Access to Finance for Small and Medium Enterprises in Emerging Market Economies - Essay Example

Access to Finance for Small and Medium Enterprises in Emerging Market Economies (AFME) PhD Thesis Proposal By Table of Contents Introduction/Background 3 Research Questions 8 Aims and Objectives 8 Significance of the Study 9 Statement of the Problem 10 Research Methodology 11 Time Line 12 Organization of the Study 13 Bibliography 14 Access to Finance for Small and Medium Enterprises in Emerging Market Economies (AFME) Introduction/Background The Organization for Economic Cooperation and Development (OECD) reports that there are a number of reports that small and medium sized enterprises (SMEs), encounter difficulties obtaining finance.1 In emerging market economies, access to finance is problematic for all firms. However, SMEs have far more difficulties accessing capital than larger businesses.2 Berger and Udell argue that in all cases, SME financing is impacted by government policies and domestic financial constructs and lending policies.3 For the most part, these policies are a result of weaker property rights which impact the extent to which lenders and borrowers can rely on assets as collateral.4 Moreover, the lack of legislation supporting SME also contributes to the difficulties SMEs have accessing finance.5 Therefore law plays a significant role in SMEs’ difficulty accessing finance. This research proposes to explore the extent to which law plays a role in tempering government intervention in commercial businesses, in particular financial institutions. This research will examine how the law functions to constrain government intervention in financial institutions and whether or not there are exceptions permitting governments to intervene directing improvements in the extent to which SMEs can gain access to finance. Exploring the role of law in tempering government intervention in financial institutions’ lending policies can lead to further research on states in which governments have intervened and whether or not these interventions are supported by law and have in fact improved SMEs’ access to finance. Domestic financial lending policies creating obstacles to financing for SMEs is demonstrated by a research study by Menkhoff, Neuberger and Suwanaporn. Menkhoff, et. al., studied data from 560 commercial banks in Thailand. The study revealed that SMEs were generally treated as high credit risks candidates and were required to provide greater collateral for loans than larger businesses.6 On the other hand, a report by the World Bank illustrates that the law plays a significant role in SMEs’ access to finance. According to the World Bank, in countries where institutional development is more advanced with the result that property protection laws are more robust, SMEs have greater opportunities for credit from “external sources”.7 SMEs are generally believed to be important for private sector development in emerging markets. However, in order for SMEs to contribute toward economic development, it is necessary for SMEs to have access to flexible capital. A lack of financial and institutional growth have contributed to the slow growth of SMEs and has in turn stifled opportunities for access to external capital.8 Governments in emerging market economies generally fail to establish policies and conditions that encourage private sector development. In emerging markets where market reforms have been conducted as in Poland, the Government has encouraged SME growth by implementing legislation reflecting EU standards and have encouraged banks to partner with SMEs as viable sources of economic development.9 In emerging economies however, the legal obligations of financial institutions to protect their deposits is juxtaposed against laws that do not compel SMEs to comply with standardized credit reporting.10 Therefore, financial institutions are unable to verify the ability of SMEs to satisfy loans and credit facilities. Therefore the question is whether or not governments and in particular legislators and regulators, can intervene to reduce the risk associated with SMEs by increasing reporting standards and by encouraging financial institutions to partner with SMEs for economic growth and development. This study examines the challenges and opportunities presented by governments and the law in developing countries with respect to SMEs access to financing. Singapore is a developing country which stands out as one in which access to finance for SMEs is no longer a difficulty. SMEs in Singapore comprise as much of 99% of “all establishments” and employs over half of Singapore’s “workforce”.11 Moreover, SMEs contribute in excess of 40% of the country’s GDP.12 The success of SMEs in Singapore is largely attributed to government initiatives toward encouraging entrepreneurship and in doing so has committed resources to improving funding to SMEs. A number of state sponsored programmes include the SPRING Startup Enterprise Development Scheme, Business Angels Scheme, Growth Financing Programme, Micro-loan Programme, Local Enterprise Finance Scheme, Loan Insurance Scheme, Export Coverage Scheme and the Internationalisation Finance Scheme.13 A review of literature reveals that most of the studies conducted on access to finance by SMEs in emerging markets tend to emphasize unsuccessful trends. There is far too little emphasis on successful trends. Thus this study fills the gap in the literature by examining access to SMEs in Singapore and the surrounding state initiatives that have worked thus far to improve access to finance by SMEs. This study will reveal the role of the law in these state initiatives. It is hoped that by including Singapore as a special case study in this study, lessons can be learned and transferred over to help other developing countries formulate government strategies and law to improve access to finance by SMEs. It is also hoped that scholars may be encouraged to conduct further research identifying the role that the law plays in improving SMEs access to finance. Germany and France will also be studied as a means of expanding the knowledge base in the literature. Germany, a developed economy might serve as an example of law and government policies that successfully encourage banks to partner with SMEs as viable sources of economic development. Since the Second World War, government policies in Germany have supported SMEs and have resulted in close relationships between banks and SMEs with SMEs having greater access to financing. By the 1990s, an increasing number of SMEs in Germany were relying on bank financing.14 Similarly, financial institution reforms in France in the 1980s improved competition among all businesses particularly in industries that are “bank-dependent”.15 The need for government and legislative intervention for banking reform supportive of SMEs is obvious in emerging markets such as those in Sub-Saharan Africa. According to an International Monetary Fund (IMF) report, officials in Sub-Saharan African states are concerned that banking institutions have failed to provide sufficient “support to new economic initiatives and, in particular to the expansion of” SMEs.16 The evidence suggests that while banks in many Sub-Saharan countries are liquid, they usually extend credit to “the most trustworthy borrowers”.17 This research study proposes to identify the factors contributing to a lack of access to financing by SMEs in emerging market economies. A comparative study is conducted between access to finance by SMEs in Singapore and developed countries such as France and Germany and access to finance by SMEs in Sub-Saharan Africa. The purpose of the comparative study is to identify the obstacles existing in emerging market economies and the lifting of obstacles in Singapore and developed countries. Drawing on evidence from Singapore and developed countries demonstrating access to finance for SMEs, it is hoped that reforms can be transferred over to emerging market economies with a view to removing obstacles to access to finance by SMEs in emerging market economies. Implications for scholars is the identification of the role of law in improving access to finance by SMEs in emerging markets with a history of success. Research Questions The proposed thesis will be guided by a primary research question and secondary research questions. The primary research question is: To what extent do SMEs in emerging market economies have access to finance? The secondary research questions are: What are the factors contributing to a lack of access to finance by SMEs in emerging markets? What role can the law play in increasing access to finance by SMEs in emerging markets? Aims and Objectives The aims and objectives of this research are to: Determine the extent to which SMEs in emerging market economies have access to finance. Identify the factors contributing to a lack of access to finance in emerging market economies. Identify the role of law in facilitating access by SMEs to finance. Significance of the Study Since innovations associated with SMEs are linked to economic growth in emerging economies,18 it is important to identify and understand how access to finance aids the growth and continuance of SMEs. In a majority of developing countries, SMEs represent most of the business firms and thus employ substantial number of citizens. In Brazil for instance, businesses with less than 50 employees comprise 99% of all business and 55 % of employment since 1980. In Bangladesh, companies with less than 100 employees represent 99% of all businesses and 58% of all employees since 1986.19 More importantly, SMEs are the cornerstone of “emerging private sectors” in emerging market economies and “thus form the base for private sector-led growth”.20 Access to finance is important for SMEs in terms of capital flexibility and thus the continuance of the SME. Finance for SMEs are also important for providing “venture and growth capital” and provides entrepreneurs with “external” start-up capital and capital for “early development and expansion stages”.21 This study is also important to the researcher since the researcher previously conducted extensive research on a similar subject for the completion of his LL.M programme in the module of “Law and Finance in Emerging Markets”. In the course of completing the study, the researcher wrote an essay on “Institutions like Microfinance help the Poor to obtain Access to Finance. While this is a valuable innovation, its effects remain limited and temporary. What is needed is the development of the Financial System as a whole.” Statement of the Problem In Sub-Saharan Africa the macroeconomic and business climates are described as “unfriendly”.22 This unfavourable macroeconomic and business climate coupled with “lack of capacity on the part of SMEs” and banking systems have resulted in a lack of finance for SMEs.23 From the banking system’s perspective SME’s lack the capacity to meet bank requirements for loans.24 Learning from the German experience, the government of Germany has made it a priority to ensure that SMEs have access to financing. In doing so, SME financing has become a special project of a newly formed Reconstruction Loan Corporation for SMEs and the German Equalisation Bank as of September 2003. In 2004, more than EUR 5.7 billion was approved in SME and entrepreneur loans.25 Evidence from France also suggests that banks, led by government policies and legislative intervention, provide a friendly environment in which SMEs have greater access to finance than in many other European states. One of the channels for greater access to finance by SMEs in France is the lower rates charged on SMEs loans by French banks. It is also reported that French banks operate under a guarantee system which makes it easier for French banks to approve financing to SMEs regardless of how risky they may perceive SMEs.26 By contrast the African Development Bank expressed the view that SMEs are required to strengthen their own capacities in order to qualify for bank financing.27 However, based on evidence from France and Germany, it would appear that access to finance can be resolved by government and legislative intervention which results in prudential practices that are more amenable to advancing finance and credit to SMEs. Research Methodology This is a comparative case study of SMEs’ access to finance in Sub-Saharan Africa, Singapore and two developing countries: France and Germany. The data will be collected primarily from secondary and primary sources. The secondary sources consist of textbooks and journal articles reflecting empirical research conducted by academics and intergovernmental organizations and national banks. International governmental organizations used in the collection of data include the OECD, the IMF, the World Bank and the United Nations. In the event, there is a paucity of SME surveys in the secondary sources, primary data will be collected from a questionnaire which will be distributed among 50 SMEs in emerging economies. The questionnaire will be delivered and returned by email. The questionnaire will be a blind item in that names of the SMEs will not be identified on the document. The questionnaire will be categorically scaled from 1-5, asking the participants to rate the extent to which they agree or disagree with the question. The questions are designed to identify the extent to which SMEs in emerging economies require external financing, have requested financing and have received it. Other questions include interest rates charges, collateral requirements, and other formalities that are associated with financing requirements (see attached appendix). Ethical considerations relate to privacy. Since the questionnaire will only be distributed to SMEs as a blind item the issue of privacy will not arise. All persons contacted will be over the age of 18 and will be in managerial positions so that the issue of competency and capacity to give consent will not arise. Time Line In the first months of the research the researcher will conduct a review of the literature. Notes will be taken formulating a hypothesis which is expected to reflect that SMEs in emerging markets have difficulty accessing finance and that governments can make the necessary reforms for encouraging financial institutions to partner with SMEs. In the latter part of the first year, efforts will be made to identify SMEs in at least one emerging economy. All efforts will be made to identify SMEs and management in a Sub-Saharan African state. The potential SMEs’ management will be contacted by email requesting their participation in a questionnaire and the reasons for conducting the questionnaire. Once consent is obtained from the SME management in emerging economies, the questionnaire will be prepared. This should take approximately one week or less. The questionnaires will be sent to the respondents by email as an attachment. The time allowed for the return will be thirty days, although it might take a bit longer. Upon receipt of the completed questionnaires, the researcher will spend a month coding, analysing and categorising the results and comparing it to the information documented in the literature review. In the event there is a need to ask follow-up questions or if questions arise from information obtained in a review of the literature or from the research material obtained on access to finance in Sub-Saharan Africa or elsewhere, the researcher will contact the respondents and request their participation in a follow-up questionnaire. The remaining time will be spent drafting and redrafting the dissertation until such time as a satisfactory final paper can be completed. Organization of the Study The proposed dissertation will be organized and presented as follows: Chapter I: An Introduction to the Study Chapter II: A Review of the Literature. Chapter III: Access to Finance by SMEs in Sub-Saharan Africa and Signapore. Chapter IV: Access to Finance by SMEs in Germany and France. Chapter V: Research Methodology. Chapter VI: Research Findings and Conclusions. Bibliography Textbooks African Development Bank and OECD. African Economic Outlook 2005, (OECD Publishing, 2005). Leone, P. and Vento, G. A. Credit Guarantee Institutions and SME Finance. (Hampshire, UK: Palgrave Macmillan, 2012). OECD, Financing SMEs and Entrepreneurs 2012: An OECD Scoreboard, (OECD Publishing, 2012). OECD, SME and Entrepreneurship Outlook 2005. (OECD Publishing, 2005). Journal Articles Beck, T. and Demirguc-Kunt, A. ‘Small and Medium-Size Enterprises: Access to Finance as a Growth Constraint.’ (November 2006) 30(11) Journal of Banking & Finance, 2931-2943. Berger, A. N. and Udell, G. F. ‘A More Complete Conceptual Framework for SME Finance.’ (November 2006) 30(11) Journal of Banking & Finance, 2945-2966. Lane, C. and Quack, S. ‘The Social Dimensions of Risk: Bank Financing of SMEs in Britain and Germany.’ (November 1999) 20(6) Organization Studies, 987-1010. Menkhoff, L. Neuberger, D. and Suwanaporn, C. ‘Collateral-Based Lending in Emerging Markets: Evidence from Thailand.’ (January 2006) 30(1) Journal of Banking & Finance, 1-21. Radas, S. and Bozic, L. ‘The Antecedents of SME Innovativeness in an Emerging Transition Economy.’ (June-July 2009) 29(6-7) Technovation, 438-450. Scherer, J. Zeidman, B. and Yago, G. ‘Stimulating Investment in Emerging-Market SMEs,’ (October 2009) 8 Milken Institute Financial Innovations Lab Report, 1-42. Smallbone, D. and Welter, F. ‘The Role of Government in SME Development in Transition Economies.’ (July 2001) 19(4) International Small Business Journal, 63-77. Official Reports Beck, T. ‘Financing Constraints of SMEs in Developing Countries: Evidence, Determinants and Solutions,’ (April 2007) World Bank, Development Research Group, 1-35. Claessens, S. and Tzioumis, K. ‘Measuring Firms’ Access to Finance,’ (May 2006) World Bank Paper Prepared for Conference: Access to Finance: Building Inclusive Financial Systems, Organized by the Brooking Institution and World Bank, Washington, D.C, May 30-31, 1-25. DBS Bank Ltd. ‘Financing SMEs – The Singapore Experience,’ (Marcy 21-April 1, 2008), APEC High Level Meeting Driving SMEs Growth to Promote Local Development Seminar, 1-32. Hallberg, K. ‘A Market-Oriented Strategy for Small and Medium Scale Enterprises, Part 63,’ (2000) The World Bank, International Finance Corporation, 1-24. Mu, Y. ‘Impediments to SME Access to Finance and Credit Guarantee Schemes in China,’ (18 December 2002). Financial Sector Operations and Policy Department of the World Bank, 1-32. OECD. ‘The SME Financing Gap.’ (2006) 1 Theory and Evidence, 1-140. Sacerdoti, ‘Access to Bank Credit in Sub-Saharan Africa: Key Issues and Reform Strategies,’ (August 2005) IMF Working Paper, Monetary and Financial Systems Department, WP/05/166, 1-39. United Nations Economic and Social Commission for Asia and the Pacific, ‘Globalization of Production and the Competitiveness of Small and Medium-Sized Enterprises in Asia and the Pacific: Trends and Prospects,’ (2009) 65 Studies in Trade and Investment, New York, NY: United Nations, 1-122. Read More