By Peter OBIORA InvestAdvocate
Lagos (INVESTADVOCATE) -Unmet credit needs of formal Small and Medium Enterprises (SMEs) in the developing world is estimated to be $850 billion; while that of Micro, Small, and Medium Enterprises is estimated to be $2.5 trillion.
This is contained in a new study “Assessing Private Sector Contributions to Job Creation” by the IFC, a member of the World Bank Group and made available to www.investadvocateng.com.
“An estimated 45 percent (45%) to 55% of formal SMEs are unserved and 21% to 24% are underserved. The unmet credit needs of formal SMEs in the developing world add up to $850 billion,” the Report said.
The IFC affirmed that of 365 to 445 million Micro, Small, and Medium Enterprises in developing countries, including informal and formal establishments, about 70% do not use external finance. Their unmet credit needs total as much as $2.5 trillion or around 14% of GDP in the developing world.
According to the study, Developing Countries still lag behind high-income countries. In companies access to finance is less than 20% of Micro, Small, and Medium Enterprises in developed economies are unserved, while in regions such as South Asia and Sub-Saharan Africa, more than 59% of these small businesses are unserved.
The IFC Report says that the lack of access to finance for Small and Medium Enterprises; a large sector which is not served by microfinance institutions and not effectively covered by commercial banking institutions, is known as the missing middle.
The Report affirms that when Companies cannot borrow directly from Financial Institutions, they have to use alternative financial sources, including their own funds or informal credit sources that can be costlier or might not cover their funding needs.
It further affirmed that alternative external sources such as Trade Finance and Equity Markets might not be available for these businesses, either; If they are unable to obtain enough financial resources, they might not be able to grow into larger firms and create more jobs.
Lack of access to finance is a key constraint to job creation, particularly for micro, small, and medium enterprises. Companies in less-developed countries tend to face more financial obstacles, given the lower level of financial development,” the Report said.
Also, evidence shows that improved access to credit lines and other types of finance can help generate jobs, and the results tend to be larger and more significant for small businesses and businesses in developing countries.
It said that a main challenge for the financial sector is to improve the sources of financing available for firms with growth potential that are unserved (do not have a loan or overdraft but need credit) and underserved (have a loan and/or overdraft facility but face financing constraints).
The Report noted that the recent financial crisis spurred questions about the role of financial markets and possible negative effects when they become too large. A study found a positive association between financial development and employment growth. However, the study also found that banking crises affect employment growth more in industries that depend on financing and in financially developed economies,” it said.
Also, a recent study found that financial depth and economic growth are positive and significantly related until the ratio of private credit to GDP reaches levels of 60% to 70%.
Ratios in lower-income countries are below these levels, suggesting that the expansion of credit can boost their growth.
According to the Report, some of the measures that can help improve access to finance include: Governments intervention, development of financial institutions, and other private-sector participants needed to relieve constraints and spur job creation.
The Report said Government can improve financial sector regulations by way of financial liberalisation that can promote the creation of new Companies and the closure of inefficient or unprofitable ones; which can cause a decrease in lending costs and allow profitable businesses to flourish.
It also noted that it’s necessary to improve enforcement of regulations; for example, better protection of property rights can increase access to finance, especially for small firms, because it safeguards lenders and supports the collection of collateral in event of a default.
Another measure is to improve financial infrastructure; whereby a more developed financial infrastructure can make more information available about potential clients, and therefore reduce transaction costs and expand credit, particularly for SMEs. The probability that small companies can obtain loans increases from 28% to 40% when they operate in countries with credit bureaus.
Also, Government can step up competition in the Banking Sector by encouraging entry of financial intermediaries or diversification of their lending, which can result in financing to previously unserved groups. Heightened competition can reduce interest rates, thus benefiting companies that obtain credit,” the IFC Report said.
Apart from these, another measure that can help improve access to finance for SMEs is by increasing funding to financial institutions or other financial intermediaries. Policies that help financial institutions broaden their lending activities to underserved groups can help generate jobs. For example, partial credit guarantees mitigate the credit losses of financial institutions in the event of default and therefore promote lending to SMEs,” the Report affirmed.
Cater to unserved or underserved groups by establishing new financial institutions or products targeting previously unserved or underserved groups can entail high up-front costs, but have significant public benefits.
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