A well-regulated and properly functioning financial system is a necessary but insufficient condition for

ensuring SMEs access to finance. Improving SMEs access to finance requires that financial institutions
construct profitable and efficient credit and equity programmes for this sector. In recent years, banks
and other institutions in developed countries have launched a number of innovative approaches which
have made SME financing profitable. As a result SME financing in developed countries has increased
because:

lending to SME clients pays off handsomely if the risks are managed properly;

an increasing external pressure from governments, SME organizations and the media

which encourages the development of appropriate financial services for the SME sector;

increased competition between banks and with other service providers. If competition

develops, banks are likely to go beyond their traditional clients and explore new markets;

the participation of SMEs as shareholders in the management of banks (this is especially

the case of savings banks and cooperatives).

Mechanisms for reducing high risks and costs of lending to SMEs

Some of the initiatives undertaken by commercial banks in developed countries to reduce risks and costs
of SMEs financing include:

credit scoring systems which automate SMEs lending and improve credit risk management; they also
offer the possibility to approach SMEs having acceptable scores through direct mail campaigns;

external credit appraisal/credit ratings to assess risks of the upper segment of SMEs. Such external
services have been created especially to support bank staff when specialized skills are needed to assess,
for example, high technology and innovative SMEs;

risk self-assessment for SME entrepreneurs which reveals the risk assumed by banks and the way
banks evaluate the SMEs’ risks;

application of IT in the whole lending process: analysis, pricing and monitoring;

decentralized structures, i.e. specialized departments and SME branches which provide SMEs with
more rapid solutions and a more professional service;

streamlined lending processes with simple and limited paperwork and rapid response to loan
applications;

a well designed plan to reach SMEs with products and services better adapted to their needs;
segmentation of SME customers which balances optimal profit and optimal support for clients,
offering personalized services for profitable customers, and encouraging less profitable ones to use
automated delivery channels.

The need for an active support of specialized financial institutions and/or public

funding institutions

The experiences of specialized financial institutions for SMEs in developing countries have been mixed.
Although they have contributed to increased access of SMEs to long-term funding, they also have
experienced low profitability and unsustainability. Factors contributing to the success of these
institutions include diversification of their products, reliance on self-mobilized resources and a
commercial orientation. Specialized financial institutions and public funding institutions in general can
reduce the financial risks of private commercial banks through loan guarantee and counter-guarantee
programmes; participating in equity funds for SMEs, especially in those areas not covered by traditional
funds (seed capital and start-ups); creating credit windows for those SME segments with difficulties to

access loans from the banking system (women entrepreneurs, start-ups, micro-borrowers, ethnic
minorities); offering incentives (commissions) to financial intermediaries managing credits or seed
capital/equity funds addressed to special SME segments; providing technical support to NGOs or other
institutions which could be able to implement SME programmes.

The need for well managed loan or mutual guarantee schemes

Loan guarantee schemes in developing countries have suffered from a number of weaknesses such as
moral hazard, inadequate procedures and delays in paying claims, which have discouraged banks to take
part in such schemes. However, lessons have been learned from unsuccessful schemes and, if managed
properly, such schemes can contribute to increased bank lending for SMEs. Some practical rules for
effective loan guarantee schemes include: they should be addressed mainly to SMEs with good business
projects; they should be adequately staffed in order to process and handle claims without delay; they
should take immediate remedial actions when certain default levels are reached; they should establish a

vigorous loan recovery once the guarantee is paid out; the lender should assume some part of the risk.
Accordingly, lenders should assume at least 30 to 40 per cent of the risk with a 20 per cent minimum.
Mutual guarantee schemes have a more market-driven approach than public guarantee schemes since
these schemes are funded by the contributions of the enterprises and managed by SMEs themselves. To
enhance the potential capacity of these funds, they could be supported by public-sector counter-
guarantees which have an advantage compared with direct guarantees or subsidies.

The need for alternative sources of funds

Traditional bank credit remains one of the major sources of finance for SMEs. There is a need to explore
alternative sources of funds which could contribute to reducing SMEs’ dependence on bank credits.
Venture capital and leasing could be significant sources of long term funds which at present are
underdeveloped. In spite of a number of initiatives from international and national development finance
institutions, venture capital funds for SMEs in developing countries are limited. When such funds are
available, they are concentrated in high-growth and risk sectors (hi-tech industry) of the economy. An
appropriate legal and regulatory framework as well as a favourable tax regime and a business culture
that promotes entrepreneurship could contribute to their growth. On their part, banks should be
encouraged to offer SMEs alternative products such as corporate credit cards, leasing, factoring,
composite loans (both long-term and working capital), seed capital and to participate, together with
large enterprises, in local investment funds for SMEs.

The need to combine financial with non-financial support through cooperation between banks and
business development services (BDS) providers

Banks tend to charge SMEs high interest rates and to adopt a rigorous and pre-emptive approach with
respect to collateral because of the difficulty they face in identifying creditworthy and promising SMEs.
The most efficient way to encourage lending to SMEs is to improve existing institutions’ ability to
construct profitable and efficient SME lending programmes. This can be achieved by minimizing the risks
through appropriate tools and methodologies to assess the creditworthiness of potential SME
borrowers and to lower the overall costs of lending to SMEs, as reviewed in the above sections. The
current review has provided strong evidence that commercial banks will lend to SMEs if there is a way to
decrease transaction costs and risks. Commercial banks in developed countries have pioneered many
techniques for reducing the costs of dealing with SMEs. These include credit scoring, client
segmentation, direct mail campaigns, mutual guarantee schemes, risk self-assessment and external
business appraisals. How effective will these techniques be in developing countries? Here the evidence
points to the necessity of combining financial with non-financial business services if credit-worthy SMEs
are to be identified and assisted in developing the necessary management, marketing, networking skills

to successfully expand their businesses. Given the lack of sensitivity of bank loan officers to SME
problems, commercial banks are probably not the most effective source of technical assistance. It would
be better for financial institutions to partner with existing business service providers than to start a new,
unfamiliar and possibly costly activity. Business development services (BDS) providers can play an
important role in this process because they are close to their clients and they have direct knowledge of
the enterprises’ financial status and past performance. BDS providers are often better placed than
financial institutions to identify potential clients, ascertain their credit-worthiness, disseminate
adequate financial and accounting techniques, pre-screen project proposals, monitor repayment, exert
peer pressure, and maintain one-to-one contacts during the entire payback period.

In developing countries, small to medium-sized enterprises (SMEs) have considerable difficulty

obtaining the necessary financial resources to effectively scale up and grow their businesses.
Access to traditional growth capital, including debt and equity, is often prohibitively costly, due
to such factors as insufficient legal and regulatory policies, and inadequate financial markets.

The development community has tried to address this challenge by creating microfinance
lending instruments and private sector investment intermediary institutions that have made
significant strides in improving access to capital for individuals seeking US$10 to more than
$1,000. Similarly, the International Finance Corporation and other investment institutions have
improved access to capital for established firms seeking US$5 million and above to expand their
operations nationally and internationally.

However, despite these successes, SMEs seeking US$50,000 to $1 million have great difficulty
accessing the required capital to grow their business. For firms operating in the information and
communication technology (ICT) industry and in ICT-enabled (ICTE) activities, the challenge of
accessing growth capital is particularly acute, because these firms possess few tangible assets
that can be leveraged as collateral for loans and often operate businesses whose economics are
poorly understood.