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Bringing SMEs Closer to Commercial BanksThe
Role of Development Partners and Regional
Development BanksProf. Andreas AntoniouHead,
International Finance and Capital
MarketsCommonwealth SecretariatLondon, UK

• Making Financial Markets Work for SMEs
• Sandton Hilton
• Johannesburg,
• South Africa,
• 26 October 2006

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Outline

• Information Asymmetries in SME Borrowing The
  Nature of the Problem
• Other Contributing Factors Affecting SME Lending
• Some Ideas on the Role of Development Partners
  and RDBs

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1. Information Asymmetries

• On the Borrowers side bounded rationality and
  principle-agent issues
• On the Lenders side, need to separate
• Large Centralised banks v Small Decentralised
  financial institutions
• Hard v Soft Data

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Hard Data

• Easily observable, quantifiable, verifiable,
  easily transferable e.g. tax returns, financial
  ratios, credit scores, accounts receivable,
  factoring and franchising agreements, etc.
• Transaction Lending Technologies e.g. financial
  statement lending, small business scoring,
  asset-based lending, factoring, trade
  credit.

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Soft data

• Qualitative Information, e.g. reliability and
  character of applicant knowledge of local
  environment and community proprietary in nature
• Relationship Lending

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Bank Size and Comparative Advantage in SME Lending
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Empirical Research Shows that

• Bigger banks lend to larger clients or with
  better accounting records
• The physical distance between a firm and the
  branch office increases with the size of the
  bank
• Large banks use more impersonal channels and less
  face-to-face meetings
• Bank-firm relations are stronger, more long-lived
  and exclusive, when borrowing from a small bank

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And that

• A small firm will (attempt to) borrow from a
  large bank, only if faced with a credit
  constraint, i.e. doesnt have access to a smaller
  bank
• In fact, additional recent research has shown
  that there is very low elasticity of substitution
  for sources of finance for borrowers of small
  banks (adverse selection), and that banks
  allocate less than 0.5 per cent of loan portfolio
  to new switching borrowers and 87 per cent to
  pre-existing borrowers!

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2. Other Contributing Factors

• Financial Institutional Structure i.e. market
  presence and degree of competition
• Lending Infrastructure i.e. prevailing legal,
  regulatory and supervisory framework

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2. Other Factors (cont.)

• Macroeconomic Framework
• Red Tape
• Business Angel Networks
• VC and SME Equity Funds
• BAS and One-stop shops
• Risk-sharing Instruments
• Race and Gender

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3. The Role of Development Partners and RDB

• The Trigger-Down Model (see diagram in paper)
  Provide ODA (Grants and/or Subsidies) to
  Multilateral and Regional Development Banks who,
  in turn, fund service-providers and financial
  intermediaries in order to enhance access to
  finance by SMEs.
• So far, limited success because it does not
  address some key factors

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Such as (see paper)

• Lack of SME market data and information
• High costs in Pre-loan Screening and Post-loan
  Monitoring
• Cost associated with Debt Collection and
  Maintenance
• Limited Market Access for SMEs
• Limited Capacity to Collect and Supply data

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Thus the need to develop Information platforms
(See paper)

• These Platforms should complement existing
  interventions
• Akin to Two-Sided markets
• Network Externality Effects and chicken-and-egg
  problem
• Market Failures and Inefficiencies need for
  targeted subsidies
• But, market-based pricing
• Expand the role and outreach of RDB
• Enhance awareness/financial inclusion
• Conscious Gender mainstreaming

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Thank You