平和
和平
평화
ASIA
26 March 2014
Sughira, works at weaving silk

Small business finance in Asia

Small business has a big problem, and that is access to finance. This is a problem everywhere, but especially in emerging and developing economies in Asia and elsewhere.

Small business has a big problem, and that is access to finance. This is a problem everywhere, but especially in emerging and developing economies in Asia and elsewhere.

For small and medium size enterprises (SMEs), access to finance usually means access to bank finance, because SMEs are usually too small to access bond and equity markets.

In normal times, access to finance is one of the most significant challenges for the creation, survival and growth of SMEs, especially the innovative ones. And SMEs are generally more vulnerable in times of crisis. Being small, it is more difficult to downsize. Often they are less diversified in their economic activities, have weaker financial structures, have a lower or no credit rating, and are heavily dependent on credit.

But let’s come back to the beginning. Why do SMEs matter?

First, SMEs (enterprises with less than 200 workers) account for a large share of manufacturing employment, 50-90% in developing Asian economies. The shares in the agriculture and services sectors are even higher. And within that, micro and small enterprises (those with less than 50 workers) are particularly important in countries like India, the Philippines and Indonesia.

Second, evidence from OECD countries and some developing Asia economies suggests that SMEs, especially new ones, can be among the most innovative and dynamic. In other words, they can be of critical importance for the economy. For example, Microsoft may be a software giant today, but it started off in typical SME fashion, as a dream developed by a young student with the help of family and friends.

The Economist newspaper reports that “whereas big Japanese electronics companies such as Panasonic, Sharp and Sony have been losing market share to rivals from China, South Korea and Taiwan, smaller, less well known Japanese firms continue to dominate niches upon which the global technology industry depends …Japanese companies serve more than 70% of the worldwide market in at least 30 technology sectors worth more than $1 billion apiece, according to the Ministry of Economy, Trade and Industry (METI). They range from certain films to diffuse light used in LCD screens (where they have the whole of a market worth more than ¥270 billion, or $3 billion) to multilayer ceramic capacitors that regulate the current in electrical equipment (77% of ¥540 billion)”.

SMEs also face many particular challenges, ones that larger enterprises do not suffer – like infrastructure (they cannot afford their own electricity generator), access to technology, and dealing with the regulatory environment.

With the increasing fragmentation of production and trade, many SMEs can be caught in a supply chain trap. Again, the Economist newspaper reports that 90% of the micro-motors used to adjust the rear -view mirror in every car are made by Mabuchi, a Japanese SME. But, when car sales drop, Mabuchi takes a direct hit.

But access to finance can be one of the greatest hurdles that SMEs face. Financing is necessary to set up and expand their operations, to develop new products, and to invest in new staff or production facilities.

Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business. The very substantial migrants' remittances to some countries like India and the Philippines can be another source of finance.

But when SMEs are successful, they need new investment to expand or innovate further. And that is when they often run into problems, because they find it much harder than larger businesses to obtain financing from banks. And when economic crisis strikes, SMEs are the first to see their financing get chopped.

Most regrettably, the financing problem is usually most acute for innovative SMEs. They tend to be newcomers to the market. They may be seeking financing for a new type of product or service. Initially, they may have negative cash flows and untried business models. They represent a higher risk to banks and cannot be assessed in the same manner as traditional SMEs or large firms. Credit constraints can stop SMEs growing into larger firms.

The Consultative Group to Assist the Poor (CGAP) estimates that more than half the households in developing Asia and most SMEs do not have access to formal financial services. In the World Bank’s report on the ease of doing business, SMEs in most developing Asian countries report that getting credit is difficult.

There are many reasons why access to finance is difficult in developing Asia:

(i) Large numbers of SMEs are in the informal sector. They are not registered. They do not have all the necessary documentation. It can be difficult for potential lenders to distinguish the financial situation of the company from that of its owners. They are less able to provide collateral.

(ii) Financial markets are underdeveloped in many Asia countries. They do not offer a complete range of financial products and services. They may also suffer from regulatory rigidities.

(iii) The fixed costs of all the paperwork mean that it is easier for banks to make bigger loans to larger enterprises.

(iv) In many countries, large enterprises enjoy privileged access to finance from banks. Many of these banks are state-owned or have close links with the government which uses bank lending as an instrument of industrial policy to develop specific sectors. Banks may also have ownership and other ties to industrial interests and will tend to favor affiliated companies. This means that it is difficult for SMEs to obtain finance.

So, even in normal economic conditions governments have recognized that, to survive and grow, SMEs need specific policies and programs especially to facilitate their access to finance. Examples include loan guarantees, subsidized interest rates, simplified lending requirements and tax incentives. But such initiatives are not always effective.

There are further things that governments can do to improve access to finance:

(i) Continued development of microfinance holds great promise, such as agent banking, mobile phone banking, diversification of financial service channels and providers, state bank reforms, financial identity, and consumer protection.

(ii) The financial sector can be strengthened by improving the institutional underpinnings of financial transactions by strengthening creditor rights, defining property rights so property can be used as collateral for credit, and enhancing credit registries and systems to screen borrowers.

(iii) Move to more market- based banking, where banks are accountable for achieving high returns to shareholders and maintaining high prudential standards, is gaining acceptance on a global level. This model creates a competitive market where there is more incentive for banks to lend to SMEs, but many emerging markets have been comparatively slow in implementing this model.

(iv) Development of “business angel networks” or venture capital markets.

(v) Making it easier to do business by removing administrative and other barriers.

As Asia progressively rebalances its economic development model away from a manufacturing/export orientation towards services/domestic demand, it will be ever more necessary to foster SME development, and SME access to finance. SMEs are the backbone of the service sector.

Author

John West
Executive Director
Asian Century Institute
www.asiancenturyinstitute.com
Tags: asia, small business, SMEs, access to finance

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