Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich SME Credit Availability Around the World: Evidence from the World Bank’s Enterprise Survey 2012 Southern Finance Association Annual Meeting Nov. 15, 2012 Rebel A. Cole, Driehaus College of Business at DePaul University Andreas Dietrich, Lucerne University of Applied Sciences and Arts

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Agenda 1 Introduction 3 Model, Methodology and Data 4 Findings and Conclusions 2 Literature Overview Andreas Dietrich 2

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Background and Motivation -Lack of access to finance is a growth constraint for small and medium-sized firms; and has a negative impact on a country‘s economy -Research has shown that SMEs are very important for any economy, esp. for employment and GDP. -In the U.S., for example, small firms account for about half of GDP growth and 2/3rd of new jobs. Andreas Dietrich 3

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Background and Motivation -The answers to the questions “who needs credit,” “who applies for credit,” and “who gets credit” are of great importance not only to the firms themselves, but also to prospective lenders to these firms and to policymakers interested in the financial health of these firms -In this paper, we analyze data from a series of World Bank sponsored surveys of 80 countries to provide new evidence on how to answer these three questions. Andreas Dietrich 4

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Research Question  What determines the credit need, credit application and credit availability? – Firm characteristics? – Market characteristics? – Environmental characteristics? Credit need/ Credit application/ Credit availability Environmental characteristics Owner characteristics Firm characteristics Andreas Dietrich 5

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Methodology – Our Approach (1) Need Credit? (2) Apply for Credit? (3) Get Credit? No Yes No Non-Borrower Discouraged Borrower Unsuccessful Borrower Successful Borrower Andreas Dietrich 6

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Why is this study important? -Almost no study analyzes the “No-Need” firms -Many existing studies ignore “discouraged” firms that need credit but don’t apply -“Discouraged” firms are numerous -To improve availability of credit, it is critically important to better understand these firms -Many studies pool “discouraged” firms with “denied” firms to analyze credit allocation -This can lead to faulty conclusions if the two groups differ systematically -We provide new evidence, analyzing data from , including 80 countries Andreas Dietrich 7

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Agenda 1 Introduction 3 Model, Methodology and Data 4 Findings and Conclusions 2 Literature Overview Andreas Dietrich 8

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Existing Literature -The availability of credit is one of the most fundamental issues facing a small business and has received a lot of attention in the academic literature (e.g., Petersen/Rajan, 1994; Berger/Udell, 1995; Cole, 1998) -Cole (2009) first proposed this taxonomy of firms. Who needs credit, who gets credit. -Some studies are using the World Bank’s SME Surveys -Beck et al. (2008; 48 countries, 3,000 firms) find that, in countries with poor institutions, firms (and especially small firms) use less finance. Andreas Dietrich 9

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Existing Literature -Chakravarty and Xiang (2009; 10 countries, 8,000 firms) find that discouraged firms differ across developed and developing countries; and that larger firms, more transparent firms, and firms with stronger banking relationships are less likely to be discouraged -Brown et al. (2011; data from 2004/5; 2008) look at 20 countries in Eastern and Western Europe prior to the financial crisis and find that small and financially opaque firms are less likely to apply for credit. Most interestingly, they also find that firms applying for credit rarely are denied credit. Andreas Dietrich 10

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Agenda 1 Introduction 3 Model, Methodology and Data 4 Findings and Conclusions 2 Literature Overview Andreas Dietrich 11

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Methodology: Univariate and Multivariate Test -Once we have classified each firm, we calculate univariate statistics for each group and test for significant differences in means across groups -We then run a sequence of three logistic regression models to explain each step of the credit approval process: -1. Need credit? (Yes or No?) -2. Apply for credit? (Yes or No?) -3. Get credit? (Approved or Denied?) -We further analyze whether the results differ between developing and developed countries Andreas Dietrich 12

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Sample Data – Our Determinants Firm Characteristics  Age  Size  Growth  Legal form  Industry  External auditor Environmental Characteristics  City Size (rural vs. City)  GDP growth  GDP per capita  Inflation  Year Dummies ( ) Market maturity  Developed vs. Developing countries Credit need and credit availability Owner Characteristics  Experience Management  Domestic vs. Foreign owned  Gender Andreas Dietrich 13

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Data -Our data are taken from the World Bank’s Enterprise Surveys. -WB conducted these surveys in 99 countries between 2006 and Since 2006: A “Global Methodology” makes the surveys comparable across countries and years) -Our final sample includes 43,418 firm-year observations from 80 countries over the 2006 – 2011 period. Andreas Dietrich 14

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Data -Limitation of the WBES: -Some data gathered are based on subjective perceptions of the owners and managers of the firms -Some key information about firms that typically are required by banks when a company applies for a loan (performance indicators, capital structure, margins, etc.) are not included in the survey data. Andreas Dietrich 15

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Desc & Univariate Stats 32% 39% 50% It seems that older firms need less credit, are less discouraged and are more likely to be granted a loan Andreas Dietrich 16

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Agenda 1 Introduction 3 Model, Methodology and Data 4 Findings and Conclusions 2 Literature Overview Andreas Dietrich 17

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Regression Results I – Firm Characteristics Andreas Dietrich 18

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Regression Results II – Market Characteristics Andreas Dietrich 19

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Regression Results III – Owner Characteristics Andreas Dietrich 20

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Results/Conclusions -As compared with results for the U.S. (see Cole, 2009), we find that firms around the world are: -much more likely to be discouraged from applying for credit (40% vs. 30%; developed: 33%; developing: 44%), -are much more likely to be denied credit (50% vs. 20%) when they need and apply for credit Credit is much less “available” around the world than in the U.S., so that policies to improve the availability of credit are even more important Andreas Dietrich 21

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Results/Conclusions -Credit constraints might limit product development and innovation by some firms, possibly harming long-term economic growth -Policy to increase information sharing and transparency (for example by external auditors) seem to be an effective way to improve credit availability Andreas Dietrich 22

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Limitations -The reason why a firm is discouraged from applying for a loan is not fully clear, e.g. discouraged borrowers due to high interest rates/ large collateral: -Non economic reasons (such as discrimination) and thus true impediments of promising firms/projects? -Or financial difficulties of the firm? -Not clear whether the large fraction of discouraged and denied borrowers is reflecting missed growth opportunities or whether it is the result of a useful screening of weak applicants -Interesting data, such as profitability, capital structure, etc. are not available from the surveys. Andreas Dietrich 23

Slide Eastern Finance Association Annual Meeting 2009Andreas Dietrich Thank you! Questions / Comments? Andreas Dietrich 24