Oct 20, 2021

Today, vibrant small and medium-sized enterprises are a major source of employment and innovation, helping to promote productivity, growth, and economic diversification. However, compared with SMEs in other regions, the contribution of SMEs in MENAP and CCA regions in terms of output and employment is relatively small. Unleashing its vitality for development requires facing a series of structural and institutional challenges, including the opportunity to obtain financing. In terms of obtaining bank financing for SMEs, the MENAP and CCA regions lag behind most other regions. In the MENAP and CCA regions, the average share of SME loans in total bank loans is about 7%, which is much lower than the global average (26%).

The analysis shows that economic foundation, banking characteristics, sound system, and favorable business environment are important factors for SMEs to obtain financings, such as macroeconomic stability, limited public sector scale (to avoid squeezing SMEs’ access to credit), the robustness of the financial sector, the competitiveness of the banking system, strong governance and financial supervision capabilities, the availability of credit information, and a supporting legal system with sound property rights and contract systems.

Among them, the influence of the legal system environment on bank credit is particularly prominent in SMEs. For example, SMEs are most vulnerable to defects such as the mortgage system, linked lending practices, and high interest rates. The adoption of a mortgage registration system for movable properties can increase the possibility of companies obtaining bank financing by 10%, while also reducing loan interest rates and increasing loan terms.

Studies have shown that the economic foundation is essential for financial inclusion among small and medium-sized enterprises. Higher incomes and better physical infrastructure can increase savings and capital pools in the economy, and improve access to financing. Macroeconomic instability and financial crisis will seriously affect the credit and other financial services of SMEs, because banks will reduce credit to restore their regulatory capital ratios, especially for high-risk borrowers such as SMEs. Better governance can help SMEs execute financial contracts, which will help SMEs obtain financing. Finally, informal financing activities can also play a role in improving corporate financing.

The structure of the financial sector and the level of bank competition are also closely related to the financing of SMEs. Intense banking competition has a positive impact on companies' access to credit, and this impact depends on the coverage of credit institutions. The higher the weight of non-bank institutions in the financial system, especially the higher the weight of professional lenders, such as financial institutions such as leasing and factoring companies, low-end cooperatives, credit cooperatives and microfinance institutions, and opportunities for small and medium-sized enterprises to obtain loans more.

Typical facts of SMEs obtaining financing in MENAP and CCA regions

(1) Data

The MENAP and CCA regions lag behind most other regions in the acquisition and use of financial services. According to the World Bank Enterprise Survey (WBES), in the MENAP and CCA countries, the proportion of companies that use banks for financing is the lowest (16%, compared with the world average of 30%), and nearly 80% of companies use internal funds to replace banks. The MENAP region also has the lowest percentage of companies with bank loans and checking or savings accounts. The CCA region performed slightly better on these measures, but still lags behind Asia, Europe, and Latin America.

(2) Calculation method of SME Financial Inclusion Index

The SME Finance Inclusive Index is constructed according to Svirydzenka (2016), using data from 2006 to 2017. Simplify the multi-dimensional data from WBES into a summary index through the following steps: (1) Standardize the variables; (2) Use the first part to summarize the normalized variables into sub-indexes through principal component analysis (PCA); (3) Summarize the sub-indexes into the final index. In WBES, several questions are designed to evaluate the financial status of the company. From these variables, select the variables most relevant to the financial status of the bank to construct the index.

The index is applicable to 119 countries in the world, 20 of which are located in the MENAP and CCA regions. At the national level, the results show that Lebanon, Morocco, and Tunisia have the highest degree of financial inclusiveness for SMEs, while fragile countries such as Afghanistan, Iraq, and Yemen have the lowest degree of financial inclusiveness for SMEs. At the regional level, the results show that the level of financial inclusion of SMEs in the MENAP region is the lowest, while the level of financial inclusion of SMEs in the CCA region is the third lowest.

Driving factors for SME financial inclusion

By clarifying the macroeconomic conditions of SMEs, we can explore the impact of broader macro-financial and institutional factors on SMEs’ financing, including the following four points:

1. Macroeconomic environment

(1) Diversification- a diversified economy provides more investment opportunities, thereby improving financing channels, which is conducive to the development and growth of SMEs.

(2) Competition- competition within and between the SME sector can increase productivity and the effective allocation of resources.

(3) Informality- the access to financing of enterprises in the informal economy is subject to stricter restrictions, because their economic activities are not traceable.

(4) Infrastructure- the availability and quality of infrastructure are key factors for the investment and development of SMEs.

(5) Public investment- the size of the public sector in the economy will affect the opportunities for SMEs to obtain credit.

(6) Oil exporting countries- the oil sector accounts for a large part of the total economic output in some countries (especially in the MENAP region). Bank loans may be concentrated in the oil sector, while small and medium-sized enterprises may not receive sufficient services.

In general, diversification, competition, and infrastructure are positively correlated with SME financial inclusion, while negatively correlated with informality, public investment, and oil-exporting countries variables. Compared with other regions, the informal sector of CCA countries is larger, while the quality of infrastructure and economic diversification of MENAP and CCA are lower than other regions (except for AFR). Compared with the rest of the sample, the size of the public sector in MENAP countries is also larger on average. In addition, competitive factors play a key role in the MENAP and CCA regions.

2. Institutional quality

A good system, including good governance and political stability, is a key factor in determining the financial inclusion of SMEs. This includes not only equal treatment, but also access to services, such as bank financing. In countries with poorer systems, large companies benefit from political care to obtain better bank financing channels, and this will squeeze out financing opportunities for SMEs. A good system includes the following factors: voice and accountability, political stability, government effectiveness, quality of policy formulation and implementation, corruption control, etc.

These variables are positively correlated with the financial inclusion of SMEs, but in fact, the institutional level of MENAP and CCA countries lags behind the average of their peers. In MENAP and CCA regions, the positive correlation between government effectiveness, corruption control, and financial inclusion for SMEs is stronger. This shows that improving the system can have a greater impact on SMEs' access to financing.

3. Characteristics and supervision of the financial industry

The characteristics of the financial industry and financial supervision are also crucial for SMEs to obtain financing, especially:

(1) Bank profitability- the increase in bank profitability may reduce banks' motivation to obtain new risk assets such as loans to SMEs.

(2) Asset quality- a high non-performing loan ratio may reduce the willingness of banks to lend to small and medium-sized borrowers, such as small and medium-sized enterprises.

(3) Bank deposits- a higher degree of dependence on bank deposits can provide banks with more stable funds and promote loans to small and medium-sized enterprises.

(4) Stability of the banking sector- a more stable banking system can enhance bank loan confidence, thereby increasing the credit of SMEs.

(5) Concentration of bank loans- concentration of bank loans may reduce opportunities for SMEs to obtain credit, especially when banks focus on certain industries or markets.

(6) Financial sector regulations and supervision- a sound legal system and effective supervision are conducive to financial inclusion for SMEs.

We found a positive correlation between the stability of the banking industry, bank deposits, financial sector regulations and supervision, and financial inclusion for SMEs. On the contrary, the profitability of banks is often related to the reduction in the financing of SMEs. As mentioned earlier, banks may be reluctant to provide loans to risky SME borrowers when their profits are high. The non-performing loan rate is also negatively correlated with the financial inclusion of SMEs, which indicates that the decline in the quality of bank assets will further restrict SMEs’ access to credit. The average performance of MENAP and CCA countries in terms of asset quality is better than APD and WHD, but lags behind AFR and EUR. CCA countries lag behind other regions in terms of banking stability and deposit rate, while MENAP countries are, on average, the regions with the most concentrated banking industry.

4. Business environment

A favorable business environment can promote the development of SMEs and reduce the motivation of SMEs to stay in the informal sector, thereby improving the financing channels for SMEs. Especially:

(1) Tax burden and entrepreneurial costs- may reduce the enthusiasm of enterprises to invest, hinder their growth, encourage the development of the informal sector, and be detrimental to enterprises' access to formal financial services.

(2) Contract execution and property rights system- both can make assets have greater transferability, and can more easily sell, transfer, or mortgage assets, which provides important financing channels for smaller and higher-risk companies.

(3) Property registration costs- high property registration costs will damage the availability of collateral, which is not conducive to small and medium-sized enterprises to obtain bank credit.

(4) Credit information- relevant borrowers can rely on good credit records to increase their chances of obtaining credit by reducing moral hazards. It can also support SME financing by reducing mortgage requirements and borrowing costs.

On average, MENA and CCA countries lag behind other regions in terms of access to credit information and legal rights. However, the performance of these two regions in terms of business tax is better than other regions, and MENAP countries, on average, have higher entrepreneurial costs compared with EUR and APD.

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