FINANCIAL INSTITUTIONS: THE ENGINE TOWARDS SMEs ACCESS TO

FINANCE IN MAASIN CITY

A Research Study

Presented to the Faculty of

Bachelor of Science in Accountancy

Saint Joseph College

In Partial Fulfillment

of the Requirements for the Degree

BACHELOR OF SCIENCE IN ACCOUNTANCY

By

Rita Carmelle G. Marquez

Joseph S. Lapasanda

Jayra Kim Handayan

Kate Hershey M. Torino

Mary Joy G. Villar

 Table of Contents

Title page i

Table of Contents ii

CHAPTER I: INTRODUCTION

Rationale

Statement of the Problem

Theoretical-Conceptual Framework

Scope and Delimitation of the Study

Significance of the Study

Definition of Terms

CHAPTER II: REVIEW OF RELATED LITERATURE

CHAPTER III: RESEARCH METHODOLOGY

Research Design

Research Environment

Research Respondents

Research Instruments

Data Gathering Data

Statistical Treatment of Data

APPENDIX
 Chapter I
THE PROBLEM AND ITS SCOPE

Rationale

Small and Medium Enterprises (SMEs) play a major role in most economies,
particularly in developing countries. SMEs account for the majority of businesses
worldwide and are important contributors to job creation and global economic
development. They represent about 90% of businesses and more than 50% of
employment worldwide. Across all countries, SMEs do more than create employment:
they are also engines of economic growth and social development. In most OECD
countries, SMEs contribute more than 50% of GDP, and some global estimates put this
figure as high as 70%. This contribution varies across sectors, and is particularly high in
the service industry, where SMEs account for 60% or more of GDP in nearly all OECD
countries. SMEs are crucial to the future of work, not just for employment creation and
economic growth, but also to drive innovation and competition in markets. But large
enterprises can invest more in training and equipment, pay higher wages and offer better
working conditions, and so outmatch SMEs when it comes to productivity and quality of
employment.

In the Philippines, there is an increasing recognition of the important role played

by the small and medium enterprises (SMEs) to promote growth, which is not limited to
the simple creation of wealth or capital. In this sense, they bring about more balanced
agro-industrial growth and equity in income distribution (BSMBD, 1996 as cited by Egay
and Bolla, 1999; Mendoza, 2001). Mallari (2000) emphasized that SMEs are recognized
by the Philippine Government as the cornerstone of economic growth. In particular, the
government has enacted the Republic Act 8289, also known as the Magna Carta for
Small Enterprises, which aims to support and strengthen the SMEs development,
particularly those that are rural and agriculture-based.

In rural communities, business establishments such as the SMEs can be a source

of power, more so, if they are making a dent on the lives of a significant number of rural
people. The emergence and growth of SMEs in rural communities becomes evident when
the needed support mechanisms that will set the business environment more conducive to
business operations are in place. One of the many factors that may prove beneficial to the
emergence of SMEs is the presence of credit institutions with good lending packages.

Finance companies borrow money from sources such as the Federal Reserve
System and commercial banks at a low interest rate and lend it at a higher interest rate.
This is the reason the interest rates charged by finance companies are higher than the
interest rates charged by banks. Companies and individuals turn to finance companies
when they don't qualify for bank loans. The functions of finance companies are to offer
both unsecured and secured loans to individuals and companies (Reddy, 2020). Financial
institutions including commercial banks and micro-finance institutions (MFIs) are
enormous potential in enhancing credit availability among SMEs. However, the
circumstances that SMEs operate in along with the small business size make it risky in
terms of lending. For instance, those who depend of agriculture have their common
setbacks including seasonality, further most traders have no marketable collaterals like
mortgage properties to pledge. This increases default risk, which in turn the banking
institutions opt to charge high interest rates which scares away traders from borrowing
funds (Madole, 2013).
Statement of the Problem

The study sought to understand how financial institutions influence small and medium-
sized enterprises (SME's) access to finance in Maasin City, Southern Leyte.

Specifically, the study aimed to answer the following questions:

1. Major Profile of Selected SMEs

1.1 Name of the firm
1.2 Type of the firm
1.3 Size of the firm
1.4 Years of Operation
1.5 Annual Income Range

2. Do loans from lending institution foster SMEs’ growth?

3. What are the barriers faced by SMEs in accessing credit from financial institutions?

4. What are the products and services that financial institutions offer?

5. Are these products and services accessible and affordable for the SMEs?
Theoretical Background of the Study

The two theories relating to Financial Institutions: The Engine towards SMEs access to
finance. The first theory is the Institutional Theory of Si Fauzi & Sheng. And the Second
Theory is the Bank-based Theory of Moradi et al. and Yinusa. These two theories
produced significant findings in a research study.

Institutional Theory gives researchers a theoretical framework to identify and examine

factors that support the survival and legitimacy of organizational practices, including
factors like culture, the social environment, regulation (including the legal environment),
tradition and history, as well as economic incentives, while acknowledging the
importance of resources.

The bank-based theory focuses on the benefits of banks for economic growth and
development as well as the flaws and failings of the financial system based on securities.

INSTITUTIONAL THEORY

An institutional theory is a capable path for exploring the borders between businesses or
society that have been shaped SMEs in various ways to sustainable growth (Fauzi &
Sheng,2020). Explaining that sustainable pursuits is not primarily a voluntary act, as the
performance of firms are featured with several challenges, including government rules
and marketplace pressures. Therefore, institutional theory focuses on factors that are
externally or internally central within the firm and sustainable innovation.

From the institutional theory of sustainable growth for small and medium-sized
enterprises, opportunities with normative, coerciveness and mimetic drivers to influence
small and medium-sized enterprises to shape environmental, social or economic decision-
making and to legitimize the vision of sustainable business practice (Shibin et al., 2020;
Caldera, Desha & Dawes, 2019). Sustainable business practice 'is an aspiration for an
increasing proportion of small and medium-sized enterprises around the world, promising
profitability, resilience and positive social and environmental impacts' (Caldera et al.,
2019).

In many creative ways, business owners are responding to institutional constraints, such
as implementing innovative business strategies, developing strength and courage,
partaking in associations, trying to give back to the community and collaborating with the
authorities (Eijdenberg, Thompson, Verduijn & Essers, 2019). Institutional theory has
been widely used in addition to establishing sustainable growth policies and procedures
(Roxas, Lindsay, Ashill & Victorio, 2007; Heiskanen, 2002) and in recognition of quality
plans or technology orientation (Hatch, 2006; Barratt & Choi, 2007; Nair & Prajogo,
2009; Liu, Ke, Wei, Gu & Chen, 2010).

Institutional theory provides enhanced enlightenment once the driving force behind the
practice of technology orientation has been acceptability (DiMaggio and Powell 1983).
There are three kinds of competitive pressures that encompass the strength of the
institutional structure; forceful pressures, imitation pressures and normative pressures
(DiMaggio & Powell 1983). All three factors act as the driving force behind the actions
of organizations to enhance their initiatives for sustainable, social and environmental
growth through which enterprises achieve appropriateness and perceived value.

Institutional theory identifies broader and more resilient approaches to social structures;
consideration of structural-building processes as rules for the social behaviour of the
authorities through rules and standards (Scott, 2004; DiMaggio & Powell, 1983). In other
words, Caldera, Desha and Dawes (2017) tend to focus on a process in which practices
can be incorporated into an institution as recognized economic, social and environmental
standards. Institutional theory refers to innovative elements or capabilities with
sustainable growth of small and medium-sized enterprises as a stimulus lens that
encourages management practices to pursue sustainable business growth (Srisathan,
Ketkaew & Naruetharadhol, 2020) in the form of factors such as culture, the legal and
social environment, traditional or cultural values, economic incentive schemes and
market value.

The general concept focused on the rules laid down by the institutions, while the new
perspective focused on institutional entrepreneurship, such as the implementation of
sustainable business models (Hadjimanolis, 2019) and focus on opportunities (Laukkanan
et al., 2013). Moral legitimacy and Isomorphism are two main reasons behind the
behavioural patterns of enterprises related to institutional theory. In order to meet the
needs of stakeholders and society, the company seeks legitimacy (Ratten & Usmanij,
2020). The pressure of institutional factors has led to huge or isomorphic decisions on
sustainability by firms (Glover, Champion, Daniels & Dainty, 2014; Ahmad et al., 2020).
Enterprises facilitate innovation within the framework of the institutional structure
through collaboration with various stakeholders to encourage sustainable growth of
SMEs.

THE BANK- BASED THEORY

The bank-based theory mainly identifies financial institutions as the core source of
finance for businesses (Moradi et al., 2016; Yinusa, 2016). The basic principle of the
bankbased theory is that banks play an important role in financial intermediation by
pooling resources, providing a risk-reducing avenue for firms, facilitating transactions
among firms, acquiring information on firms, and providing effective corporate
governance control (Moradi et al., 2016).

The theory stressed the importance of a strong banking system for economic
development. According to the theory, the financial system is the pillar on which the real
sector of any economy stands. Provision of capital and efficient capital allocation remains
the most crucial role of the banks in the firms’ financing (Acharya & Naqvi, 2012).
Furthermore, supporters of this theory stress the importance of knowledge on the best
financing options for businesses, which is related to the reduction of risk associated with
each bank’s financing option (The World Bank, 1999).

According to the theory, all the roles of the banks in financial intermediation are
interwoven, and they are essential to firms' financing, which will eventually facilitate
economic growth (Moradi et al., 2016; The World Bank, 1999).

The bank-based theory stresses banks’ positive role in development and progress while
also emphasizing the flaws of market-based financial systems. It claims that banks can
fund development in emerging nations more effectively than capital markets and that
market flaws may be overcome, and savings allocated wisely in the case of state-owned
banks (Lin et al., 2020). Banks that are not restricted by regulatory limits can use
economies of size and breadth in information gathering and processing.

The bank-based perspective emphasizes the role of banks in identifying promising

initiatives, mobilizing resources, monitoring managers, and risk management (Rumler &
Waschiczek, 2016). Similarly, it emphasizes the shortcomings of market economies. For
example, banks are adept at funding projects with significant asymmetric information
because of their developed competence in identifying the type of borrowers (Levine,
2005).

Thus, the bank-based perspective emphasizes banks’ favorable position in mobilizing

resources to take advantage of strategies of balance, managing liquidity risks, resulting in
increased investment competence along with substantial economic development, and
gathering knowledge about companies and managers (Levine, 2005; Moradi et al., 2016;
Rumler & Waschiczek, 2016; The World Bank, 1999).

Conceptual Framework
 The input-process-output conceptual paradigm, which depicts a collection of
boxes connected to one another, will be employed in this research investigation.

INPUT PROCESS OUTPUT

 Demographic profile of the  To understand the

respondents effectiveness of
 Age  Questionnaire
lending institutions in
 Gender
 Civil Status
order to find the
 Interview
 Number of Family Members strengths, threats and
 Residential Type weaknesses of the
 Tabulation
 Source of Income small and medium
 Source of Loan enterprises.
 Monthly Income

 Identify and
 Statement of the problem
 Common reasons why small recommend solution
and medium enterprises for the problem
borrow money encountered between
the lending
 The pros and cons on the
part of the small and
institutions and
medium enterprises when SMEs.
they transact with the
lending institutions  Conclusion for the
subject matter of this
study.

FEEDBACK

Figure 1. Paradigm of the Study

 The Figure 1 shows the details and process that the researchers have conducted this
study.

The demographic profile contains the needed preferences about the background or
profile of the respondents (age, gender, civil status, number of family members,
residential types, source of income, source of loan and monthly income). The statement
of the problem contains all the questions on the survey questionnaire and the needed
statistical data for the study in order to determine the number of the respondents.

The researcher processed this study with the use of questionnaires distributed to
the respondents; tabulation of gathered data’s using statistical treatment such as
frequency and percentage. This was produced further interpretation and analysis of data’s
being collected.

The output will lead the researchers to understand and identify the behavior of
micro-entrepreneurs in order to find the strength, threats and weaknesses of the small and
medium enterprises and identified the solution for in the proposed problems by both
lenders and micro-entrepreneurs in order to prove the effectiveness of the said business to
the micro-entrepreneurs in recommending alternative courses of action about the
effectiveness of the lending institution to the micro-entrepreneurs.

Scope and Delimitation of the Study

The researcher focused their study in the Maasin City, Southern Leyte, the goal which is
to identify how financial institutions drive SMEs' in gaining access to finance. The
researcher decided to have a sample size of 35 respondents which are selected randomly
in Maasin City, Southern Leyte. However, the study limits to the answers and
information from the questions of the research and irrelevant or inconsistent data are
henceforth not included. Furthermore, due to several constraints that may hamper the
accessibility of gathering information from the respondents such as but not limited to
confidentiality, policies, prohibitions, industrial secrets, among others. The study shall
only limit to the information that can be accessed or extracted without restrictions.
Significance of the Study
This study contributes to the knowledge in many important areas of financial institutions
and SMEs studies. Firstly, it advances to a better understanding of functions and roles of
financial institutions towards SMS's. Secondly, it increases the understanding of how
financial institutions influences the development of SMEs and, third, it will pave the way
forward for the government, policy makers, financial institutions and to the general
public at large to understand the different roles of financial institutions in the enterprises
development process. Therefore, this study is significantly devoted or place as its main
focus, the examination of the financial institutions role in SMEs growth particularly in
Maasin, City. Finally, this study will also be used as a basis for any future study that will
examine the relationship between financial institutions and enterprises and for those who
further needs to explore on some other concerns of SMEs.

Definition of Terms
For better understanding and interpretation of this study, the following terms are
operationally defined.

1. Finance - is the process of raising funds or capital for any kind of expenditure. It is the
process of channeling various funds in the form of credit, loans, or invested capital to
those economic entities that most need them or can put them to the most productive use.
2. Collateral - is property or asset used by a borrower to secure a loan from a lender.
Collateral acts as an assurance to the lender that the borrower will refund the money they
have borrowed.
3. Credit - is a contractual agreement in which a borrower receives something of value
immediately and agrees to pay for it later, usually with interest.
4. Financial institution – is a broad range of business operations within the financial
services sector including banks, trust companies, insurance companies, brokerage firms,
and investment dealers. Financial institutions can vary by size, scope, and geography.
5. Small and Medium Enterprises (SMEs) - are businesses that maintain revenues,
assets, or a number of employees below a certain threshold. Small-sized enterprises are
companies with fewer than 50 employees and a medium-sized enterprise as one with
less than 250 employees.

6. Capital funding - is the money that lenders and equity holders provide to a business
for daily and long-term needs. It will also concentrate on the funding methods used to
generate the SME’s assets, such as its capital or investments, that arise from sources
related to the owner's actions to take such money and use them as capital for the
corporation, or controlling entity of the
business.

CHAPTER II

REVIEW OF RELATED LITERATURE

The review of related literature covers the study on the roles of the financial
institutions to the financial condition of small and medium entities within the locality of
Maasin City, Southern Leyte. The related literature provides a fundamental background
for the discussions and considerations in finding the present study. In an extensive review
of the literature, a considerable amount of the research examines for the literature review
dates 5 to 10 years ago. Because of very little attention given to this topic in recent
literature, the outcome from the research and data of this study provides a renewed aspect
on finance institution roles to businesses. The review of literature is organized into three
sections. The first section examines the independent variables that affect such roles. The
second section identifies and discusses the factors that shows the outcomes. The final
section describes the possible applications in the global scenario or what could be the
future implications of this study.

Overview of Small and Medium Entities (SMEs)

We all have known Small and Medium Entities as independent firms that have
a lesser number of employees such as sari-sari store businesses, printing businesses, and
many more. Liberto (2022) defined Small and Medium Entities (SMEs) as businesses
with revenues, assets, or fewer than a certain number of employees. Each country defines
a small and medium-sized enterprise differently. Certain size criteria must be met, and
the industry in which the company operates is sometimes considered. In the Philippines,
SMEs are defined as any enterprise with 10 to 199 employees and/or assets valued from
P3 million to P100 million. SMEs and micro enterprises combined make up 99.6% of
establishments in the country (Suarez, 2016). In the Philippines, MSMEs are
operationally defined by two criteria: employment and asset size. The PSA classifies an
enterprise as micro if it employs fewer than ten people, small if it employs ten to ninety
people, medium if it employs 100 to 199 people, and large if it employs 200 or more
people. Small and medium-sized enterprises (SMEs) are vital to most economies,
particularly those in developing countries. SMEs account for the vast majority of
businesses worldwide, and they play an important role in job creation and global
economic development. They account for roughly 90% of businesses and more than 50%
of global employment.

Small and medium enterprises (SMEs) have a very important role in

developing the Philippine economy. They help reduce poverty by creating jobs for the
country’s growing labor force. They stimulate economic development in rural and far-
flung areas. They serve as valuable partners to large enterprises as suppliers and
providers of support services. They serve as breeding ground for new entrepreneurs and
large corporations. A vibrant SME sector is thus an indication of a thriving and growing
economy. Despite policies that aim to provide an enabling environment for SME
development, the sector still faces various constraints that prevent it from realizing its full
growth and potential (Senate, 2012). The role of SMEs in the global economy is critical
in the development of a poverty-free society. The reason for this is that they not only
provide ample job opportunities to the various strata of society, but they also ensure the
flow of money across the various levels of society. Muritala, Awolaja, and Bako (2012)
stated that SMEs also play a very critical role in the world economy by contributing to
the employment scenario along with the input and output. There are certain points to be
understood here. As per a report published in 2015, approximately 600 million jobs
would be required worldwide over the next 15 years. Predominantly, most of the formal
jobs that are available in developing markets are created by the SMEs. That is almost four
out of five jobs available in the market. Despite playing a vital role in the development of
the economy, it is observed that around 50% of the SMEs lack access to finance or
capital investment. At any given point of time, the formal SMEs create around 33% of
the national income and 45% of the total employment in developing countries. When we
include the informal SMEs in the list, the numbers rise even higher.

The Philippines provides relevant context to develop our study because micro,
small, or medium enterprises account for over 99% of all firms, about two-thirds of
employment, and a third of gross value added (GVA), serving as the backbone of the
economy. Furthermore, our estimates in this paper suggest that 42% of small and 33% of
medium enterprises are credit-constrained. In comparison, 47% of both small and
medium enterprises are quasi-constrained from a sample of 480 SMEs in the National
Capital Region (NCR) and Calabarzon region. By identifying which factors enable access
to finance in both formal and informal markets, we can evaluate policy options to make
financing more inclusive. Alternative financing sources that support projects typically
considered too small or risky by traditional banks have experienced rapid growth (World
Economic Forum, 2015) in recent years.

Nature and Roles of Financial Institutions

Financial institutions refer to the entities that facilitate financial transactions and act as
intermediaries in financial operations. There are various functions of financial
institutions, including banking services, capital formation, monetary supply regulation,
pension fund services, and the economic growth of a nation.

Microfinance aims to improve financial services access for marginalized groups,

especially women and the rural poor, to promote self-sufficiency. (Finca, 2021)

It is primarily used in developing economies where firms lack access to other forms of
financial assistance. In addition to financial intermediation, some MFIs offer social
intermediation services such as group formation, self-confidence development, and
financial literacy and management training for group members.

The vast majority of microfinance organizations specialize in small working capital

loans, also known as microloans or microcredit. Many of them do, however, offer
insurance and money transfers, and licensed microfinance banks offer savings accounts.

Microcredit stood out because it avoided the flaws of previous generations of targeted
development financing by requiring repayment, charging interest rates high enough to
cover credit distribution costs, and focusing on clients whose only other option for a loan
was the informal sector.

Microfinance institutions (MFIs) exist. The responsibilities of microfinance institutions

include making small loans to low-income borrowers, creating job opportunities, and
increasing borrowers' capacity by teaching them skills such as loan management,
entrepreneurship, and management.

Microfinance has emerged as a viable financial option for poor people who do not have
access to formal financial institutions' credit. Its goals include poverty alleviation by
encouraging small-scale entrepreneurship through easy credit access. It distinguishes
itself from formal credit by making small loans to the poor and employing non-traditional
loan structures such as loans without collateral, group lending, progressive loan
structures, immediate repayment arrangements, regular repayment schedules, and
collateral substitutes (Quayes, 2012).

Small-scale lending extends beyond traditional institutions and includes a variety of

lending options, many of which are facilitated by informal organizations. Furthermore,
informal groups increase the competitiveness of microfinance institutions. Other types of
microfinance lending revolve primarily around group lending and saving.

Microfinance institutions have a variety of legal statuses. Cooperatives, credit unions,

non-governmental organizations (NGOs), non-banking financial institutions (NBFIs),
rural banks, postal banks, and commercial banks are among the various types of formal
and semiformal institutions in the market (Daher & Le Saout, 2013). NGO, NBFI,
Banks, Rural Banks, Credit Unions/Cooperatives, and "other" are among the legal
statuses identified. Institutions operate in a variety of ways. For example, NGOs typically
make smaller loans that are significantly more expensive per dollar lent and thus require
higher interest rates than microfinance providers chartered as banks or NBFIs.

Many MFIs not only lend, but also provide additional services such as bank accounts and
insurance products, as well as financial and business literacy. Some may provide
additional resources such as savings accounts, insurance, health care, and personal
development, broadening the scope of MFI work beyond just financial matters (Jha,
2016). In general, MFIs strive to create a one-of-a-kind environment of financial
inclusion intertwined with a sustainable livelihood aimed at empowering poor
communities. Many MFIs are also involved in a variety of social development initiatives,
including capacity building, education, financial literacy, water and sanitation, livelihood
promotion, preventative healthcare, and training (Jha, 2016).

Constraints to SMEs Development

In spite of the commendable contributions of SMEs, the sector still faces some
challenges that seriously need to be addressed if its full potential was to be fully
unleashed and tapped (Frimpong, 2013).

The market access problems of SMEs have been well-documented in the

literature, although there is a dearth of studies using Philippine data. The country has
certain characteristics that could create different SME market access problems from those
in other countries. It is an archipelago made up of more than seven thousand islands and
dozens of languages. Reaching far flung markets is often difficult, and cultural
differences mean tastes and preferences vary. Product adjustments may be necessary for a
firm that seeks to reach a new market. In addition, infrastructure is poor in many areas
making it difficult to reach markets in these locations. The extent to which a firm can
access new markets depends on factors such as the infrastructure availability, distance
from markets, access to financial resources, the extent of the owner’s knowledge and
information, government policies and regulations, and competition from big businesses
(Biswas & Baptista, 2012; The Economist, 2012; Ladzani & van Vuuren, 2012;
Siemens, 2014). Businesses located in urban areas have easier access to large markets,
customers and clients, and modern infrastructure and services like internet connection
and banking (Siemens, 2014).

However, for businesses located far from big cities, smaller market size limits
growth and access to resources. This is especially true for firms located on small islands
that may face difficulties getting raw materials (Camara, 2016; Siemens, 2014). This
finding is particularly relevant to the Philippines because it is made up of thousands of
islands, many of which are remote and hard to access.

Distance can also affect the relationship between the SME and the
organizations and networks to which it belongs. And while these organizations help
SMEs access international markets, a firm located far from the association’s headquarters
is less likely to export than one located nearby (Boehe, 2013). Owners and managers of
SMEs in remote locations also have less time to manage their businesses because services
like banking and other activities such as meeting with clients involve travelling to the
nearest urban center. This is exacerbated if the firm cannot find competent employees in
their area.

Isolation from larger markets, coupled with limited infrastructure, also

increases the firm’s business costs due to higher product transportation and distribution
costs (Siemens, 2014). Infrastructure is crucial especially for the delivery of fresh
products such as fish and crops, and delays can cause product quality to decline and
spoilage to increase (Camara, 2016). Businesses also face e-commerce challenges in
remote areas. Remote regions tend to have poor internet connection compared to urban
areas (Siemens, 2014).

A lack of knowledge affects both an SME’s ability to enter a new market and
survive once it has gained access (Gentry, Dalziel & Jamison, 2013; Janjuha-Jivraj,
Martin & Danko, 2012). Because they lack experience, SMEs face finance and profit
uncertainties. Experienced owners and managers in dynamic industries such as
information technology may also find their knowledge obsolete if they can’t adapt to the
constantly-changing business environment (West & Noel, 2015).

Another contributing factor to SME expansion and entry to new markets is the
extent of government bureaucracy and interference. Zapalska and Edwards (2012)
wrote that enterprises prosper and grow when economies liberalize and reform. When
government officials and bureaucrats meddle too much with the running of businesses,
firm owners and managers cannot effectively manage and lead their businesses. This is
especially true in economies where SMEs must contend with restrictive laws and
regulations, minimal laws on property rights, and bureaucracies with biases toward state-
owned enterprises (Minh & Hjortso, 2015). Aside from government bureaucracy and
interference, regulatory inefficiencies, lack of competition, and corruption also
discourage firms from expanding to new markets. Regulatory and elite capture, where
public resources benefit only government cronies, discourages SMEs from expanding
into markets where this is widespread. This has been demonstrated in multiple studies
from developing countries (Knuth et al., 2016; Rahman, Uddin & Lodorfos, 2017).

Access to Formal Finance

Macroeconomic factors do not entirely drive firms’ inability to access external

financing. Firm characteristics and other institutional variables also determine their
capability to access finance, and many firms have characteristics that may hinder them
from receiving external financing (Peñaloza, 2015). Building on the reviewed literature,
we propose several hypotheses on the relationship between firm characteristics of SMEs
and access to finance through both formal and informal markets in the Philippines. Ease
of access to finance is typically correlated with firm size, which means smaller
companies find it more difficult to access financing. This is due to fewer collateral
options, a higher perceived risk profile, lower accounting and financial management
capacity, and higher informality rates among smaller firms (OECD et al., 2019). In this
sense, among firm characteristics, the most common determinants of credit constraints
studied in the literature include firm size, firm age, and ownership type. Several empirical
studies, such as Beck et al. (2012) and Canton et al. (2013), indicated firm size and firm
age as determinants, while Quartey et al. (2017) identified firm size, ownership type,
and credit information. Using data from a sample of over 10,000 firms covering 80
countries, Beck et al. (2012) found that larger, older, and foreign-owned firms
encountered fewer barriers in accessing finance. In addition, Canton et al. (2013) found
that the youngest and smallest SMEs had the worst perceptions regarding bank loan
access. Using firm data from SMEs across West Africa, Quartey et al. (2017) found that
larger firms were more likely to gain access to finance because of adequate collateral, a
more established bank history, and perceived creditworthiness compared to smaller firms.

The availability of collateral has been cited as a key determinant of access to

finance, especially in developing economies. In a study that analyzed the credit
constraints faced by new SMEs in South Africa, Fatoki and van Aardt Smit (2011)
identified collateral availability as a key factor in determining an SME’s access to credit.
In addition, Kira (2013) identified collateral availability as a key factor that influenced
access to finance in a study that used data from SMEs in Tanzania. Fixed assets, such as
land, buildings, and equipment, are typically eligible as collateral. Some studies (Okura,
2012; Le, 2012) identified fixed assets as a credit-worthiness characteristic. Moreover, a
history of fixed asset purchases makes an SME more attractive to creditors. Bougheas et
al. (2016) asserted that collateral is an important factor for SMEs to access debt finance
since collateral reduces a loan's riskiness by giving the lending financial institution a
claim on a tangible asset without compromising its claim on the outstanding debt (Kira,
2013). In addition, some studies (Coco, 2020) regarded collateral as the lender’s second
line of defense (Kira, 2013).

SMEs with more developed financial management practices are more attractive
to financial service providers (OECD et al., 2019), enabling them to have greater access
to finance through formal channels. The use of digital accounting and financial
management tools allows firms to organize their records and examine their financial
condition. Digitizing the accounting and financial management operations of SMEs has
improved their productivity, performance, and overall efficiency (Hoang & Le Dinh,
2019). Although the relationship between the adoption of digital technologies in firm
operations and their access to finance has been studied in the literature, the role of the
digital transformation of accounting and financial management in enabling greater access
to finance has yet to be investigated extensively. Several studies provide empirical
evidence linking credit constraints with a firm’s ability to adopt new technologies and
innovate. In addition to firm size, Peñaloza (2015) identified the firm's technological
capacity as a key factor in determining a firm’s access to credit markets primarily
because of competitive advantages brought about by increased use of technology. Using
data from a survey of 4,220 firms across Russia, Bircan and de Haas (2015) showed the
channels by which firms’ technological adoption was affected by credit constraints. In
particular, Bircan and de Haas (2015) provided empirical evidence that access to
finance helps firms adopt new technologies, although they found no evidence that bank
credit stimulated firm innovation through in-house research and development (R&D). By
analyzing the relationship between bank credit and innovation in more than 19,000 firms
across 47 developing economies, Ayyagari et al. (2017) found a positive association
between using external finance and increased firm innovation. Using data from 6,422
small firms across 22 emerging economies, Qi and Ongena (2020) provided empirical
evidence that lack of access to finance restrains a firm from adopting technologies.
Wignaraja and Jinjarak (2015) examined firm-level determinants of SME finance
using World Bank Enterprise Survey data, covering 8,080 firms in several Asian
countries. Numerous aspects of access to finance, including credit, lender type, bank
borrowing, line of credit availability, and collateral, were found to be correlated with firm
characteristics (Wignaraja & Jinjarak, 2015).

Access to Informal Finance

Difficulties in accessing external finance are common for SMEs in developing

countries. Empirical evidence from studies in other developing counties such as Ethiopia
(Fanta, 2015) and Kenya (Mungiru & Njeru, 2014) indicated that SME owners that
faced obstacles in accessing finance actively resorted to informal channels to circumvent
credit constraint. On the one hand, informal financing sources may have dampened the
negative impacts of credit constraints on an SME’s operations and growth (Fanta, 2015).
However, while some informal channels such as group loans and loans from family and
friends may have benefited a credit-constrained SME, others such as loan sharks that
charged high interest rates with more stringent terms and conditions may have done more
harm than good (Mungiru & Njeru, 2014).

Informal credit may be the only viable financing option for some borrowers
deemed ineligible for formal financial services, such as smaller firms with little to no
collateral and borrowers in rural areas. Financial transactions unregulated by the
government and outside traditional financial institutions are referred to as informal
finance. Various informal credit sources include peer-to-peer networks, family, friends,
informal credit unions, savings collectors, moneylenders, and loan sharks (Hanedar et
al., 2014). Typically, interest rates in informal markets are more volatile compared to
traditional markets. Informal moneylenders can charge high and unfair interest rates,
while loans from family and friends commonly have lower interest due to altruism
concerns, making it more attractive to borrowers (Hanedar et al., 2014).

Determinants of access to finance through formal channels may differ from

those in informal channels. Since informal financing works in an environment where
social networks are typically used in conducting business (Allen et al., 2018), firm
characteristics such as firm size and history of asset purchases may not be as relevant in
determining access to informal credit. However, the use of digital financial management
may improve SME’s access to informal finance.

The adoption of digital technologies facilitates SMEs' access to finance

(Lukonga, 2020). Digital lending platforms that connect borrowers to lenders directly,
such as peer-to-peer networks, are increasingly utilized as an informal lending channel
and alternative funding source for small businesses (Lukonga, 2020). Although not as
stringent in terms of requirements compared to formal financial institutions, digital peer-
to-peer lending networks still require financial data from firms. Thus, alternative
financing options in informal channels such as peer-to-peer lending networks are more
accessible to firms that use digital technologies to organize and manage their financial
data. Digitalization improves access to and diversifies the supply of financing for SMEs
(Disse & Sommer, 2020). The emergence of new financing options in the market that
capitalize on digitalization, reduced transaction costs, and a wider network mitigates
several of the challenges in SME finance (Disse & Sommer, 2020). Many of these
options, such as peer-to-peer lending networks that match borrowers to lenders online,
are part of informal financing channels, some of which have emerged from small
informal banks (Deer et al., 2015). Digital financial management improves the access of
small businesses to digital finance in informal channels. The adoption of digital
technologies in accounting and financial management reduces asymmetric information
between borrowers and lenders in both formal and informal financing channels. Digital
financial management organizes and enhances the availability of SME’s financial data.
This improves screening and credit assessment, enabling greater access to finance for
SMEs, even in informal channels (Disse & Sommer, 2020). Moreover, digital financial
management can lower risk and default for financial service providers (Disse &
Sommer, 2020).
 Chapter III

RESEARCH METHODOLOGY

This chapter explains various methodologies that are being used in gathering data
and analysis which were relevant to the research. The methodologies include areas such
as the location of the study, research design, respondents, environment, instrument, data
gathering procedure and statistical treatment of the data.