Small and Medium Enterprises: Overcoming Financing Constraints Thorsten Beck, Leora Klapper, Soledad Martinez Peria DECRG-FI

Firm size, financing patterns & growth: The Empirical Evidence Research based on the World Business Environment Survey of 4,000 firms in 54 countries shows: Financing obstacles constrain firm growth – firms reporting higher obstacles grow more slowly. Size is of critical importance – small firms are the most adversely constrained by financing obstacles. Small firms use less external finance, esp. less bank finance, but more informal finance.

How financial and institutional developments affect SME financing In countries with higher levels of financial and institutional development, firms finance a larger share of investment with external, esp. bank & equity finance, & a smaller share from informal sources. Property right protection increases the use of external finance more for small than for large firms. Financial development alleviates the impact of financing obstacles on firm growth. Financial and institutional development helps leveling the playing field – small firms benefit more from financial and institutional development than large firms.

The Impact of Foreign Bank Entry for SME Financing Latin America study: –F oreign banks with a small local presence do not appear to lend much to small businesses –Large foreign banks in many cases surpass large domestic banks. From analysis of borrower’s perceptions across 36 developing countries: –Financing obstacles (High interest rates and access to long-term loans) are lower in countries with high levels of foreign bank penetration –Strong evidence that even small enterprises benefit in some ways and there is no evidence that they are harmed by foreign bank participation.

The Role of Factoring for SME Financing Factoring is the sale of accounts receivables at a discount Advantages for SMEs Does not require good collateral laws or efficient judicial systems Export factoring can facilitate and reduce the risk of international sales Reverse Factoring allows small, risky firms with large high-quality buyers to transfer credit risk and borrow on the credit risk of customers. Benefits lenders, small sellers, and large buyers: Lender: low information costs and credit risk SME Seller: Access to working capital financing Big Buyer: Ability to negotiate better terms with its suppliers and outsource supplier payments. Challenges in developing Countries: Taxes (VAT, Stamp, interest deductions) Regulations (cross-border, prudential supervision, license fees, capital requirements) Legal code (Factoring Act) Accurate and comprehensive credit information