This presentation was given at the Policy Dialogue: Financing SMEs: Sharing Ideas for Effective Policies which was held in Jakarta, Indonesia on 15-16 October 2014.Read more about the event: http://bit.ly/1VZsLcb
Access to Finance and SMEs in East Asia: key issues and policy implications Charles Harvie School of Accounting, Economics and Finance Faculty of Business University of Wollongong, Australia Presented at: Financing SMEs: Sharing Ideas for Effective Policies Capacity Building and Training Workshop ADBI/Bank of Indonesia Jakarta, Indonesia, 14 October 2014 The views expressed in this presentation are the views of the author and do not necessarily reflect the views or policies of the Asian Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms.
Transcript
Access to Finance and SMEs in East Asia: key issues and policy implications
Charles Harvie School of Accounting, Economics and Finance
Faculty of Business University of Wollongong, Australia
Presented at:
Financing SMEs: Sharing Ideas for Effective Policies Capacity Building and Training Workshop
ADBI/Bank of Indonesia Jakarta, Indonesia, 14 October 2014
The views expressed in this presentation are the views of the author and do not necessarily reflect the views or policies of the Asian Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms.
Presentation structure 1. Introduction – overview and key issues
2. SME access to finance – critical issues
3. SME priorities – stage of economic development matters
4. Results from a recent study 5. Conclusions and recommendations
1. Introduction – overview and key issues
SMEs are important: – Business numbers – Output – Employment – Exports – Innovation – Poverty alleviation – Economic empowerment
lenders) • Flexible, quick but expensive • Micro-finance
3. Internal • Own funds, relatives and family
(quasi-equity) • Major source of funds for most
SME entrepreneurs • Funds severely limited for growth
5. Access to funds 1. Size (harder for small firms) 2. Age (start-up, young firms) 3. Collateral 4. Profitability assessment for banks
(opaqueness and lack of transparency) 5. Risk (default/insolvency)
- Legal system (property rights and bankruptcy law)
6. Bank-client relationship 7. Cash flow 8. Credit history 9. Process time 10. Business plan 11. Type of loan (short vs long term)
4. SME Access to and Cost of Funds • Market failure • Credit rationing (Stiglitz and Weiss,
1981) • Asymmetric information and agency
problems • Distinguishing between good and bad
risk • Adverse selection and moral hazard • Financial gap (demand > supply)
6. Cost of Funds 1. Risk (default/insolvency) 2. Collateral (e.g. real estate)
- Preferred option - Creates difficulties for SMEs
in low income/transition economies
3. Credit rating 4. Compliance costs
9. Policies to support SME access to and cost of finance
General 1. Macroeconomic policy 2. Financial markets 3. Legal/regulatory/institutional environment 4. Microeconomic policies Specific 5. Loan quotas 6. Interest rate subsidies 7. Tax concessions 8. Guarantee loans 9. Development financial institutions (specialist lending institutions e.g. SME Banks) 10. Business Developments services 11. Stock exchange listing 12. Venture capital
7. SME performance (economic)
1. Growth 2. Employment 3. Profitability 4. Exports 5. Efficiency 6. Investment and productivity 7. Return on assets
8. Other factors • Macroeconomic policy
(national saving – investment balance)
• Legal, institutional, regulatory framework
• Financial system structure
4. SME Access to and Cost of Funds…..
• Market failure • Credit rationing (Stiglitz and Weiss, 1981) • Asymmetric information and agency problems • Distinguishing between good and bad risk • Adverse selection and moral hazard • Financial gap (demand > supply) • Inadequate lending (FGl and higher cost of borrowing (FGr) • See Figure 2
Figure 2 Credit rationing
5. Access to funds….. • Size (harder for small firms, “pecking order” viewpoint) • Age (start-up, young firms) • Collateral • Profitability assessment for banks (opaqueness and lack of transparency) • Risk (default/insolvency) • Legal system (property rights and bankruptcy law) • Bank-client relationship • Cash flow • Credit history • Process time • Business plan • Type of loan (short vs long term)
6. Cost of Funds….. • Risk (default/insolvency) • Collateral (e.g. real estate) preferred option • Creates difficulties for SMEs in low income/transition
economies • Credit rating • Compliance costs
7. SME performance…… • Output growth • Employment • Profitability • Exports • Efficiency • Investment and productivity • Return on assets • Innovation
8. Other factors…… • Macroeconomic policy (national saving – investment
balance)
• Legal, institutional, regulatory framework
• Financial system structure
9. Policies to support SME access to and cost of finance…..
General • Macroeconomic policy
• Financial markets
• Legal/regulatory/institutional environment
• Microeconomic policies
Specific
• Loan quotas • Interest rate subsidies • Tax concessions • Guarantee loans • Development of financial institutions (specialist lending
institutions e.g. SME Banks) • Business development services • Stock exchange listing • Venture capital
3. SME financing priorities – stage of economic development matters Advanced economies:
• Interest in all types of SME development
• Particular interest in those SMEs with high growth • potential
• Raise productivity and maintain competitiveness
• Little overall evidence of a financial gap for SMEs in general
• Except for innovation intensive SMEs (OECD) many of which are found in the high technology sectors
• Employment and growth potential
• In many countries they lack dynamism
• Linked to financial gap in the provision of funds to them
• Unsuited to traditional forms of SME finance (bank lending, government guarantee programs)
• Require special equity related financing
• Seen as having high return but high risk
• Need to develop risk capital markets
Emerging market and developing economies:
Financial gaps and credit rationing most prevalent in emerging and developing economies
They have many SMEs (principal-agent and asymmetric information problems most intense)
Macroeconomic imbalances and distorted legal, institutional and regulatory environments
• Many SMEs in the informal sector shun the formal financial system, limiting their growth
• Bureaucracy and tax system may encourage SMEs to remain informal
• If the informal sector remains large, and tax and regulation avoidance become standard practice there may be a lack of enforcement and compliance by government to laws and regulations
4. Results from a recent study
• A recent study of 8 East Asian economies was conducted by the Economic Research Institute for ASEAN and East Asia (ERIA) into the possibility of credit rationing being imposed on SMEs, that they had a shorter loan term and the cost of the loan was higher
Key areas of focus of the study…… 1. Key sources of internal and external finance for SMEs
2. Are SMEs systematically disadvantaged/rationed with respect
to external finance on the basis of their size, country of location and in aggregate (based on loan size, loan duration and cost of finance).
3. What are the factors contributing to the extent of this rationing, focusing upon firm characteristics, owner characteristics and firm performance
4. How important is rationing for the performance of SMEs in a sample of East Asian economies (using innovation and export activity as a measure of this performance)
The following tables summarise the major empirical findings from this study
1 to 5 6 to 49 50 to 99 100 to 200 Total % of TotalGarment 62 193 53 32 340 32.2%Parts, Components, and Automotives 22 55 13 11 101 9.6%Electrical, Electronic, parts and machinery 23 87 33 35 178 16.9%Others 146 215 37 38 436 41.3%Total 253 550 136 116 1055
24.0% 52.1% 12.9% 11.0% 100.0%
Table 1. Sample Distribution
Table 2 Characteristics of the Surveyed SMEs
Characteristics Garment Parts, Components, and Automotives
Control Variables 12. Age +/- +/- +/- 13. Size + + - 14. Dummy countries +/- +/- +/- 15. Dummy sectors +/- +/- +/-
Independent variables Expected Sign
Innovation Export
1. Loan size + +
2. Term of loan + +
3. Interest rate - -
Control Variables
4. Age +/- +/-
5. Size + +
6. Dummy countries +/- +/-
7. Dummy sectors +/- +/-
Table 5. Dependent Variable: SMEs’ Innovation Capability and Export performance
Table 7a Source of Finance for Business Start-up
N Mean S.D
Loans from friends or relatives of business owner(s) 1055 0.564 0.496 Retained earnings 1055 0.528 0.499 Commercial or personal loans and lines of credit from financial institution including credit cards. 1055 0.362 0.481 Trade credit owing to suppliers 1055 0.331 0.471 Leasing 1055 0.183 0.387 Loans from individuals unrelated to the firm or its owner ("angels") 1055 0.171 0.376 Personal savings of business owner(s) 1055 0.156 0.363 Government funding, grants 1055 0.111 0.314 Micro-credit 1054 0.102 0.302 Other sources of financing 1055 0.047 0.213
Table 7b Source of Finance for Business Operations
N Mean S.D
Personal savings of business owner(s) 1034 0.721 0.449 Loans from individuals unrelated to the firm or its owner ("angels") 1034 0.646 0.478 Government funding, grants 1032 0.499 0.500 Commercial or personal loans and lines of credit from financial institution including credit cards. 1030 0.331 0.471 Retained earnings 1033 0.329 0.470 Trade credit owing to suppliers 1029 0.232 0.422 Loans from employees 1028 0.190 0.392 Leasing 1027 0.155 0.362 Micro-credit 1055 0.116 0.320 Other sources of financing 973 0.055 0.229
Table 7c Purpose of Requested Finance
N Mean S.D
Working capital/ operating capital, such as inventory or paying suppliers 598 0.540 0.499 Other Machinery and equipment 595 0.262 0.440 To grow the business 599 0.230 0.421 Vehicles/ rolling stock 597 0.136 0.343 Land and buildings 596 0.104 0.306 Debt consolidations 595 0.074 0.262 Research and development 595 0.066 0.248 Other 568 0.039 0.193 Computer hardware and software 599 0.033 0.180 Intangibles? (such as training, customer list, goodwill) 595 0.017 0.129 Purchase a business 595 0.008 0.091
Centre for Small Business & Regional Research, School of Economics
Table 12
Major findings – SMEs actively seeking finance, from multiple institutions and multiple sources – key characteristics
• Domestically owned • High growth, mature, larger SMEs and low profit
making • Have business expansion aspirations • Lack sufficient internal funds and constrained by
low profit margins • Operate in more developed economies • Owners run multiple businesses • Operate in many industrial sectors
Conditions of finance offered to SMEs - summary of major findings
Loan size – key SME characteristics Foreign ownership (+)* Owner’s multiple businesses (-) Profit margin (-)* Size of SME (+)* Less developed economy (-)* Garment sector (-)* Auto parts (-)* Owner’s net worth (+)*
Financial statements (+)* Business plan (+)* Cash flow (+)*
Summary of major findings (cont’d) Term of the Loan – key SME characteristics Business life cycle (+)* Foreign ownership (-) Owner’s multiple businesses (+)* Sales growth (+)* Profit margin (-)* Size of SME (+)* Less developed economy (+) Owner’s net worth (+)*
Collateral (+)* Financial statement (+)* Business plan (+)*
Summary of major findings (cont’d) Cost of the Loan – key SME characteristics Sales growth (-) Size of SME (-)* Less developed economy (+)* Owner’s net worth (-)* Business plan (-)*
Summary of major findings (cont’d) SME access to finance and performance Innovation Size of SME (+)* Garment sector (-)* Auto parts and components (-)* Electronics (-)* Loan size (+)* Term of the loan (+)* Exports Size of SME (+)* Less developed economy (+)* Loan size (+)* Interest rate (-)*
Summary of major findings Is their evidence of discrimination/rationing and the imposition of risk premiums against SMEs? There appear to be problems for small businesses in particular and those operating in less developed economies . They face difficulties in terms of: 1. Loan size (less) 2. Duration of the loan (shorter) 3. Cost of the loan (higher) This can impact start-ups and the performance of existing small businesses
This is consistent with the literature A lack of transparency in firm operations and poor governance contributes to asymmetric information and greater lending risk as perceived by financial institutions. The following are critical in determining access to and the terms and conditions of loans to SMEs from financial institutions: • Owner’s net worth • Collateral • Business plans • Financial statements • Cash flow
It is essential in this context to improve the following: • Legal framework (property rights protection for
lenders against bankruptcy and delinquent loans, land use rights)
• Institutional framework • Regulatory framework
5. Conclusions and policy recommendations • Financial gaps or credit rationing is more pervasive in
emerging market and developing economies
• The overall legal, institutional and regulatory environment is a critical determinant of SME access to finance
• In emerging market and developing economies access to finance for start up and young enterprises is critical
• In advanced economies there is less evidence of financial gaps or credit rationing. But there appear to be financial gaps specifically for innovation oriented SMEs
• An improved mix of financial instruments and institutions are required to improve SME access to finance
• Government has an important, but limited, targeted role to play in promoting SME finance
• Size of loan, key SME characteristics -foreign ownership (+), owner’s multiple businesses (-), profit margin (-), size of SME (+), less developed economy (-), garment sector (-), auto parts (-), owner’s net worth (+), financial statements (+), business plan (+), cash flow (+)
• Term of the loan – key SME characteristics - business life cycle (+), foreign ownership (-), owner’s multiple businesses (+), sales growth (+), profit margin (-), size of SME (+), less developed economy (+), owner’s net worth (+), collateral (+), financial statement (+), business plan (+)
• Cost of the Loan – key SME characteristics - sales growth (-), size of SME (-), less developed economy (+), owner’s net worth (-), business plan (-)
Specific policy recommendations
• Encourage formalisation • Reduce bureaucratic regulations and taxes that encourage
informal business behaviour • Increase firm size • Improve SME governance and entrepreneurial skills • Target wealthy entrepreneurs/owners to establish new
firms or expand their existing businesses. Also target these for upgrading skills etc.
• Encourage foreign owned enterprises to establish in the country, or establish majority foreign owned joint ventures with local SMEs
• Improve book-keeping requirements of SMEs to improve transparency
• Provide advice/assistance in the preparation of business plans
• Clarify collateral ownership by SMEs • Reduce taxes/charges on SMEs • Tackle legal, institutional and regulatory distortions that
discourage commercial bank-SME loans
• In addition to these, governments needs to tackle: macroeconomic imbalances (national savings and investment), limited depth and breadth of financial markets and implement microeconomic reform measures that encourage competition (in financial markets)
• Establish venture capital markets, in collaboration with the private sector, for high tech SMEs, as well as access to equity markets.
• Establish a credit rating agency for businesses, where possible, to make the task of banks lending to SMEs much easier.
