Improving SME Access to Finance: the Role of Government Workshop on Improving Access to Finance for SMEs in the Asia-Pacific Region Shanghai, June 16 - 17, 2008 Improving SME Access to Finance: the Role of Government Qimiao Fan Lead Economist, The World Bank

Outline of the Presentation Why Is It Difficult for SMEs to Get Finance? Traditional Government Strategy to SME Finance What Should Be Done? The Role of the Government 2019/4/21 WBI Investment Climate Program

Why Is It Difficult for SMEs to Get Finance? A universal problem: small firms are more constrained than large firms: 2019/4/21 WBI Investment Climate Program

Why Is It Difficult for SMEs to Get Finance? Higher risks due to inadequate or lack of credit information on SMEs Inconsistent SME financial statements and audits Lack of third party information providers in the marketplace Higher cost of obtaining credit information on SMEs Lower quality of credit information 2019/4/21 WBI Investment Climate Program

Why Is It Difficult for SMEs to Get Finance? Higher unit transactions costs, and therefore low profitability, of lending to SMEs small loan size relative to fixed transactions costs Higher processing costs per loan and per dollar Lower profitability per loan and per dollar Traditional financial institutions not equipped with technology and skills to process SME loans 2019/4/21 WBI Investment Climate Program

Why Is It Difficult for SMEs to Get Finance? Intrinsically higher risk of lending to SMEs Capital highly liquid – more likely to default More vulnerable to market changes Limited or inadequate management capabilities High “death rates” – average annual closure rate is above 20% in most countries Imperfections in collateral markets 2019/4/21 WBI Investment Climate Program

Why Is It Difficult for SMEs to Get Finance? Financial sector policy distortions Interest rate ceilings make it unprofitable to make SME loans State ownership and segregated markets discourage competition among financial institutions Poor regulations discourage innovation in new forms of financing Direct credits to large companies and state-owned enterprises disadvantage SMEs Weak judicial and legal framework and lack of property rights make secured lending difficult 2019/4/21 WBI Investment Climate Program

Traditional Government Strategy to SME Finance Focusing on bank lending Directed credit by government to SMEs through banks and other financial institutions Subsidized interest rates Portfolio requirements on banks – often supplemented by credit guarantee schemes 2019/4/21 WBI Investment Climate Program

Traditional Government Strategy to SME Finance Achieved little to increase SME access to financial services Failed to deal with the fundamental problems that make banks reluctant to service SMEs: high transactions costs and high risks Inhibited the development of sustainable financial institutions Fostered a nonpayment culture among firms Created distortions in financial markets 2019/4/21 WBI Investment Climate Program

WBI Investment Climate Program What Should Be Done? Focuse on reducing risks and transactions costs associated with lending to SMEs Increase competition in financial markets and strengthens capacity of financial institutions to service smaller clients Promote profitable and sustainable lending to SMEs 2019/4/21 WBI Investment Climate Program

The Role of the Government Set a sound financial sector policy framework Liberalizing interest rate regime Refraining from direct public sector intervention such as directed lending Fostering competition Invest in financial infrastructure Information infrastructure Legal, judicial and bankruptcy environment The tax and regulatory environment 2019/4/21 WBI Investment Climate Program

The Role of the Government – Information Infrastructure Accounting Strong and consistent accounting standards Credible and independent accounting firms Credit information sharing Lowers information asymmetry and allows more efficient credit allocation Allows lenders to more accurately evaluate risks and improve portfolio quality Reduces adverse selection problems and lowers costs of credit for good borrowers 2019/4/21 WBI Investment Climate Program

The Role of the Government – Information Infrastructure The role of credit bureaus They are critical elements of the institutional framework for modern financial system They provide rapid access to standardized information of potential borrowers Survey results show availability of credit bureau information reduces loan processing time, costs and default rates by more than 25% 2019/4/21 WBI Investment Climate Program

The Role of the Government – Information Infrastructure An adequate legal and regulatory environment necessary for the operation of credit bureaus The legal and regulatory environment affects the usefulness of credit reports An enabling environment encourages information sharing Balance between protection of privacy and consumer rights is critical 2019/4/21 WBI Investment Climate Program

The Role of the Government – The Legal and Judicial Environment Property rights Bankruptcy laws and systems Laws on security interests (collaterals) and secured transactions Enforcement 2019/4/21 WBI Investment Climate Program

The Role of the Government – The Tax and Regulatory Environment An efficient taxation system that is stable and transparent minimizes inconsistent and discretionary interpretations avoids negative impact on new financing instruments An enabling regulatory environment that encourages innovations in new forms of financing fosters competition in the financial sector levels playing field for firms of all sizes 2019/4/21 WBI Investment Climate Program