested the hypothesis that personal bank- ruptcy regimes stimulate entrepreneurship. They demonstrate that bankruptcy laws have the most statistically and economically signi�cant effect on levels of self-employment across countries, and that more “forgiving�64 bank- ruptcy systems increase the supply of entrepreneurs. Few countries have placed insolvency reform at the top of the policy agenda. Between 2004 and 2009, in every region of the world other than Eastern Europe, Central Asia, and the OECD countries, fewer than 25 percent of countries engaged 59 See for example, La Porta et. al (1998), Levine and Zervos (1998), Rajan and Zingales (1998), Beck and Levine (2004), Beck, Demirgüç- Kunt, and Levine (2004). 60 Beck and Demirgüç-Kunt (2006) 61 Many legal systems prescribe specific classes of debts for which an officer of the company might be personally liable. These usually relate to debts arising under extraordinary circumstances (such as money held in trust for third parties) and do not usually relate to ordinary debts of the corporation. 62 Some countries, such as Jordan, have specifically included a class of businesses, called “merchants,� in their corporate insolvency law to extend that law to proprietorships. 63 The incidence of credit card debt in China has resulted in young entrepreneurs getting into severe debt, with the result being that debt collectors from banks are hounding them and their parents for repayment. See 64 Four dimensions are considered in assessing how “forgiving� a bankruptcy regime is: (i) availability of and time to discharge; (ii) exemptions; (iii) restrictions on debtor’s rights during bankruptcy; and (iv) difficulty in reaching an agreement with creditors. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 35 in insolvency reforms65, a number that is dramatically lower if �ltered for reforms materially impacting SMEs. Indeed, as noted in a report on the MENA region by the World Bank, OECD, and other partners, there has been a disproportionate focus on legal reforms relating to business entry and credit origination, without properly addressing the issue of exit.66 A modern framework for SME insolvency will start with legislation for corporate SMEs that will include “fast-track� and expedited bankruptcy provisions in uni�ed or corporate bankruptcy laws. Additional frameworks for dispute resolu- tion, such as mediation, might also be included to help improve efficiency.67 For the vast majority that are non-corpo- rate, however, this will involve entirely new legal frameworks for personal insolvency or dramatic updates to outdated personal insolvency legislation. In engaging in such reforms, countries may wish to distinguish between personal (i.e., household) debts and debts incurred by individuals on behalf of, or for the purpose of funding, SME activities. However, the act of distinguishing between such debts may be difficult and, if left to the courts, may exacerbate delays in resolv- ing insolvencies. Legislation on personal/SME insolvency will have a number of critical components. It should set out a clear and trans- parent process by which entrepreneurs can seek to rescue their troubled businesses (including stays of proceedings and methods for making proposals to creditors for plans of arrangement) and, should the business fail, will articulate a very clear method for liquidating the business, repaying creditors in a timely manner, and discharging the remaining debts.68 There should be clear punishments for fraudulent behavior, such as the act of dissipating the assets of the busi- ness so that creditors cannot recover their claims and for negligently incurring obligations from creditors when the entrepreneur knew, or should have known, that the business was insolvent. These critical protections for creditors will help ensure that SMEs continue to be able to access credit at reasonable rates. Legislation, alone, will not be enough and should not negatively impact access to �nance. Although it has been noted that many countries have focused on business entry and credit origination, without adequately addressing exit, the new exit mechanisms for SMEs should not undo these access to �nance reforms or unduly inhibit access to �nance. Legislation must be balanced, as an insolvency framework for proprietorships cannot be achieved by legislation alone and there must be an equilibrium between debtor and creditor protection. Balancing legislation will require ensuring that entrepreneurs seeking the protection of reorganization procedures will assume the burden of making the prima facie case that the busi- ness cannot be reorganized. Where the business enters a reorganization process and the creditors do not approve of the business plan, it must be moved swiftly to liquidation so that creditors can be repaid as quickly as possible.69 There will need to be severe penalties for fraud, to act as a disincentive to entrepreneurs for malfeasance or for “asset tunneling� (stealing assets from the business so as to defraud creditors). The rules of discharge will have to be clear and the debts that survive the discharge process should be well articulated. Creditors should also be given a chance to object to the debtor’s discharge on clearly enumerated grounds, and there should be lifetime limits on the number of times an indi- vidual entrepreneur can go bankrupt. A range of other institutions must also be in place to ensure that the SME insolvency framework is properly implemented and does not harm the already fragile ability of small businesses to get credit. First and foremost, this will require credit information bureaus. For instance, where lenders had access to comprehen- sive information, interest rates for SMEs increased by 5.4 percentage points (and for corporate �rms, by 2.1 percentage points) in situations where a previous insolvency �ling had already been made.70 As such, a well-functioning credit bureau will be critical to ensuring that lenders do not unnecessarily scale back credit to SMEs. A good secured transac- tions regime is also important, as it will enable countries to focus their attention on developing bankruptcy regimes that provide flexible solutions for SMEs. Finally, a key component of the framework will be the insolvency administrators who deal with the debtors on a day-to-day basis. Efficiency in the personal insolvency framework will likely require CONTINUED ON NEXT PAGE 65 Doing Business Database 66 Hawkamah Institute/World Bank/OECD/INSOL International, “Study on Insolvency Systems in the Middle East and North Africa�, (2009). 67 Canada, for example, uses court mediation for small claims involving corporate entities. 68 Different countries take different approaches to the concept of discharge and the assets with which the debtor will be left after the process is concluded. These could be arranged along a spectrum from “most debtor-friendly� to “most creditor-friendly.� What is most important is the clear articulation of the discharge rules and process. 69 Many models can be looked at in this regard, ranging from Canada to the U.K. to France. 70 Jeremy Berkowitz and Michelle White, “Bankruptcy and small firms’ access to credit� 35 RAND Journal of Economics, (2004) 68–84 at p. 81 36 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 3.5 CONTINUED the financial institutions’ capabilities in using such products. For example, leasing cannot flourish when debtors to seek the assistance of these individuals, who providers experience dif�culties in repossessing the will help prepare the necessary �nancial information to leased asset and disposing of the asset. Bankers may submit to creditors for their approval in a reorganization. In a liquidation, they will work to ensure that the assets be reluctant to apply the concept of project �nance in are sold for maximum value and that creditors are repaid general, and especially with SMEs, for lack of techni- as quickly as possible. This will require a cadre of trained cal understanding or perceived high risks. professionals (usually accountants or lawyers). There is a trend towards the introduction of licensing requirements A recent study by the IFC and Oliver Wyman sug- for such professionals (where they do not already exist) gests that about 80 percent of the SME Finance to ensure a certain level of skills and ethical behavior. Gap can be directly attributed to the cost of dis- In addition to legislation, however, the necessary institu- tributing credit, although this figure varies by tions that are required to implement the law will be critical. market. The � ndings of the study suggest that inter- The so-called “implementation gap� (the gap between the quality of the legislation and the quality of the institutions ventions that focus on reducing a lender’s loss in the that implement it) has been shown to have a signi�cantly event of default are likely to have the largest impact deleterious effect on the functioning of the overall insol- on closing the SME Finance Gap (Box 3.8). vency framework. Reform of such institutions is a complex undertaking. Indeed, countries that have, for example, Financial providers can implement approaches introduced specialized courts to deal with insolvency and delivery models that help expand their set of cases have found that these courts have very little positive impact unless they are well-funded and adequately SME clients, but the quality of the enabling envi- resourced to fundamentally change how these cases are ronment will ultimately define the SME finance dealt with.71 Efforts are underway in a number of countries frontier. The SME Finance Frontier, or Productivity to reduce dependence upon the courts by introducing Frontier, de� nes the maximum number of SMEs that frameworks for “out of court� solutions and for encourag- can be served prudently and cost effectively by ing the use of mediation and other forms of alternative � nancial institutions. Individual providers can dispute resolution (ADR) to resolve insolvency cases. achieve ef�ciency gains, both in terms of costs and risk management, and the collection of these indi- vidual efforts can expand the overall SME � nance frontier to some degree. However, the expansion of into the pricing of various financial products. the frontier will depend to a large extent on factors Experience suggests that effectively priced non-lend- that are exogenous to the individual providers ing products are the major drivers of SME banking (Figure 3.15).73 pro�tability, while loan products may be used to attract and retain clients. Typically, SMEs are willing 3.4 Policy Interventions Designed to to pay the risk-adjusted prices, as the � nancial prod- Expand SME Finance ucts offered tend to be cheaper than alternative �nancing sources.72 Governments play a fundamental role in ensuring a supportive enabling environment and expanding Alternative lending technologies, such as project the frontier for SME Finance. Ensuring a stable mac- financing, leasing, and factoring can expand access roeconomic environment, an effective �nancial infra- to finance, but these technologies also depend on structure, and a supportive legal and regulatory the legal and institutional framework, as well as framework, is arguably the most important and 71 Uttamchandani et al. (2005) 72 IFC (2009) 73 Beck and De la Torre (2004) S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 37 effective contribution that governments can make to Government may also play a critical role in ensuring a expand the supply of �nance to SMEs. For example, in legal and regulatory framework that fosters �nancial countries where public credit registries are the only development and competition. In some cases, it may source of credit information, government has a direct also play a fundamental role in introducing techno- responsibility for ensuring maximum coverage of logical platforms for some sources of �nance, such as �nancial and non-�nancial institutions, extensive venture capital and reverse factoring. reporting of the relevant information, and easy access to credit reports. Government action is also funda- Ensuring a supportive enabling environment is not a mental in the regulation and supervision of private trivial task, as it frequently requires facing vested credit bureaus, ensuring effective credit reporting and interests and, in some low and middle-income curbing any abuse of market power (through regula- settings, also overcoming technical limitations. tion or promotion of entry and competition). For example, government attempts to introduce BOX 3.6 SME BANKING: BEST PRACTICES Contrary to the conventional wisdom that banks are not interested in SMEs, studies have found that most banks in both developing and developed countries have SME clients.74 The main driver for banks’ involvement with the segment is the perceived pro�tability of this line of business. A majority of banks are setting up dedicated units and developing speci�c business models to target this segment. In most cases, the dedicated business units approach SMEs in an integrated way, offering them a wide array of products and services, such as deposit accounts, investment products, factoring, leasing, and international trade �nancing, , among many others. On the �nancing side, there are more products than just the typi- cal loans offered through relationship lending. Box 3.6: Table 1 shows that the average number of deposit products varies between 5.3 and 10.6 for developed and developing countries, respectively. The number of credit products ranges between 9.4 and 18.7, while payment and other transactional products are between 7.7 and 16.9 for developed and devel- oping countries, respectively. Each SME client uses an average of �ve deposit and credit products. The diversity and number of products is associated with the revenues that they generate. Box 3.6: Table 1 also displays the revenue break- down by type of product. The table shows that credit generates only part of the revenue, 32 percent and 38 percent for developed and developing countries, respectively. The rest is divided between deposits and other products and services. In the case of developing countries, 29 percent corresponds to deposits and 32 percent to other products. Bank headquarters typically design the strategy and the campaign in terms of which SMEs banks will target and what products they will offer to them. The products tend to be standardized or combined with some tailored products (Box 3.6 Figure 1), with the importance of tailoring rising with the size of the �rm. Banks design products tailored to SMEs with similar needs, such as schools, �shing companies, and agricultural producers. The individual SME perceives the products as tailored to its speci�c needs, though these are frequently the same products with some degree of customization. Banks that can sell these products on a large scale tend to bene�t the most, by having branches and SME account manag- ers that act as the “personalized� point of contact for SMEs while delivering mostly generic products that have been designed centrally at headquarters. Many banks, particularly the larger ones, have created business centers that service various branches within a geographic area. This helps them reduce costs by centralizing some functions that are subject to economies of scale, such as back-office functions. The account manager in a branch reaches out to new SMEs and manages the daily operations with existing SMEs, relying on the business center for speci�c back-office work. CONTINUED ON NEXT PAGE 74 De la Torre, A., Martinez Peria, M.S., and Schmukler, S, (2010) and Beck, T., Demirgüç-Kunt, A., and Martinez Peria, M.S., (2010) 38 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 3.6 CONTINUED As they learn to deal with SMEs, banks are reorganizing their credit risk management systems, with a greater degree of sophistication among international banks and large domestic banks. In most large banks, and with the exception of pure credit scoring, credit risk management is not automated, often involving a credit risk analyst. Typically, risk management is a function that is organizationally separate from sales and is done primarily at headquarters (Box 3.6: Figure 2). The risk management department is given independence and strong approval and veto powers, an arrangement not typically found among small, niche, and public banks. While maintaining independence in judgment, risk analysts and managers work cooperatively with those who sell products and originate loans (e.g., the SME account managers in countries where business models are more advanced). In effect, risk analysts endeavor to train SME account managers and raise their risk awareness, so that the credit approval process is streamlined and the loan application has a higher likelihood of not being rejected later on by risk analysts. BOX 3.6 | TABLE 1 PRODUCTS OFFERED TO AND USED BY SMES AND BREAKDOWN OF REVENUE GENERATED CO N C E P T DEVELOPED COU N TR I ES DEVELOPI N G COU N TR IES Average number of products offered to SMEs Deposit products 5.33 10.6 Credit products 9.38 18.7 Transactional products 7.67 16.9 Number of Products used per SME client Deposit products 2.75 2.29 Credit products 3.25 2.41 Breakdown of Revenue from SME segment by Product type (% of revenue)* Credit (%) 31.7 38.47 Deposit & Acc Mgt (%) 42.4 29.11 Other (%) 23.9 32.33 * The percentages across products do not add up to 100, as averages across banks and within banks are considered. BOX 3.6 | FIGURE 1 STANDARDIZATION OF BOX 3.6 | FIGURE 2 RISK MANAGEMENT SME PRODUCTS PRACTICES 100 90 83 83 80 80 80 75 PERCENT (%) 80 67 70 PERCENT (%) 60 50 60 33 50 40 40 40 20 40 17 20 30 0 20 0 10 Mostly Similar proportion of Mostly 0 standardized standardized & tailored 0 products tailored products products Largely Done by risk Separate Done primarily automated credit analyst from sales at headquarters Developed countries Developing countries Developed countries Developing countries Source: Bank interviews conducted by the World Bank and the IFC Source: Bank interviews conducted by the World Bank and the IFC S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 39 BOX 3.7 CREDIT SCORING Credit Scoring is a mathematical technique that uses historic credit data to predict a future outcome, typically the probability of default (PD). More commonly used in retail/consumer credit, the methodology has been adapted successfully for use with smaller SMEs where traditional �nancial analysis has proven to be unreliable. The tech- nique involves the development of a mathematical algorithm, using characteristics of the borrower and/or his/her past repayment behavior, which produces a series of “odds,� in the form of a score, that represent the probability of future repayment. In the context of lending to SMEs, this technique is particularly valuable, as it is not only an objective measure of risk but also a means of establishing credit worthiness using a minimum of data that can be easily validated. While traditional underwriting techniques typically require extensive analysis of � nancial statements, which in the case of SMEs are often unreliable or need to be physically constructed by the loan offi cer, credit scoring uses a combination of simple predictive variables, including: length of time in business; nature of business; length of time with bank etc. These factors help generate a score that can be easily calibrated into an Accept/Reject cut- off strategy. While it is unlikely that lenders in emerging markets would rely solely on a credit score to make a lending decision, these models can be effectively deployed as an early pre-screening tool to establish which applications to investi- gate more thoroughly and which to reject before having to investigate in depth. Credit scores are also ideally suited to partial automation of the lending process and have a tendency to improve the overall quality of lending decisions in environments where experienced human underwriters are hard to � nd. As such, they play an impor- tant role in reducing the average time to process applications and therefore the cost of acquisition, two key factors that deter lenders from servicing the SME market. However, the methodology has its limitations, not the least of which is the availability of historical data from which to build the models. Most lenders are unlikely to have suffi cient portfolio data, in particular the requisite number of “bad� accounts, for the model-building process to be statistically reliable. In these circumstances, one option is to deploy a generic model that has been proven to work in a similar environment, then � ne tune the variables and points allocation over time in the light of experience. Credit scoring is not to be confused with “credit rating� which, despite similarities, is typically deployed as a post- acceptance means of quantifying portfolio risk. Credit rating is typically performed on higher value loans to cat- egorize exposures into buckets of risk. These risk buckets are then used for tracking portfolio quality over time and the allocation of speci�c provisions. Under Basel II principles, credit ratings would also tend to go further than simply calculating PD and would usually incorporate a measure of Loss Given Default (LGD), the net amount at risk after collateral has been liquidated, and Expected Loss, the probable ultimate loss dependent on the time the debt is crystallized. 40 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 3.8 QUANTIFYING THE POTENTIAL IMPACT OF INTERVENTION ON THE SME FINANCE GAP The recent IFC / Oliver Wyman study developed a methodology to establish how much of the SME �nance gap in any given market could be linked to the cost of lending in that market. The model �rst assumes that the price for debt charged by a rationale lender will be function of its costs, plus a reasonable return on capital. It uses a detailed under- standing of these costs to calculate the maximum level of debt that the SME sector can — in theory — support, and compares this to the level of debt that is actually being provided to the SME sector, to calculate the SME �nance gap. In the model, the cost of lending comprises operating and funding costs, as well as credit losses. Credit losses, in turn, are disaggregated into the number of customer defaults, and the lender’s loss in the event of a customer default. The value of each cost component clearly varies by country, and therefore an aggregate picture of the actual cost of lending in each market can be built up using country speci�c data for each of these cost components. The model also assumes a best practice value for each cost component, drawn from Oliver Wyman’s experience of lead- ing lending institutions in mature SME markets around the world. The results showed that the majority of gap could be eradicated if lenders in each country were able to move towards a best practice cost base, and transfer these bene�ts through to the customer via prices. Using a sensitivity analysis, bounded by the differences between the best practice and actual value of each cost component, the model quanti�es the contribution of each cost component to the relative inefficiency of SME lending in each market. Although results differed slightly across the six markets (France, Kenya, Morocco, Philippines, Turkey, CONTINUED ON PAGE 42 BOX 3.8 | FIGURE 1 SME FINANCE ABATEMENT CURVE Probability of Loss Given Default Cost Base 6,000 Default Financial institution capacity building Incremental tax revenues (USD $MM) Financial infrastructure Financial infrastructure: Collateral registries Public support 5,000 mechanisms Public support mechanisms Financial institution capacity building 4,000 Financial infrastructure: Related laws and regulations 3,000 SME capacity building Financial institution capacity building 2,000 Financial infrastructure: Institutional component 1,000 The steepness of the line indicates the size of the tax multiplier 0 2,000 4,000 6,000 8,000 10,000 12,000 SME �nance gap (USD $ MM) BOX 3.8 | TABLE 1 MAPPING WELL KNOWN BARRIERS TO SME FINANCE AGAINST COST COMPONENT, AND CLASSIFYING POTENTIAL INTERVENTIONS TO TACKLE EACH BARRIER Cost component Barrier to SME �nance Potential intervention Description of potential intervention IFC classi�cation Probability of Asymmetry of information Business registration Streamline and standardize business registration Financial infrastructure: Default (PD) (e.g., lack of relevant credit processes Institutional component information on SMEs) Increase transparency of incorporation information to the general public Credit bureau Improve lender’s access to historical delinquency and behavioral credit information, allowing more informed discriminate of good customers from bad Accounting standards Greater transparency and reliability of �nancial accounts would enable more robust risk assessments of SMEs to be undertaken by lenders and other creditors Institutional capacity of �nan- Technical assistance To improve lender skill levels in credit risk measurement Financial institution cial intermediaries (e.g., no and management capacity building rating tools) SME access to skills / knowl- Financial literacy program Promote understanding of �nancial markets, products SME capacity building edge / markets (e.g., low and investments through �nancial education programs levels of �nancial literacy) Business advice networks Provide advisory services for enterprises, assisting them in making good investment choices and entrepreneurial decisions Loss Given Default Legal environment (e.g., Creditor rights Ensure creditors’ rightful claims on assets to reduce Financial infrastructure: (LGD) poorly drafted laws, and/or losses during liquidation or bankruptcy proceedings Related laws and weak enforcement of them) regulations Bankruptcy law Improve efficiency of bankruptcy laws to ensure creditors’ rightful claims on assets during bankruptcy Property rights Improve efficiency and ease of registering property and collateral Institutional capacity of Technical assistance To improve lender skill levels in product design, collat- Financial institution �nancial intermediaries eral management, collections, restructuring and capacity building (e.g., collection unit) recovery Public policy support (e.g., to Guarantee schemes Stimulate private sector lending by passing on a Public support S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD stimulate private sector lending) proportion of Loss Given Default to the scheme mechanisms Asymmetry of information Collateral registry Improve access to information on collateral Financial infrastructure: (e.g., understanding which type and value Collateral registries unencumbered assets are available as collateral) Cost base High transaction costs (e.g.,due Technical assistance To encourage best practices from around the Financial institution to limited scale of lenders, or world (in the absence of international competition capacity building Operations lack of products tailored to within a local market) Funding needs of SMEs) High �xed cost base Infrastructure joint ventures Share common platforms where this ensures scale Financial infrastructure (e.g., due to limited scale bene�ts are maximised, but does not affect competition of individual lenders) at front line 41 Underdeveloped local capital Bank funding schemes Provide a low cost source funds to be distributed Public support markets (e.g., for term local by lenders directly to SMEs (i.e., ring-fenced) mechanisms currency funding) 42 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 3.8 CONTINUED and UK) examined in the study, this analysis established that loss in the event of default typically has the highest influence of all the cost components, often accounting for the majority of relative inefficiencies. The likelihood of a customer default (more commonly known as the probability of default) was found to be the next most signi�cant driver, while funding and operating cost components do not have as big an impact as the others. The various barriers to SME �nance have been well documented, and these can be mapped against each of the cost components contained within the model. It is possible, for example, to identify barriers that unnecessarily drive up a lender’s loss in the event of default: these might include a legal environment that results in weak creditor rights, or a lengthy and unpredictable bankruptcy process. The study used this mapping, coupled with the results of the sce- nario analysis described above, to determine which interventions were likely to have the greatest impact on reducing the relative inefficiency of lending in each market, and hence close the SME �nancing gap. A simple tax multiplier was then used to estimate the second order bene�ts that an increase in SME �nance — as a result of a successful interven- tion — would have on the economy. With this, a marginal abatement curve for each type of potential intervention was developed as illustrated in Figure 1 for Philippines. mandatory data reporting to private bureaus may face Deficiencies in the enabling environment and residual opposition from powerful incumbents, which may not market failures (such as enforcement difficulties, want to share information on their clientele. Private imperfect information, protection of depositors, and bureau legislation may also be blocked in legislative market power) have motivated government interven- bodies due to concerns over data secrecy. Strengthening tions in the SME Finance space.75 Well-designed policy of collateral regimes may be hindered over concerns interventions may be justi�ed in periods where the gov- that debtors may become unprotected. Attempts to ernment is trying to strengthen �nancial infrastructure improve competition in banking systems may also be and the legal and regulatory framework. It may also be hindered by incumbents and concerns that the system justi�ed in cases where some groups remain dif�cult to is already overbanked. These constraints may delay reach, even when ef�cient �nancial infrastructure and signi�cantly the pace of reform in some countries. regulations are in place. Interventions are warranted in period of crisis, where there is a systemic collapse of Even an effective enabling environment may not be �nancial intermediation by private agents. Traditionally, able to ensure access to some target groups, especially such policy interventions have included partial credit start-ups and very young firms, without sufficient guarantee schemes, direct lending facilities (sometimes credit history or collateral. Young and small �rms may entailing credit subsidies), and lending by state-owned have sound business plans and promising growth poten- �nancial institutions.76 These interventions provide dif- tial, but they may not have a suf�cient credit history to ferent combinations of liquidity and risk mitigation strat- be captured by credit reporting systems, or lenders may egies and can be priced at or below market rates. The have lingering doubts about the quality of their collat- choice of instrument/intervention typically depends on eral. SME lending also depends on internal credit and the binding constraint in the respective environment. risk management capacity, and this may take time to Whenever there is a subsidy component associated with build in some countries. Furthermore, SMEs may suffer these interventions, a consistent assessment of cost-bene- a loss of access in periods of �nancial crisis, even in �t analysis of using subsidies is called for in order to min- sophisticated environments. imize their potentially market-distorting consequences. 75 Besley (1994) 76 The World Bank (2008) provides a review of some of these interventions. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 43 FIGURE 3.15 THE SME FINANCE PRODUCTIVITY FRONTIER HOW? New �nancial information and communication technologies Better credit risk decisions and access to SMEs Lower unit costs per transaction or service Old credit and service allocation techniques Better cross and up-selling decisions unpro�table Broader service offerings Sustained pro�tability and higher asset quality Source: IFC Partial Credit Guarantee (PCG) schemes are operated highlighted the importance of this countercyclical role by a large number of countries around the world. In — several governments (including Canada, Chile, developed countries, such schemes have been operational Germany, Korea, the Netherlands, and Malaysia) scaled for over four decades, while their use in developing coun- up their guarantee schemes or introduced new and tries is fairly recent. In PCG schemes, loans offered by a special schemes to soften the impact of the credit �nancial institution to the borrower are partly guaran- crunch on SMEs. teed by a third party (typically a government agency) subject to the payment of a premium and other rules and PCG schemes may add limited value and prove conditions. When default occurs, the lender is compen- costly when they are not designed well. PCGs differ sated by the guarantor as per the initial agreement.77 signi�cantly in fundamental design features, such as eligibility criteria, fees, coverage ratios, and payment PCG schemes are considered one of the most mar- rules. Loose criteria, low fees, and overly generous ket-friendly types of interventions. Unlike other coverage ratios and payment rules may result in the types of interventions, they may generate fewer distor- provision of guarantees to enterprises that would tions in the credit market and are more consistent with have obtained credit anyway. They may also result in a well-functioning banking system.78 PCG schemes �nancial imbalances requiring large and recurrent may prove an effective vehicle for reaching under- government contributions. Although country studies served groups such as start-ups and small �rms. They have found evidence that some of these schemes alle- may also generate positive externalities by encourag- viate SME �nance constraints, measuring the addi- ing banks to get into the SME market, and improve tionality of PCGs accurately remains technically their lending technologies and risk management sys- challenging. More research on PCG schemes is war- tems. Historically, PCG schemes have been used for ranted, as this is one of the interventions that can countercyclical purposes, as with the case of Korea, contribute to promoting access while minimizing illustrated in Figure 3.16. The recent �nancial crisis distortions in the marketplace. 77 Beck, Klapper, and Mendoza (2008) provide an overview of PCGs based on a worldwide survey. Saadani, Arvai, and Rocha (2010) provide an overview of PCGs in MENA based on a recent regional survey. 78 Beck and De la Torre (2006). 44 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P Direct lending to SMEs, which may be subsidized, State-owned financial institutions have been used in can take several forms, including provision of lines many countries to serve the SME sector. Surveys con- of credit to financial institutions and co-financing ducted by the World Bank show that state-owned banks facilities. Some governments impose quotas on bank have played an important role in SME �nance in many lending to SMEs or offer lines of credit through SME countries.82 These have included commercial banks, agencies or development banks to retail banks for SME development banks, and banks specialized in SME lending. These lines of credit may entail co-�nancing Finance. In contrast with credit guarantee schemes, arrangements. International organizations also offer however, the risks associated with more direct interven- concessional loans to governments to support bank tions such as state-owned banks are higher. The same lending to SMEs, usually channeled through an SME surveys show that state banks have, on average, weaker agency or state bank. These lines of credit usually entail risk management systems.83 Empirical research indicates conditions to strengthen the capacity of �nancial inter- that state banks in developing countries have not per- mediaries and prevent market distortions.79 More formed well in general and have negatively impacted recently, equity funds supporting SMEs have been economic and �nancial development.84 Research also developed by some governments, typically focusing shows that state banks provide political patronage and on fast growing young and technology sector �rms. that their lending is correlated with the election cycle.85 There are many cases of state banks that are subject to There is evidence that some of these programs have systematic political interference and that have to be alleviated credit constraints, but there are also unsuc- recurrently recapitalized at a high cost to taxpayers. At cessful experiments, and the impact of many of these the same time, some countries seem to have been able interventions has not been properly evaluated. to introduce reasonable mandates and governance struc- Research on some of these schemes has shown that they tures to state banks.86 Indeed, there is some research that can release constraints and promote enterprise growth, indicates that once public banks are provided with the rather than substitute for subsidized credit.80 However, right incentives they can play a positive role in mobiliz- some programs can prove costly and be politically cap- ing savings and reducing credit pro-cyclicality.87 In addi- tured, especially when they involve subsidies.81 Thus far, tion, state banks have played an important countercyclical there has not been suf�cient research on the impact of role in the recent �nancial crisis in many countries. the variety of directed lending programs implemented worldwide. This is especially the case of programs that While state-owned financial institutions may play a entail lending quotas at below-market rates, and where useful complementary role in the provision of credit there is a less transparent element of cross-subsidization to SMEs, a review of the more successful cases shows from non-favored sectors. that the preconditions for sustained positive 79 The World Bank’s policy on lending to SMEs through financial intermediaries highlights that the ultimate goal is for financial intermedi- aries to raise funds on a self–perpetuating and growing basis. This requires the development of market sources rather than continued dependence on official lending with sovereign risk cover. The World Bank’s policy on financial intermediary lending also establishes eligibility criteria to assess participating financial institutions, including portfolio quality, capacity domestic resource mobilization, managerial autonomy and appropriate prudential policies and business procedures while providing guidance on directed credit and subsidy issues to ensure that the line of credit does not create market distortions. 80 Banerjee and Dufloe (2004). 81 Adams, Graham and Von Pischke (1984). 82 Beck, Demirgüç-Kunt, and Martinez Peria (2008) and Rocha, Farazi, Khouri, and Pearce (2010). 83 Rocha, Farazi, Khouri, and Pearce (2010). 84 Micco, Panizza, and Yañez (2007) show that state-owned banks tend to have lower profitability, higher overhead costs and higher NPLs when compared to private banks. La Porta, de Silanes and Shleiffer (2002) find that government ownership of banks is associated with slower subsequent financial development and economic growth. 85 Sapienza (2004), Khwaja and Mian (2005), Micco, Panizza, and Yañez (2005), Dinç (2005), and Cole (2008). 86 Rudolph (2009). 87 Levy Yeyanti, Micco and Panizza (2006) examine a database of Latin American banks and conclude that not all state banks have performed poorly. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 45 FIGURE 3.16 KOREA GUARANTEE SCHEME (KODIT) — OUTSTANDING GUARANTEES (% OF GDP) 5.0% 4.5% 4.0% Banking 3.5% Crisis 3.0% New Economy 2.5% Crisis 2.0% Subrime Crisis 1.5% Asian Crisis 1.0% 0.5% 0.0% 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: Based on raw data from KODIT outcomes can be demanding. The successful cases institutional capacity building has been a signi�cant usually entail legislation specifying clear mandates, component of their SME �nance assistance strategy, establishing sound governance structures with inde- wherein assistance is provided to �nancial institutions pendent boards, and imposing clear performance cri- in understanding the needs of the SMEs, developing teria. In some cases, speci�c legislation or board appropriate structures/products for servicing the directives stress that the bank will not compete directly SME clients, training staff and management in SME with the private sector but will �ll remaining gaps and �nancing, and managing information and knowledge target the segments that remain underserved. These ef�ciently. Over the years, IFC has been effectively banks may have a mandate to serve SMEs, but are providing advisory services and capacity building essentially run on a commercial basis. Not all coun- programs for �nancial institutions, which should tries are able to replicate these conditions.88 be further scaled up in order to provide sustainable �nancial services to SMEs. In addition, the capacity Government may play a role in building the capacity building of SMEs themselves (�nancial education, of financial institutions to serve the SME sector, assistance in the development of business plans and frequently with the assistance of international loan applications) is important, although this is not the organizations. For many international organizations, focus of this report. 88 Rudolph (ibid) 46 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P CHAPTER 4 Exploring Various SME Finance Models As part of the SME Finance work plan, and as a comple- Replicability: Models should be able to prove ment to the literature and evidence review conducted their potential to be replicable in other countries in Chapters One through Three of this report, the FIEG and contexts. SME Finance sub-group has developed a comprehen- Results and Track Record: Models should have a sive collection of successful models that can maximize clear and measurable �nancial access impact on the deployment of private sector resources on a sus- SMEs, as demonstrated by the results from pilot or tainable and scalable basis. The models were identi�ed empirical testing. and analyzed between January and March 2010, under Implementation Capacity: Models must have a realis- the leadership of the sub-group co-chairs. Members of tic time frame for implementation and be suited to the the FIEG, other OECD country representatives, and technical, legal, and �nancing capacity of the IFIs. bilateral and multilateral development �nance institu- tions have contributed a total of 164 models of SME A standardized template has been designed for the �nance interventions, covering the following: purpose of this exercise, with a view to capture as Legal and regulatory interventions that enable SME comprehensively and accurately as possible the key access to �nance; features and data points needed for the evaluation of a Financial infrastructure components designed to given model across the �ve dimensions (Table 4.1). help address information asymmetry and reduce Although SMEs require a variety of �nancial services, transaction cost; the main focus of the stocktaking exercise is on lend- Public support mechanisms to foster SME �nancing; and, ing/credit services rather than on the other types of Private sector models suited to provide sustainable �nancial services.89 Nonetheless, some of the stocktak- �nancial services to SMEs ing models cross-sell �nancial products, while others provide only credit services. 4.1 Stocktaking Exercise Methodology The comprehensive list of all collected models with a Five criteria have been used to evaluate the relevance of the summary of the key descriptive information relevant to submitted models in the context of the FIEG objectives: each model is provided in Annex C.90 For the purpose of Leverage: Models should maximize the leverage of this report, and particularly for Chapter 4, the words public interventions — if any — in catalyzing pri- “model� and “case� are used interchangeably. vate SME �nance to a maximum number of �rms. Scale and Sustainability: Models must credibly The stocktaking exercise is designed to illustrate objec- demonstrate either existing relevant scale or poten- tively a broad range of current practices and features in tial to be scaled up over the long term, and must be the SME �nance space. It does not attempt to be an aca- able to function on a sustainable basis. demic exercise or a comprehensive inventory of SME 89 Tables, figures, and boxes in this chapter are based on the data from the G-20 SME Finance Stocktaking Exercise, unless otherwise stated. 90 Annex C attached separately. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 47 TABLE 4.1 STOCKTAKING REPORT TEMPLATE Stocktaking Exercise Template: Case Information Requested Basic Information Name of the initiative Implementing parties Year started Targeted SME sector Category of information Summary of initiative and results achieved Links to background research Model Description Initiative background and rationale Objective Description of the mechanism: Sources of public and/or private sector funding Performance of mechanism in leveraging public funding to facilitate private �nancing Pricing policy Results: Timeframe for results Amount of �nancing facilitates to date Number of SMEs reached to date Cost bene�t: (i) For public initiatives: amount of public funding needed per USD 100 of �nancing to one SME; (ii) For private initiatives: total private investment, break-even period, and internal rate of return (IRR). Expected results by end of the initiative Key Success Factors, Scalability Description of success factors based on categories, and and Replicability scalability and replicability opportunities FIGURE 4.1 COLLECTED SME FINANCE MODELS BY TYPE OF INTERVENTION AND REGION Developed 36 Legal and regulatory 10 World 14 AFR 27 Financial infrastructure 13 LAC 13 EAP 26 Public support scheme 109 ECA 25 SAR 13 Private sector initiative 32 MENA 10 0 5 10 15 20 25 30 35 40 0 20 40 60 80 100 12 Source: G-20 SME Finance Stocktaking Exercise 2010 48 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P �nance experiences worldwide. It should be further in various countries and regions. The mix of sub- noted that the case collection captures a small sample of mitted models seems fairly representative of the four actual SME �nance models worldwide and, as a result, main categories of interventions described earlier the composition of cases from the stocktaking might not (Figure 4.1). Public support schemes and private match the global composition of mechanisms and expe- sector initiatives are the most widely represented cat- riences. The purpose of the stocktaking is not to advo- egories, accounting for 86 percent of collected cate for speci�c SME �nance models and policies. Rather, models. A broad range of initiatives are included the stocktaking is aimed at gathering and presenting under each category, and the cases are further classi- valuable insights on SME �nance, based on the set of �ed by sub-categories (Figure 4.2). criteria mentioned above, and serving as resource for the G-20 in expanding SME �nance practices. Legal and financial infrastructure initiatives are the least represented cases in the collection. While 4.2 Overview of the Case Collection good legal frameworks and � nancial infrastructure set the necessary pre-conditions for SME �nance to As a part of the stocktaking exercise, 164 models of flourish; they take longer time to implement com- SME finance interventions have been gathered. pared to other initiatives and thus may be relatively Collected models represent all regions of the world less preferred forms of interventions in the SME and display a balance of developed and developing �nance space. country cases. Models implemented in developed economies represent the largest share of the collec- Private sector initiatives and providers of financial tion, followed by models in the East Asia and Paci�c services are primarily represented by banking ser- region and the Africa region. The cases include single, vices and equity finance, and account for 20 per- multi-country, regional, and multi-regional models cent of collected models (Figure 4.2). Lending and (Figure 4.1). commercial banking services represent the primary channel for SME �nancing. Given the important role The database of collected models provides an excel- of commercial banks in the SME �nance space, as lent overview of a wide range of SME finance well as the different types of banking services pro- mechanisms and policy interventions implemented vided under the stocktaking, initiatives under the FIGURE 4.2 PUBLIC SUPPORT SCHEMES AND PRIVATE SECTOR INITIATIVES BY SUB-CATEGORIES 100 — Other (private sector) initiatives — Other schemes 90 — Credit guarantee — State-owned banks 80 — Equity �nance — Equity �nance 70 PERCENT (%) — Credit guarantees 60 — Other lending services 50 40 — Micro�nance up-scaling Lending — Community banks & Banking 30 Services — Funded facilities 20 — Commercial bank downscaling 10 0 PRIVATE SECTOR INITIATIVES PUBLIC SUPPORT SCHEMES Source: G-20 SME Finance Stocktaking Exercise 2010 S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 49 banking services sub-category have been further FIGURE 4.3 NUMBER OF CASES PER COUNTRY CLASSIFICATION divided into four types of models: commercial banks that are down-scaling to SMEs; micro�nance institu- 100 tions up-scaling to SMEs; community banks; and, Public support scheme other lending services targeting SMEs. 90 Private sector initiative 80 Public support schemes are the most widely repre- Legal and regulatory sented models in the collection, with 66 percent of 70 cases (Figure 4.2). Under this category, funded �nanc- Financial infrastructure ing facilities and credit guarantee schemes supported 60 —57 by the public sector represent the largest share of sub- 50 mitted initiatives. These models appear to be govern- ments’ preferred SME �nance interventions, as 40 government sources submitted 70 percent of such cases. Funded and guarantee facilities are primarily 30 —14 implemented at a country level, although there are —29 various initiatives at a regional and multi-regional level 20 —12 —8 —11 involving the support of development agencies. Other 10 —11 public support models include state bank initiatives, —2 —9 —5 1— —3 —1 —1 equity investments, and institutional capacity pro- 0 High Income Middle Income Combined Low Low Income grams, while models designed to strengthen the & Middle Income enabling environment include credit and collateral Source: G-20 SME Finance Stocktaking Exercise 2010 registries and regulatory reforms. TABLE 4.2 OUTREACH DATA: ILLUSTRATIVE EXAMPLES Category and Sub-category Name of Initiative SME Outreach Financial infrastructure: Egypt’s I-Score Credit Bureau 45,000 Credit bureau Legal and regulatory: Pakistan’s Prudential Regulation for SMEs 60,000 Financial sector law and regulation Public support scheme: India’s Credit Guarantee Trust Fund for Micro, 250,000 Credit guarantee Small, and Medium Enterprises Public support scheme: China’s Commercially Sustainable Micro and 35,000 Funded facility Small Business Finance Private sector initiative: ProCredit Bank Bulgaria 160,000 Commercial banking Note: This table is not meant to be comparative. By nature, different kinds of mechanisms address different financing needs and have varying levels of outreach. Source: G-20 SME Finance Stocktaking Exercise 2010 50 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P Initiatives located in middle-income countries select only high-growth SMEs are not measured by the (MIC)91 represent the largest share of cases in the number of �rms reached but by the �nancial perfor- stocktaking (54 percent), while initiatives in low-in- mance of the fund, job growth at investee level, and come countries (LIC) are the least represented (10 �rm development impact such as bene�ts of better percent). The higher percentage of models in middle- governance and management of social and environ- and high-income countries may suggest that initiatives mental risks. But even across similar initiatives, com- in these nations tend to be more effective and/or suc- parisons are dif�cult given that collected mechanisms cessful due to stronger enabling environments, greater have various maturities, operate in different environ- macroeconomic stability, and more business opportuni- ments, and cater to different target segments under the ties relative to LIC. However, G-20 donors and develop- generic SME umbrella. Even when outreach, sustain- ment agencies account for the large majority of ability, and leverage data are provided, it is often dif- case-submitting entities, which may have led to a higher �cult to draw conclusions in the absence of thorough number of submitted cases in MIC. As illustrated in impact evaluations (Table 4.2). This chapter does not Figure 4.3, MIC cases represent the highest share in set out to identify good or poor practices, but instead every category (i.e., legal, �nancial infrastructure, pri- draws key lessons from the qualitative comparison of vate sector, and public schemes), while case sub-cate- models inside a given category of interventions. The gories present varied results. For instance, guarantee purpose is to highlight initiatives that seem particu- schemes from the sample are evenly distributed among larly promising, while keeping in mind the informa- high-income countries (HIC) (47 percent), and MIC tion weaknesses described above. and LIC (53 percent combined). Meanwhile, funded facilities are primarily implemented in MIC (62 per- The remainder of this section of the report discusses cent), suggesting that developing economies rely more qualitative findings drawn from the collected SME on direct support relative to HIC. Initiatives with grants finance models. The discussion starts from the per- or subsidy components are also more widely found in spective of the providers of �nancial services to the MIC (80 percent of cases), followed by HIC (14 per- SME segment, and explores what models have been cent) and LIC (7 percent). While the lack of LIC cases deemed successful and why. Next is an examination of including subsidies or grants may suggest that such the few enabling environment initiatives (legal and models have a lower probability of success relative to regulatory, �nancial infrastructure) that may have similar models in MIC or HIC, it is dif�cult to draw helped these providers of �nancial services reduce conclusions based on the collected sample and the information asymmetry and transaction costs, leading nature of the stocktaking exercise. to an expansion of the SME �nance frontier. The sec- tion also explores the 109 submitted examples of gov- There is still a long way to accurately quantify the ernment and development interventions representing performance of the proposed models in terms of the large majority of the collected models, which sug- outreach, sustainability, and leverage. It has been gest that SME �nance support can effectively address dif�cult to quantify outreach in a way that can be weaknesses and possible market failures in that space benchmarked across models. For instance, the devel- when the support is well designed. Finally, the analysis opment impact of an SME credit guarantee facility takes a more speci�c look at initiatives that address would be measured on number of SMEs reached. In more speci�c gaps in the SME Finance space and pres- contrast, the development impact of equity funds that ent features that may warrant further analysis. 91 Classification of countries follows the World Bank definition based on per capita income. The cutoffs in U.S. dollars as of 2010 were: low-income countries (LIC), USD 995 or less; middle-income countries (MIC), USD 996 to USD 12,195; high-income countries (HIC), USD 12,196 or more. These cutoffs are updated annually. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 51 4.3 Primary Providers of Financial approaches for client acquisition, assessment, and Services to SMEs servicing, and rely on limited external support from governments and IFI/DFIs. To assess SME risk in a Eighteen of the models in the stocktaking exercise cost-effective manner, banks such as Wells Fargo and describe direct providers of �nancial services to the Standard Chartered Bank rely on proprietary credit SME segment within the category of private sector ini- scoring models and differentiated credit processes. tiatives, including: Full-fledged commercial banks that have successfully 2. Emerging market banks, which tend to follow more down-scaled toward the SME segment; traditional banking models with no differentiated Micro-�nance institutions that have successfully strategy for SMEs. These banks operate within lim- up-scaled to serve the needs of the SME segment; ited �nancial infrastructure and comparatively Community banks, whose shareholders (including the weaker regulatory environments, and typically rely State) may have a primary interest in economic devel- on DFI support through loans, institutional capacity, opment in addition to pure economic pro�t; and, and technical assistance to expand their access to Private equity/venture capital funds. the SME segment. This is reflected in the cases of Banque Nationale de Développement Agricole in Some models may have features that fall under more Mali and Cooperative and Rural Development Bank than one of these sub-categories. In such cases, team in Tanzania. However, some banks in emerging judgment was used to classify the models on a best-�t markets, such as ICICI Bank in India, show similar basis. Because this report classi�es state-owned banks features to developed country models, making use and development banks as support mechanisms in the of innovative methods to reach out to SME clients. SME �nance space, submitted cases are discussed under public support schemes (section 4.5). Of these nine models, three private bank examples have been particularly successful in down-scaling to 4.3.1 COMMERCIAL BANK DOWN-SCALING the SME market and have achieved strong levels of outreach, scale, and sustainability, despite operating Nine commercial bank cases with significant out- in very different environments. The three models reach to SMEs from developed and developing leverage their respective core competency and adapt to countries were submitted to the stocktaking exer- their local environment to effectively serve SMEs. cise. Seven of the models operate in emerging mar- Wells Fargo operates in the United States and is able to kets, one operates in a developed country, and one is rely heavily on transactional lending (e.g., through the implemented at a global level. These models suggest use of technology and credit scoring systems), leverag- that private sector players are �nding effective solu- ing on available credit bureau information, and a rela- tions in reaching to the SME segment, which was pre- tively strong enabling environment. ICICI Bank, on the viously perceived as risky and too costly to serve. other hand, operates in India and primarily follows a Based on distinct characteristics resulting from the relationship lending strategy (e.g., evaluating risk environment in which they operate, these banks are through a combination of �nancial and non�nancial classi�ed into two types: parameters) in order to overcome de�ciencies in its enabling environment. Standard Chartered, which has 1. Developed country banks, which leverage robust operations at a global level, adapts its lending technol- local enabling environments and information tech- ogy to local conditions while seeking to follow a con- nology to reach SME clients and overcome informa- sistent, over-arching strategy. As a result of the different tion asymmetry. They use innovative systems and environments in which it operates, Standard Chartered 52 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 4.1 THREE APPROACHES TO SME BANKING Initiatives: ICICI Bank, Wells Fargo, and Standard Chartered Bank ICICI Bank was initially founded as a development �nancial institution in India in 1955 and today it is the largest pri- vate sector bank in the country. ICICI is implementing its SME banking model in India despite a weaker environment and relatively poor �nancial infrastructure. ICICI’s model is based on an effective segmentation of the SME market by industry and business linkages, a proprietary 360-degree credit risk evaluation covering �nancial and non-�nancial parameters to compensate for SMEs’ lack of �nancial information, and a “beyond lending approach� that relies pri- marily on deposit products and other banking services for SMEs (95 percent of SME clients) rather than only on lending products (5 percent of SME clients). Client servicing is done though multiple channels: relationship manag- ers, doorstep banking, branches, Internet, and automatic teller machines (ATMs), relying primarily on cost-efficient, technology-based channels. Wells Fargo, founded in 1852, is now one of the �ve largest banks in the United States. Wells Fargo decided to enter the SME market space by initially following a learning approach and building a foundation of SME client understand- ing. The bank has capitalized on a strong enabling environment in the United States, making automated use of per- sonal and business credit reports to assess SME risk and relying on an effective legal system that enforces creditors’ rights. In 1992, Wells Fargo pioneered the use of credit scoring systems for small businesses. Today, two thirds of Wells Fargo’s revenues come from its Commercial Banking Group, which serves consumers and small businesses. The bank manages SME credit risk through a total portfolio approach instead of the more traditional individual loan approach, making use of statistical methods that tolerate losses similar to consumer lending. Automation is a key for efficient cost management and fast customer response: credit reports and scoring, a large percentage of credit deci- sions, and customer communication are automated. Customer acquisition is done via branches and direct marketing, which also keep costs low. Standard Chartered Bank was formed in 1969 from the merger between Standard Bank of British South Africa and Chartered Bank of India. In 2002, Standard Chartered implemented a client-centric model on a global scale, separat- ing its SME banking operations as a distinct business within the consumer bank unit, with its own resources and credit processes. Today, the SME banking business unit operates in over 30 countries. Income from SME banking has grown nearly four-fold over the last 5 years. SMEs are sub-divided into small businesses (SB) and medium enterprises (ME). Credit processes for SB follow a more standardized program lending approach, whereas ME credit processes are modeled after wholesale banking. The bank follows three customer acquisition and servicing approaches: larger MEs are served by relationship managers, middle-sized SMEs are managed by a portfolio team via a mix of salesper- sons and virtual relationship managers, and smaller SBs — whose needs are more similar to those of individuals — are serviced by branches. Standard Chartered has a program to assist SMEs in their cross-border trades and expansion plans, and the bank manages costs by leveraging extensively on systems, infrastructure, and resources across both consumer and wholesale banking. SME Outreach SME Financing Facilitated (USD) Average Loan Size (USD) ICICI 946,000 3,000,000,000 3,171 Wells Fargo 764,200 20,200,000,000 26,433 Standard Chartered 550,000 13,300,000,000 24,180 S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 53 uses a mix of relationship lending (primarily) com- by providing equity capital, technical assistance, and bined with some transactional lending. Box 4.1 pres- guiding business principles. BRAC Bank, a commercial ents the different approaches for pro�table SME bank focused on the lower segments of the population, banking followed by these three banking models. is modeled on collateral free SME lending and commu- nity development through a wide distribution network, The cases include several banking initiatives that including remote rural areas. While the SME segment is address specific SME sub-segments, such as gender BRAC’s main target market, the bank’s major share- financing, supply chain, and sustainable energy holder, BRAC NGO, supports primarily micro-entrepre- financing. These models are largely mainstreamed neurs, resulting in the case’s classi�cation under MFI into SME banking practices, but they can also cut up-scaling. Box 4.2 presents a comparison of the three across different categories of interventions in this micro�nance models in the stocktaking. report, including commercial banking, community and state banks, and public support-funded facilities. All stocktaking cases of MFI up-scaling rely heavily Banking initiatives targeting speci�c SME segments on IFI/DFI support in their start-up phase. The IFI/ or addressing speci�c gaps in SME � nance are dis- DFI support is particularly needed in adapting the MFIs’ cussed in section 4.6. lending technologies to serve the new clientele, as well as in building the �nancial institutions’ capacity in staff 4.3.2 MICROFINANCE INSTITUTIONS training and information management. In the case of UP-SCALING BRAC, the bank’s second and third largest shareholders are Shorecap International Limited and IFC, with 7 per- The stocktaking includes four cases of microfinance cent and 5.8 percent ownership respectively. ProCredit institutions (MFIs) that are up-scaling their models to bank models from Colombia, Honduras, and Mexico address the SME segment in developing markets. These were established with equity investments from the institutions have modi�ed their micro�nance business Inter-American Development Bank (IADB), and Access models to incorporate SME operations by taking advan- Holding has investments from EIB (European Investment tage of their market knowledge and network, and by Bank) and committed investments from CDC (Citizens adapting their micro�nance methodologies. Models from Development Corps.), IFC, and the German develop- the stocktaking include three multi-regional models, and ment bank KfW. one local model in Bangladesh. Sample commercial banks that are down-scaling and The models share a common objective based on sample MFIs that are up-scaling to SMEs lean towards socially responsible and profitable banking, targeting different ends of the SME spectrum, based on their primarily microfinance entrepreneurs. The ProCredit strategies and core operational competencies. Group and Access Holding models are both internation- Up-scaling MFIs typically target the lower end of the ally established models implemented in multiple regions SME spectrum, namely very small businesses that have and countries. Two of the submitted cases refer to more features in common with their main target market ProCredit models in Latin America and Bulgaria. BRAC of micro�nance clients, as reflected by the average loan Bank in Bangladesh is largely owned by one of the larg- size of these institutions. For small �rms operating on est non-governmental organizations (NGOs) in the the verge of informality, up-scaling of micro�nance to world, the BRAC NGO, which is known for its micro�- SME �nance seems to have great potential. In such cases, nance support. ProCredit and Access banks are inte- up-scaling would comprise offering �nancial services/ grated under their respective international holding products that cater to the special needs of a small enter- companies and leverage group experience and syner- prise. The bene�ts of up-scaling may encourage a transi- gies. Both holding companies support their group banks tion from an informal to a formal enterprise. However, 54 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 4.2 UP-SCALING TO SMES Initiatives: Access Micro�nance Holding, ProCredit Group, and BRAC Bank Access Micro� nance Holding was founded in 2006 by an international group of private and public investors, with the purpose of investing in a network of micro� nance institutions in low-income countries. Access investments are developed through a combination of growth capital, holding services, and management assistance. Access con- centrates on start-up and early-stage MFIs, and transforms existing non-bank micro-lending institutions into full- service micro� nance banks. To date, AccessBank Network comprises �ve network banks located in Azerbaijan, Nigeria, Madagascar, Liberia, and Tanzania. SME products, procedures, and organizational set-ups were � rst devel- oped, implemented, and improved in the � rst AccessBank (Azerbaijan), which was established in 2006 and is the largest of the network banks. As of December 2009, the AccessBank network had a total outstanding portfolio of USD 320 million, with 120,000 loans outstanding and a portfolio at risk of 0.88 percent (30 days past due). Market rates are applied to clients in all network banks. Since 2008 the bank has registered pro�ts and reached out to 2,200 SMEs. While the four newer banks are still experiencing start-up losses, these are off set by AccessBank Azerbaijan’s pro�ts. ProCredit Group was established in 1998 to invest in both socially responsible and commercially viable MFIs. After consolidating its position in the micro�nance market, the Group began �nancing small businesses with the purpose of diversifying its loan portfolio. The German Development Bank KfW was involved in establishing ProCredit Holding and its precursor at the beginning, and is the largest institutional shareholder in the holding reflecting its support in the buildup of this network. ProCredit has become a pioneer in establishing green�eld full-fledged banks that spe- cialize in micro- and small business lending in developing countries. The ProCredit network comprises 22 ProCredit banks in Latin America, Africa, and Eastern Europe, which adhere to common group-wide ethical, environmental, and professional standards. As of December 2009, more than 89 percent of ProCredit’s outstanding loans were for amounts less than USD 12,000. In the case of ProCredit Bulgaria, ProCredit Holding came together with Commerzbank from Germany and DFI investors (DEG, EBRD, and IFC) in 2001 to establish a specialized SME bank with a total investment of USD 7.3 million. Today, the bank’s asset base comprises 85 percent small business loans, accompanied by a broad and stable deposit base that funds 75 percent of the loan portfolio. In 2007, ProCredit institutions were established in Colombia, Honduras, and Mexico. In cooperation with ProCredit Group, IADB supported the opera- tions with minority equity investments in each bank (USD 3 million, USD 2.5 million, and USD 3 million, respectively) as well as technical assistance for staff training. Micro- and small business outreach is 9,966 for Colombia, 9,265 for Honduras, and 9,303 for Mexico. BRAC Bank Ltd. was established in 2001 with a focus on the small business sector, operating with a “double bottom-line� agenda: a combination of pro�t and social responsibility. The SME Banking unit goes beyond traditional banking and works as a business partner to entrepreneurs, building awareness, providing training, and arranging road shows to sup- port and develop their businesses. BRAC Bank is the premiere small business bank in the Bangladesh in terms of small business loans outstanding, with nationwide coverage and a network (44 percent of coverage is in rural areas). The bank’s small business banking model emphasizes relationship banking and collateral free lending up to USD 14,000. SME Outreach SME Financing Facilitated (USD) Average Loan Size (USD) Access Holding 120,000 320 million 2,666 ProCredit (Bulgaria) 160,000 1.8 billion 11,250 BRAC Bank 100,085 414 million 4,136 S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 55 in some countries up-scaling can entail enormous costs their market and social targets, their retained earnings to the enterprises, with stringent documentation and are reinvested to create a strong equity base, providing disclosure requirements. Down-scaling commercial stability and sustainability. While each bank in the com- banks, on the other hand, tend to focus on the higher munity bank group is independent in its business deci- end of the SME segment, mostly small enterprises that sions, they achieve economies of scale by closely are closer to retail, and medium enterprises, whose cooperating with their network of banks, sharing expe- assessment and servicing is relatively similar to corpo- rience, training, external auditing, and/or political lob- rate and commercial clients. For comparison purposes, bying, which further supports their pro�tability. refer to the average loan size in Boxes 4.1 and 4.2. Three sample community banks mention technol- 4.3.3 COMMUNITY, COOPERATIVE, ogy as a key success factor in the operations. AND MUNICIPAL BANKS Technological support is necessary due to the granu- larity of loans, short — sometimes daily — loan pay- Community, cooperative, and municipal banks are ment cycles. Caja Municipal Sullana in Peru and represented by five cases and tend to have a similar Fedecredito provide wireless Personal Digital Assistants social mandate to MFIs in their goal to serve the (PDA) to their salespersons and loan servicing of�cers, lower segments of the population However, these which allow them to process loan payments and col- banks also tend to serve a broader client base in line lect savings in the �eld during their client visits. This with commercial banks, and further differ from MFIs technology allows them to personally visit clients to in that they are groups or unions of member-owned or assess their businesses, and collect clients’ loan pay- local state-owned banks. While there are differences ments and savings at the same time. among these three categories of banks – such as their ownership structures – they are grouped together for All community bank initiatives in emerging mar- the purpose of this report due to their common inter- kets receive substantial support from DFIs. Financial est in supporting economic development in their com- access is especially scarce among rural entrepreneurs munities. Four of the models in the collection are in developing countries, and the broad branch network being implemented in the developing world, and one of community banks provides the foundation to reach in a developed country. out to rural SMEs. Raiffeisenbank in Bulgaria has loan facilities from EBRD, KfW, and EIF to facilitate access All community bank initiatives claim that proximity to �nance for farmers and small enterprises in rural to their local clients and communities is one of their areas, and to support SME investments in expansions strongest competitive advantages. Close interaction and energy ef�ciency projects. with clients provides banks with the capacity to under- stand and assess client risk more effectively, resulting in The Savings Banks model from Germany presents their ability to support riskier clients that are usually particularly high levels of scale, sustainability and neglected by commercial banks. The German Savings track record. The Savings Banks have been providing Banks Finance Group (Sparkassen Finanzgruppe) pro- loans to MSMEs for over 150 years and have a business vides loans for almost 50 percent of start-ups in Germany. relation with 72 percent of SMEs in Germany (2.6 mil- Despite higher risk-taking, the collection of community lion). The group comprises 438 independent local bank models appears relatively sustainable and pro�t- Savings Banks in every region, which are owned by able. Fedecredito of El Salvador, for instance, currently their municipalities or counties (Box 4.3). This model has an annual internal rate of return of 60 percent and has been replicated successfully by Cajas Municipales has been operating for over 50 years. As community in Peru (including Caja Sullana) since the 1970s. The banks do not seek to maximize pro�t but rather balance Peruvian banks have not only survived economic and 56 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P political crises, they are also �nancially successful and 4.3.4 EQUITY FUNDS the most important providers of �nancial services to SMEs in Peru. SME equity and venture capital funds included in the stocktaking exercise comprise 12 cases of country In general, the unique characteristics of mutual specific funds, regional funds, and funds of funds. banks derive from their membership and owner- Ten of the cases refer to private equity funds and two ship structures, as well as the incentives to meet refer to local government supported equity funds. Due member borrowing needs — including those of to equity funds’ intrinsic risk, these initiatives are typi- SMEs — while managing risk and protecting deposi- cally found in advanced economies; however, 10 cases tors. There is evidence that external donor funding for from the stocktaking collection operate in emerging savings and credit cooperatives — which are a form of markets, including six in Africa, con�rming the grow- mutual bank — can disrupt those incentives and cause ing trend of equity investments in developing countries. unsustainable expansion that no longer protects depos- Such funds have the potential for signi�cant positive itors or serves member needs.92 Therefore, while �nancial and developmental impact, including increased mutual banks and other mutual �nancial institutions employment, skills development, corporate governance are well-suited to serving SMEs, care must be taken in best practices, and innovation. All submitted private supporting their expansion, to ensure that the provi- fund cases are supported by DFI investments, allowing sion of external funding (such as credit lines) is not them to serve dif�cult-to-reach clients. DFI support is disproportionate compared to member deposits and highly desirable, as most emerging markets lack both institutional capacity. highly skilled human resources and the skills to manage BOX 4.3 SME SUPPORT BY GERMAN COMMUNITY BANKS Initiative: Savings Banks Finance Group (Sparkassen Finanzgruppe) Savings Banks was founded in Germany over 250 years ago by philanthropic societies and municipalities, with a mandate to serve the lower segments of the population. SMEs are served on a cost-covering basis and no subsidies are provided. The Savings Banks Finance Group also provides professional training and services to partner institu- tions around the world through its development arm, the Savings Banks Foundation for International Cooperation (SBFIC). The Banks’ pricing policy is market-based, but the main purpose of the Sparkassen’s business is not to maximize pro�t, but rather to promote a balanced approach with both market and social targets. In contrast to stock-listed banks, Savings Banks do not need to maximize dividends nor reduce equity in order to maximize their return on equity (ROE) or their share price. In order to bene�t from economies of scale, Savings Banks cooperate closely through a common network that provides common services to the banks such as training, external auditing and political lobbying. At present, all subsidies to the banks have been removed and since 2005, they operate with- out sovereign guarantees. Today, the Group comprises 438 independent Savings Banks, 7 regional banks, 10 build- ing societies, 6 leasing companies, 3 factoring companies, and 12 insurance companies, among others. The Group provides 42 percent of all corporate loans and loans for almost 50 percent of start-ups in Germany. Success factors from this initiative include: (i) proximity to clients; (ii) stakeholder value instead of shareholder value; (iii) highly sophisticated systems to serving SME and mass markets; and (iv) local re�nancing through deposit mobilization. Amount of �nancing facilitated: USD 230.6 billion in SME loans. SME outreach: 2.6 million 92 As cited by CGAP in Donor Brief 25, 2005 S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 57 BOX 4.4 THREE TYPES OF EQUITY FUNDS Initiatives: Business Partners International Kenya SME Fund, Aureos Regional Funds , and Korea Venture Capital Investment Corp. Local Fund: Business Partners International (BPI) Kenya SME Fund is a private, �xed-life fund established in 2006 that invests in equity, quasi-equity, and debt instruments in Kenyan SMEs. The �rm’s success has attracted DFI and IFI investors, including CDC, Norfund, East African Development Bank, EIB, IFC, and Trans-Century. The fund’s lean organization is viewed as a success factor, with staff performing multiple roles that ensure their full engagement with investments from proposal to realization. BPI provides technical assistance to investee companies in order to strengthen management capacity, information systems, and accounting systems, and also provides consulting sup- port for new lines of businesses. BPI can invest up to USD 500,000 per deal. To date, BPI has approved more than 50 investments in Kenyan SMEs, with a total value of around USD 5 million. Regional Fund: Aureos East Africa Fund (AEAF), Aureos West Africa Fund (AWAF), and Aureos South Africa Fund (ASAF) invest in the Africa region and were set up in June 2003 to have an 8-year limited life, with the support of CDC, Norfund, European Investment Bank (EIB), and IFC. The three funds are wholly-owned subsidiaries of Aureos Capital, a fund management �rm with extensive experience and presence in Africa, Asia, and Latin America. AEAF, AWAF, and ASAF facilitate equity for African SMEs in a commercially sustainable manner. AEAF had a �nal close at USD 40 million, while AWAF and ASAF both closed at USD 50 million. To date AEAF, AWAF, and ASAF have dem- onstrated commercial success, and SME investees have adopted sound governance, environmental, and social stan- dards. Aureos has a successor fund in the market that has raised USD 380 million to date, with a large proportion of private sector investors. Fund of Funds: The Korea Venture Capital Investment Corp (KVIC) is a government-backed fund of funds estab- lished in 2005 to provide stable capital to SMEs in innovative technology sectors. KVIC currently has USD 1.5 billion assets under management in over 150 venture capital and buyout �rms, and commits USD 200 to USD 300 million every year to venture capital funds. The KVIC also supports partnerships funds to invite foreign investors into the funds, promoting global networks and ensuring transparent fund management systems. The establishment of KVIC led to creation and strengthening of Korean legislation to provide stable capital to the venture capital industry, and also influenced the amending of regulation to attract more private investors into venture capital funds. Internal Rate of Return (IRR) BPI Kenya SME Fund low teens Aureos Regional Funds mid to high teens KVIC Fund of Funds 13.8% (multiple IRRs) FIGURE 4.4 EXTERNAL SUPPORTING FACTORS FOSTERING PRIVATE SECTOR INITIATIVES DFI/IFI support 50% Subsidized capacity building 25% Government support 6% Subsidized funding 4% Available �nancial infrastructure 2% None 13% 0 10% 20% 30% 40% 50% 60% 58 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P such funds. Continuous support for equity funds is Subsidized capacity building programs for �nancial insti- solicited in expanding �nancial access for SMEs. tutions and SMEs seek to foster sustainable access to Government-supported funds from the collection �nance for this market segment. Models in which no par- operate in developed countries, namely in Korea and ticular external factors were identi�ed are mostly driven New Zealand. Both funds target specialized SMEs in by internal or private incentives and appear to require no the relatively riskier segments of high-growth technol- external drivers for their development (e.g., Garanti Bank ogy and innovation, reflecting their more mature SME in Turkey). Available �nancial infrastructure provides rel- equity markets and lower information asymmetries evant external support in only one submitted initiative relative to developing countries where equity funds — Wells Fargo — which operates in the relatively solid have recently begun to develop, and thus cater to the enabling environment of the United States. This suggests overall SME segment. that further support to strengthen the enabling environ- ment in most countries can lead to additional private Equity is a necessary complement to debt for high- sector initiatives in SME �nancing. In fact, surveys con- growth, innovative SMEs. As such, development ducted with banks in MENA identify the lack of SME impact is based on financial performance and job transparency and the weak �nancial infrastructure (e.g., creation rather than SME reach. Outreach by equity weak credit information, weak creditor rights, and col- funds ranges from 156,000 to 930 SMEs in the case of lateral infrastructure) as the main obstacles for further funds of funds, and from 120 to 3 SMEs in the case of engagement in SME �nance. External support actions to individual equity funds. Compared to other SME improve �nancial infrastructure can entail expanding the �nance initiatives presented in this report, equity range of movable assets that can be used as collateral, funds have a limited SME outreach, as they focus on improving registries for movables, and improving the best �rms with high-growth potential. These �rms enforcement and sales procedures for both �xed and receive hands-on, in-depth development to encourage movable assets. It can also entail upgrading public credit growth, which often leads to high job growth in the registries and introducing complementary private credit �rms and formalized systems, as required by investors. bureaus capable of expanding coverage and the depth of Box 4.4 compares examples of local, regional, and funds credit information. of funds. Key success factors of these equity fund cases include having a skilled and experienced fund manager, 4.4 The Enabling Environment and achieving the targeted �nancial return through the for Access fund’s investments. In addition, regional funds tend to be preferred over country-speci�c funds in smaller 4.4.1 LEGAL AND REGULATORY INITIATIVES emerging markets, as this allows the funds more access to investment opportunities and outreach. Governmental policy support to lower the barriers to SME financing is demonstrated by stocktaking cases 4.3.5 KEY SUCCESS FACTORS FOR aimed at strengthening financial sector laws and regu- PROVIDERS OF FINANCIAL SERVICES lation, and supporting the creation of an enabling TO SMES environment for SMEs through targeted or integrated approaches. Some models show an increase in the level For the submitted private sector initiatives, an attempt of SME bank loans after the introduction and implemen- was made to identify external supporting factors that tation of legislative and regulatory measures. However, effectively foster the involvement of private sector players conclusive results from these measures, as well as levels of in the SME �nance space (Figure 4.4). Development agen- outreach, are dif�cult to assess due to the lack of qualita- cies appear to play a key role in promoting the mobiliza- tive data. It should be noted that having a strong legal and tion of private funds, primarily through credit facilities. regulatory framework for SME �nance is not suf�cient for S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 59 TABLE 4.3 INTEGRATED APPROACHES TO SME DEVELOPMENT: FRANCE, KOREA, AND MALAYSIA Country Category Initiative France Legal & Regulatory Banking regulation and capital requirement for retail/SME risk under Basel II Financial Infrastructure Fichier Bancaire des Entreprises (FIBEN) Companies Database INFOGREFFE’s initiative for collection of SME information Public Support Scheme OSEO Innovation Facility OSEO Financing Facility for SMEs through FIs OSEO guarantees for SMEs Korea Public Support Scheme Aggregate Credit Ceiling Loans for SMEs through FIs Building up the foundation for active SME direct �nancing Korea Credit Guarantee Fund (KODIT) Korea Fund of Funds: Korea Venture Investment Corp. Network Loan Facility through Industrial Bank of Korea Technology Appraisal Guarantee Scheme Credit guarantee programs for small and micro enterprises Malaysia Legal & Regulatory Comprehensive SME Development Framework Financial Infrastructure SME Competitive Rating for Enhancement (SCORE) Central Credit Reference Information System Public Support Scheme Small Debt Resolution Scheme (loan restructuring for SMEs) Cradle Investment Program to support start-ups MAVCAP Venture capital funding (with outsourced fund management) Venture Debt and Project Financing Facilities for Information & Communications Technology and Biotechnology Companies Perdana Fund for venture capital in high growth, high tech start-ups Credit Guarantee Corporation Malaysia SME Assistance Guarantee Scheme Working Capital Guarantee Scheme Development of a Sustainable Micro�nance Framework Outreach programs to enhance access to �nance by MSMEs Business Advisory Services for SMEs SME Financial Advisory by Bank Negara Malaysia 60 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P expanding access; such frameworks must be effectively cases refer to legislation in developing countries and one enforced in order to maximize their impact. in a developed country. The measures include a range of initiatives, from the development of leasing legislation in Three countries submitted multiple interventions Jordan and Kosovo, to the set-up of mandatory SME lend- that seem to follow a comprehensive approach, ing targets for banks in India. Box 4.5 illustrates the intro- aimed at creating a more conductive environment duction of legislative reform for the creation of a leasing for SMEs by coordinating and addressing SME devel- market in Jordan. This initiative has multiple components opment efforts in an integrated manner. France, that provide policy support to draft and introduce the leg- Korea, and Malaysia appear to follow an integrated islation and capacity building support for leasing stake- SME development approach by submitting initiatives holders in order to develop a �nancial leasing market and that cover a wide range of measures across categories, increase �nancing alternatives for SMEs. including crisis-response schemes. Their SME initia- tives are illustrated in Table 4.3. The case collection includes five examples that aim to support legal policies in developing countries to ben- The stocktaking includes five cases in which legislative efit SMEs, mainly through the provision of loans and and regulatory measures for the financial sector have technical assistance programs to governments or been introduced to promote SME lending. Four of the government entities. Initiatives include support for the BOX 4.5 FOSTERING SME LENDING THROUGH THE CREATION OF A LEASING MARKET Initiative: Jordan Leasing Project Jordan’s Ministry of Industry and Trade, in coordination with IFC, introduced an initiative in 2006 with the objective to improve the leasing environment in Jordan, and to promote and increase the volume of leasing activities. The project’s main activities include: (i) provide support to policymakers to draft, lobby, and promote leasing legislation based on best practices; (ii) build capacity of leasing stakeholders (e.g., FIs, equipment suppliers, investors) through consultations and training; (iii) increase awareness of bene�ts of leasing to MSMEs to �nance business assets; and, (iv) promote and facilitate leasing investments. As a result of the initiative, four laws were introduced: Law on Leasing, Movable Leased Assets Registration Instructions, Registration Instructions for Leased Vehicles, and Internal Procedures for Land Registration. Financial leasing has become more favorable and the leasing market has grown substantially. From 2005 to 2008, annual leas- ing volume more than doubled, from USD 111 million to USD 240 million. At the same time, the number of registered lessors grew from 18 (2005) to 31 (2008) and the cumulative leasing portfolio increased from USD 227 million to over USD 450 million. The leasing market growth is expected to continue as MSMEs are becoming more familiar with leas- ing, and as �nancial institutions have greater capacity and willingness to offer the product. BOX 4.6 FOSTERING AN ENABLING ENVIRONMENT THROUGH COMPREHENSIVE SME DEVELOPMENT APPROACHES Initiative: Comprehensive SME Development Framework Malaysia’s National SME Development Council (NSDC) and SME Corp Malaysia created the Framework in 2004 to increase SMEs’ ability to participate and contribute more effectively to Malaysia’s economic development and growth process. The Framework follows a three-phased approach: (i) strengthening the infrastructure for SME develop- ment; (ii) building capacity of domestic SMEs; and, (iii) enhancing access to �nancing. SME Corp Malaysia was estab- lished to ensure a coordinated and effective implementation of SME development initiatives, including those under this approach. To further enhance the Government’s role, and for greater coordination and focus in SME develop- ment, the NSDC was established in June 2004 to provide direction for Government policies that ensure that suffi- cient support programs are in place and are effectively coordinated and implemented to assist SMEs. Since the establishment of NSDC, various initiatives have been implemented to bene�t policy-makers and SMEs in the areas of improved policy formulation, monitoring and assessment, capacity building of SMEs, enhanced access to �nance, improved statistical information, and provision of a comprehensive dissemination framework. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 61 BOX 4.7 COMPARATIVE ANALYSIS OF CREDIT BUREAU CASES While there are only 11 examples of how this vital component of �nancial infrastructure can signi�cantly reduce information asymmetry, and thereby facilitate access to �nance for SMEs, these cases represent the broad spec- trum of possible interventions. Each case is unique and addresses different sectors of the SME market with meth- odologies that are both innovative and proven. The cases demonstrate the complementary roles of the public and private sectors, and how the strengths of each can be leveraged. As such, there are numerous lessons to be learned and clear opportunities for these initiatives to be replicated and scaled in emerging markets. The most commonly argued case against lending to SMEs from a commercial bankers’ perspective is the per- ceived risk that, for the most part, is derived from the opacity of the business and its owners. The cost of reducing this information asymmetry typically makes the prospect of lending to SMEs uneconomical, especially for smaller businesses and lower value loans. Easy, cost-effective access to information is the key to driving down the cost of acquisition, thereby making the business of serving the SME market more lucrative and sustainable. Each of the high- lighted models goes some way to achieving this goal and has had signi�cant impact on access to credit. Traditional credit risk management underwriting techniques typically used in corporate lending (one-on-one customer relationship management and a reliance on detailed analysis of �nancial statements) are, for the most part, impractical for SMEs in emerging markets. The vast majority of businesses in these countries do not maintain or record detailed �nancial statements and those that do are most likely considered to be unreliable. In many cases, simply con�rming that a small business is correctly incorporated and entitled to trade is a major challenge. To this end, models such as the FIBEN companies’ database managed by Bank of France and Infogreffe’s database of court records and trade registries provide a source of reliable information to validate the bone �de nature of the business in question. They also append to these records both historical credit data (FIBEN) and good will commitments (Infogreffe), which help lenders assess both credit exposure and the legitimacy of proposed collateral. The FIBEN case demonstrates how a central bank can add value in a market in which commercial banks are reluc- tant to share information. Even in developed markets, it is not uncommon to �nd resistance on the part of commer- cial banks to share information, usually owing to a fear that they will lose market share or valuable customers. Central banks have the power to enforce the provision of data on loan performance, initially as part of their duty to monitor systemic risk. However, as the Bank of France illustrates, such banks can also expand this role to provide valuable information back to commercial lenders (despite the fact that positive data, such as the history data of loan accounts that are up-to-date, is currently not available in France). This model has value in emerging markets where private credit bureaus have thus far failed to gain acceptance, although there are limitations in the role of the central bank and different models to overcome these de�ciencies. Having established that a prospective SME customer is legitimate, the next challenge is to establish relative risk, then price the loan accordingly. This is typically achieved by some form of scoring algorithm or credit rating. Objective mathematical modeling of this kind is common in developed markets but faces serious constraints in emerging markets, particularly for smaller organizations with limited experience in the SME �eld. The models in question use historical information to predict a future outcome. Lenders who do not possess such historical data �nd it very difficult to collate the requisite data to build the models. To bypass this situation, credit bureaus and service providers can build generic models, using data from a variety of sources that provide a foundation for implementing this type of methodology. The Banco Estado (Chile) case study demonstrates how this can be successfully achieved within the public sector, while the SMERA case in India is an example of how the private sector can achieve similar results on a commercial basis. On balance, the private sector approach is perhaps more appropriate, as it avoids any potential conflict of interest between the central bank as supervisor to the industry and provider of guidance as to who should be eligible for credit. For markets in which understanding of the SME market place is signi� cantly impaired, there may be value in out-sourcing a greater portion of the credit evaluation process. Some lenders in emerging markets lack experi- ence in working with SMEs and do not know how to evaluate the comparative strengths and weaknesses of poten- tial customers. In such cases, credit bureaus have a role to play in both mapping the landscape and undertaking CONTINUED ON NEXT PAGE 62 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 4.7 CONTINUED detailed diagnostics on behalf of the lender. In both cases, the objective is to reduce information asymmetry and present to the lender a business proposition that is more “bankable.� The FINPYME model in Latin America and the SCORE model in Malaysia both achieve this by undertaking detailed diagnostics of both the market place and spe- ci�c industry sectors. Access to traditional credit history data does not overcome reluctance on the part of lenders to make loans to small businesses with little or no track record. The majority of credit bureaus and public registries maintain history data on the performance of existing or prior loans. This information is typically sourced from within the formal lend- ing sector. But many SMEs �nd it difficult to obtain credit simply because they never previously had credit and have had no opportunity to build “reputational collateral� by way of a proven repayment history. Nontraditional credit data, such as payment history on contractual obligations with utilities and telecommunications companies, can pro- vide a good proxy for repayment behavior and has been statistically proven (see Policy and Economic Research Council — PERC research) to add value to the credit evaluation process. Capturing this data enables SMEs to build a credit pro�le without access to formal credit. This form of credit reporting is particularly important at the bottom of the pyramid (micro-�nance), as demonstrated by the San Riegos project in Nicaragua. Expanding beyond collecting data from the formal banking sector is one of the limitations faced by public registries and is, therefore, one of the core strengths of the private credit bureau sector. Perhaps the biggest challenge to providing services to help reduce information asymmetry in the SME space is the shear diversity of the entities in question. SMEs are not homogeneous, and are in fact intrinsically heteroge- neous. While some of the case studies recognize this fact, there is still a tendency on the part of lenders to consider SMEs as smaller versions of their larger corporate client base. While these lenders may entertain a top-down strategy to develop services to the “M� sector, few recognize the potential of the mass market of SMEs, over 90 percent of which are small and micro-enterprises. Engaging these clients requires an altogether different approach, one that is more commonly aligned with retail banking methodology. At the lower end of the SME spectrum, the �nancial behavior of the individual business owner is, for all intents and purposes, the same as his or her personal �nancial circumstances. To penetrate this market requires a detailed understanding of both retail lending methodology and access to personal credit data. There is no single, universal solution, as different models address different circumstances. Following the Asian �nancial crisis in 1997, Bank Negara (Malaysia) recognized the importance of sharing credit data as a means to improve the quality of lending decisions and prevent over-indebtedness. As such, the bank initiated the Central Credit Reference Information System (CCRIS) project, which today provides perhaps the most comprehensive repos- itory of �nancial data in the region. The data set incorporates information on both individuals and companies, and is used by practically all lenders in Malaysia. The CCRIS database is among the best examples of a modern public reg- istry, but while it adequately serves the needs of the retail sector, it has its limitations in the SME sector. Recognizing these weaknesses, Bank Negara is exploring ways to develop more SME-centric services in cooperation with the Credit Guarantee Corporation of Malaysia and the private sector. In Egypt, the central bank also recognized its capacity limitations in respect to credit reporting and decided to encourage more active participation from the pri- vate sector. Local banks were tasked with forming a private credit bureau (IScore) to which was added the historical data from the public registry. This bureau is now looking to expand its data coverage to non-bank �nancial institu- tions and the MFI sector. The central bank in Morocco adopted a more public/private partnership approach. Recognizing its ability to enforce participation in the credit information sharing environment, it engaged the private sector to build a platform for information sharing, which the central bank ultimately controls. Data within the public registry is available to any licensed private sector credit bureau to enhance, append, or build value added services. Each of these initiatives could be replicated in other markets, depending on the stage of market development and the willingness of lenders to participate in information sharing. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 63 strengthening of SME Credit Management Systems in the Philippines and the development of �nancing poli- Credit where credit is due: the Singapore example in cies and mechanisms for SMEs in China. Four of the promoting the development of SMEs. It is no coinci- �ve cases are supported by DFIs, which is not surpris- dence that Singapore consistently tops the World Bank Doing Business ratings on Getting Credit. The combina- ing considering DFIs’ signi�cant involvement in policy tion of public sector policy reform and private sector reform support in emerging markets. The comprehen- implementation is effectively demonstrated in the case sive SME development framework created by the of Credit Bureau Singapore (CBS). This bureau was Malaysian government, illustrated in Box 4.6, aims to another post-crisis initiative, but unlike Malaysia, the support the promotion of SME development and their Monetary Authority of Singapore (MAS) tasked the pri- participation in the economy from multiple fronts, vate sector with building an industry-wide credit infor- mation system. Membership and participation in the including comprehensive development programs to bureau remains heavily supervised by MAS, but CBS has enhance SMEs’ capacity and access to �nance support. been given free rein to develop a service offering that To translate Malaysian SME development strategies into meets all the market needs, with particular focus on effective results, the National SME Development supporting SMEs. The bureau combines information Blueprint has been established as a structured approach from both the consumer and the corporate sectors, to track the implementation of SME development pro- which it blends with commercial trade credit data, effec- tively linking the personal credit behavior of individuals grams. The Blueprint outlines: (i) objectives, strate- with the businesses they run. More recently, the bureau gies, and targets for SME development; (ii) key has launched a “blended credit score� designed to pro- programs and �nancial commitment; and, (iii) minis- vide an evaluation of risk for any business, large or small, tries and agencies involved in the implementation of based on statistically proven characteristics. The such programs. However, monitoring data are not yet research and development for this offering was funded available to assess the impact of this initiative. by SPRING, a government institution (Singapore Business Federation) and developed by Fair Isaac, a globally recognized leader in the development of credit 4.4.2 FINANCIAL INFRASTRUCTURE scoring solutions. While the bureau is still relatively young, the value of these techniques has been proven The private sector considers an enabling environ- previously in developed markets such as the United ment, including financial infrastructure, to be a key Kingdom and Australia, and represents an example of success factor for SME finance development. Despite effective modern credit bureau methodology. their key role in reducing information opacity and Sharing of information is good for business, good for asymmetry to increase the supply of �nance for SMEs, lenders, and good for SMEs. Each of the highlighted only 13 models for �nancial infrastructure were sub- cases demonstrates how increased access to informa- tion can lead to better, easier, and more cost-efficient mitted. Over 75 percent of these cases are implemented lending decisions. The case is intrinsically win-win. in developing countries in East and South Asia, Latin Improved �nancial infrastructure reduces information America, and Middle East and North Africa; eight are asymmetry, reduces the cost to serve, and makes lend- supported by DFIs. ing to SMEs less risky and more viable and sustainable. At the same time, credit reporting helps to prevent Financial infrastructure cases represent a variety of unnecessarily risky loans and over-indebtedness, and promotes responsible lending and a fairer allocation of initiatives, including 10 models for credit bureaus, capital. In turn, understanding the value of reputational and one model each of collateral registries, SME collateral helps SMEs appreciate the importance of rating agencies, and SME banking codes of conduct. maintaining a good credit history and promotes better Access to credit information is needed when applying repayment behavior. modern �nancial technologies to credit decisions for the SME market segment on which �nancial informa- tion is particularly lacking. Success factors mentioned 64 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 4.8 ADDRESSING DEFICIENCIES IN FINANCIAL INFRASTRUCTURE Initiative: Credit Bureau Singapore, FIBEN Companies Database, China’s Collateral Registry, and SMERA SME Rating Agency Credit Bureau: Credit Bureau (Singapore) Pte (CBS), with support from the Government of Singapore (SMART), rec- ognized at the beginning of the �nancial crisis that lending to SMEs was tightening and that additional tools were need to reduce information asymmetry. CBS is one of the few private credit bureaus in South East Asia that collates data with respect to both consumers and businesses. Through its association with Dunn & Bradstreet, CBS has access to the “trade credit� data of thousands of Singaporean companies. In May 2010, CBS, in association with Fair Isaac Corporation, launched a purpose-built credit scoring solution designed to accurately quantify the risk (prob- ability of default) associated with SMEs’ applications for credit. The algorithm behind the score incorporates credit history data from the business, including trade credit experience, and blends this with the personal credit history of the business owner and/or key stakeholders. This form of blended score is especially useful when assessing the risk pro�le of smaller businesses, where detailed �nancial information is either not available or often unreliable. Companies Database: FIBEN is a corporate database set up by France in 1982 to facilitate the implementation of monetary policy and verify credit quality of bills issued for rediscounting. FIBEN is managed by the Banque de France. Credit institutions and public economic bodies have access to the FIBEN database, which contains data nec- essary for the analysis of credit risk (identity, legal event, management, indebtedness, �nancial appraisal by the Banque de France), serving as an important tool for analyzing risk, making decisions, and monitoring companies. Companies may also gain access to re�nancing through the banking system, using private bills as collateral and sup- ported by the central banks’ payment systems operations. As of November 2009, the total amount of credit to SMEs in France was USD 262.4 billion. Credits granted by the banking sector to SMEs increased by over 1.9 percent between November 2008 and November 2009, whereas credits granted to the private sector in general decreased by 0.9 percent over the same period. Collateral Registry: In 2004, China embarked upon a reform of its movable collateral framework to encourage � nancing against valuable movable assets. Before the reform, use of movable collateral under Chinese law was a key constraint for SME � nancing, as bank lending was largely based on real estate collateral, which SMEs typically do not possess. The model had three phases: development of the property law; creation of an electronic registry for pledged assets; and training of lenders to use movable assets as a basis for lending. As a result of the reform, USD 910 billion in loans were facilitated, 40 percent of which went to SMEs. Through awareness raising and knowl- edge dissemination, the reform led to further development of factoring, from USD 6.4 billion in 2004 to a value of USD 77 billion in 2008. SME Rating Agency: The government of India initiated the creation of SMERA in 2005, in coordination with other stakeholders, including 11 public and private FIs exposed to SMEs, in order to improve credit flow to the MSME sector. Diversi�ed equity ownership by 11 banks enabled the lenders to accept SMERA’s ratings and extend both �nancial and non-�nancial bene�ts to well-rated SMEs. SMERA ratings categorize MSMEs based on size, so that each MSME is evaluated among its peers. The pricing policy aims to keep fees affordable for SMEs. The rating fee does not exceed USD 1,155, for which the government provides a 75 percent rating fee subsidy. SMERA has completed over 6,500 ratings. The ratings have improved access to bank �nancing for at least 20 percent of rated clients, and col- lateral requirements have decreased in 10 percent of rated cases. A rating renewal in 20 percent of cases indicates usage of ratings for monetary bene�t as well as a self-improvement tool. By the end of 2011, SMERA operations are expected to generate pro�ts of 15 percent. Over the course of the global �nancial crisis, the perspective of bankers has shifted from heavy reliance on External Credit Rating Agency reports as a risk mitigation tool toward local rat- ings, helping SMERA to increase its business from the lenders. However, a challenge for sustainability of the model lies in the government subsidy of rating fees. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 65 by credit bureau cases share similar trends, including: 4.5 Public Support Schemes (i) an active exchange between the agencies that col- lect data and the suppliers of data to maintain an Governments actively seek to encourage access to updated database; (ii) the use of non-traditional data finance through direct government interventions. sources to assess a company’s credit risk; and (iii) As such, public support schemes comprise the larg- increasing or recurring use of the database by the est share of cases in the collection with 109 models. �nancial sector (Box 4.7). The government support initiatives with the greatest representation in the stocktaking exercise include: One model each of a credit bureau, a company’s Funded �nancing facilities extended via state banks database, an SME rating agency, and a collateral reg- and/or private �nancial institutions; istry illustrate the positive impact of financial infra- Credit guarantees also extended via state banks and/ structure initiatives in reducing information or private �nancial institutions; and, asymmetries and improving financial access by State bank initiatives. SMEs. The Credit Bureau Singapore was created in 2002 as the country’s �rst commercial credit bureau, 4.5.1 FUNDED FINANCING FACILITIES with the objective of helping lenders make faster and better-informed credit decisions. The FIBEN compa- The stocktaking exercise includes 54 cases of funded nies’ database, managed by Bank of France, was estab- facilities, which account for the highest share of lished to facilitate the implementation of monetary public support schemes at 49 percent. Models from policy and payment systems operations, and provides every region of the world are represented, two-thirds of banks with access to needed data for credit analysis. which are implemented in developing countries, most Over 1 million SMEs in France have bene�ted from of which are in Africa. Regional and global facilities are this model. In addition to strengthening France’s �nan- presented in eight submitted cases. Funded facilities cial infrastructure, the initiative has supported the range from simple structures such as loans for SME on- strengthening of legislation for SME development by lending through the �nancial sector, to more complex providing the central bank with all rights to collect lending structures involving lending facilities with vari- data and give access to such information to the bank- ous components such as risk-sharing mechanisms, ing community. India’s SMERA is the country’s �rst capacity-building support, and technical assistance fea- rating agency focusing on the MSME sector, and pro- tures for SME lenders and/or SME borrowers. The col- vides comprehensive ratings for the use of �nancial lection includes a balance between simple structures of institutions in the assessment of credit. By the end of funded facilities that are relatively easier to structure or 2011, the agency is expected to have reached over faster to implement, and structures with multiple com- 80,000 SMEs. Following China’s reform of a movable ponents that may have a broader impact on SMEs by collateral framework and establishment of the receiv- addressing market de�ciencies from various fronts. ables registry, SMEs can now use movable assets, such as inventory and receivables, as a basis for borrowing. Models supported by governments include 28 cases, The percent of movable=based lending in China has while DFI-supported models are represented by gone from 12 percent to about 20 percent since the 26 cases. Fourteen models include grants and/or sub- reform, which has facilitated approximately USD 340 sidy components, most of which are government-sup- billion in credit to 48,000 SMEs in the 2 years of its ported models. Subsidized interventions from the existence (Box 4.8). collection fall under two categories based on 66 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 4.9 COMPARATIVE ANALYSIS OF FUNDED FACILITY CASES Funded Facilities often direct credit toward a speci�c sector, such as SMEs and infrastructure. In many emerging markets, potential borrowers in certain productive sectors — even though they are viable and bankable — may not have full access to �nancial services. This market failure may be due to infrastructure problems, such as lack of lender experience, or real sector policies, such as nonexistent or weak land titles. Directed credit through funded facilities, when managed appropriately in the context of actions to eliminate the sources of market failure, can help overcome such obstacles sustainably. Some of the key factors of successful facilities are highlighted below. 1. Complementing Funding with Capacity Building/Technical Assistance. The analysis shows that a key design feature is to complement funding interventions with tailored capacity building programs. This factor is closely related to ensuring the quality of private �nancial institutions (PFIs). For example, the EU and EBRD SME Finance Facility features a comprehensive technical assistance program managed by EBRD, funded by the European Union, and aimed at developing the capacity of PFIs to engage in SME �nance on a sustainable basis. By complementing the restricted-purpose credit line with valuable capacity-building technical assistance, the Facility equips PFIs with the tools, human resources, and a change in attitude towards the segment (for more details on the EBRD/EU SME Finance Facility, please refer to Box 4.18). The German Azerbaijani Fund (GAF), a revolving credit fund, funded by KfW, provides a case for the importance of selecting appropriate PFIs and building PFI capacity. The GAF Facility started in 1999 when the German Federal Government (represented by KfW) extended a credit line to the Republic of Azerbaijan totaling 8.6 million EUR (according to IDA conditions). As of December 31, 2009, within the framework of the GAF, six partner banks have disbursed more than 20,000 loans for a total volume of USD 120 million. At the outset, GAF focused on strengthening the overall institutional capacity of partner banks with regard to organization, internal control, and risk management. A key GAF focus was to establish organizational preconditions for SME lend- ing and to implement delegation and control mechanisms. The provision of loans to SMEs resulted in bene�ts to the partner banks (risk diversi�cation, pro�tability, and pro�t smoothing) and to the community, by contributing to job creation. The impact analysis shows that 54 percent of the SMEs and 26 percent of the microenterprises have raised the numbers of full-time employees. 2. Balanced Government and Private Sector Role. While the de�ning feature of Funded Facilities is that these pro- grams represent government supported initiatives, the role of the government must be appropriately balanced and tailored to the project objectives. For example, the Inovar Program — which is fostering the creation of an SME ven- ture capital market in Brazil — showcases how important it is both to leverage the government role and to incorpo- rate a strong private sector delivery angle. The program was funded through a technical assistance grant with money from the Multilateral Investment Fund (MIF) and FINEM (Brazilian government agency), totaling approximately 11.1 million USD. FINEP hired new staff for the Program, with a private sector mentality from the beginning and trained staff in venture capital best practices. A key success factor was gaining engagement and support from the private sector, especially local and international fund managers, which considers FINEP and the MIF’s investments as a seal of quality that facilitates fundraising with other investors. 3. Niche Sector-Speci�c Focus. Funded Facility cases with a niche, sector-speci�c focus demonstrate strong repli- cability potential. The Inovar Program, which was targeted to Brazilian technology-based SMEs and towards foster- ing the creation of an SME venture capital mar ket in Brazil, served as model for MIF projects in Peru and Colombia and envisions further replication in Africa and Asia. Malaysia’s Cradle Investment Programme (CIP), the country’s �rst development pre-seed and commercialization funding programme supporting the conversion of innovative technologies ideas to a successful SME technology start-up, can be replicated in a developing country that aspires to build a critical mass of technology entrepreneurs and develop a dynamic innovation ecosystem. Similarly, Malaysia’s Venture Debt and Project Financing Facilities for Information and Communications Technology (“ICT�) and Biotechnology Companies Program, implemented by Malaysia Debt Ventures Berhad (MDV), has high replica- bility potential for interventions in other country’s technology sectors, given the universal nature and characteristics of the technology sectors. As of December 2009, MDV approved applications to �nance more than 388 ICT and Biotech projects cumulatively since 2003 with total loans amounting to USD 1.4 billion. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 67 BOX 4.10 SMALL BUSINESS LOAN PROGRAM WITH CAPACITY BUILDING AND TECHNICAL ASSISTANCE COMPONENTS Initiative: Small Business Loan Program — SELP II SELP II was created in Turkey in 2008 as a small business lending program (mainly long-term lending) with a techni- cal assistance component for on-lending through private banks. Implementing organizations of the initiative are the Undersecretariat of Treasury (European Commission), KfW, and Council of Europe Development Bank (CEB), Private Commercial Banks, and the Frankfurt School of Finance and Management. SELP II originated from the successful creation and implementation of SELP I in 2002, but with higher volumes and broader outreach. The program lever- ages funds sourced from European Union (EU) grants to Turkey and includes the following components: (i) the European Fund for Turkey is a revolving fund totaling USD 116 million for small business on-lending through banks, with a structured fund comprising EU grants and public funds (�rst loss tranche), and DFI funds (mezzanine tranche). Issuance of shares for private investors is projected for the near future; (ii) Exchange Risk Coverage Fund for USD 2.4 million to mitigate currency risk, as loans by banks are denominated in local currency; and (iii) technical assistance aimed at improving small business lending capacity of banks. TA is delivered by a consulting �rm and supervised by the Treasury and KfW. Participating banks are funded with close-to-market conditions, and the pricing for loans to SMEs is also market based. Amount of �nancing facilitated: USD 118 million SME outreach: 7,275 BOX 4.11 COMPARATIVE ANALYSIS OF CREDIT GUARANTEE MODELS An analysis of the 31 cases on credit guarantees shows that country models submitted differ on fundamental design features. The key design parameters — eligibility criteria, coverage ratio, fees, and payment rules — vary substantially across schemes. For example, the main Korean scheme (KODIT) has generous ceilings (loans up to 3 USD million), while the Canadian scheme (SBFP) is targeted toward small investment loans (up to USD 500,000). Coverage ratios are �xed and low in several African countries (50 percent) but can be as high as 90 percent in other cases. Fees are �xed and low in some cases, and high and risk-based in others. Payment rules are stricter in some developed countries such as the United States (payments based on realized losses after loan recovery) and more generous in other countries (payments triggered by default and initiation of loan recovery). These differences in design reflect to some extent local conditions and the different weights given to conflicting objectives. For example, developed countries can maintain stricter payment rules because loan recovery is more efficient, while the same rules would make the system unattractive in some developing countries. Design features also reflect the weights given to different objectives. The Canadian scheme focuses on additionality, while the main Korean scheme emphasizes outreach. While the stock-taking exercise entailed an effort to examine outcomes and replicability, the variety of local conditions and the existence of trade-off s underline the need for pragmatism. Regarding outcomes, some of the submitted schemes are too young and cannot be properly assessed, although some look more promising than others. Several schemes introduced in Africa in recent years seem to have a limited outreach (less than 100 guarantees issued). This could be partly explained by the low coverage ratio in some of these schemes (50 percent), possibly insufficient to cover the risks and attract the interest of credit institutions. At the same time, the schemes introduced in Afghanistan and Palestine have generated some positive initial outcomes (about 1,200 loan guarantees issued and low loan losses), and have also contributed to the build-up of capacity in participating institutions, showing that credit guarantee schemes can work in challenging environments. Several of the submitted cases entail recent schemes especially created to soften the impact of the �nancial crisis. Some countries simply scaled up the resources of their main schemes to meet the higher demand for guaran- tees resulting from the crisis (e.g., Korea), while other countries created special schemes with pre-de�ned funding and time limits. For example, the submitted cases include temporary schemes recently introduced in Germany, the Netherlands, Malaysia (two separate schemes), and Turkey. These schemes seem to have softened the impact of the 68 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P the purpose that they serve: (i) medium and long-term average outreach, with 139 SMEs, while loan facilities initiatives developed for vulnerable SME groups with through �nancial institutions have the broadest average the least access to �nance, such as France’s Agency for outreach with 55,000 SMEs. Despite differences in Innovation (OSEO) model for innovative small enter- design features, several facilities share common views prises, and (ii) short-term initiatives that support SMEs on successful implementation criteria. Some of these in times of crisis, such as Turkey’s subsidized interest criteria include: close coordination among implement- rates for SME groups during the recent global crisis. ing parties, support and/or partnership with private While subsidies and grants can be justi�ed under cer- sector entities, lean structures with staff performing tain conditions, they are likely to face sustainability con- multiple roles and good quality of human capital, and straints, as discussed in Chapter Three. Moreover, it is the use of information and online technology to provide critical to ensure that such programs do not crowd out ef�cient turnaround to clients (Box 4.9). other private sector players who are engaged in SME �nance activities without the bene�t of subsidies. One model illustrates a facility with multiple compo- nents, designed to maximize the leverage of public Outreach for funded facilities varies, depending on funds under effective coordination by stakeholders the design features and objective of the model. For from the public, development, and private sectors. example, facilities for equity investments have the lowest The SELP II program in Turkey uses grants and public credit contraction somewhat, but the available information does not allow an in-depth evaluation of their effective- ness. It is also difficult to assess the pros and cons of the option of scaling up the resources of existing schemes to address the crisis versus the option of creating completely new schemes for this purpose. Several mature schemes seem to have had a reasonable performance overall, although outcomes still differ in important aspects. The table below shows that the Chilean, Korean, and French schemes seem to have achieved a good outreach, although that does not necessarily mean that these schemes have been equally successful in achiev- ing additionality (i.e., restricting guarantees to SMEs that would not have had access to credit otherwise). The Canadian scheme has a lower outreach ratio than these schemes, but this is partly due to a stricter targeting policy (smaller and riskier SMEs), suggesting higher additionality. However, few of the schemes have made an effort to evaluate rigorously their economic impact, and accurately measuring additionality remains a challenge, as noted in Chapter Three. The net loss rates of these schemes vary between 1.5 and 3.5 percent, suggesting that they are �nan- cially sustainable, but the information provided does not allow a full assessment of long-run sustainability. SA M P L E O F C RE D IT GUARANTE E S CH E M ES SU B MI TTED Amount of Guarantees Country Year Started Number of Guarantees Issued/Year Issued per Year (USD) Total Per Million People Netherland – BMK 1915 3,200 200 700 Million Chile – FOGAPE 1980 30,000 1,800 450 Million Korea – KODIT 1976 200,000 5,000 25 Billion Canada – SBFP 1999 10,000 300 1 Billion France – OSEO 1982 80,000 1,250 4 Billion USA – SBA 7 (a) 1959 80 000 266 10 Billion India – CGTMSE 2000 100,000 78 900 million Note: Average 2006–2008 S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 69 funds in combination with DFI funds to leverage private 4.5.2 CREDIT GUARANTEES sector capital through a local currency structured lend- ing facility and exchange risk coverage fund for SME on- As part of the stocktaking exercise, 31 models of lending through banks, combined with a DFI-supported credit guarantees were submitted by 20 partici- technical assistance component for institutional capacity pating countries (including the EU). These models building of banks dealing with SMEs. Grant and public account for 29 percent of government support funds bear in full the �rst loss in case of payment default schemes and 19 percent of all cases submitted, rep- on the loans and provide a risk cushion for private sector resenting the second largest category in the collec- investors in the fund. The project aims at addressing tion after funded facilities. Some countries submitted currency risk for lenders and borrowers, strengthening more than one scheme, including the main guaran- the ability of banks to mobilize their own long-term tee scheme and complementary schemes targeting lending resources (Box 4.10). particular SME segments or types of loans (e.g., BOX 4.12 TWO PROMISING MODELS OF PARTIAL CREDIT GUARANTEES Initiatives: FOGAPE and Small Business Financing Program FOGAPE is a Chilean SME guarantee fund and government initiative to increase access to �nance to SMEs by provid- ing a partial credit guarantees to banks in favor of SMEs who lack necessary collateral to gain access to credit, or need longer maturities. FOGAPE guarantees are risk sharing instruments meant to leave some risk with the lenders. The fund was originally �nanced by the government, but over time pro�ts from operations contributed signi�cantly to the fund’s capital base. The Small Business Financing Program (SBFP) is a statutory loan-loss guarantee program in Canada. Loans are approved and funds provided and disbursed by private sector lenders. The purpose of the SBFP is to increase the availability of �nancing for the establishment, expansion, modernization, and improvement of small businesses. The SBFP shares in the risk of lending to SMEs by sharing in loan losses. In the event of default, the SBFP will pay a lender 85 percent of the eligible loss. FOGAPE SBFP Outreach (per year) 30,000 guarantees issued 10,000 guarantees issued (1,800 per million people) (300 per million people) Sustainability Net loss rate = 1.5% Net loss rate = 3% Additionality Increases probability for small �rms to get 74% of �rms using the guarantee would credit by 14 percentage points not have been able to get a loan otherwise PCG Design Targeted to small �rms (low ceilings) Targeted to small �rms (low ceilings), investment loans Portfolio approach Portfolio approach Variable coverage ratio (70%-80%), higher for investment loans Lower coverage ratio for larger loans Unique bidding procedure Reasonable fees (2%) Risk-based fees, set at reasonable levels Strict payment rules (1%-2%), depending on default rates Evaluation efforts 70 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 4.13 TWO EXAMPLES OF STATE BANKS ADDRESSING SMES Initiatives: Development Bank of Canada and Banco Estado Development Bank of Canada (BDC) provides support to businesses in all stages of development, with particular focus on riskier segments than those targeted by commercial banks, including SMEs. Because the pricing policy of BDC reflects the risk of the borrower, loans from BDC are generally more expensive than loans from commercial banks. BDC is expected to generate a return similar to the long-term cost of funding of the government. BDC has pioneered innovative solutions for entrepreneurs. It was the �rst institution to offer flexible long-term loans to busi- nesses and was also one of the �rst banks to offer an integrated approach to business development via its �nancing and advice to improve Canadian business capacity. While non-performing loans at BDC are higher than those of its peers due to higher-risk clients, revenues are sufficient to ensure a consistent return in line with shareholder objec- tives. BDC has played an important countercyclical role during the �nancial crisis. While credit conditions were tight for many entrepreneurs — particularly in the manufacturing sector — BDC’s �nancing and securitization services increased and produced record results. BDC increased its loan allocations about 50 percent in �scal year 2010*, compared to the same period of the previous year. This was achieved by participating in syndicates and replacing departing lenders; sharing new deals with other �nancial institutions on a 50/50 basis; buying commercial mort- gages; and creating a line of credit guarantee. In addition, BDC supported a government program for purchasing term asset-backed securities. In the context of the crisis and as a way of supporting Canadian businesses, BDC decided to increase its tolerance to risk. As a result of BDC’s sophisticated enterprise risk management system, the bank was able to maintain risks at a desired level. Banco Estado of Chile targets SMEs and segments of the population not generally served by commercial banks. The Chilean government supported Banco Estado in its early years, but later pushed an autonomous and independent management of the bank. Banco Estado has since competed in an open �nancial market and reinvests the bank’s own pro�ts in order to grow. Competition and prudential regulation have supported Banco Estado’s sustainable business model. Pricing policy is based on market references and the bank is not allowed by law to subsidize credit operations or lend to state-owned institutions. Banco Estado applies the same standards of efficiency as the rest of the commercial banks, and is required to have a return on equity aligned with the average of the banking industry. In association with private partners, Banco Estado has been efficient at using its broad, countrywide capacity to pro- vide access to MSMEs, as well as low-income households. In 2009, Banco Estado played an important countercycli- cal role in the Chilean economy by providing credit to companies and individuals that, as a result of the crisis, were no longer eligible for credit from privately owned commercial banks. Under strict control of the risk parameters, BancoEstado increased its market share by almost 3 percentage points, from 13.3 percent to 16.2 percent, between December 2008 and November 2009. Another decision that proved to be material was an anticipated reduction of the foreign exchange net position of the bank to levels close to zero. The sound �nancial position of bank at the beginning of the crisis and the timely capitalization of the bank (USD 500 million) were essential for applying coun- tercyclical �nancial policy. BDC Banco Estado SME Outreach 27,617 24,017** Financing facilitated (USD) close to 19 billion*** 613 million** Net pro�ts (USD) 90 million (2009) 86 million (2008) *BDC’s fiscal year 2010 ran from April 1, 2009 to March 31, 2010 **Data refers only to Banco Estado’s SME lending guarantee fund (FOGAPE) ***Financing facilitated refers to the size of BDC’s portfolio S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 71 high-tech SMEs, microenterprises, and investment The state bank models from Canada and Chile provide loans), especially designed to soften the impact of access to finance and capacity building to SMEs and the � nancial crisis. These countries include Korea, other segments of the population while maintaining a Malaysia, the Netherlands, and the United States. positive and sustainable track-record. Both banks are The large number of credit guarantee schemes sub- playing an important countercyclical role in their local mitted is not surprising, as these schemes are a pop- economies in response to the global �nancial crisis. Despite ular policy instrument to facilitate SME access to being state-owned, these banks are managed and governed � nance, both in developed and developing coun- independently, with little if no involvement by the govern- tries, as discussed in Chapter Three (Box 4.11). ment. Banco Estado of Chile acts as a full-fledged commer- cial bank competing with private sector banks, while BDC Several of the mature schemes can be replicated in of Canada plays a complementary role to the �nancial other countries, but their relevance depends on the sector and, instead of competing with commercial banks, weights given to different objectives, and replica- provides �nancing for higher-risk transactions not taken on tion will require adapting the design parameters to by other banks, pricing these transactions on a risk basis local conditions. Box 4.12 provides additional infor- (Box 4.13). The two other examples illustrate the use of the mation on two particular schemes — the Chilean state bank network for a particular SME �nancing function, FOGAPE and the Canadian SBFP. The Chilean scheme such as the �nancing of energy saving equipment by has achieved a good outreach with a low net loss ratio MSMEs (India) and support for viable small businesses of 1.5 percent. An evaluation of the scheme suggests facing dif�culties by facilitating rescheduling or restructur- that it increases the probability of SMEs obtaining ing of �nancing facilities and, where appropriate, provid- credit by 14 percent. These good results are due to an ing new �nancing to these enterprises (Malaysia). innovative design that includes a bidding procedure and risk-based fees. The Canadian scheme is an inter- 4.6 Models Addressing Speci�c Gaps esting example of a scheme that has been able to achieve a reasonable outreach despite a strict target- Beyond the various categories of interventions ing policy. An evaluation of the scheme suggests that described above, a few initiatives from the stocktak- 74 percent of �rms using the guarantee would not ing seek to address more specific market gaps in SME have been able to obtain a loan otherwise. The net finance. These cases cut across different categories of loss ratio has been kept at 3 percent, despite the intervention (e.g., private sector initiatives, public sup- higher risk of the targeted population, possibly due to port schemes, �nancial infrastructure) and include: strict payment rules. Crisis-response; Gender �nance; 4.5.3 STATE BANKS Sustainable energy �nance; and, Other innovative models. State bank models are represented in four93 cases of the stocktaking exercise. One of the submitted models 4.6.1 CRISIS RESPONSE comes from Canada, while three models are from developing countries in different regions: East Asia Various cases in the stocktaking aim to support SMEs and the Paci�c (Malaysia), Latin America (Chile), and in overcoming periods of crisis with the least possible South Asia (India). All four models share a mix of impact. Some of the models from the collection are spe- policy and commercial mandates. ci�cally designed as crisis-response mechanisms, while 93 One of the five models refers to Banco Estado in Chile, which submitted two cases: a credit bureau and a credit guarantee initiative. Both cases are also classified under those respective categories (e.g., financial infrastructure and credit guarantees). 72 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 4.14 PRIVATE INITIATIVE IN RESPONSE TO ECONOMIC CRISIS Initiative: Union of Chambers and Commodity Exchanges of Turkey (TOBB) Support Program The TOBB Support Program was created in 2001 by TOBB, a private non-pro�t business organization, together with 16 Chambers and Commodity Exchanges in Turkey, in order to support SME exporters during a period of crisis in the �nancial sector. The initiative aims to increase credit volume for SMEs through the banking system. Under this struc- ture, TOBB makes deposits in selected public banks (Eximbank and Halkbank), creating a pool of funds that used by the banks to provide loan packages for SMEs. TOBB’s (and its members’) cash funds are used to: (i) buy commercial paper issued by Eximbank; and (ii) make 1-year deposits in Halkbank. The pool of funds is used by the banks to on- lend to SME members of TOBB as 1-year cash credits at below-market rates. The banks are in charge of the selection and servicing of loans for SMEs. Amount of �nancing facilitated: USD 813 million SME outreach: 33,192 BOX 4.15 TWO MODELS FOR SME GENDER FINANCE Initiatives: Financing women-owned SMEs (Nigeria) and Women Entrepreneurs’ Package (Turkey) The program for �nancing women-owned SMEs was created under the coordination of Enterprise Development Center (EDS), Fate Foundation, and IFC, in order to support African �nancial institutions. The initiative consists of a direct credit line for on-lending to women-owned SMEs, coupled with an advisory service program for �nancial insti- tutions to assist them in expanding their reach to women-owned SMEs. The three components of the program are: (i) advisory services to �nancial institutions; (ii) capacity building for banks to increase growth prospects of women- owned businesses in the program, training them on �nancial literacy, trade, business planning, etc.; and (iii) invest- ments by IFC in banks to support increased lending to women-owned SMEs. Since 2006, the program has been implemented by Access Bank PLC Nigeria. Access Bank has received USD 15 million in IFC loans but has lent over USD 35.5 million (with non-performing loans of less than 0.5 percent). Close to 700 women have been trained as part of the program. The Woman Entrepreneur’s Package has been offered by Garanti Bank in Turkey since 2006, with the objective of meeting businesswomen’s communication networking, training, and �nancial needs, and thus help grow their busi- nesses. The package includes: (i) a support loan (term up to 60 months, grace period, and a special rate); (ii) supple- mentary banking products (overdraft account, point of sale (POS) terminal, business credit card, insurance coverage, and automatic payment orders); and (iii) networking and training support, including Women Entrepreneur meetings organized by Garanti and the Women Entrepreneurs’ Association — KAGIDER, Turkey’s Women Entrepreneur of the Year Contest, along with a free training program known as “Basic Entrepreneurship,� Results from the package reflect that USD 157 million in loans have been granted to 8,400 women, and approximately 1,600 participants have attended the Woman Entrepreneur Meetings to share expertise, business ideas, and experiences. Over 3,000 appli- cations have been submitted to Turkey’s Woman Entrepreneur of the Year contest in the three years since the pro- gram was launched. SME Outreach SME Financing Facilitated (USD) Financing Women owned SMEs 1,300 35.5 million Woman Entrepreneur’s Package 8,400 156 million S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 73 BOX 4.16 ADDRESSING SUSTAINABLE ENERGY FINANCE FOR SME DEVELOPMENT Initiative: Russia Sustainable Energy Finance The program was created in 2005, led by IFC with the sponsorship of the Global Environment Facility (GEF), Finland, Denmark, and Free State of Saxony, to address local challenges by fostering investments in energy efficiency pro- grams. Energy prices had been rapidly increasing in Russia. However, many industrial companies were still using energy-intensive equipment installed more than 20 years ago. As a result, the program supported the creation of the federal law on Energy Efficiency Improvement and Energy Saving, which removes key barriers to large-scale mod- ernization of Russian SMEs. In addition to legal and policy reform, the program provides a combination of advisory services in support of long-term loans to Russian �nancial institutions, in order to stimulate the �nancing of energy- efficient projects of Russian SMEs. Currently, eight banks have �nanced over 130 energy efficiency projects worth USD 135 million, with bank loans totaling over $100 million. These projects have an expected lifetime carbon dioxide equivalent (CO2e) savings of almost 5.7 million tons and an annual energy savings of 727,000 MWh. Amount of �nancing facilitated: USD 104 million SME outreach: 132 BOX 4.17 TWO INNOVATIVE APPROACHES TO SME FINANCING Initiatives: Reverse Factoring at Nacional Financiera — NAFIN (Mexico), and Inovar Program (Brazil) NAFIN is a local development bank in Mexicothat offers on-line factoring services to SME suppliers. In 2001 Na�n developed a “Productive Chains� program that works by leveraging the links between large corporate buyers and small suppliers. The program allows small suppliers to use their receivables from big buyers to receive working capi- tal �nancing, effectively transferring suppliers’ credit risk to their high-quality customers to access more and cheaper �nancing. Two types of factoring are offered: (i) Factoring offered to SMEs without any recourse, collateral, or ser- vice fees, at variable risk-adjusted rates; and (ii) Contract Financing, which provides �nancing up to 50 percent of con�rmed contract orders from big buyers with NAFIN supply chains, with no fees or collateral, and a �xed rate. Financial training and technical assistance are also offered under the program. As of mid-2009, the program com- prised 455 big buyers (about 51 percent in the private sector) and more than 80,000 SMEs, and had extended over USD 60 billion in �nancing. About 20 domestic lenders participate in the program, including banks and independent �nance companies. The Inovar Program in Brazil was designed in 2001 by Financiadora de Estudos e Projetos (FINEP), which provides funding to strengthen technological and scienti�c development in Brazil, in coordination with the Inter-American Development Bank. The objective of the program is to support the development of new, SME technology-based companies through the establishment of a venture capital (VC) market and to enhance private investment in technol- ogy businesses. Inovar created a research/knowledge and information dissemination platform and develops mana- gerial capacity for channeling and accelerating VC investments in small-company funds in Brazil. The program successfully achieved the creation of a VC portal with information on how to register for different program compo- nents, with over 2,650 registered entrepreneurs, and over 200 investors. It also established a Technology Investment Facility where investors can perform joint analyses and due diligence on VC �nds, which resulted in over 50 joint due diligences with approximately USD 165 million committed/approved in 15 VC funds. The program has also estab- lished 20 venture forums for SMEs to interact with potential investors and present business plans, resulting in 45 SMEs receiving over USD 1 billion in VC/PE investments. SME Outreach SME Financing Facilitated (USD) NAFIN 78,600 60 billion Inovar Program 3,250 11 million 74 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P other models are helping SMEs to mitigate the impacts One stocktaking model submitted by Turkey illustrates of economic crises, despite having been created for an innovative crisis-response initiative created by a other purposes. These initiatives are represented in a private business organization and implemented wide range of cases — mostly lending facilities and through public banks. The TOBB support program guarantee schemes — including: (i) liquidity facilities (Union of Chambers and Commodity Exchanges of such as the multi-regional Micro�nance Enhancement Turkey) was created in response to the 2001 economic Facility through MFIs; (ii) credit guarantee facilities crisis and represents the �rst case in Turkey where a pri- with subsidized guarantee fees to support SMEs during vate business chamber sought public banks to launch an crises, such as Malaysia’s SME Assistance Guarantee initiative to revitalize SME export �nancing, a key chal- Scheme; and (iii) programs designed to support com- lenge in times of crisis. Box 4.14 provides additional plete banking solutions (e.g., loans, deposits and tech- information on the TOBB initiative, whose innovative nical assistance) that allow banks to more easily justify approach has potential for replicability in other markets. SME involvement in times of crises, such as the Africa SME Finance (AMSME) Program developed for Sub- 4.6.2 GENDER FINANCE Saharan Africa. As discussed in Chapter Three, the crisis response models were instrumental in support- Two submitted initiatives in Nigeria and Turkey are ing SMEs during the �nancial crisis, as is evident from seeking to address the gap in women entrepreneurs the experiences of the OECD countries. in SMEs, and are fostering the development of a new market for this segment. One of the models is a DFI- A recent OECD study on the impact of the global supported program for �nancing women-owned SMEs crisis describes several initiatives by governments in Africa that consists of a credit line speci�cally that are seeking to maintain or increase business designed for women-owned SMEs, coupled with an cash flows in response to the global crisis. There are advisory services component to assist banks in under- two important factors that signi�cantly increase SME standing and expanding their reach to the target seg- vulnerability in times of crisis: (i) extended payment ment. The program has had a catalytic effect in the delays on receivables, combined with (ii) increased Nigerian market, and other �nancial institutions have dif�culty in accessing short-term loans, as banks started to replicate the model. The second model, a tighten their credit conditions. Several government Woman Entrepreneur’s Package, is a private sector ini- interventions in OECD countries seek to mitigate and tiative launched by Garanti Bank in Turkey (commer- address liquidity constraints by reducing or shortening cial bank) to support capacity building and �nancing payment delays for public procurement. This is a needs of women SMEs in cooperation with Turkey’s simple but key initiative in support of SMEs, since the Women Entrepreneur Association. Results from both largest source of �nancing for these enterprises comes programs have shown positive results, suggesting that from internal cash flows that can become constrained women-owned SMEs are a pro�table business with by the lengthening of payment schedules. Speci�c good repayment rates, in turn reflecting the fact that measures being undertaken by governments include women are often good savers. More information on the European Commission’s recommendation that these two cases is provided in Box 4.15. public authorities pay their bills within 30 days, as well as the Commission’s commitment to expedite 4.6.3 SUSTAINABLE ENERGY FINANCE payment of goods and services to fully respect the tar- gets for bill payments. In addition, countries such as Four developing country models from different regions Australia, France, the Netherlands, New Zealand, and are supporting sustainable energy finance, with the the United Kingdom are also easing tendering and aim to reduce costs and climate change risks for SMEs. procurement procedures and policies. These initiatives are being implemented in different S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 75 regions, including South Asia, Latin America, and Eastern Two initiatives submitted by Brazil and Mexico Europe and Central Asia. By stimulating �nancing in stand out as promising models to SME finance, based energy ef�ciency (EE) and renewable energy (RE), these on the uniqueness of their features. These cases are initiatives seek a double purpose — to increase SME prof- having a positive impact in their respective markets itability and sustainability while also reducing green- and show potential for replicability, particularly in the house gas emissions. developing world. Both cases are being supported by DFIs and government entities: Submitted cases address Sustainable Energy Finance through various approaches. These approaches include: Supply chain finance. The reverse factoring initia- (i) legal and policy reforms to promote EE investments tive of Nacional Financiera (NAFIN) in Mexico is a across multiple sectors; (ii) lending facilities targeting supply chain credit mechanism that allows high-risk banks (e.g., stimulating them to support energy ef�cient suppliers to transfer credit risk to their high-quality project �nancing) or directly targeting SMEs (e.g., stimu- buyers. Suppliers’ accounts receivable are discounted lating the purchase of EE equipment); and, (iii) technical on a non-recourse basis once a buyer has agreed to assistance to raise awareness of sustainable energy bene- pay on the due date, thus mitigating supplier perfor- �ts among �nancial sector players and SMEs. Russia’s mance risk and isolating credit risk to the buyer. Sustainable Energy Finance initiative (Box 4.16) is an Supply chain �nance is particularly attractive to example of a facility that includes all three components SMEs in emerging markets, as SMEs (e.g., suppliers) and involves strong collaboration among DFIs, govern- can borrow based on their buyer’s credit rating, ment of�cials, and the �nancial sector. This collaboration which is often superior in the case of large domestic is considered a key success factor for the initiative. and foreign �rms. These mechanisms are a promis- ing source of �nancing in many developing coun- 4.6.4 OTHER INNOVATIVE MODELS tries where the �nancial information infrastructure remains relatively weak. Governments can stimulate Innovations in delivering financial services to factoring and other sources of supply chain �nance SMEs have the potential to expand the SME finance by creating a supportive regulatory and legal envi- frontier. The channels through which this can ronment, such as electronic security and signature happen can be cost related (reduction in costs allow- laws necessary for the quick and electronic sale of ing previously unserved population to use newly accounts receivable. affordable �nancial services) or outreach related (changes in lending technology allowing reaching Venture capital markets for SMEs. The Inovar new clientele that remained inaccessible earlier). Program is a unique model that fostered the creation Although some of the underlying mechanisms in of an SME venture capital market in Brazil. The ini- these models have existed for some time (e.g., supply tiative created infrastructure conductive for venture chain �nance) and have shown signi�cant potential capital investments in new, high-tech SMEs, enhanc- for success, they are not yet widely mainstreamed ing private investment in technology businesses, relative to other mechanisms, especially in develop- attracting, for instance, pension funds that had pre- ing countries, which allows for such categorization. viously never �nanced venture capital funds. Some of these innovations have been adapted to serve the local markets; other mechanisms are country- The NAFIN and Inovar cases are explained in further speci�c and may not be replicable elsewhere. detail in Box 4.17. Both cases are already serving as However, sharing examples of such innovative initia- models for replication in other Latin-American coun- tives from around the world might prove useful in tries, such as Peru and Colombia (Inovar) and the promotion of SME �nance in other countries. Argentina, Chile, and Central America (NAFIN). 76 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P BOX 4.18 THREE EXAMPLES OF DFI SUPPORT TO SMES THROUGH FINANCIAL INTERMEDIARIES Initiatives: European Union and EBRD SME Finance Facility, Africa MSME Finance Program, and Micro and Small Enterprise Fund (MASSIF) The EU and EBRD SME Finance Facility is a regional facility, created in 1999, consisting of EBRD-funded loans to participating �nancial intermediaries (banks or leasing companies) (FIs) for on-lending to eligible SMEs for invest- ment and working capital needs. EBRD supports the loans with comprehensive technical assistance programs, and grants funded by the European Union are aimed at developing the capacity of FIs to engage in SME �nance on a sustainable basis. As a result, EBRD funds have �nanced over 100,000 loans, with an average individual loan size of USD 30,000. Technical assistance funds have been used to train more than 7,300 FI staff across all areas of their business (sales, credit analysis, management, back-office support, etc). The FIs graduate from the European Union grant support under the Facility after 5 years, and the majority of these institutions continue to provide �nance to the SME segment as a key strategic market. The IFC Africa MSME Finance (AMSME) Program is a regional facility developed in 2006 to increase SME access to �nancial services in Sub-Saharan Africa through capacity building efforts of selected �nancial institutions. The pro- gram draws on lessons from various DFIs, including IFC’s experience in the region and EBRD’s experience in accel- erating SME lending in Eastern Europe and the former Soviet Union. The program has two components: (i) investments in African banks with an appetite for MSME business (e.g., up to 5-year debt investments); and (ii) advisory services for those banks to grow, better manage, and service their SME portfolio. The IFC AMSME Program has demonstrated its replicability by spreading to 16 banks in Africa in a period of 4 years. An additional eight banks are expected to join the program in 2010. MASSIF is a revolving fund created in 1986 and originally funded by the Dutch government. The fund is managed by FMO and, by bearing the currency risk, provides local currency �nancing to �nancial institutions for on-lending to small enterprises. MASSIF is generally used to fund �nancial institutions in early stages of development. Despite being funded primarily by public funds, the fund operates without grant schemes and on a sustainable basis. Public funds are thus rolled over on a constant basis and MASSIF loans are priced based on market reference plus a margin for credit risk. MASSIF mitigates its risk through the following strategies: (i) portfolio risk diversi�cation worldwide; (ii) variable interest rates on MASSIF loans (if a currency depreciates, the local interest rate usually increases, par- tially compensating for the loss); (iii) no-prepayment policy, which avoids potential prepayment by clients shortly after depreciation. MASSIF can only operate in relatively stable macroeconomic environments and not in hyper- inflation situations, as currency losses would have a substantial negative impact on the fund’s portfolio. SME Outreach SME Financing Facilitated (USD) EU AND EBRD SME Finance Facility 101,000 3.2 billion Africa MSME Finance Program 28,151 473 million* MASSIF n/a 487 million *Financing facilitated cannot be exclusive attributed to the AMSME Program. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 77 4.7 Development Interventions in the development policy loan to improve access to credit for SME Finance Space MSMEs, and in the case of the Inter-American Investment Corporation’s (IIC) development of a standardized SME As part of the stocktaking exercise and the international scoring methodology in Latin America (FYNPYME). By development agenda, DFIs and IFIs support models supporting public interventions, DFIs seek to foster the across all the dimensions previously described, namely creation of new markets and mechanisms that will private sector initiatives, financial infrastructure, legis- strengthen SME growth and development, for instance lation and regulation, and public support schemes. Over by creating the necessary conditions for the develop- 15 different DFIs and IFIs submitted and support cases from ment of venture capital markets in Brazil (Box 4.17) or the collection, and at least half of those cases have received promoting the development of leasing markets in support from one or more development agency. DFIs and Kosovo and Jordan in initiatives supported by the World IFIs that submitted cases include, among others, the African Bank and IFC respectively. Development Bank (AfDB), Asian Development Bank (AsDB), EBRD, IADB, KfW, and the World Bank Group Private sector initiatives, widely viewed as engines (represented by the International Bank for Reconstruction for sustainable development, are part of at least 30 and Development (IBRD) and IFC). Not surprisingly, close percent of DFI-supported cases. These initiatives to 95 percent of development interventions in the collec- include lending facilities through private banks, equity tion target developing countries. A key value added by investments in �nancial institutions or equity funds, DFIs is their ability to go beyond lending and provide and risk-sharing facilities in the form of credit guaran- additional necessary support in the form of risk-sharing, tees. Most of these sample cases seek to obtain com- equity investments, technical assistance, and capacity mercial returns (e.g., pro�ts) as well as social returns building, as well as regional or global know-how to (e.g., increase SME access to �nance). This is particu- maximize development impact. Relying on their expe- larly illustrated in the cases of Advans SA, ProCredit, rience, DFIs can add signi�cant value by fostering coop- and Access, all of which are dedicated to the establish- eration and collaboration among local, development, ment of sustainable banks in developing countries tar- and international stakeholders, including public and geted for underserved market segments, and receive private sector players, for the creation and implementa- strong support from DFIs and private sector investors. tion of projects. Development interventions include global, regional, Two thirds of DFI interventions support public sector and country specific facilities. Global and regional facil- initiatives. In general, these projects seek to provide a ities not only diversify risk, but can also achieve broader stronger platform to increase �nancial intermediation scale. For instance, the European Fund for Southeast for underserved segments. DFI support is primarily pro- Europe (EFSE), the Micro�nance Finance Facility for Sub- vided through: (i) funded facilities for SME loans; and Sahara Africa (including equity support to MFIs as well as (ii) credit guarantee facilities that share the risk of SME REGMIFA, which provides debt to MFIs (supported by loans with lending institutions. DFIs provide support to KfW)) and the Micro�nance Enhancement Facility (sup- more than half of the legal, regulatory, and �nancial ported by multiple DFIs) invest in �nancial institutions at infrastructure initiatives in the collection, seeking to a regional and global level. Through their investments, provide the platform to ease constraints for SME �nanc- they have reached out to over 200,000 SMEs in 20 coun- ing. This is seen in the case of the Japan International tries. The IFC Africa MSME Finance (AMSME) Program Cooperation Agency’s (JICA) endorsement of Indonesia’s provides �nancing to qualifying African banks through a 78 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P combination of tailored on-site technical assistance and The largest share of DFI-supported interventions is an IFC investment package to better service SMEs (see Box being channeled through the financial sector. 4.18 for further details on the IFC AMSME Program). On Development interventions primarily rely on �nan- the other hand, country or project-speci�c initiatives cial institutions for credit risk assessments, loan generally seek to address speci�c market gaps, which approval decisions and, ultimately, SME on-lending, include: (i) provision of long-term �nancing for SMEs allowing DFIs to reach out to a larger number of SMEs through �nancial institutions, as in the cases of Vietnam’s in a more ef�cient manner. Furthermore, on-lending Cooperation Program on the Development of SMEs (sup- through the �nancial sector targets dual results by ported by JICA) and South Africa’s Promotion of SMEs fostering sustainable access to �nance for SMEs while (supported by KfW); and (ii) stimulation of energy-ef�- also supporting the development of �nancial markets. cient investments by SMEs, as in the cases of the Green for This is con�rmed by the fact that about 60 percent of Growth Fund in Southeastern Europe and the Micro, cases with DFI support — across both public and pri- Small, and Medium Enterprises Energy Saving Project in vate initiatives — have technical assistance and/or India (supported by KfW and JICA, respectively) capacity building components for � nancial institu- tions that seek to promote sustainability, and there- Local currency financing initiatives, although scarcely fore play a key part in the development agenda. present in the stocktaking, can substantially increase However, in order to evaluate the development and development impact, and play an important role in sustainability of �nancial institutions with more addressing the needs of SME borrowers and lenders. accuracy, start-up subsidies and technical assistance Among the stocktaking cases, the Micro and Small funds provided by DFIs and IFIs should be accounted Enterprise Fund (MASSIF) represents the only case for as part of the institutions’ capitalization costs, as whose main purpose is to address local currency risk.94 these funds sometimes prove to be signi�cant. MASSIF was created by the Netherlands Development Technical assistance activities conducted by submit- Finance Company (FMO) and the Dutch government in ted initiatives support areas such as SME sales and recognition that hard currency loans can have a negative understanding of the market, credit assessment, client impact on �nancial institutions and/or their SME cli- portfolio management, and back-of�ce support, among ents, since the vast majority of SME borrowers and lend- others. Box 4.18 provides an example of a design com- ers do not earn hard currency income. Thus, the monly present in DFI models of the stocktaking: a resulting higher risk from currency mismatches puts regional DFI-led initiative that combines a regional SME them in a vulnerable position in case of depreciation/ lending facility through banks with a technical assis- devaluation of the local currency, which in turn can tance component for capacity building of �nancial insti- erase the positive development results that the initiatives tutions. The dual objective of this and similar facilities may have created. MASSIF operates on a global level by from the collection is to maximize access to �nance for bearing the currency risk of FMO projects with �nancial underserved segments of the population while promot- institutions targeting SMEs, and to date has funded 125 ing the development of �nancial markets. �nancial institutions worldwide. (Further information on MASSIF is provided in Box 4.18.) 94 Other cases such as SELP II (Box 4.10) offer local currency support as part of their multiple components. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 79 The stocktaking exercise examines various SME finance models practiced globally and consequently sheds light on the magnitude of the SME finance market that remains to be served. The current prac- tices span a variety of interventions, multitude of countries and regions, and comprise a diversity of implementing agencies. However, as seen in Chapter Three, the SME �nance gap remains enormous, and systematic efforts are needed at the national, regional, and international levels to expand the SME �nance landscape in the near future. Given this background, the G-20 has the unique opportunity to scale up the scope of the global SME �nance agenda by leading the collaborative effort on initiatives related to �nancing, knowledge sharing, and capacity building in the SME �nance space. 80 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P CHAPTER 5 Increasing Financial Access for SMEs: Suggested Actions and Policy Recommendations The global gap in access and use of � nancial services including hard-to-reach populations (poor, rural, remains a challenge. An estimated 2.7 billion95 people informal, and groups that are discriminated against - lack access to basic formal �nancial services, such as women or ethnic minorities). Such services are typi- savings or checking accounts, while access to �nan- cally provided by a variety of �nancial service providers cial services is equally challenging for micro, small while respecting the dignity of clients and with appro- and medium sized businesses. The largest share of the priate consumer protection measures in place.98 “unbanked� live in Sub-Saharan Africa (12 percent banked) and South Asia (22 percent banked). East There have been substantial efforts and funding for Asia, Middle East and North Africa, Latin America, improvements in �nancial inclusion from various stake- and Eastern Europe and Central Asia are also low-ac- holders, including governments, the development com- cess regions, with 50 percent or less of their popula- munity, standard setting bodies, the private sector, tion banked. Among the unbanked, a large proportion NGOs and research bodies, and others. The G-20 has lives on less than USD 5 a day.96 Empirical evidence also committed to improving �nancial inclusion with suggests that improved access to �nance is not only concrete and pragmatic actions. The G-20 commitment pro-growth but also pro-poor, reducing income to addressing the global �nance gap includes the two inequality and poverty.97 Finance performs two key sub-groups created after the Pittsburgh Summit. The functions bene�cial to households and businesses: deliverables of the two sub-groups consist of this report, risk management and inter-temporal consumption the Principles for Innovative Financial Inclusion that smoothing. These functions yield multiple direct and were agreed upon at the Toronto Summit in June 2010, indirect bene�ts to households and �rms, allowing and the G-20 SME Finance Challenge. The Principles them to take advantage of investment opportunities, aim to help create an enabling policy and regulatory smooth their consumption, manage day-to-day environment for innovative �nancial inclusion. resources, and insure themselves. In order to maximize the impact of the various on- With access to �nance remaining limited for many going efforts and the G-20 activities related to �nancial households and small businesses in developing coun- inclusion, to monitor progress over time, and to ensure tries, �nancial inclusion has become an important continuity in the global discussions, an effective coor- policy objective in these countries. Broadly speaking, dination mechanism is crucial. It is in this context that �nancial inclusion entails sustained and convenient the FIEG has proposed establishing the Global access to a range of quality �nancial services at a rea- Partnership for Financial Inclusion (GPFI). The GPFI’s sonable cost for everyone who can use such services primary role would be to serve as a consultative body 95 CGAP 2010 96 Ibid 97 Beck et al. (2009) and World Bank (2008) 98 Accion International S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 81 to enhance coordination and effectiveness of �nancial On the basis of the conceptual and empirical � ndings inclusion efforts, as well as to coordinate and ensure of this report, the FIEG recommends that G-20 Leaders the follow-up of the work plan, and monitor the prog- implement a four-fold action plan to achieve the ress. Through the GPFI, the G-20, as the premier forum above objective: for global economic cooperation, is in the best posi- tion to initiate and promote a more integrated and sys- 1. Endorse a set of recommendations for policymakers tematic global effort by leveraging its convening power in the developing world to establish a supportive and leadership. enabling environment for SME access to �nancial services in their respective countries. Moving forward, the GPFI would support both the FIEG sub-groups: the access through innovation sub-group 2. Establish a Global SME Finance Forum as a knowl- and the SME �nance sub-group. The �nancial inclusion edge sharing and monitoring platform to further work being prepared in advance of the Korea Summit identify and promote best practices across countries highlights that �nancial inclusion should leverage dif- and institutions, establish baselines, and monitor ferent types of �nancial services providers to address the progress made. global gap in access and use, and emphasizes the impor- tance of SMEs as the main driver of job creation in 3. Fund the winners of the SME Finance Challenge and emerging markets. The �nancial inclusion agenda, scale up successful development interventions in which forms part of the broader development agenda the SME Finance space, including improvements to for the G-20 Korea Summit, is linked to the SME �nance the �nancial infrastructure. Set up a longer term agenda, as progress on both fronts and parallel imple- and more sustainable funding framework to increase mentation of recommendations will accelerate global access to �nance for SMEs, complementing existing improvements in increasing �nancial access. mechanisms. This would be a global funding plat- form to build capacity, mitigate risks, and create Speci�cally related to SME � nance in emerging mar- incentives for the delivery of sustainable and scal- kets, over two thirds of all formal small and medi- able �nancial services to SMEs, through means of a um-sized businesses in emerging markets seek collaborative effort implemented by the bilateral credit, and over a quarter do not even have a bank and multilateral development �nance institutions. account. Out of a total of 25 to 30 million formal SMEs in emerging markets, 12 to 15 million SMEs do 4. Lead the efforts to gather SME �nance data in a not have a loan or overdraft but need one, and 5.5 to coordinated fashion by establishing a platform to 7.0 million do have some form of credit, but are credit consistently collect cross-country data. This might constrained.99 fall under the mandate of the Global SME Finance Forum. Progress is being made in the developing world, with strong support from local governments and from It should be noted that the recommendations proposed the development community. However, successful deal only with directly increasing access to �nance for models must be better identi�ed, evaluated, and rep- SMEs. As pointed out in Chapters 1 and 2, other non- licated more systematically, while taking into account �nancial issues, including informality, need to be regional and local conditions. The G-20 is in a unique addressed for the overall SME development agenda, but position to leverage the most recent research on the non-�nancial issues remain outside of the scope of the SME finance space, and support a strategic and this stocktaking report. comprehensive effort to bridge the significant SME finance gap. 99 IFC-McKinsey Study (2010) 82 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P 5.1 Endorse a Set of DEVELOPING A SUPPORTIVE LEGAL AND Recommendations for Policymakers REGULATORY FRAMEWORK in the Developing World to Establish a Supportive Enabling Environment Financial services for SMEs are best served by strong for SME Access to Financial Services banking and non-banking institutions that can develop various business models to achieve the optimal bal- By endorsing and promoting a set of key policy recom- ance between risk, reward, and cost to serve the SME mendations that are directly derived from decades of segment. The more supportive the overall enabling envi- SME �nance experiments in both developed and devel- ronment in a given country is, the larger the size of the oping markets, the G-20 will help policymakers in the bankable SME space, which provides incentives for �nan- developing world focus their resources on creating the cial players to engage in this space, and increases odds of right environment for SME access to �nancial services, success and demonstration effects. address remaining market failures through well- designed government interventions, more consistently Competition is a key incentive for financial players measure effectiveness, and continuously strive for the to expand business lines beyond the large corporate adoption of best practices by benchmarking them- segment and develop the SME business. An effective selves to their international peers.100 On the basis of the legal and regulatory framework will promote competi- key lessons learned from the stocktaking exercise, tion by avoiding overly restrictive licensing require- these recommendations are outlined as follows: ments and allowing international and regional banks with better SME lending technologies and downscal- DEVELOPING COUNTRY SPECIFIC ing capacity to enter the market. It will also enable the DIAGNOSTICS AND STRATEGIES growth of institutions that have proved effective, such as mutual banks, and promote the development of The development of an effective SME �nance strategy alternative lending technologies such as leasing and for an individual country should ideally be based on a factoring. Finally, an effective legal framework pro- comprehensive diagnostic of its SME �nance gap and motes the development of securities markets and insti- the quality of its SME �nance architecture. Such a tutional investors as an alternative to bank lending for diagnostic would encompass an evaluation of demand the largest �rms, thus producing positive spillovers and supply side data aimed at estimating the SME effects to SME lending. �nance gap, an assessment of the quality of �nancial infrastructure and relevant laws and regulations, as Competition among financial sector players can be well as an evaluation of the range and effectiveness of promoted further by introducing technological plat- policy interventions. Such a diagnostic would identify forms in key areas, facilitating a variety of financial existing weaknesses, facilitate the formulation of products and services, driving down the costs of finan- coherent and integrated policies and provide the basis cial access, and reaching previously untapped markets. for monitoring progress in expanding the SME �nance Mexico’s platform for reverse factoring and Brazil’s infor- space. With their expertise and resources, IFIs are well mation platform for venture capital are good examples of positioned to provide such strategic support to national government interventions that can mobilize private governments. resources for SME �nance. The competitive marketplace for SME �nance should include both �nancial institutions and non-�nancial institutional providers with extensive 100 Although it is acknowledged that demand-side constraints can be binding for SME financial access, the focus of this report and thus of the suggested recommendations is on the supply side. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 83 business networks meeting appropriate criteria.101 Example build a credit history, which is critical in helping to of this includes the agent banking model in Brazil, where address both challenges of information asymmetry �nancial services are successfully provided by private and cost to serve. agents using point-of-sale devices.102 Accounting and Auditing Standards: As mentioned Of course, competition should not be introduced at the in Chapter Three, there has been substantial debate expense of prudential safeguards. Minimum capital around developing accounting and auditing standards requirements, adequate �t, proper tests, and other reg- for SMEs that strike the right balance between trans- ulations should still apply.103 Moreover, banks in devel- parency and regulatory simplicity. SMEs are typically oping countries will also be subject to more stringent non-public entities with simple �nancial transactions. capital requirements (with greater reliance on core tier Many of the disclosures aimed at public shareholders capital), leverage ratios, and other rules being pro- and lenders may be unnecessary for SMEs. Several posed at the international level by the Basel Committee countries still resist adopting IFRS for SMEs, claiming for Banking Supervision (BCBS). This should not pose that these standards remain excessively complex and an immediate problem, as emerging country banks are costly for smaller �rms. Therefore, a further review generally better capitalized and less leveraged than of IFRS rules for those �rms below, say, 50 employ- banks in developed countries, but these banks will ees, may be warranted. Likewise, and for precisely need to build up more capital in order to meet the the same reasons, governments may consider adopt- growing needs of their economies, including the ing the EU policy of exempting �rms with fewer than demand for credit by SMEs. Emerging country banks 50 employees from obligatory audit requirements. will also need to strengthen their risk governance in These thresholds should be calibrated according to line with the more stringent standards being currently country conditions. proposed by the BCBS. Credit Bureaus/Registries: Governments and public STRENGTHENING THE FINANCIAL authorities have a critical role to play in developing public INFRASTRUCTURE credit registries and/or promoting the development of private credit bureaus. The aim should be to develop a Establishing a solid financial infrastructure (audit- comprehensive credit reporting system that covers both ing and accounting standards, credit registries/ personal and commercial credit information, and hence bureaus, collateral, and insolvency regimes) should can seamlessly cover micro, small and medium-sized be a priority in the financial development agenda of businesses and thus help lenders better manage credit risk most developing countries. As indicated in Chapter and extend access to credit. Provision of data to credit Three, �nancial infrastructure remains weak in many registries/bureaus should be made mandatory, as well as of these countries, particularly those in Africa, Asia, the consultations to the registries/bureaus. This would and the Middle East. Weak infrastructure remains ensure the rapid build-up of coverage and a reliable data- one of the most important obstacles to SME �nance, base. Moreover, credit registries/bureaus are most effec- and the need for greater efforts in this area cannot be tive when their data are electronically accessible and stressed enough. A sound � nancial information infra- available in real time, and the credit report information structure should improve transparency and disclo- (positive as well as negative) is up-to-date and processed sure for SMEs in a cost-effective way, and help SMEs in a short time. In a developing country context, where 101 Center for Global Development (2009) 102 ATISG (2010) 103 Ibid 84 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P the information environment is particularly weak, DESIGNING EFFECTIVE GOVERNMENT there is a need to start collecting information from all SUPPORT MECHANISMS relevant players inside the �nancial services industry, including micro�nance institutions, banks, non-bank Government support mechanisms can expand sig- �nancial institutions, and — as far as it is economically nificantly the SME finance space, although it is always and practically feasible — players outside the �nancial important in these cases to minimize their potential services industry, such as utilities and retailers. Finally, market distorting consequences. As is clear from the bureaus should be encouraged to provide additional stocktaking exercise, government-supported interven- services such as credit scores. tions in the SME �nance space are commonplace. The perfect enabling environment for �nance being a long- SME Rating Agencies: Some countries, such as India, term/tentative objective, government support is likely have introduced SME rating agencies as an additional to always be needed to provide incentives, catalyze a institution designed to generate and provide more market, or create demonstration effect, if not for purely information to prospective lenders. This is a relatively political reasons. It is critical that the government-sup- recent initiative that merits consideration by other ported special support programs be used as comple- countries. There are some critical issues that need to ments to, rather than substitutes for, the development of be revisited, such as who pays for the ratings to avoid basic enabling environment for �nancial services. conflicts of interest (like those observed in the case of credit rating agencies). It is also possible that these In all cases, government interventions (state banks, agencies require a critical size of market to break even lending facilities, credit guarantees, risk-sharing, and become pro�table. If this is the case, DFI and capacity-building, etc.) should be carefully designed governments could consider regional solutions, and better evaluated with a view to accurately measure involving regional hubs that are large enough to dilute their achievements in terms of outreach, additionality, �xed costs, but that also contain expertise at the and leverage. Such interventions should be designed to country level. respond to market needs in a timely and cost-effective manner, and should be suf�ciently flexible to respond Secured Transactions Regime: Governments are to changing macro-economic conditions. It is also central to developing another crucial component of important to ensure alignment of interests between the �nancial infrastructure: an effective secured the public authority providing funding and the imple- transactions regime. A well-functioning collateral menting institution, so that the latter also has an inter- regime is characterized by a wide range of allowable est in achieving the policy objectives. In general, any collaterals (immovables and movables), the establish- �nancial support scheme should be able to make a ment of clear priority rankings of claims over collat- pro�t. Subsidies should not distort the market and eral, ef�cient collateral registries making priority should only be reserved to address more severe market interests publicly known, and effective enforcement failures, and focus on cases where there are substantive of collateral in the case of default, including both sei- positive externalities. Moreover, there should be a zure and disposition. In the case of developing coun- measure of subsidy dependence, and a practical and tries, it will prove essential to develop out-of-court meaningful impact evaluation approach involving a enforcement mechanisms, given the low ef�ciency of real cost-bene�t analysis that assesses whether the pos- court systems and the long time period necessary for itive net impact was worth the cost in subsidy. reforms to take effect in this area.104 104 World Bank (2009) S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 85 Partial Credit Guarantee Schemes: These schemes continue to remain a popular intervention in the SME should probably remain an important form of interven- �nance space due to its simple structure and faster tion. However, empirical research and the stocktaking implementation. However, the impact of many of these exercise do not provide clear guidance either on the programs has been limited due to the subsidy and polit- optimal number of guarantee schemes (some countries ical components associated with them. More research maintain several schemes) or on their design features. needs to be conducted on the impact of the various In this regard, it would be highly desirable for DFIs to directed lending programs that have been implemented coordinate an initiative aimed at developing core prin- globally. Furthermore, guidelines for designing such ciples/guidelines to orient developing countries in the programs should be developed in order to maximize design of such schemes that also minimize their subsidy their impact while minimizing the subsidy component, component (depending on the guarantee pricing/con- political involvement, and crowding-out effects impact- ditions). These principles would contain guidelines on ing the private sector. To further minimize their market eligibility criteria, coverage ratios, fees, payment rules, distorting effect, an optimal exit strategy for such pro- use of collateral/down-payment, and equity ratios, grams should also be developed. among other parameters. Moreover, these schemes should be subject to more systematic evaluations of BUILDING CONSISTENT AND RELIABLE impact that assess, inter alia, their degree of outreach, DATA SOURCES ON SME FINANCE additionality, and sustainability. Finally, credit guaran- tee schemes can play a much more proactive role in The task of measuring the SME financing gap and capacity building and training of participating banks, tracking progress remains a challenge at the local especially in less-developed �nancial systems. There and global levels. It is, however, a necessary condi- seems to exist substantial scope for assistance from DFIs tion for continuous improvement. An effective data in this area. collection framework at the national level should include efforts to standardize the de�nition of SMEs, State Banks: For those countries that do not already centralize the collection of supply-side data by the cen- have such institutions, this report does not recommend tral bank/banking supervisors and other �nancial the creation of new state banks to serve the SME market. supervisors, and survey SMEs in order to identify and If there is a rationale for a market intervention, it could quantify under-served SME segments. Demographic arguably be better achieved by a well-designed credit data on SMEs by number of employees, turnover, and guarantee scheme with an adequate capital base. Where asset size should be available and help normalize access state banks already exist and play a role in SME �nance, to �nance data across countries with different SME the �rst priority should be to ensure clear mandates and de�nitions, thus allowing global aggregation. Increased governance structures. Moreover, in countries where information on all aspects of SME market development there is a state bank operating side by side with a credit could promote SME �nancing, as �nancial institutions guarantee scheme, the role and target markets of the would be better able to judge the attractiveness of the two institutions should be well de�ned. Arguably, the segment and adapt their business models to serve it. In credit guarantee scheme would target the segment of order to get a more complete picture of the SME �nance riskier and smaller �rms. This would presumably pro- landscape, systematic efforts should be launched to mote transparency and facilitate the identi�cation of estimate the number of SMEs in the informal sector as losses and the possible need for government support. well as to examine their access to �nancial services. Lending Facilities: Direct lending in the form of soft Promoting computerized business registries would loans/lines of credit/co-�nancing/equity funds would further facilitate the data gathering process and 86 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P would serve as an important �rst step for �rms joining 5.2 Establish a Global SME the formal sector. Required annual �lings of business Finance Forum and �nancial information can provide important mea- sures over time on the size of the SME sector, their While the stocktaking exercise has highlighted the entry/exit, job creation/destruction, access to �nance, individual and innovative initiatives undertaken by etc. In addition, credit bureaus can also report the policymakers, governments, and private sector play- number of small loans — which is a good proxy for ers, it also revealed the lack of a global center of exper- SMEs that receive credit — and the aggregate new tise on SME finance. Unlike the micro�nance industry, credit granted, by size (and other) buckets. where CGAP and the MIX Market are the recognized cen- ters for expertise, knowledge and data sharing, and moni- BUILDING CAPACITY OF THE FINANCIAL toring among industry stakeholders, the SME �nance INSTITUTIONS industry lacks a global central repository of knowledge. The capacity building of financial institutions is The G-20 should lead the establishment of a Global critical in their sustained expansion and strength- SME Finance Forum as continuation of the SME ening. It helps participant institutions in accessing finance sub-group. The Forum is envisioned to be new markets/clients, broadening their product offer- an independent operation and research center ings, and learning the skills to integrate sustainable advancing the financial access for SMEs to foster �nance practices into their strategy and operations. For economic growth, employment, and poverty alle- many international organizations, institutional capac- viation. It would further formalize the long-term ity building (streamlining credit processing, standard- commitment of the G-20 to the SME �nance cause izing product offering, segmenting the SME market, and could become an integral part for the GPFI. The training staff and management, introducing manage- Forum would require appropriate funding. Its objec- ment information system, etc.) has been a signi�cant tives would be to promote and disseminate best prac- component of their SME �nance assistance strategy. tices in the SME Finance space; offer global access to DFIs/IFIs can scale up their efforts to provide capacity a network of peer institutions, tools, and benchmarks; building/advisory services to �nancial institutions and organize workshops and events on the subject matter; help them serve SMEs more ef�ciently. and conduct relevant research. The Forum’s goal would be to strengthen the SME market infrastruc- The capacity building of SMEs is also important in ture by disseminating information and providing improving their formal �nancial access and would consistent support and reference to relevant stake- include providing technical and business support ser- holders. The various stakeholders of the Global SME vices such as training, business development services, Finance Forum would include policymakers, DFIs, assistance in formalizing �nancial statements, and loan practitioners, researchers, data providers, investors, application preparation. Such services could be poten- and SME representatives. A Global SME Finance Forum tially provided by appropriate associations such as SME would promote improved access to information with development agencies, SME associations, or chambers the objective of catalyzing a movement of consensus of commerce, but remain beyond the focus and scope amongst stakeholders on good practices and perfor- of the report. mance standards which would ultimately bene�t the advance of the SME �nance industry. S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 87 The Global SME Finance Forum would offer a vari- 5.3 Fund the Winners of the SME ety of services while acknowledging regional condi- Finance Challenge and Set up a tions. As part of its networking service provisions, it Global Funding Platform to Build would coordinate annual meetings/workshops, pro- Capacity, Mitigate Risks, and Create vide global access to a network of peers, broaden and Incentives for the Delivery of engage new network of players to increase the reach Sustainable and Scalable Financial and impact of �nancing to SMEs, and share best prac- Services to SMEs tices and standards on SME �nance. The Forum would also facilitate developing the SME �nance data collec- The stocktaking exercise seems to confirm the tion framework, analysis, and dissemination. This proactive role that the development finance would involve coordinating the aggregation and main- community has attempted to play, with some suc- taining of benchmarks at global, regional, and coun- cess, in the SME finance area in emerging markets. try-speci�c levels. Coordination would also be required IFIs and DFIs have supported both public and private for data collection frameworks, monitoring global sector initiatives in the SME �nance space, with a mix funding needs for SMEs, evaluating policy impact on of capacity-building, risk mitigation, and funding SME �nance, and conducting analytical assessments on mobilization. The G-20, through its high convening SME �nance and industry trends. The Forum would power and high level strategic support, has a unique conduct research and disseminate publications on rel- opportunity to leverage this experience and accumu- evant topics, coordinate the development of technical lated know-how, in order to further scale-up this assistance tools and advisory services for key stake- effort and complement existing initiatives and efforts holders, and leverage the expertise of complementary on a comprehensive and strategic basis. SME �nance initiatives from DFIs/IFIs, private govern- ments and funders, while also facilitating efforts for The immediate focus should be on funding the win- capacity building to SMEs and supporting the develop- ners of the SME Finance Challenge and advancing ment of SME non-�nancial support. improvements to necessary financial infrastructure, while establishing a funding platform that would While supporting the general industry infrastructure further leverage resources of IFIs, DFIs and the pri- and key stakeholders is critical, capacity building of vate sector to bridge the SME finance gap. The fund- the SMEs themselves is also an important component ing platform would complement existing channels on the demand side. Hence, although beyond the for SME finance support. The stocktaking exercise has Forum’s core scope, it would, at a high level, support identi�ed a signi�cant demand-driven gap in SME SME development agencies, SME associations and �nancing and a need for the establishment of a multilat- chambers of commerce seeking to provide capacity eral SME �nancing initiative, over and above the imme- building programs to SMEs. The Forum would facili- diate contributions to the SME Finance Challenge, to tate efforts from agencies for the creation of non-�nan- help put in place a longer term and more sustainable cial support services such as training and business mechanism for enhancing SME access to �nance. This development services targeted to enhance the skill sets platform, based on voluntary funding, is expected to of SME management. help promote and apply successful models and best practices, leverage and share lessons learned in the SME �nance space from the experiences of other countries, and ensure the adoption and the replication of the most effective identi�ed models across developing countries. 88 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P 5.4 Lead the Efforts to Gather Better level data on �nancial institution serving SMEs) that SME Finance Data in a Coordinated need to be �lled in order to accurately measure the Fashion and Establish a Platform SME �nance space. to Consistently Collect the Cross-Country Data As indicated in Chapter 3, there has not been suf�cient evaluation of the impact of policy interventions The need to obtain better data on SME finance in a designed to expand SME �nance. These interventions coordinated fashion goes beyond the guideline for may be justi�ed in many cases, but they frequently national governments to collect SME finance data. entail �scal costs and may also distort resource alloca- Data on SME �nance are scarce and fragmented. As a tion and hinder market development. A more rigorous starting point, it would be important to build on the evaluation of the developmental impact of different existing data exercises, such as the World Bank Group’s classes of interventions, such as credit guarantee enterprise surveys on the demand side and �nancial schemes and directed lending, would greatly contrib- access surveys on the supply side, which can be used to ute to the improvement of SME �nance strategies establish cross-country benchmarks, assess common adopted by national governments and IFIs. Such evalu- patterns, and inform coordinated policy responses. ation could be carried out according to various criteria Furthermore, Multilateral Development Banks (MDBs), such as leverage, scalability and sustainability, replica- IFIs and DFIs should be encouraged to harmonize the bility, results and track record, implementation capac- reporting on their support for SME �nance. ity, effectiveness in addressing market failures, added value (through public funding as opposed to other In May 2010, the G-20 Working Group on SME data types of intervention), and cost ef�ciency. The G-20, was launched with the United Nations Secretary through the Data Working Group, could contribute General’s Special Advocate for Inclusive Finance for signi�cantly in this area through the provision of Development, Her Royal Highness Princess Máxima of resources for research and impact evaluation. the Netherlands, as the honorary chair, and with par- ticipation from donors, international organizations, In summary, given the fragmented SME �nance data and the private sector. The G-20 Working Group on space, the G-20 has a unique opportunity to lead the SME Data has been established with the aim to consoli- collaborative effort on improving the availability date and harmonize various international efforts for and quality of SME �nance data globally. This can be SME data collection and to improve the overall avail- achieved through encouraging and coordinating the ability of data on SME �nance. As a �rst step, the SME data collection efforts at regional, national, and global Finance Data Working Group cataloged the existing levels conducted by a multitude of sources including data on SME �nance. The catalog focused on three national governments/agencies and international orga- main dimensions: demand-side data (what �rms report nizations and effectively addressing the data collection about SME �nance), supply-side data at the market level challenges along the way to ensure continuity of these (what central banks and regulators report about SME efforts moving forward. �nance), and supply-side data at the institutional level (what each �nancial institution reports about SME- �nance). While there is a signi�cant amount of exist- ing data and research available on SME �nance, there are still many gaps (lack of data on micro/informal �rms, scarcity of consistent and disaggregated data on the supply side, and fragmented data availability on DFI/IFI support to SME �nance as well as institutional S C A L IN G - U P SM E ACCESS TO FINANCIAL S ERVI CES I N THE DEVELOPI N G WOR LD 89 ANNEX A SAMPLE SME DEFINITIONS TABLE A.1: MALAYSIA SMIDEC DEFINITION Firm Size Manufacturing, Agro-based Industries Service, ICT, or Primary Agriculture Micro <5 employees OR <66,000 in sales <5 employees OR <$53,000 in sales Small <50 employees OR <$ 2 million in sales <19 employees OR <$200,000 in sales Medium <150 employees OR <$6.6 million in sales <50 employees OR <$1 million in sales TABLE A.2: OTHER COUNTRY EXAMPLES Country Employees Annual Sales (Revenues) United States 10–499 <$7 million for most non-manufacturing, but ranges up to $ 35.5 million Canada 10–499 has 2 EbrD rural Finance Facilities (each for usD 13 mln) for farms and small businesses > KfW sME credit line (usD 27 mln) for investments in energy sav- ings projects > EiF Guarantee Facility (usD 97 mln) for investments and expansion of enterprise facilities. public support scheme credit Guarantee the 7 (a) loan program is sba’s primary program to help start-up and existing sMEs obtain financing by providing guarantees on loans from eligible banks that otherwise would not lend to the sME. as a government initiative, sba does not make loans itself but guarantees loans made by Fis (so taxpayer funds are only used in event of borrower default). lenders can be approved for delegated lending (they can approve applications themselves) under certain conditions. program terms: > loan size up to usD 2 mln > Guarantee terms 75 percent of loans > 150,000; 85 percent Eligibility: small businesses not able to obtain credit elsewhere. public support scheme credit Guarantee through the cDc/504 loan program, small businesses can access long term, fixed-rate, low- cost capital for their fixed asset projects (expansion and modernization). Financing is available for up to 90 percent of the project cost. cDcs leverage sba guarantees to provide loans in con- cert with private bank loans. cDcs are non-profit organizations in an area of operation set up to contribute to economic development. a typical 504 project includes: 1. a secured loan from a private bank (up to 50 percent of project cost) with a senior lien. 2. a secured loan from a cDc (100 percent backed by an sba guarantee) 3. a contribution from the borrower of < 10 percent equity cDc’s role: market program, process loan applications, service loans, and provide techni- cal and financial assistance to borrowers in relation to the loans. public support scheme Funded facility this is a small enterprise lending program (mainly long-term lending) with a ta component aimed at private on-lending banks. sElp leverages funds sourced from Eu grants to turkey. program components include the following: > European Fund for turkey: revolving fund totaling usD 116 mln for small business onlending through banks. the fund comprises Eu grants (first loss tranche), which provide a cushion for investors, and DFi funds (mezzanine tranche). issuance of shares for private investors is projected for the near future. > Exchange risk coverage Fund: to mitigate currency risk, as loans by banks are denominated in local cur- rency. total volume: usD 2.4 mln. > tech. assistance: aimed at improving small business lending capacity of banks. tas are delivered by a consulting firm and supervised by the treasury and KfW. private sector initiative lending/ banking the facility was designed to provide medium- to long-term finance for fixed asset investments services of sMEs. the loan was secured from the European investment bank and tsKb designed the structure and was the borrower of the loan. turkey’s treasury guaranteed tsKb’s obligations and tsKb acted as wholesale (apEx) bank providing credit lines to approved banks and leasing companies (aFis) for on-lending to sMEs. aFis manage project risk assessments and submit loan/leasing applications to tsKb. Minimum leasing/loan maturities are 4–6 years (including a 1-year grace period) and loans up to 50 percent of investment cost. public support scheme Funded facility Kalkınma revised its business strategy in 2006 to add wholesale lending business to exist- ing direct lending, in an effort to improve effectiveness as a development finance agency and compensate for the lack of a branch network. two examples of wholesale banking in Kalkinma are: 1. ostiM-ivdik industrial apex program, using own bank funding (usD 27 mln); 273 sMEs have been supported. 2. aFD loan (usD 13 mln) for sMEs in less developed regions of turkey; 32 sMEs supported. 128 Fin a n ci a l i n clusi on ExpErts Gr oup |  sME Fi n a n cE sub -G rou p basic projEct Data Code Region Country Submitting Entity Name of the Program Implementing organization Starting Year 137 Eca turkey turkey treasury support to credit undersecretariat of treasury, 2009 Guarantee institutions credit Guarantee Fund, private banks 138 Eca turkey turkey tobb support program union of chambers and 2001 commodity Exchanges of turkey (tobb), 2 state banks: türk Eximbank (2001–2003), and türkiye halk bankası (2004, 2005, 2006, 2008, 2009) 139 Eca turkey turkey sME export promotion small and Medium Enterprise 2008–2009 support credit Development and support organization (KosGEb), public banks (3), private banks (7), credit Guarantee Fund 140 Eca turkey turkey sector specific sME support small and Medium Enterprise 2008/ 2009/ credit Development and support 2010 organization (KosGEb), public banks, private banks, credit Guarantee Fund, tradesmen and craftsmen cooperatives union (tEsKoMb) 141 Eca turkey turkey 1000+1000 sME Machinery- small and Medium Enterprise 2008 Equipment support credit Development & support organizations (KosGEb), private banks (2), credit Guarantee Fund 142 Eca turkey turkey Emergency support credit small and Medium Enterprise 2009 Development & support organizations (KosGEb), public banks (3). private banks (10), credit Guarantee Fund. 143 Eca turkey turkey Machinery Equipment credit small and Medium Enterprise 2009 of southeastern anatonia Development & support project (Gap) provinces organizations (KosGEb), public banks (2). private banks (10), credit Guarantee Fund. s c a l in G - u p sM E accEss to Financial s Ervi cEs i n thE DEvElopi n G Wor lD 129 projEct DEscription Type Sub-type Project Summary public support scheme credit Guarantee the scheme was designed to ease credit constraints faced by the sMEs after the global financial crisis, providing financial support of usD 650 mln to sMEs through credit guarantee institutions that provide guarantees to eligible banks lending to sMEs. the scheme will remain in effect until july 2011. Mechanism: sME loan maturities range from 6 months to 4 years, for up to usD 650,000 per sME. all loan applications are channeled through the 20 banks participat- ing in the program. treasury guarantees cover up to 65 percent of risk, while the remaining 35 percent risk is borne by the banks. collateral and a commission fee of 0.5–1.5 percent on the guaranteed loan amount is required from the sMEs. public support scheme Funded facility tobb and the selected public banks signed several deals to provide 1-year loan packages to sMEs. this was the first time in turkey in which a business organization (tobb) launched an initiative with public banks to support sME access to finance. using tobb’s (and its members) cash funds, tobb buys commercial paper (issued by Eximbank) and deposits a certain amount of money for 1 year (in halkbank). the pool of funds is used by banks as 1-year cash credits for sMEs, at below-market rates. the banks are in charge of selection and servicing loans of sMEs. public support scheme Funded facility the program aimed to promote sME exports while decreasing financial constraints of export costs. loans (trade loans) to sMEs are for up to usD 200,000, for maturities up to 6 months. Export has to be realized up to 18 months after credit approval. the program has an interest rate subsidy component: two thirds of the interest rate is paid by KosGEb to banks on behalf of enterprises. the remaining one third of the interest is paid by the enterprises. public support scheme Funded facility KosGEb provided special financial support programs to different sectors of sMEs to cope with the global economic crisis. loans are provided by banks in the program. General sME loans are for a maximum of usD 16,500, and women-owned sMEs have a higher limit of usD 19,700. public support scheme Funded facility the programs provide loans for sME machinery-equipment investments of (program 1) medium-high, high and (program 2) medium-low, low-technology sectors (as defined by oEcD criteria). the maximum loan for each program 1 loan is usD 395,000, and usD 197,000 for program 2. all KosGEb database registered sMEs are eligible for support. a subsidy of 100 per- cent of the loans’ interest rates to banks is covered by KosGEb on behalf of borrowing sMEs. payment on principal is covered by the sMEs themselves. sMEs must certify that machinery equipment has been purchased with the credit and is operational for repayment period. public support scheme Funded facility this is a credit program providing special financial support to sMEs to cope with natural disas- ter effects (e.g., floods, earthquake, droughts, storm, wars, fire, etc.) that have damaged their businesses. the maximum for each loan is usD 65,800. all KosGEb database registered sMEs are eligible for support if they documented firm’s disaster effects with official authorities. a subsidy of 100 percent of the loans’ interest rates to banks is covered by KosGEb on behalf of borrowing sMEs. payment on principal is covered by the sMEs themselves. public support scheme Funded facility this program provides loans for sME machinery-equipment investments in the southeastern anatolia region (the region comprises about 10 percent of turkey). all KosGEb database regis- tered sMEs are eligible for support. a subsidy of 75 percent of interest rates to banks is covered by KosGEb on behalf of borrowing sMEs. payment on principal and 25 percent of the interest rate is covered by the sMEs themselves 130 Fin a n ci a l i n clusi on ExpErts Gr oup |  sME Fi n a n cE sub -G rou p basic projEct Data Code Region Country Submitting Entity Name of the Program Implementing organization Starting Year 144 Eca turkey turkey credit support for the small and Medium Enterprise 2007–2008 Movement of the leather Development & support sector to organized organizations (KosGEb), industrial Zones public banks (3) 145 Eca turkey turkey tradesmen-craftsmen credit undersecretariat of treasury, 1951 program halkbank, tradesmen- craftsmen credit & Guarantee cooperatives. 146 Eca turkey turkey Woman Entrepreneur’s t. Garanti bank, Woman 2006 package Entrepreneurs association turkey (KaGİDEr) – nGo 147 Developed usa usa small business investment small business 1958 company (sbic) program administration (sba), small business investment companies 148 Developed italy italy avviso comune alla italy’s Ministry of Economy 2009 Moratoria dei Debiti delle and Finance, banking pMi association (abi), industry associations 149 Developed italy italy Guarantee Fund for sMEs Ministry of Economic 2000 Development, unicredit, industry associations (MGis) 150 Developed Germany Germany KfW startGeld program KfW and European 2008 investment Fund (EiF) 151 aFr republic of congo belgium brazzaville Funds Government of the republic 2009 (brazzville) of congo brazzaville and the Minister for sMEs, belgian Federal Minister for sMEs, belgian bankers academy and participation Fund 152 Developed Korea, rep. Korea credit guarantee programs KorEG – Korean Federation 2000 for small and micro of credit Guarantee enterprises Foundations s c a l in G - u p sM E accEss to Financial s Ervi cEs i n thE DEvElopi n G Wor lD 131 projEct DEscription Type Sub-type Project Summary public support scheme Funded facility KosGEb provided special financial support for the relocation of the leather sector to industrial zones with proper water treatment facilities (in response to claims to reduce risk of environ- mental pollution). all KosGEb database registered sMEs are eligible for support. subsidy of 100 percent of loans’ interest rates to banks is covered by KosGEb on behalf of borrowing sMEs. payment on principal is covered by the sMEs themselves. the maximum for each loan is usD 75,600 with a 1-year grace period. public support scheme Funded facility the program’s objective is to encourage and develop tradesmen and craftsmen enterprises. a subsidy of 50 percent of the loans’ interest rates to banks is covered by the treasury on behalf of borrowing sMEs. suretyships from cooperatives serve as insurance: 6.5 percent of credits are blocked in cooperatives accounts as a guarantee for the bank. the maximum for each loan is usD 75,600 with a 1-year grace period. private sector initiative lending/ banking Garanti offers the Woman Entrepreneur’s package in all sectors in order to meet business- services women’s communication network, training, and financial needs to grow their businesses. the package includes: (i) a support loan (term up to 60 months, grace period and a special rate); (ii) supplementary banking products (overdraft account, pos terminal, business credit card, insurance coverage, and automatic payment orders); and (iii) networking and training sup- port (Women Entrepreneur meetings organized by Garanti and KaGiDEr), turkey’s Women Entrepreneur of the Year contest, free training support “basic Entrepreneurship�). public support scheme credit Guarantee the sbic program mission is to provide long-term debt and equity to small businesses. under the program, sba licenses, regulates, and provides guarantee leverage for privately owned and operated venture capital investment firms. Mechanism: sbics are public-private partner- ships in which sbics raise capital from private resources and the government (sba) guarantees long-term debentures (10 years) to provide up to two to three times the private capital raised. leverage is pooled in the market with the sba guaranteed debentures. private sector initiative other Due to the financial crisis, a large number of italian sMEs were having difficulty repaying their loans with Fis. consequently, the abi and several industrial associations, with the sponsorship and under the management of the italian Minister of Economy and Finance, agreed to tempo- rarily suspend the payment of installments in favor of sMEs having some minimum require- ments, and with no additional cost to sMEs. in order to benefit from the program, sMEs must meet a set of criteria and demonstrate adequate financial prospects. the project is financed entirely by the private sector, particularly by banks in the treaty. public support scheme credit Guarantee the Fund began operations in 2000 with an initial endowment of usD 90 mln. the fund can guarantee about usD 40.5 mln p.a. of loans that meet a tight criteria. the Fund grants three types of subsidiary guarantees: (i) direct guarantee to banks; (ii) counter guarantees to MGis; and (iii) co-guarantees with MGis. Guarantee coverage is between 60–80 percent per loan, up to usD 2 mln. public support scheme credit Guarantee the KfW startGeld program was launched in january 2008 to address start-up finance. KfW and the European investment Fund (EiF) entered into a guarantee agreement in which EiF guarantees financing transactions for start ups. the guarantee is part of the sME Guarantee Facility funded by the European community and operated by the EiF. EiF guarantee defaults are covered up to a certain percentage rate and amount. public support scheme Funded facility the participation Fund is a belgian public credit institution, whose objective is to share its know- how by providing financial, technical, and administrative services to other institutions. the mecha- nism studied for the republic of congo brazzaville includes three complementary tools: 1. coaching Fund for sME training 2. Quasi-capital Fund to strengthen sME capitalization 3. Guarantee Fund to reduce financial partners’ risk. public support scheme credit Guarantee KorEG and 16 cGFs have introduced various kinds of special guarantee programs for micro- enterprises that have low credit ratings and are unregistered (informal sector). 132 Fin a n ci a l i n clusi on ExpErts Gr oup |  sME Fi n a n cE sub -G rou p basic projEct Data Code Region Country Submitting Entity Name of the Program Implementing organization Starting Year 153 sar india india code of banks commitment banking codes and standard 2008 to Micro and small board of india (bcsbi) and Enterprises member banks 154 World FMo Micro & small Enterprise FMo 1986 Fund (MassiF) 155 MEna afghanistan DEG sME credit Guarantee DEG, usaiD 2005 Facility (KGF) for afghanistan 156 World DEG public private partnership Ministry of Economic 1999 program cooperation and Development, DEG, private companies 157 World Developing coun- belgium bio’s Financial sector belgian investment company 2001 tries. Fifty percent Department (formerly for Developing countries of the funds of the Development Fund) (bio) Development Fund should be invested in the partner coun- tries of the belgian Development cooperation and 10 percent of the funds in central- africa (Drc, rwanda, burundi). 158 World Developing coun- belgium Enterprises Department belgian investment company 2004 tries. Fifty percent (formerly sME Fund) for Developing countries of the funds of the (bio) Development Fund should be invested in the partner coun- tries of the belgian Development cooperation and 10 percent of the funds in central- africa (Drc, rwanda, and burundi). 159 aFr Ghana unctaD capacity Development & Government of Ghana, 1996 utilization program (cDup) unDp-Ghana, EMprEtEc Ghana Foundation (private sector) s c a l in G - u p sM E accEss to Financial s Ervi cEs i n thE DEvElopi n G Wor lD 133 projEct DEscription Type Sub-type Project Summary Financial infrastructure sME banking the bcsbi was set up by the reserve bank as an independent body to plan, evolve, prepare, codes develop, promote, and publish voluntary comprehensive codes and standards for banks for fair treatment to their customers. in 2006 the bcsbi finalized a code of banks commitment to Micro and small enterprises and the code was launched in 2008. the code is funded by the reserve bank of india and registered as an independent and autonomous body. banks agreeing to comply with the standards and as members pay an annual subscription, which is building up reserves for when the rbi funding is exhausted. public support scheme Funded facility MassiF was established by the Dutch Ministry of Foreign affairs and FMo to provide local currency financing to financial institutions for onlending to small enterprises. recognizing that hard currency loans can have a negative impact on sMEs because the vast majority of sMEs do not earn hard currency income, MassiF bears the currency risk. the creation of MassiF was the result of FMo not being able to take on the risk of local currency lending. therefore, the Ministry of Foreign affairs provided most of the funding for MassiF, but FMo manages the fund. public support scheme credit Guarantee this is a credit guarantee fund to facilitate sustainable access to financing for sMEs (working capital and investments) through the issuance of guarantees to afghan Fis. the facility also provides technical assistance to partner Fis. public support scheme Funded Facility through ppp, DEG provides co-financing for private sector projects in the developing world. German and European companies are eligible for ppp projects if they can demonstrate good financial standing and sustainability of the project. projects can be in the form of investments, joint ventures, export and imports, and contributions to country development. the program also contains a ta component for companies involved in the ppps. public support scheme Funded facility bio’s Financial sector Department takes equity stakes, and provides debt and other related forms of financing under market conditions to financial institutions and investment funds/ companies. bio has the right to: co-found companies; participate directly in the equity of com- panies; provide subordinate loans, or medium- or long term loans; and supply guarantees to or in favor of companies. Financial institutions and investment funds financed by bio must be established in or focus exclusively on developing countries and have goals that are compatible with bio’s mission. public support scheme Funded facility in 2001, the belgian state and the belgian corporation for international investment established bio as a Development Finance institution. the main goal of bio’s Enterprises Department is to support the private sector in developing countries through long-term financing. bio directly finances local enterprises by means of different instruments: (i) loans; (ii) equity; (iii) quasi- equity; and (iv) guarantees. public support scheme Funded facility the unDp, as part of its support to the Government of Ghana’s capacity Development and utilization program (cDup), made available to EMprEtEc Ghana an amount of usD 700,000 (then equivalent of Gh¢114,000) to be used in setting up a revolving fund out of which credit would be made available to micro, small, and medium enterprises in tourism, Manufacturing, construction, and non-traditional export sectors, in order to expand their businesses. 134 Fin a n ci a l i n clusi on ExpErts Gr oup |  sME Fi n a n cE sub -G rou p basic projEct Data Code Region Country Submitting Entity Name of the Program Implementing organization Starting Year 160 lac argentina unctaD “Entrepreneur’s credit� Fundación Empretec 2009 (crédito Emprendedor) argentina (private sector) banco de la nación argentina (govt) instituto nacional de tecnología industrial – inti (national industrial technology institute) subsecretaría de la pequeña y Mediana Empresa y Desarrollo regional de la nación (sepyme) (national sME and regional Development undersecretariat) 161 MEna Morocco iFc improving the credit central bank of Morocco 2009 information system private credit bureaus, iFc, banks 162 MEna Morocco World bank caisse centrale de Garantie Moroccan government, 2007 World bank 163 MEna Egypt iFc i-score credit bureau twenty-five banks in addi- 2007 tion to the social Fund for Development, Dun & bradstreet international, iFc 164 Eap china iFc chengdu small Enterprise iFc, chengdu cGc, DFiD, 2001 credit Guarantee (chengdu and state secretariat cGc) for Economic affairs of switzerland (sEco) s c a l in G - u p sM E accEss to Financial s Ervi cEs i n thE DEvElopi n G Wor lD 135 projEct DEscription Type Sub-type Project Summary public support scheme Funded facility the initiative entails offering newly established dynamic and innovative companies’ medium and long-term financing in more flexible conditions and with lower rates of interest than the financial system would otherwise offer them. in the case of technology companies, the initia- tive also offers free (or partially subsidized) technical assistance. in light of the difficulties the financial system presents to sMEs with regard to obtaining financing (due to strong regulations the system has to face), the banco de la nación argentina created a trust fund that allows it to finance promising projects of companies that would usually be excluded from any kind of exter- nal financing. in the case of newly created companies, the initial selection is accomplished by Fundación EMprEtEc due to its previous contacts with the different institutions and because of its knowledge in the entrepreneurship field and the creation of companies. Financial infrastructure credit bureau in 2006 the central bank of Morocco (baM), under the guidance of iFc, undertook a radical / Financial or reform of the aged national credit reporting system by revamping the outdated public credit credit information registry (pcr) and simultaneously establishing the first private credit bureau. all supervised registry entities (banks, nbFis, MFis) are mandated to provide baM with full data on all loans on a monthly basis. baM consolidates the data and provides the same to all licensed credit bureaus. baM plays an active role in the initiative through support the private sector and by delegating the pcr services, while also being the only licensing and supervising authority of private credit bureaus. First credit bureau became fully operational in nov 2009. public support scheme credit Guarantee in 2007, Morocco initiated a reform of the national credit guarantee scheme (caisse centrale de Garantie-ccG). the objective of this reform is to enable the ccG to provide access to credit to a larger number of sMEs with better loan origination incentives and to overcome the old system’s deficiencies. Financial infrastructure credit bureau Egypt’s first private credit bureau was established in 2007. information in the credit report is / Financial or collated from the members of the credit bureau. credit information registry public support scheme credit Guarantee chengdu cGc was set up in 2001 under a DFiD project for the restructuring of state-owned enterprises (soEs). the objective of chengdu cGc is to support sME lending through the provision of partial guarantees to the local lenders in a commercially sustainable manner. cGc only guarantees up to 70 percent of the loan amount and charges a market/risk based fee on guarantees. cGc leverages on key strategic partnerships with selected banks that share the same vision in this business model. iFc has provided a range of technical assistance tools to cGc. sEco and iFc have investments in the company, with 20 percent and 9.48 percent owner- ship, respectively. 136 FI N A N CI A L I N CLUSI ON EXPERTS GR OUP |  SME FI N A N CE SUB -GROU P Bibliography Accion International. “Financial Inclusion: What’s the Vision?� Report Prepared for the Center for Financial Inclusion. http://www.centerfor�nancialinclusion.org/Document.Doc?id=778 Adams, D.W, D.H. 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