Access to Finance by Small and Medium Enterprises: a Cross-country Analysis with a New Data Set

Published: 2021-07-11 21:00:12
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Small and medium enterprises are a vital part of every countries economy and on average, SME credit accounts for 13% of GDP in developed countries, whereas for developing it stands at 3%. According to Beck et al. (2005a), the relative size of SME sector has a positive relationship with economic growth. SME’s are also the biggest creators of jobs and in ‘high income countries’ contribute to 50% of GDP and also contribute 60% of the workforce in manufacturing industry Ayyagari et al. (2007). Beck et al., 2008b found that two-thirds of countries’ workforce in OECD countries is employed by SME’s. SMEs have also had a higher jobs growth compared to large companies, and Ayyagari et al. (2011) found that in low income countries majority of people are employed by SMEs. Despite their importance, SMEs struggle more when it comes to access to finance and face higher barriers. These barriers include lack of collateral, difficulties in proving creditworthiness, small cash flows, inadequate credit history, high risk premiums, underdeveloped bank-borrower relationships and high transaction costs. Beck et al. conclude that smaller firms and firms in countries with underdeveloped financial and legal systems use less external finance, based on data from a firm-level survey in 48 countries. During periods of crisis, SME are more likely to be negatively impacted than larger companies.
Structure and development of financial sector also plays a role in SME performance. Ayyagari et al. (2007) find that better credit information sharing is associated with a larger size of the SME sector. Rocha et al. (2010) provide evidence from banks in the Middle East and North Africa, noting lack of Small and medium enterprises transparency and underdeveloped financial systems as the main obstacles to SME finance.SME have also been found to have a costlier access to finance. Cressy and Toivanen (2001) ‘find that collateral provisions and loan size reduce the interest rate paid and that better borrowers receive larger loans and lower interest rates’. Hernandez-Canovas and Martinez-Solano (2007), ‘using firm-level data from Spain, argue that close relationships with financial institutions may generate advantages such as improved conditions of financing and increased credit availability’. Dietrich (2010) argues that the lack of negotiating power of small enterprises has significant explanatory power in explaining differences in lending rates between small and large enterprises.
Bank size is another determinant of how access to finance is affected for SMEs. Research has found that smaller and local banks are more likely to engage with Small and medium enterprises due to the value given to ‘relationship banking’. The strength of the bank–borrower relationship is found to be positively related to various credit terms. However, some recent studies have thrown doubt over these results including research by Berger and Udell (2006), Berger et al. (2007), de la Torre et al. (2010) and Beck et al. (2008b), their research that large banks, relative to other financial institutions, can have a comparative advantage in financing SMEs through arms-length lending technologies, such as asset-based lending, factoring, leasing, fixed-asset lending and credit scoring. In addition, Beck et al. (2008b) indicate that most commercial banks perceive the SME sector as profitable. In research, the lack of a consistent framework to define SMEs or access to finance has made it harder to do a cross-country analysis. This also means that data collected using different methodology could also lead to it not being able to allow for an extended analysis.
Due to data limitations, empirical results in the existing literature are based on analysis of the largest firms, usually public listed and thus unrepresentative, across countries. Also, the definitions of external financing used in these studies focus on equity and external debt, and they do not take into account the possibility that in some countries firms could substitute other forms of financing, such as supplier credit or government financing (could add micro-credit, working capital over draft,
Paper examines the, if any, difference between financing methods of Small and medium enterprises and large business. The paper also examines the relationship between a firms’ external (such as share issue, loans, bonds, OD) and the ‘resident’ country country’s financial and legal institutions and its framework. The paper offers some insight into the different external finance methods that can also be suitable for use by SMEs. Lastly, the paper will assess whether the relation between firms’ financing patterns and firm size varies across different levels of financial and institutional development.
For sake of a proper conceptual framework, the following definitions were used
• small those with 5–50 employees,
• medium firms are those that employ 51 – 500 employees,
• large firms are those that employ more than 500 employees.
This will allow for a cross-country analysis to be ready for comparison and any such differences that would arise because of a lack of clear framework and definitions would now be gone/outta way. Data used was from firm-level survey data from the World Business Environment Survey (WBES), and included almost 3000 firms in more than 47 countries. The regression relates the firms financing characteristics with firm and countries specific variables that capture their characteristics. Gross domestic product (GDP) per capita and its PPP equivalent, growth rate of GDP, and inflation and the G n I score to capture the income inequality effect. To measure of financial intermediary development, the variable private credit is used. Private credit shows the credit issued to private sector by banks (that use deposit as their main source) and other financial institutions as a percentage of GDP (Beck, Demirguc-Kunt, and Levine, 2000 b). it is found that growth rate is directly linked with private credit: countries with a higher private credit also experience faster growth. Stock market development is captured by value traded, which is given by value of shares traded divided by GDP and is a good indicator of stock market liquidity. a robust relation between stock market liquidity and GDP per capita growth was also found by Levine and Zervos (1998) and Beck and Levine (2004). Lastly the paper presents an indicator of measure for legal system effectiveness by using property rights protection as a proxy: property rights, which is an indicator compiled by the Heritage Foundation. Its values vary between one and five, with greater values indicating a greater level of protection of private property rights. While not an indicator of financial development, property rights measures a key input into the efficient operation of financial contracts and thus financial development: the degree of protection of private property rights (.
Interesting takes: Both financial intermediary and stock market development, Private Credit and Value Traded, are higher in more developed countries although significant variation still exists at different levels of development. Property rights protection also increases with GDP per capita in general, but there are many exceptions. For example, China’s income per capita is higher than that of Pakistan’s, but property rights protection in Pakistan is rated highly at four, whereas China’s rating is one of the lowest at two. Generally, countries with higher rating for financial development are expected to have better access to finance for firms. External finance is used as a proxy and is the sum of bank, equity, leasing, supplier credit, development bank and informal finance. They are also added independently to the regression equation to help in differentiating between the effects that each of them can have, as some of them are substitutes for each other. For example, a firm unable to get a loan to purchase a building /property/ car can resort to lease financing, allowing flexibility and eligibility.
Below is a summary of the 4 different types of studies that are conducted to measure access to finance.
The first group of studies are early studies that combined firm-level data with broad macroeconomic indicators of financial development for a cross-section of countries to examine the relationship between a more developed financial sector and firm performance. Such studies include Demirguc-Kunt and Maksimovic (1998), Beck et al. (2008, 2006), and Demirguc-Kunt et al. (2006). The second group of studies is country-specific studies which also combined firm data with financial development. Such studies include Butler and Cornaggia (2007) and Girma et al. (2008). The broad consensus from these studies is that better developed financial systems foster the growth of firms. The third group of studies makes use of recent firm-level data, especially from the World Bank which relies on responses from firms on various constraints to doing business and on their accessibility to financial markets. This has given rise to new studies which make use of strictly firm level data to examine how access to finance and other constraints affect firm performance. Such studies include Beck et al. (2005), Ayyagari et al. (2008), Dinh et al. (2012), Aterido and Hallward-Driemeier (2010), and Aterido et al. (2011). This last group of studies forms the central focus of this study. Existing studies into the effects of financing constraints and access to finance on the performance of firms have largely made use of data across a broad spectrum of developed and developing countries.
In summary, results have found that small firms use significantly less external finance than large firms. General understanding is that the major reason for this is the lack of access to share issues for small firms, as such this paper will also look at the difference in access to finance amongst measures that are accessible to both, to try and understand the underlying impact that causes a different level of access across size.

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