Overcoming Barriers to Credit Availability for SMEs - Dissertation Example

Assessing and Overcoming Barriers to Credit Availability for SMEs This document presents a research proposal on the assessment of credit availability for SMEs in Singapore, the barriers that exist in lending to SMEs and how these can be overcome so that financing options are easily accessible for SMEs. This will be achieved by accomplishing the following research objectives: Gain an insight into the openness among financial institutions to lend to SMEs The lending process that is followed by banks (foreign and state owned) and Non Banking Financial Companies (NBFCs) in lending to SMEs Understanding the factors that impact credit availability for SMEs Determining steps that can be taken by financial institutions as well as SMEs to improve financing options for SMEs The proposal begins with an introduction giving a broad overview and explaining why this research subject is both important and interesting. The fact that SMEs play a key role in boosting the economy of the nation makes it a topic worth being examined. The proposal also gives a brief review of literature and explains the methodology that will be used in conducting the research. It concludes by examining the possible issues that may arise in the completion of this research and how they will be dealt with. The proposal defines the timescale for conducting this research. Introduction and Relation to Previous Research Availability of finance for small and medium enterprises (SMEs) has been a topic of research among academicians since it impacts the economy of a nation (Beck and Demirguc-Kunt,2006; OECD,2004). One of the perennial problems faced by SMEs is the access to capital (Scholz,2007).There has been extensive research on why SMEs find it difficult to obtain funding, why transparent SMEs stand better chance of finance availability than opaque SMEs, how financing differs from traditional SMEs to innovative SMEs and what SMEs can do to improve their chances of obtaining finances, given that they function in a regulated environment. This topic is of interest since access to financing has been identified in many business surveys as one of the most significant obstacles to the survival and growth of SMEs (OECD,2004).It will be of value to understand what are the barriers that exist in financing of SMEs and what can be done both by financial Institutions and SMEs to overcome the same. Barriers to SME Financing According to OECD (2006) reasons identified for SMEs inability to procure finances especially in comparison with larger firms usually include: Incomplete range of financial products and services Regulatory rigidities or gaps in the legal framework Lack of information on both the bank’s and the SME’s side. Banks may avoid providing financing to certain types of SMEs, in particular, start ups and very young firms that typically lack sufficient collateral, or firms whose activities offer the possibilities of high returns but at a substantial risk of loss. High volatility pattern in growth and earnings, with greater fluctuations, than larger companies. Low survival rate compared to larger companies – one analyst found that manufacturing firms with fewer than 20 employees were five times more likely to fail in a given year than larger firms. SME’s life cycle also impacts its fund availability. OECD (2004) states “after the firm has passed through the early stage, it requires a further injection of capital to fund the growth of its manufacturing and distribution capacity as well as to fund further R&D. However, its reliance on intangible assets with uncertain cash flows still make it less than an ideal candidates for debt financing. In addition, the difficulty of obtaining loans is compounded by the limited number of in-house innovation/technology experts in traditional banks, who could properly assess the future growth prospects of innovative projects. Moreover, a low profitability and short track record make it unsuitable to raise equity through public listing. On the other side of the coin, young expanding SMEs faced with uncertain earning prospects may prefer to avoid debt financing which require regular payments to principal and interests for reasons of flexibility” (11). Figure 1 – Life Cycle of SME (Source:OECD, 2004) Additionally it has also been observed that fund availability is also impacted by the type of SME requesting funds. For instance, innovative SMEs find it difficult to obtain funding since they work with a new product or service which can also be intangible, making it difficult to assign it a monetary value. They can also show negative cash flow, skewed or uncertain returns, and untried business models. Thus representing a higher risk to banks while also posing the problem of assessment that does not fit the traditional model of assessing SMEs (OECD 2004). Credit Availability for SMEs Review of literature indicates that several factors impact credit availability for SMEs. Ram Consultancy Services (2005) points out that the reason why financial institutions appear less inclined to financing SME is: Lack of skills needed to understand and evaluate SMEs Risk adverse to informationally opaque SMEs Mindset issue of ‘bigger is better’ which makes the institutions ask for collateral, requires onerous documentations and subject the SME to the same evaluation criteria as they would large and structured corporations. Credit options for SMEs is also impacted by foreign-owned banks individually (or larger shares for these banks ) which are associated with greater credit availability for SMEs (Gerard, Goldberg, Kinney, 2000; Beck, Demirguc-Kunt, and Maksimovic,2004) Literature also suggests that less SME credit is available in nations which have large market shares for state-owned banks (Beck, Demirguc-Kunt, and Maksimovic, 2004; Berger, Hasan, and Klapper,2004). RAM Consultancy services (2005) states that “ a survey of financial institutions throughout ASEAN revealed that many banks and non-bank institutions are generally keen to lend to SME as they realise that on a portfolio basis, SME loans provide higher returns and lower risk compared to large corporate loans. However, these funding institutions face several impediments in financing SME. Naturally, financial institutions attribute most of the impediments to either the government, the prevailing legal and regulatory framework, or the SME. The objective view is that no party is entirely free from blame” (11). On the other hand it has been observed that non-bank financial institutions (such as finance or credit companies) and smaller boutique banks are usually found to be more perceptive and knowledgeable about SME financing than their larger counterparts (Ram Consultancy Services, 2005). It is interesting to observe how venture capitalists fund SMEs. In order to deal with uncertainty associated with SME and mitigate informational lacunae they actively scrutinise firms before providing capital and constantly monitoring afterwards. Examples include spreading out financing in stages over time, forming alliances or syndicates with other venture capitalists, becoming a member of the board of directors, and arranging compensation schemes including stock options (Gompers and Lerner, 1998). SPRING (2007) points out that financing of SMEs can have unique requirements and many financial institutions have dedicated units to serve SMEs and/or developed services to engage them at different stages of their growth. For example, OCBC Bank in Singapore has a business unit that nurtures smaller SMEs, and another that serves larger SMEs with more complex needs. This way, the bank seeks to provide relevant expertise and continual support for SMEs. Berger and Udell (2004) refer to six lending technologies that can be applied to financing SMEs. Financial statement lending which involves underwriting loans based on the strength of a borrower’s financial statements. Small business credit scoring which is uses hard information about the SME and its owner. Asset-based lending wherein the financial intermediary looks to the underlying assets of the firm (which are taken as collateral) as the primary source of repayment. Factoring involves the purchase of accounts receivable by a “lender” known as a factor. Trade credit Relationship lending which is designed to address information problems that are not feasible or cost-effectively solved by the other technologies. The primary information used by lenders is based on “soft” information about the relationship between the lender and the borrower (Rajan, 1992). Proposed Methods In order to assess the availability of finances for SMEs and also determine the lending technologies used by financial institutions in financing SMEs this research will use both- extensive literature review and a survey among financial institutions. Literature Review A large part of data collection will be done through books, journals and internet sources to answer the research question and achieve the objectives of this dissertation. The study will undertake an indepth review of literature to understand the financial environment and regulatory systems that govern financing of SMEs and the current state of finance availability for SMEs in Singapore. Survey A survey is used to measure variables by asking people questions and then examining the relationships between the identified variables. Surveys aim to understand the attitudes and patterns of behaviour (Babbie, 1990). A descriptive survey of financial institutions will be undertaken in Singapore to gain an insight into financial institutions lending to SMEs. Survey is an appropriate technique for this research since it will help in identifying attitudes and pattern of behaviour of financial institutions with regard to SME financing. Besides, survey is also easy to administer. A face-to-face interview will be conducted with the Head of Credit/ SME business in these institutions. Prior appointments will be sought and the participants will be explained that the study is academic in nature. Their consent on disclosing their identity in the final report will also be sought so that results can be presented in accordance with the participants’ approval. The sampling strategy and interview questionnaire for this study is given below: Sample Size: 15 Institutions- 5 foreign banks, 5 state owned banks 5 non banking financial companies Sample Selection: The selection will be made on a random sampling basis, and every second institution in its category in the directory of financial institutions will be selected for survey. If the particular organization and its staff is unavailable or unwilling to respond, the next organization in the list will be selected. Questionnaire: The questionnaire will comprise both open ended and close ended questions and will be personally administered, face to face..The questionnaire contains 14 questions (please refer Appendix A) will assess the following parameters: Openneess in lending to SMEs (questions 1-5) Lending process (questions 6-10) Factors impacting credit availability for SMEs (questions 11-14) Findings and Analysis The research will involve rich descriptive reporting, based on the secondary data gathered through the review of literature. Responses gathered through the questionnaire will be collated in an excel file for analysis. Quantitative analysis will also be conducted based on the data gathered through the survey. A percentage analysis will be presented and correlation technique will be used wherever relevant. Analysis will include both quantitative and qualitative assessments and will be supported with graphs and charts wherever relevant. Reflections Being a research student, I look forward to the opportunity to produce a research rather than only accepting or rejecting the available theories. While conducting this research, it is possible that I may encounter problems that can affect the quality of my work. I have therefore thought of alternatives to deal with these issues. The biggest obstacle to successful completion of this project is access. Time could be another hindrance if it is not managed properly. Due to the methodology being adopted, there is a lot of dependence upon the availability of others. It sis possible that their sense of urgency and priority does not always coincide with mine. I will personally visit Singapore or email my survey questionnaire to obtain responses. Having worked for 18 years in the SME sector as Finance Manager and Financial Controller, I have been able to establish a good rapport with people in the industry who I hope will be able to help me in the completion of this dissertation. In order to deal with the problem of gaining sufficient management time to conduct the pre-set tasks or interviews with them, owing to busy schedules or even absence from work, I will set slightly advance time spans by which I aim to conduct my research, so that I am still able to adhere to the final deadline. In case an appointment cannot be completed during the time period of this study, or there is unwillingness on the part of the participants, this dissertation will solely rely on the secondary data gathered through books, journals and internet sources. The only ethical issue that can arise is related to confidentiality. In case the institutions do not wish their identity to be disclosed, it will be kept confidential. If I need to use direct quotes from the interview, I will seek the respondents’ permission before mentioning any names. It is acknowledged that the progress in this study will be influenced by my interest and knowledge as the researcher. Unlike in qualitative research where the researcher is also the data collecting instrument and chances of pre conceived notions impacting the study are high; in this case owing to a structured questionnaire such bias can be minimised. Although I believe that this proposal will achieve its objective of identifying financing barriers for SMEs a further research on the problems faced by SMEs in meeting requirements of financial institutions and what they can do to solve these issues will truly complete this research initiative. However how SMEs process their finance requests is not within the scope of this study. Conclusion This research proposal is designed to understand the financial institutions’ perspective on lending to SMEs, the problems, difficulties, limitation and regulations faced by them. Through the review of literature and the survey the project endeavours to arrive at a better understanding of nuances involved in lending to SMEs and what SMEs can do to better their chances of obtaining finances. This research will be conducted between October 2007- November 2007.The timelines for the same are presented below. Sept - 07 Oct - 07 Nov - 07 Activity Start Date Finish Date 7 14 21 30 7 14 21 31 7 14 21 30 Prepare Research Proposal and Submit 10-Sep-07 19-Sep-07 Conduct Review of Literature 22-Sept-07 14-Oct -07 Make Appointment 22-Sept-07 14-Oct -07 Conduct Survey 14-oct-07 31-Oct-07 Update data in data entry sheet 14-oct-07 31-Oct-07 Analyse data 1-Nov-07 7-Nov-07 Write dissertation and submit project 1-Nov-07 21-Nov-07 Deadline Time period References BABBIE, E.(1990) Survey Research Methods. CA: Wadsworth. BECK, T. and DEMIRGUC-KUNT, A. (2006) “Small and medium-size enterprises: Access to finance as a growth constraint.” Journal of Banking & Finance, Vol 30, pp. 2932. BECK, T., DEMIRGUC-KUNT,A. AND MAKSIMOVIC,V. (2004). “Bank Competition and Access to Finance: International Evidence.” Journal of Money, Credit, and Banking .vol 36, pp. 627-648. BERGER, A.N., HASAN,I. AND KLAPPER,L.I.(2004) “Further Evidence on the Link between Finance and Growth: An International Analysis of Community Banking and Economic Performance,” Journal of Financial Services Research . vol 25 pp. 169-202. BERGER,A.N., UDELL,G.F. (2004) A More Complete Conceptual Framework for SME Finance. Unpublished paper, Prepared for presentation at the World Bank Conference on Small and Medium Enterprises: Overcoming Growth Constraints World Bank, MC 13-121. GERARD, D.B; GOLDBERG,L. and KINNEY,D (2000) “Foreign and Domestic Bank Participation in Emerging Markets: Lessons from Mexico and Argentina,” Federal Reserve Bank of New York Economic Policy Review . vol 6, no. 3,pp. 17-36. GOMPERS, P. A. and JOSH, L. (1998), “What Drives Venture Capital Fundraising?”, Brookings Papers on Economic Activity, Microeconomics. pp. 149-92. OECD.2006. Observer. 18 Sept. 2007 RAM CONSULTANCY SERVICES (2005) SME Access To Financing: Addressing The Supply Side Of Sme Financing. Unpublished Paper Repsf Project No. 04/003. SCHOLZ,P.(2007) LEASING: A Financing Alternative For SMEs? Unpublished Paper, Faculty Of IMADEC University, SPRING (2007) A Wealth of Financing Options for SMEs. Appendix A 1. How do you define an SME? By no. of employee. (Yes. More than_______) By firm revenue/ sales (Yes. More than_______) By loan amount (Yes. Less than_______) By asset value (Yes. Less than_______) 2. For how long have you been lending to SMEs? 3. What is your opinion on loan to SME vs Corporate Loan Higher risk on SME loan Lower risk on SME loan Indifferent Higher margin on SME loan Lower margin on SME loan Indifferent 4. What types of SMEs have you been lending to Innovative Traditional Opaque Transparent 5. How has your experience been in financing SMEs? 6. Which department looks after the financing of SME? Do you have a special SME lending unit? _____________________________________________________________________ 7. What are your primary requirements from SME when they request for Finance Financial Statements Buisness Plan/ Proposal/ Cash Flow Bank Statements Proof of Income Proof of Asset Ownership Others 8. If SMEs cannot provide adequate documentation do you: Reject loan Refer Loan to Credit guarantee scheme Approve loan with conditions Others 9. What type of information do you use in lending to SMEs: Internal database Credit bureau or similar central database Credit rating agency Private information providers Associations Formal/ informal check with other banks Others 10. What has been your experience regarding the information provided by SMEs who request for loan? Ease of obtaining the information (High/Medium/Low) Reliability of the information (High/Medium/Low) Accuracy of the information (High/Medium/Low) Cost of obtaining the information (High/Medium/Low) 11. What in your opinion is the driving force for institutions to lend to SMEs? _____________________________________________________________________ 12. What in your opinion are the reasons why Institutions do not lend to SMEs Lack of quality/ sufficient collateral Lack of bankable business plan Lack of/ no track record of firm or owner Lack of/ poor financials of SME Lack of accurate and comprehensive information Lack of information/ published data Not familiar/ lack expertise to evaluate SME Others a. 13. What Lending technology do you use and why? Financial statement lending Credit scoring Asset-based lending Factoring Trade credit Relationship lending 14. What are the reasons why you may not be usinga specific lending technology? Availability of information Cost concern Insufficient infrastructure to accommodate Lack of expertise in-house Banking restrictions Lack of credit bureau/ central database of SME info Others Read More