The CIS-7: Micro, Small & Medium Enterprises and
Access to Financial Services
April 2003 – Preliminary Draft
Document of the World Bank
Ira L. Lieberman
Zeynep Kudatgobilik
Maya Meredova
Enrico Pinali
I.
Introduction
This paper discusses access to financial services by micro, small and medium
enterprises (MSMEs) in the CIS-7.1 The paper is divided into two major sections.
Section I defines the universe of MSMEs, their importance for growth and development
in the CIS-7 countries the constraints to their development and finally their existing
situation given these constraints. Section II discusses access to financial services by
MSMEs in the CIS-7 and how to improve access over time..
Section I The Universe of MSMEs in the CIS-7
II.
MSMEs Defined
Most countries for convenience and ease of gathering statistics define MSMEs by
size, almost universally by number of employees. Micro-enterprises are generally firms
from 1-10 employees, small firms from 11-50 employees and medium size firms from
50-200 employees as an example. But this typology varies by country and a small firm in
Russia, may in fact be viewed as a medium to large-size firm in the Kyrgyz Republic or
in Georgia. Some countries further qualify these statistics by reported assets and/or sales.
While this information allows us to report out MSME statistics by countries and may
serve as a useful typology to determine whether or not SMEs are highly clustered on the
smaller end of the scale in any one country, these statistics are not especially useful in
that they are not actionable. That is, they fail to tell us much that is useful with respect to
providing assistance to these firms, both financial and non-financial assistance. Reported
statistics on MSMEs are generally weak in the CIS-7 countries and perhaps this would be
a valid place to start our work to determine their contribution to overall employment,
their value added, their broad sectoral composition—manufacturing and distribution,
trading, and services. Also useful would be knowledge of their lines of business—light
1
The CIS-7 are a group of countries that are lagging reformers amongst the countries in Central and
Eastern Europe and the CIS. Based on GDP per capita, ,these countries rank amongst the poorer
developing countries. The CIS-7 countries include 3 Central Asian countries—the Kyrgyz Republic,
Tajikistan, Uzbekistan, 3 countries in the Caucasus—Georgia, Armenia and Azerbaijan, and Moldova in
Europe.
2
industry such as food processing, textiles and garments, leather goods, agriculture and
agribusiness, software and other IT services, as examples.2
Another distinction that would be useful, but is very difficult to obtain is their
origin --- that is have MSMEs been created through small scale privatization or new
entry. EBRD’s Transition Report 2001 indicates that all of the CIS-7 countries score 3
or 4 with respect to small scale privatization, meaning that small business creation
through privatization is largely completed.3 De novo entry therefore becomes the focus of
new business creation amongst these countries and it would be highly useful to measure
the rate of new business entry. The business environment and difficulty of entry is a
serious issue in many of the CIS-7 countries, discussed later in this paper.
Finally, it would be highly useful to understand the dynamics of MSME
development—their growth rates, their contribution to overall employment in their
respective country, their density relative to other transition countries, and their value
added. It is this data that have led Mitra and Selowsky4 to posit that small-scale business,
especially de novo entry, has played a critical role in the growth of the key accession
economies and that is largely what sets those countries’ performance aside from other
countries in the region, especially in the CIS and above all the CIS-7. It is the degree of
dynamism in the MSME, the growth rate and contribution to value added, that is a
critical issue.
MSMEs can range from “household” type firms that exist largely to support a
family unit or self-employment opportunities. These firms cluster at the micro and very
small end of the size range, employees, if any, are normally family members who often
Efforts to “map” SMEs, for example, in the Kyrgyz Republic by the World Bank Group SME Department
and a recently published Trade Study on Armenia, “Armenia Trade Diagnostic Study,” World Bank ECA
Poverty Reduction and Economic Management Unit, June 28, 2002, with other such studies in progress
for other CIS-7 countries will assist in bridging the present knowledge gap, but this does not alter the need
to improve regularly collected statistics on MSMEs in these countries.
3
European Bank for Reconstruction and Development, Transition Report 2001, Progress in Transition,
Table 2.1
4
Pradeep Mitra and Marcelo Selowsky, Transition the First Ten Years: Analysis and Lessons for Eastern
Europe and the Former Soviet Union, World Bank, 2002.
2
3
will not receive cash wages or unpaid apprentices seeking to learn a skill. For want of a
better definition, we term these firms “life style” firms and their primary characteristic, of
great importance in the CIS-7 countries, is that they keep their owner-operators out of
deep poverty. These firms often operate on the border between the informal and formal
sector. In between are small and medium size manufacturing and distribution businesses,
mostly in light industry that have the chance to grow, generally in line with or closely
correlated to the growth of the overall economy. Another important class of such firms
are small scale utilities such as bus or van operators in urban, peri-urban, inter-city or
village transport and also small-scale distributors of drinking water. Finally, at the far
end of the spectrum from “lifestyle” firms, are the most dynamic firms in hightechnology sectors such as software and internet services as examples.
Yet another category, is formal versus informal firms. There are also degrees of
informality ranging from smaller firms operating entirely in the informal sector to larger
firms, operating in the gray economy, which may under-declare the number of workers
they employ and/or revenues. Informality, is an important issue in the CIS-7 countries
addressed later in this paper.5
An important reason for classifying or creates a typology of MSMEs in these
countries is in defining their need for finance. For example, micro and small life-style
firms primarily require working capital finance. Therefore, to the extent microfinance
institutions (MFIs) develop and are subsequently able to scale-up in the CIS-7 countries,
an important financing gap may be bridged.6 These micro and small life-style firms will
also need safe places to save, perhaps more important to their survival than credit. 7 To the
extent, MFIs formalize over time and become licensed financial institutions, their ability
to develop sound savings products that are extended to micro-entrepreneurs and small
life-style firms will have great importance. Alternatively, postal banks, handling social
Simeon Djankov, Ira Lieberman, Joyita Mukherjee, and Tatiana Nenova, “Going Formal: Benefits and
Costs,” World Bank, June 11, 2002 (mimeo)
6
See Sarah Forster, et. al., “Microfinance in Central and Eastern Europe and the New Independent States,”
Microfinance Centre, 2002 (mimeo) and Hoonae Kim "Presentation for Expanding Microfinance in Central
Asia” conference, April , 2003, for a recent analysis of the development of microfinance in the region.
7
See Marguerite Robinson, The Microfinance Revolution, 2001, and Stuart Rutherford, The Poor and
Their Money, DFID, Oxford university Press, 2000, on the importance of savings for micro-entrepreneurs.
5
4
security and pension payments, savings and eventually micro-credits may be a faster way
to scale-up and increase access to financial services for these same categories of firms.
Small manufacturing or agri-processing firms, distribution and transport companies, and
small infrastructure providers will inevitably require intermediate- term financing for
machinery and equipment purchases, in addition to working capital financing needs, and
that can come both from commercial banks and leasing institutions. Finally, more
dynamic firms that are growing rapidly will require private equity and in time venture
capital. For many reasons this will be a scarce commodity in these countries for some
time to come, so the question will arise can IFIs or publicly sponsored institutions bridge
the gap and seed such an industry, as they were able to do to some extent in Chile, Israel
or Ireland. In examining the issue of access to finance for MSMEs in the CIS-7 countries,
there is a real need to understand the market—who are the potential customers for such
finance, what is their real demand for financial services and of what type, can they
service their debts and are they even “financeable or bankable”.
III.
Importance of MSMEs in the CIS-7 and Their Potential Contribution to
Growth and Development
Many analysts and researchers have written about the importance of MSMEs for growth
and development, but why are small firms especially important in the transition
economies and why, above all, in the CIS-7 countries?8
MSMEs constitute a high percentage of all firms in advanced industrial countries,
developing and transition countries. They are important simply because they are there.
Politically and socially they are a large constituency that needs to be supported by any
8
For generic or overall discussion of this issue not specifically focused on transition economies see
Thorston Beck, et. al., “Financial and Legal Constraints to Firm Growth Does Size Matter,” January, 2002,
World Bank (mimeo); Kristin Hallberg, “A Market-oriented Strategy for Small and Medium-Scale
Enterprises,” International Finance Corporation, Discussion Paper 40, April, 2002 and for papers focused
on transition economies see Mitra and Selowsky, Opus Cited; Jan Winiecki, “The Role of the New
Entreprenurial Private Sector in Transition and Economic Performance in Light of the Successes in Poland,
the Czech Republic and Hungary,” Bank of Finland, Institute for Economies in Transition, Discussion
Papers No. 12, 2001; Robert J. McIntyre, Small Enterprises in Transition Economies: Casual Puzzels and
Policy Relevant Research, May 15, 2001 (mimeo); and Andras Inotai, “The Recent Experiences of SMEs
in CEECs” (mimeo).
5
government.9 That is why, in fact, governments often push for support to this sector,
sometimes to its detriment. In transition countries, the density of SMEs matters
significantly. To the extent they form a critical mass of private firms, they establish the
basis for a market economy and what is sometimes called democratic capitalism.
Winiecki notes that, “SME density can be described in terms of numbers per
thousands of population, per unit (say of billions) of GDP, or some other similar
indicator. They all indicate whether the network of firms is sufficiently dense to
undertake new tasks of supplying large old firms, or modernizing their production
profile. Interestingly such indicators are fairly rudimentary, despite the enormous
amount of empirical research on transition. The rare exception… conclude that
successful transition economies converge with the average density of SMEs in
Western Europe.” 10
Table ___ Share of SME in manufacturing output in select OECD countries in the
late 1990s
Country
OECD
Italy
Greece
Portugal
Austria
Japan
Belgium
Turkey
United Kingdom
Sweden
Finland
USA
Eastern Europe
Poland
Czech Republic
Hungary
Share as % of total
54.8
54.1
53.3 a
44.0
43.0 a
40.6 a
39.7
36.9
35.8
30.2
14.3 b
38.1 c
37.5
36.7
Note: Output in firms employing up to 249 persons, except where indicated.
a = Output of firms employing up to 199 persons
b = Output of firms employing up to 99 persons
c = Industrial output (mining, manufacturing, and utilities)
Source: Jan Winiecki, 2001, The Role of the New, Entrepreneurial Private Sector in Transition
and Economic Performance in Light of the Successes in Poland, the Czech Republic and Hungary, BOFIT
2001
Hallberg, Opus Cited, argues that many of the views of SMEs’ unique contribution to growth and
development does not stand-up to analytical scrutiny when one examines advanced industrial economies
and developing economies (note she does not address transitional economies), but simply the fact that they
are there in such large numbers, makes SMEs important and as such their developmental needs should be
addressed.
10
Winiecki, Opus Cited, p. 12
9
6
MSMEs are important in transition economies because they absorb labor and
provide employment opportunities for workers that have been shed in large state owned
enterprises (SOEs) that were a legacy of the former Soviet Union (FSU).11 This labor
shedding has arisen from a number of different circumstances---the withering away of
these large SOEs because their overall loss of competitiveness, at time of privatization or
due to post-privatization restructuring. Divestiture of social assets, asset spin-offs and
simply laying off of workers in large firms, has by necessity forced many former workers
in these firms to become entrepreneurs. This has occurred in heavy industry, for example,
in the machine building and metal mechanic sector, often over-dimensioned in former
socialist economies and in farming as kolkhozes, former state owned farms, are dissolved
in favor of privately owned smaller farming units.
Micro-enterprises
are
important
because
they provide
self-employment
opportunities and provide income smoothing for those on fixed incomes such as teachers
or pensioners, those adversely affected by war or conflict, as has been the case in many of
the CIS-7 countries—Armenia, Georgia, Moldova and Tajikistan as examples, and for
individual workers made redundant by larger SOEs or recently privatized SOEs. The
disadvantages of micro-enterprises is that they rarely demonstrate growth potential and
are not really a platform for SME growth and development. Also, they are not a
particularly good way of addressing deep seated poverty. But micro-enterprises offer a
good alternative to the working poor who need to supplement their incomes or to farm
families, for example, who need to generate alternative sources of cash income.12
MSMEs are important in transition economies because they fill the gap or niches
in these economies that have long been neglected. This has initially started in trading,
with market traders providing consumer and other goods that are in demand, but short
supply in the domestic economy. One important example in terms of economic welfare
of the population, is the supply of the most up-to-date medicines or pharmaceutical
products and medical supplies, produced in the West and in short supply in hospitals and
11
12
McIntyre, Opus Cited, p 1-6
Robinson, Opus Cited, pp. 9
7
health care institutions in many of the CIS countries. The process of filling missing
niches normally moves upstream over time to distribution, transport, agri-processing and
small scale manufacturing. In Armenia, as an example, important niche industries have
been created in diamond cutting and software. The agility of MSMEs are important in
this respect in identifying gaps and then filling the niche.
Finally, SMEs are important for generating productivity and growth. But in this
respect, we distinguish between micro-enterprises as noted above and existing firms that
have been privatized or simply spun-off firms versus de novo entry. Both, Winiecki and
Mitra and Selowsky13, have developed a well articulated view that de-novo entry has
been an important determinant in the early success of
a number of the accession
countries. Moreover, the extension of this logic, when this early success in transition
economies is compared to a select number of CIS countries, is that the failure to create a
substantial new private sector has played an important role in inhibiting growth
throughout the CIS. In the absence of sufficient data, we project this hypothesis or
viewpoint as highly relevant for the CIS-7 countries.
Winiecki observes,” My thesis… is that different types of private firms behave
differently in the first three to seven years of transition. In de novo generic private
firms, the structure of ownership and the relationship between owners and
management (when they are not the same person) reflect the requirements of the
capitalist market economy….. The behavioral patterns in privatized SOEs, on the
other hand, tolerate at least temporarily the survival of old patterns inherited from
communist times”14
Winiecki, then proceeds to develop stylized alternative output paths in transition with a
large new private sector versus an output path with a small new private sector as
presented in Figures __ and __ below.
13
Winiecki, Opus Cited pp. 12-16 and Mitra and Selowsky, Opus Cited, Chapter 4 Discipline and
Encouragement, PP. 33-52.
14
Winiecki, Opus Cited, p.12
8
Source: Jan Winiecki, 2001, The Role of the New, Entrepreneurial Private Sector in Transition
and Economic Performance in Light of the Successes in Poland, the Czech Republic and Hungary, BOFIT,
2001
9
Mitra and Selowski, take much the same path as Winiecki and term this
development in transition economies as one of “discipline and encouragement”
Discipline is in essence maintaining a hard budget constraint over older firms, especially
those under state ownership. Encouragement starts with liberalization of prices and trade
to enable new entry plus the quality of structural reforms
including a supportive
investment climate . Encouragement goes much further to include the quality of public
goods such as, inter alia, the following, the legal and judicial system and enforceability
of contract and property rights, a social system that allows for the development of human
capital and a stable marco-economic environment.
They note, “Using small enterprise employing fewer than 50 employees as a
proxy for new enterprises, the contribution to value added in 1998 was around 55-65
percent of GDP in the Czech Republic, Hungary and Lithuania, compared to 10-20
percent in Belarus, Kazakhstan, Russia and Ukraine. Data on small enterprises as
providers of employment divide countries into two groups leading reformers and
countries further behind. ”15
15
Mitra and Selowsky, Opus Cited, p.39.
10
Figure___ Share of Employment and Value Added in Small Enterprises, 1989-98
Source: Pradeep Mitra and Marcelo Selowsky, Transition the First Ten Years: Analysis and Lessons for
Eastern Europe and the Former Soviet Union, World Bank, 2002;
An additional source of analysis in support of SME led growth in Eastern Europe
is based on analytical work on the AMADEUS
data base containing financial
information on some 5 million registered firms in Eastern and Western Europe. The
analysis in this case is based on a sub-set of the AMADEUS data base evaluating some
97,000 firms in some 15 countries in the CEE and CIS (unfortunately none of these are
11
CIS-7 countries). The authors’ conclusions with respect to SMEs, growth and financing
in the region are significant. They find that16 :

There is a positive relationship between firm size and age;

There is a positive link between profitability and leverage (short-term debt),
which suggests a relationship between profitability and access to working capital;

Younger firms (presumably de novo firms) have higher leverage and growth;

Older and larger firms have smaller cash ratios, suggesting that these firms are
more dependent on internally generated cash flow;

Younger and smaller firms are likely to be in the service sector
A potential problem with theory based on SME led growth is that in advanced
market economies, SMEs often have a symbiotic or inter-dependent relationship with
larger enterprises. The SME sector needs larger enterprises as a source of inputs, for
example large upstream commodity producers of scale in steel, petrochemicals and
plastics, as a source of demand for its output and as a source of advanced market
development in a given sector in areas such as research and development, design, and
marketing. Also, importantly, as a source of financing.
This is especially true in economies with large industrial groups such as those in
Japan, Korea where small firms operate largely as satellite firms to the larger firms
known respectively as keiretsu or chaebols. While, in Turkey and Russia, as example,
large financial industrial groups have been created with banking interests extending tied
Leora F. Klapper, Virginia Sarria-Alende, Victor Sulla, “Small- and Medium-Size Enterprise financing
in Eatern Europe,” World Bank Research Working Paper 2933, December 2002, pp. 20-21
16
12
loans within the group structure.17 In the advanced industrial economies in the West these
relationships are largely arms length through contractual agreements or simply purchase
orders. But tied relationships between large retailers and their suppliers are very common
or in key sectors such as the ties between large auto makers and their world wide,
hierarchical, web of auto parts suppliers. As McIntyre indicates, “ In many prior and
contemporary economic systems, large and small firms interacted in complex
relationships that conferred reciprocal advantages.”18 To the extent larger firms have
largely withered away or are not competitive in the CIS-7 countries, than trade
liberalization and trade ties become essential for SMEs to obtain competitive sources of
inputs and to begin to export their goods and services.
The message is abundantly clear, unless CIS-7 countries do everything in their
power to encourage and enable new entry, SME density, contribution to employment and
value added will lag and presumably growth will also lag. Moreover, more dynamic,
growth oriented firms, with behavior attuned to the market, are those likely to attract
financing. Constraints to SME development discussed below, are therefore important
issues to be addressed.
IV.
Constraints to SME Development in the CIS-7—Market Structure, Policy
Biases and Market Distortions
A.
Initial Endowments in the CIS-7 countries were well below those of countries in
Central and Eastern Europe (CEE) and the Baltics. The CIS-7 countries are located far
from advanced industrial markets,
they are land locked
and have generally poor
transportation infrastructure, thereby increasing the costs of trade relative to CEE or
Baltic countries. With the dissolution of the FSU not only were traditional trade patterns
disrupted, but industry in these countries, often functioning as satellites or “subsidiary”
operations of larger Russian enterprises, lost their linkages to the “parent” firms and in
many cases their rationale to continue operating. These countries had no experience with
17
recent reforms of the Turkish banking system during the 2001 financial/ economic crisis seek to reduce
the level of tied loans within the groups, but the reforms have not separated the groups so it remains to be
seen how effective supervisory reforms will be over time.
18
McIntyre, Opus Cited, p. 1-8
13
advanced market economies and unlike, the CEE or Baltic countries, did not have readily
observable examples at their borders. Moreover, given their remoteness, these countries
were unable to serve as low cost sources of labor for assembly and basic production
operations for Western European firms. They have, therefore, attracted little in the way
of foreign direct investment. (FDI). In addition, to poor initial endowments, many of
these countries were set-back by war, civil strife or conflict in the region—Armenia,
Georgia, Moldova and Tajikistan as examples. Therefore, a number of the CIS-7
countries had to simultaneously begin reconstruction, basic development and the
transition to a market economy. This made it inevitable that reform would take longer
and prove more difficult when compared, for example, to the accession countries.19
B.
Market structure . What determines the size of any individual firm or the overall
size distribution of any given economy is shaped by a number of factors—natural
endowments and economies of scale, transaction costs and market structure. 20 Countries
with important natural endowments or natural resources such as oil and gas, metals and
other minerals which require substantial capital and economies of scale to
exploit
efficiently, may pay little attention to other sectors of the economy and find themselves
largely dependent on exploitation and export of these resources for economic growth and
development. Central Asian countries and Azerbaijan in the Caucuses, have a
combination of oil, natural gas, raw cotton, ferrous and non-ferrous metals, gold and
uranium. In 1998, these commodities accounted for more than four fifths of exports from
these countries. In 1998, gold accounted for half of Kyrgyz exports, about 85 percent of
Tajik exports were focused on electricity, aluminum and cotton, Uzbekistan is dependent
on cotton exports and to a more limited extent oil and gas and Azerbaijan is dependent on
oil.21 The Caucuses and Moldova, demonstrate a similar tendency with natural resource
based exports accounting for 59.2 percent of exports in Armenia, 59.3 percent in Georgia
and 85.7 percent in Moldova.22
See Nancy Vandycke, “Economic Development and Private Sector Growth in the Low-Income CIS-7
Countries: Challenges and Policy Implications, World Bank,” January 2003 (mimeo)
20
See Kristin Hallberg, Opus Cited, pp. 6-7 for a more detailed view of this issue.
21
Vandycke, Opus Cited, pp.20-22
22
World Bank, “Armenia Trade Study,” June 28, 2002, p. 28.
19
14
C.
Bias towards heavy industry. In other sectors, primarily commodity sectors such
as steel, fertilizers, petrochemicals, aluminum, and cement, but also true in sectors such
as auto production and machinery and equipment building technology-based economies
of scale determine the minimum efficient scale of production. The
former Soviet
economy focused to a great extent on commodity based and heavy industry, where
economies of scale were of paramount importance such as Tadaz Aluminum in
Tajikistan, accounting for an important share of the country’s exports and GDP. Farming
or agriculture was also biased towards large state owned farms or to commodity crops
such as the cultivation of cotton in Uzbekistan. Little attention was paid to consumer or
market demand and the development of the retail and services sector or light industry
such as textiles and garments, food and agri-processing. As a result of this bias, SMEs
played an insignificant role in the economy of the FSU. Therefore, the starting point for
the CIS-7 countries structurally was an SME sector that was structurally insignificant to
the economy as a whole and even with privatization of small scale enterprises, their
density--share in terms of number of firms, employment and contribution to value added
was not meaningful when compared to Western economies and after the early years of
transition to the accession countries.
D.
Level of technological development. Competitiveness of scale is increasingly
determined on a global basis. In recent years, the costs of bringing some products to
market and the pace of new product introduction, have made economies of scale
important in advanced technological industries or research and development intensive
industries such as chip production, computers, and pharmaceuticals as examples. It is
clear that the CIS-7 countries lack competitiveness in any of these advanced
technological sectors.
E.
Size of the SME sector. Due to a paucity of data, it is difficult to estimate the
actual size and structure of the SME sector in the CIS-7 economies, but we do know from
surveys, from mapping exercises, and from field visits that SME development in these
economies has not passed the critical threshold necessary to help lift growth and
development with respect to their density, contribution to employment and value added.
15
For example estimates indicate that in23:

Azerbaijan the total number number of registered firms are between 2030,000 and the total number of individuals engaged in entrepreneurial
activities, but not necessarily registered, at 63,000-180,000;

Georgia registered SMEs account for 58 percent of employment;

In Moldova 90% of enterprises are SMEs, and they employ 25% of the total
workforce and account for 28% of total sales24

Kyrgyz Republic SMEs account for 36 percent of GDP and 23 percent of
industrial production;

Uzbekistan, SMEs account for 16.2 percent of employment and about 80
percent of SMEs are in the agricultural sector.
Figure____ Shares of the Kyrgyz Economy by SMEs and sectoral distribution
SMEs share of the Kyrgyz economy
Kyrgyz SMEs categorized by activity
100%
9%
80%
10%
4%
23%
7%
60%
5%
40%
32%
20%
0%
GDP
Individual entreprises
Small
Employment
M edium
Farms
Large
Agriculture
Trans. & Comms
Trade & Catering
General Commercial Activity
10%
Industry
Construction
Services
Other
Source: IFC Mapping of SMEs in the Kyrgyz Republic, 2001
23
See Vandycke, Opus Cited, p.17
The data is taken from the President Vladimir Voronin’s speech during the business-government forum
on SME s in Moldova
24
16
Figure___ SME sectoral distribution in Uzbekistan (1999-2001)
Number of active Uzbek SMEs by Sector* (1999-2001)
Th. Units
80.0
70.0
1999
2000
2001
60.0
50.0
40.0
30.0
20.0
10.0
0.0
Industry
Agriculture
Construction
Whole sale
Retail sale
and catering
Other
*Not including Individual Enterpreneurs
Source: Business Environment in Uzbekistan as Seen by Small and Medium Enterprises. IFC 2002;
Figure___ Shares of the Uzbek Economy by SME and Individual Enterprise (IEs)
Shares of the Uzbek Economy by SMEs and IEs (1999-2001)
60%
53%
50%
47%
50%
40%
29%
31%
34%
Nominal GDP
Labor Force
30%
20%
10%
0%
1999
2000
2001
Source: Business Environment in Uzbekistan as Seen by Small and Medium Enterprises. IFC 2002;
17
F.
Informal sector. What we do know, however, is that the SME sector is probably
under-represented in official statistics due to the large-scale informal sector that exists in
each of these countries, again as compared to the accession countries.25
Size of the Informal Economy in CIS-7
(As a Share of GDP (in 2001) and Employment (in 1999))
Country
Share of GDP Share of
Employment1
CIS-7
Armenia
45.3
40.3
Azerbaijan
60.1
50.7
Georgia
66.1
53.2
Moldova
44.1
35.1
Kyrgyzstan
39.4
29.4
Uzbekistan
33.4
33.2
Memo item
Poland
Czech Republic
Hungary
Estonia
Latvia
Lithuania
1.
2.
27.4
18.4
24.4
39.1
39.6
29.4
20.9
12.6
20.9
33.4
29.6
20.3
Working age population between the ages of 16 and 65.
Source: Report on Hidden Economy by Ekonomski Institut, 1997
Schneider (2002)
Typology of informal enterprises. Firms operating in the informal sector usually fall into
thee broad categories: underground enterprises, dealing in illegal activities such as drugs,
subsistence level firms coping to support a family or self-employment and unofficial
enterprises seeking to escape or avoid administrative and financial burdens of taxation
and excessive regulation (permits, licenses, labor laws, etc.) Subsistence level enterprises
are invariably micro and small firms, but unofficial enterprises in CIS-7 countries can be
medium to large, with some of their activities in the formal sector and others in the
informal sector. See Table __ for a typology of informal sector enterprises.26
25
26
From Djankov, et. al., Opus Cited, p. 3
Ibid, p.4
18
Table _. Typology of informal sector enterprises
INFORMAL SECTOR
Subsistence
Enterprises
of 100%
FORMAL
Unofficial
enterprises
High. Proportion of
sales undeclared and
workers not registered
Unofficial
Official
Enterprises
enterprises
Some
proportion
of
sales
undeclared and
Degree
workers unregistered. May use outside the
Informality
official purview (eg internet to deliver
software)
Type
of single street traders, small manufacturers, small and medium manufacturers, service
cottage/micro
service
providers, providers, software firms
activity
enterprises,
distributors,
subsistence farmers contractors
Technology
labor intensive
Owner
profile
Poor, low education, Poor and non-poor,
low level of skills
well educated, high
level of skills
Low barriers to Low barriers to entry,
entry,
highly highly
competitive,
competitive,
high some
product
product homogeneity differentiation
Markets
mostly labor intensive Knowledge and capital intensive
Non-poor, highly educated, sophisticated
level of skills
Significant barriers to entry, established
market/product niche
Finance
needs
Working capital
Other needs
Personal insurance, Personal and perhaps Personal and business insurance, business
social protection
business insurance
development services
II.
Working capital, some Investment capital and working capital,
investment
capital, letters of credit, supplier credit
supplier credit
Least dynamic
Completely informal
Highly dynamic
Partially formal
Benefits and costs of informality for entrepreneurs. The primary benefit to staying
informal is the avoidance of taxes and regulations. These regulation such as licensing
and registration processes, can substantially raise the cost of doing business in CIS-7
countries. Licensing and registration costs in terms of time, their opportunity costs, and
out-of-pocket costs vary substantially across the CIS-7 countries as demonstrated by
Table ___. But this is far from the entire story. Harassment and corruption by various
official tax inspectors and various licensing authorities, may multiply these costs of
19
doing business, as demonstrated by various business environment surveys of countries in
the CIS-7 as noted below in the discussion on the Business Environment.
Table___ Number of Procedures, Time and Cost for Registering a New Business
(Time is presented in business days; cost as a share of GNP per person)
Country
Procedures
Time
Cost
CIS-7
Armenia
11
55
12
Azerbaijan
15
79
19
Georgia
12
48
39
Kyrgyz Republic
9
22
14
Moldova
11
31
32
Uzbekistan
7
29
34
Memo item
Poland
Czech Republic
Hungary
Latvia
Lithuania
11
10
7
7
11
58
62
65
23
47
23
5
64
34
5
Source: Djankov, Lieberman, Mukherjee, and Nenova, p.8
One of the major costs of staying informal, as demonstrated by various World Bank
surveys, is that firms in the informal sector pay about 20 percent of their revenues in the
form of bribes to government officials, i.e. there is an implicit tax of 20 percent for
staying informal.27 Another cost of staying informal is the absence of benefits for
employees. Employees working in informal enterprises are not covered by the insurance
and pension systems available to workers in the formal sector.
Most relevant for this paper, is the inability of informal firms to tap into formal credit
sources. Informal enterprises are forced to rely on informal sources of credit—personal
savings, family or friends, and money lenders. Money lenders rates in transition countries
will range from 5-10 percent a month and finance from friends and family may prove
unreliable with respect to timing and the amount required to sustain or expand a business.
A major exception is micro-finance. Micro-finance institutions will often finance micro-
27
Ibid, p. 8
20
entrepreneurs operating in the informal
sector. However, to the extent access to
financing can be made available to SMEs at affordable interest rates, tenor and in
amounts required, a major incentive is created for firms to go formal.
Governments often note the costs of the informal sector in terms of taxes
foregone, but the real cost may be the limits to firms’ growth that implicitly exist from
their decision to remain in the informal sector. Getting firms to leave the informal sector
is largely about incentives--- costs and benefits. A major benefit would be the reduction
of regulatory costs discussed below and another would be access to finance, as discussed
in Section II. of this paper.
G.
Business environment. The performance of all firms is affected by the business
environment in which they operate. In addition, a favorable environment is an important
inducement to FDI. But in this paper we go beyond the common need for a generically
good environment -- stable macro economic environment, liberalized trade, an adequate
legal framework—respect for property and contractual rights and the ability to enforce
those rights through a reliable judiciary system, and a competitive financial sector.28
There are certain aspects of the business environment that are of specific relevance to
entry of new businesses and to the competitiveness of SMEs: those that affect market
access, the cost of acquiring information, transactional efficiency, and the fixed cost of
doing business.29 The costs of doing business are of particular importance to SMEs
because of the asymmetric impact that these costs have on smaller firms. We measure the
cost of doing business by the costs of regulation--- taxation, licensing and registration
requirements, frequency of changes in laws and regulations governing these areas,
frequency of inspections by tax inspectors and other officials, coerced payments in the
form of bribery to inspectors in order to remain in business and the opportunity costs to
businessmen in terms of days spent occupied with these matters. Costs of doing business
See Thorsten Beck, Asli Demirguc-Kunt and Vojislav Maksimovic, “Financial and Legal Constraints to
Growth:Does Size Matter,” World Bank, January, 2002 (mimeo). Based on data from firm-level survey of
54 countries, the author’s note that their results indicate that financial, legal and corruption constraints do
affect firm growth rates adversely. That the smallest firms are most adversely affected. And that marginal
development of the financial or legal system or reduction in the level of corruption level, helps relax these
constraints most for small and medium firms.
29
Hallberg, Opus Cited, P. 9
28
21
have been measured by surveys in a number of the CIS-7 countries and the invariable
conclusion is that these costs are very high, again compared to the accession countries or
those costs in advanced industrial countries. For example, a recent survey in Georgia of
the cost of doing business30 rated regulatory issues from 1 (least) to 10 (most
problematic)
Figure___ Cost of doing business in Georgia
(Scale: 1 = no problems, 10 = severe problems)
Neces s ity to pay informally
Unpredictable requirements
Selective law enforcing for econ. reas ons
Us e of s tate power for unfair competition
Overlapping and contradictory rules
Complicated rules
Rules change too quickly
High regulatory cos ts
Time s pent with officials
Courts can not protect from s tate
Selective law enforcing for polit. reas ons
0
2
4
6
8
10
1 - 10 sca le
Figure__: Focus group ranking of the types of regulations
(Scale: 1 = no problems, 10 = severe problems)
Non-tax fis cal ins pections
Cons truction permits
A ccountancy rules for taxes
Certification
Cus toms for imports
Non-licens ing permits
Environment regulations
Licens ing
Cus toms for exports
Municipal regulations
Planned tax audits
Unplanned tax ins pections
Getting land for cons truction
Statis tical reporting
Labor regulations
0
2
4
6
8
10
1 - 10 sca le
30
Trends in the Business Environment in Georgia, World Bank, 2003 (draft)
22
Figure___ Share of working time that company management spends on interaction
with state officials, in % (CODB Surveys) on a comparative basis
Georgia, 00
12.40%
Georgia, 02
15.20%
Ukraine, 02
15.30%
Albania, 02
16.10%
Belarus, 01
18.30%
Moldova, 02
18.50%
Bulgaria, 02
22.60%
Armenia, 01
23.20%
Romania, 02
24.00%
The cost of registration, securing approval of premises and obtaining licenses
were likewise compared in tables ___, __ and __.
Table __ Comparison of registration procedures (CODB Surveys)
Georgia, 2002
Georgia, 2000
Armenia, 2000
Armenia, 2001
Belarus, 2001
Moldova, 2002
Ukraine, 1999
Registration time
Registration costs
9.7 days
15.2 days
27.3 days
21.0 days
57.1 days
22.3 days
26.4 days
$150.2
$114.0
$109.7
$92.3
$223.0
$132.0
$67.0
%
Unofficially
paid
28.7%
46.4%
20.3%
14.8%
12.0%
26.4%
12.0%
$ Unofficially paid
$147.7
$126.0
$58.7
$58.3
$107.0
$119.0
$76.0
Table __ Comparison of regulations of premises (CODB Surveys)
Georgia, 2002
Georgia, 2000
Armenia, 2001
Belarus, 2001
Moldova, 2002
Ukraine, 2002
Time, preconstructio
n permits
Cost of preconstruction
permits
% informal
payments
$ informal
payments
Time
exploitation
permits
Cost
of
exploitation
permits
28.9 days
20.0 days
35.6 days
93.8 days
88.8 days
14.3 days
$275.0
$1,000
$472.5
$583.0
$563.0
$437.1
17.8%
20.0%
11.4%
10.0%
50.4%
22.8%
$168.0
$155.0
$79.0
$1,083.0
$178.4
$248.8
22.4 days
5 days
26.9 days
48.3 days
57.9 days
6.8 days
$71.1
$285.0
$229.3
$265.0
$220.8
$360.5
23
Table __: Comparison of licensing regime (CODB Surveys)
Georgia, 2002
Georgia, 2000
Armenia, 2001
Belarus, 2001
Moldova, 2002
Ukraine, 2002
Companies
that have
licenses
Number of
licenses per
business
Time to get
one license
Official
fees
%
Unofficially
paid
$
Unofficially
paid
59.7%
65.6%
58.3%
91.3%
82.0%
62.1%
1.1
0.9
0.8
5.5
3.0
1.7
23.0 days
12.0 days
18.5 days
30.0 days
28.6 days
69.3 days
$147.7
$167.0
$287.5
$135.0
$389.2
$295.4
32.1%
19.0%
13.0%
18.9%
37.6%
18.6%
$168.0
$157.0
$447.9
$67.0
$157.9
$264.7
Moreover the costs of inspections following registration, licensing and occupation
of premises—that is on-going payments to remain in business are as follows per Table__:
Table __: Comparison of inspection data (CODB Surveys)
Country
Georgia, 02
Georgia, 00
Belarus, 01
Moldova, 02
Times
2.6
3.7
2.2
3.5
Fines, %
48.2%
45.4%
44.0%
63.6%
Fines, $
$224.4
$1,017
$1,050
$1,027
Informal, %
36.8%
43.9%
8.6%
45.4%
Informal, $
$285.6
$468.2
$123.0
$217.6
Fire inspection
Georgia, 02
Georgia, 00
Belarus, 01
Moldova, 02
3.5
2.5
2.2
2.2
5.5%
8.0%
16.0%
15.3%
$17.6
$47.0
$60.0
$26.0
21.9%
24.3%
6.0%
23.0%
$30.0
$39.9
$78.0
$32.9
Sanitary
inspection
Georgia, 02
Georgia, 00
Belarus, 01
Moldova, 02
5.8
3.9
4.0
3.8
6.5%
9.0%
14.0%
12.0%
$25.6
$40.0
$115.0
$63.5
22.9%
29.4%
5.2%
21.6%
$27.5
$19.0
$47.0
$50.8
Tax Inspection
There is a pervasive tendency in the CIS-7 to over-regulate and to intervene in the
operations of SMEs as a legacy of socialism. It will be very difficult for SMEs to grow
and develop unless this “culture” of excessive government intervention can be overcome.
H.
Infrastructure. The absence or the malfunctioning of infrastructure essential to
the daily operations of SMEs are affecting profoundly businesses in the CIS-7 countries.
Basic services as electricity, telecommunications and transportation have an impact on
the performance of SMEs since, among other things, they cause delays in the timely
delivery of requested goods and services. This problem in the CIS-7 countries can be
clearly observed from the results of a survey conducted by the World Bank and the
24
EBRD, the Business Environment and Enterprise Performance Survey (BEEPS).31 The
survey identifys the perception of small businesses32 in the CIS-7 with respect to their
evaluation of the general constraint represented by certain types of infrastructures. If we
focus on the CIS-7 countries, it is possible to notice the common perception is that they
lack adequate infrastructure and is an obstacle to their operations . In particular,
telecommunications appear to be afflicting small businesses in Armenia while
transportation represent in percentage a minor but still relevant issue across the CIS-7
countries. Electricity remains the biggest concern in the region, with a peak in Georgia,
where 50% of small businesses sees it as obstacle to their activity.
Figure___ Small businesses perception of three types of basic infrastructures
(Telecommunications, Electricity and Transportation) as a constraint for
operations.33
Basic Infrastructures as a constraint for operations in CIS-7
50
40
30
%
20
10
0
Armenia
Azerbaijan
Georgia
Telecommunications
Kyrgyzstan
Electricity
Moldova
Tajikistan
Uzbekistan
Transportation
Source: Business Environment and Enterprise Performance Survey (BEEPS), World Bank and the
European Bank for Reconstruction and Development, 2002; 34
31
The Business Environment and Enterprise Performance Survey (BEEPS), developed jointly by the World
Bank and the European Bank for Reconstruction and Development, is a survey of managers and owners of
firms across the countries of Eastern Europe, the former Soviet Union, and Turkey designed to generate
comparative measurements of the quality of governance, the investment climate and the competitive
environment, which can then be related to different characteristics of the firm and to firm performance. The
first round of the BEEPS was conducted in 1999 and the data is accesible on
http://info.worldbank.org/governance/beeps/.
The second round of the survey (BEEPS II) was conducted in 2002 and the results are available on an
interactive dataset. For more information on the survey, the BEEPS research project and related papers,
click on http://www.worldbank.org/wbi/governance/wp-statecapture.htm.
32
In BEEPS, the category Small businesses, is identified as having less than 100 employees.
33
To these three questions there were five possible answers (No obstacle, Minor obstacle, Moderate
obstacle, Major obstacle, Don't know). The figures refers to the percentage of businesses that have
answered that the type of infrastructure represents a major or moderate obstacle.
34
The BEEPS instrument needs to be employed carefully since the answers given by the firms interviewed
reflect their perception of certain business environment elements as obstacles to operations. The samples of
25
I.
Regional economic integration. One of the driving motivations for reform in the
CEE and the Baltics has been accession to the EU and from a trade and business
perspective the market opportunities this presents.. There are a couple of trade pacts
between the Central Asian countries and their neighbors,35 but little or no real momentum
for regional economic integration. Given the small size of most of the CIS-7 countries
and
their remoteness from major markets, there is a need to think about regional
economic integration, starting at a minimum with a customs union and progressing to
agreements on common infrastructure to promote trade such as in transport
infrastructure—railways, trucking and roads, telecom, electricity and water reforms 36. A
customs union would enlarge the market for SMEs and would eliminate the present
difficulties most of these firms now encounter as they try to move good across borders in
the region. While customs reforms may be a necessary condition to expand trade outside
the region, at a minimum every effort should be made to lower transaction costs within
the region.
V.
Conclusions Section I.
The CIS-7 countries began transition in a highly unfavorable initial position
relative to the accession countries. Also, these countries were adversely affected by
conflict which prevailed throughout the region, setting them further back. The Russian
economic crisis slowed growth in 1998-1999, with a strong adverse impact in both the
real and the financial sector. While regional tensions still remain, for example, the spill
these firms varies from country to country and sometimes the results might not reflect different national
approaches to answer certain questions.
35
The states in the region have created various regional groupings for trade and/ or security purposes with
and without Russia, including or not including China and Iran. For example, GUUAM the political,
security and economic alliance of Georgia, Azerbaijan, Moldova Ukraine and Uzbekistan excludes
Russia. While, the Kyrgyz Republic, Tajikistan, Belarus, and Kazakhstan have formed a customs union
with Russia. Turkey initially viewed Central Asia as the Turkic speaking republics, but it initiatives have
not gone far to-date. Integration with the Caucuses would create a market of 11million people, while the
CIS-7 market on its own consists of 57.4 million inhabitants. See Vandycke, Opus Cited, p.29 for a
discussion of this issue,
36 TRACECA (Transport Corridor Europe, Caucasus and Asia) a project funded by EU has been making
effort to develop alternative routes for access to European and World markets. The project is promoting
closer co-operation among the local governments to keep transit fees at competitive levels as well as
simplify border crossing formalities (see www. traceca.org for more information)
26
over from the war in Afghanistan and
political instability in the Ferghana Valley,
stability in the region, the absence of strife, strong economic growth in Russia and other
CIS energy (oil and gas exporters) Kazakhstan, Turkmenistan and Azerbaijan, with real
appreciation of the ruble vis-à-vis other regional currencies, has provided the CIS-7 the
opportunity to improve its economic performance and grow again 2001-2002. The
average aggregate increase in GDP of the CIS-7 was 8.1 percent in 2001. Growth varied
by country. But in all of them there was a recovery in agricultural output following the
drought in 2000.37 In order to sustain growth, the CIS-7 countries need to support new
entry and to facilitate the development of existing SMES. In addition, to improved
access to financial services, discussed in the next section of this report, there is a need
above all to substantially improve the business environment, improve the quality of
infrastructure in the region and to take serious steps towards regional integration. These
three measures would substantially lower transaction costs for SMEs and serve as
powerful incentives to move firms out of the informal sector.
Section II. Access to Financial Services
VI.
Introduction
This section of the paper will discuss the issue of access to finance for MSMEs in
the CIS-7 countries.. As such it will not deal with necessary reforms of the financial
system, rather its perspective will be the needs of firms and specifically MSMEs. The
section will begin with micro-finance-- both savings and credit, as an important tool for
financing micro-entrepreneurs, defined in this paper as businesses with ten or fewer
workers. Under micro-finance we include the role of credit unions, village banks, and
cooperative banks. In fact, we will also discuss the role of more conventional commercial
banks in down-scaling to micro-finance and increasing access financial services for
micro-entrepreneurs. The paper will then discuss access of SMEs to finance and the role
of commercial banks and specialized financial institutions such as rural banks and postal
banks. We will also discuss the importance of non-bank financial institutions such as
leasing and factoring companies. Finally, we will discuss removing constraints to
financial intermediation within the CIS-7 countries.
37
Ibid, p. 12
27
SMEs, as other enterprises, need a heterogeneous mix of financing in order to
grow and develop. This mix includes working capital finance, term finance primarily to
purchase equipment and machinery, export finance for those SMEs that export and, for
the more dynamic firms that are growing strongly sources of equity through, for example,
venture capital firms. Capital markets are too thin and illiquid to expect that firms will be
able to raise equity or long-term debt financing through capital markets in the foreseeable
future. It is also clear that the financial sector is too weak in all of the CIS-7 countries to
offer such a mix of financing. A good start, therefore, would be to focus on short-term
working capital finance through MFIs and commercial banks, a necessity for all firms,
leasing and factoring as particularly important to SMEs, and in time postal banks with
their ability to extend outreach to rural areas and more remote towns and villages in these
countries.
Presently most MSMEs in the CIS-7 lack access to finance. They are largely
reliant on internally generated resources, family and friends for capital. The problem is
particularly acute in rural areas.
The BEEPS survey Figure __ below demonstrates that majority of SMEs in the
CIS-7 consider access to finance and the cost of finance as a constraint to doing business.
Fig. - Small businesses perception of the access to and the cost of financing as a
constraint for operations
Access to and cost of financing as a constraint for operations in CIS-7
80
70
60
50
% 40
30
20
10
0
Armenia
Azerbaijan
Georgia
Kyrgyzstan
Access to Financing (e.g. collateral)
Moldova
Tajikistan
Uzbekistan
Cost of Financing (e.g. interest rates)
Source: Business Environment and Enterprise Performance Survey (BEEPS), World Bank and the
European Bank for Reconstruction and Development, 2002;
28
VII.
Microfinance
A.
Why micro-finance?
Microfinance and other related financial services are
increasingly viewed throughout the developing world, but more specifically within the
CIS-7 countries, as effective ways to intermediate financial services to the underserved,
that is to the working poor in developing and transition countries who have little or no
access to formal financial services. “About 90 percent of households in developing
countries lack access to financial services, either credit or savings, among them are nearly
all the poor of the developing world…”38 Microfinace and related services should include
short term working capital loans, and savings products. But increasingly mature microfinance institutions (MFIs) are providing diverse products-- housing loans (primarily
improvements, repair and maintenance), insurance both health and life insurance and
private pensions. Once an MFI reaches scale and financial sustainability, 39 there is no
reason why the MFI cannot go beyond basic lending and savings product to offer a
diverse set of financial services to its client, just as more traditional formal financial
institutions increasingly are doing. In fact, MFIs are also diversifying their product
offerings, because their poor clients demand and need such services.
MFIs come in many shapes and sizes—non-governmental-organizations (NGOs)
(also termed not-for-profit organizations), the vast majority of MFIs; specially licensed
financial institutions that cannot legally mobilize savings; NGOs transformed into
commercial banks a process known as scaling-up; commercial banks downscaling into
microfinance, postal banks, credit unions increasingly serving the poor ; and consumer
finance houses crossing over to serve micro-enterprises through credit cards, installment
loans and other consumer type credit, agricultural cooperatives, etc. In the CIS-7
countries at present most MFIs are NGOs, largely supported by donor funding.
Marguerite Robinson, “Microfinance as a Sustainable Development Tool,” p.3, APEC, 9 th meeting of
Ministers Responsible for Small and Medium Enterprises, 24-25 August, 2002 (mimeo), adapted from the
Microfinance Revolution, Volume I, Sustainable Finance for the Poor, World Bank and OSI, 2001
38
39
Financial sustainability means that the MFI cover all operating costs and generates a profits after
financial adjustments which should include adequate loan loss provisions, inflation adjusted accounting,
and the pricing of donor or other subsidies at market
29
B.
The need for sustainable micro-finance. As the microfinance industry continues
to develop and take shape in the CIS-7, it is becoming increasingly clear that
microfinance will only fulfill its potential if both donors and private sector investors
focus on commercially viable MFIs—that is financially sustainable institutions that are
able to scale-up.40 NGOs have played an important role in breaking into poor and
difficult markets such as Tajikistan,
as an example, and will continue to play an
important role in the immediate future, but they are not the answer to scaling-up and
meeting the millennium goals.
As Robinson notes, “ Unmet demand for microcredit worldwide is estimated in
the hundreds of millions of households…Demand on this scale cannot be met by
government and donor funds. Microfinance demand can only be met by financially selfsufficient institutions…The microfinance revolution is currently emerging in many
countries around the world. This term refers to the large-scale, profitable provision of
microfinance services—small savings and loans--to economically active poor people by
sustainable financial institutions.”41
C.
Why should we scale-up microfinance? There are many reasons for scaling-up
microfinance, but the following are the overarching reasons:

Many of the CIS-7 countries will need to consolidate their fragmented banking
sectors. Without intervention, this threatens to reduce the already limited access
that the micro-entrepreneurs, who are primarily the working poor in the CIS-7
countries, have, at present, to formal financial intermediation;

Without functioning and integrated financial markets that service the poor, other
interventions to alleviate poverty may be less effective;
40
A number of recent publications have focused on the issue of commercialization of MF. See Marguerite
Robinson, The Microfinance Revolution, Volumes I and II, World Bank and OSI, 2001-2002; Robert Peck
Christen, “Commercialization and Mission Drift, The Transformation of Microfinance in Latin America”
CGAP, December 22, 2000; Editors: Deborah Drake and Elizabeth Rhyne, The Commercialization of
Microfinance, Balancing Business and Development, Kumarian Press, 2002
41
Ibid
30

Despite the initial successes of microfinance outreach to the poor is still very
limited in these countries;

MFIs serve micro-enterprises which are often indistinguishable from the family
units that operate these businesses. As the business generates surplus cash, this
cash goes into the home to provide food, education and for savings to shelter the
family against a rainy day;

Commercialized MFIs generally mobilize savings. It is clear that the poor not
only need loans, but in fact may even need a safe and convenient place to serve
more than loans;42

By providing financial services to the working poor, MFIs plant the seeds for
potential growth in low income countries, in this case the CIS-7 countries. For the
foreseeable future many CIS-7 countries can only grow, if the vast majority of
their firms which are micro and small enterprises, most often working in the
informal sector, have access to finance. This will allow some of these firms to
grow and increase trade, production, employment and investment;

Finally, from observation we know that microfinance works. As a vehicle for
economic development. MF is unique in that it started in the developing countries,
and has spread as a grass roots movement around the world and in recent years to
the transition countries with donor, but very little government, support and
intervention.
D.
The Existing Microfinance Industry in CIS-7 Countries. The microfinance
industry is at an early stage of development in the CIS-7 countries, for example, the
42
See Marguerite Robinson, opus cited, on savings and Stuart Rutherford, The Poor and Their Money,
DFID and Oxford University Press, 2000—both authors make a convincing case as to why safe savings and
savings products geared to the poor are so necessary
31
average age of MFIs is approximately 4.5 years in Central Asia. Most donor supported
MFIs are NGOs. USAID and other bilaterals have provided most of the funding for these
NGOs, with international NGOs such as the Aga Khan Foundation (largely funds its own
program), Mercy Corps, Finca International and IPC, as examples,
providing the
institutional capacity building and technical expertise. The Asian Development Bank
(ADB) has supported the formation of credit unions in Central Asia, EBRD has supported
MSME lending through “down-scaling” by commercial banks, and various IFIs, such as
the IFC, have supported stand alone micro-finance banks.. Therefore, there is a
reasonable institutional mix or diversity, but virtually all MFIs in the region are donor
dependent for funding at present and also unsustainable.
A recent report on microfinance in Central and Eastern Europe (CEE) and the
New Independent States (NIS) indicates that microfinance is dominated by NGO in the
Caucusus and that approximately 50 percent of their clients have been affected by
conflict that dominated this region in the early transition years.43 The sub-region has four
commercial banks, all in Armenia,
that have downscaled and
one dedicated
microfinance bank. There are also many small credit unions in the region, but statistics
are weak on their performance and outreach. Overall, MFIs in the Caucasus, as of
September 2001, reached 66,000 borrowers and 33,000 depositors, or some US$38.7
million in loans and US$5.7 million in savings.44
The figure below represents a snapshot of Microfinance Institutions in the
Balkans, Central Eastern Europe, Caucasus, Central Asia and other CIS, as of September
2001.
Sarah Forster, Seth Greene, Justyna Pytkowska, “Microfinance in Central and Eastern Europe and the
New Independent States,” CGAP, OSI and USAID, 2002 (mimeo)
44
Ibid
43
32
Figure___
Number of MFIs
121
5,216
1
79
9
7
5
3
292
6
1
184
12
1
41
31
10
30
2
21
13
Balkans
NGOs
CEE
Caucasus
m icrofinance banks
Central Asia
com m ercial banks
Russia/Ukr/Belarus
credit unions
Source: Sarah Forster, Seth Greene, Justyna Pytkowska, Microfinance in Central and Eastern Europe and
the New Independent States, 2002
Microfinance is growing rapidly in Central Asia, albeit from a small base. Institutions
providing microfinance services are less than 10 years old, with a number of specialized
institutions operating for only 3-5 years. With MF clients growing by about 30 percent a
year, it is s evident that there is strong demand for microfinance services in the region.
Figure____
Central Asia: Population, Poverty and
Microfinance
30
25
25
20
15
10
5
0
3
5
0.10
KG
Total poor
6
5
7
0.04
TJ
Total population
0.02
UZ
Total MF clients
Source: Hoonae Kim, Presentation for “Expanding Microfinance in Central Asia” conference, April 2003
33
When you look at the Central Asian countries in the CIS-7 group, Central Asia has over
22 million people (or 38% of population) living below the poverty line, of which 15
million are in the rural areas, virtually excluded from formal credit markets, with less
than 2% of them having access to credit through existing MFIs. According to the
preliminary findings from the World Bank MF Study team, outreach is 2% of the total
poor in Uzbekistan, 10 % in Kyrgyz Republic, and 4 % in Tajikistan. (The poorest subregion with average incomes of US$180 in Tajikistan, US$280 in Kyrgyz Republic and
US$550 in Uzbekistan.) Tremendous gaps exist as well as a significant un-served or
under-served segments of the economies. 45
In Central Asia, again the microfinance sector is dominated by NGOs and
commercial bank downscaling programs. The ADB has also supported the development
of credit unions in the Kyrgyz Republic. As of September 31, 2001 MFIs in the region
reached 80,000 borrowers and 17,000 depositors, accounting for US$76.5 million in
loans outstanding and US$2.8 million in deposits.46 Together, the Caucasus and Central
Asia represent 15 percent of the total MFI loan portfolio in the CEE and NIS, 9 percent
of the active borrowers, 1 percent of deposit amounts and 2 percent of the active
depositors.47
Some of the critical gaps are: (i) fragmentation of NGOs involved in MF activities,
(ii) MFIs mostly provide short-term credit only (over 90% of total credit) and investment
credit for fixed asset is still lacking, (iii) Clients are mostly urban poor, while rural poor
also need financial services, (iv) Savings mobilization in MFIs is limited due to both
limited surplus of income and limited capacity of MFIs, (v) The poor in general do not
have collateral. The poor in general do not have valuable real-estate based collateral and
even if a loan is secured with collateral, seizing and liquidating collateral is extremely
difficult. Problems become worse for agricultural or rural borrowers who need longer term
production credits (not generally considered the domain of micro-finance), since their
activities do not generate interim cash flows. The lack of financial services makes it
Hoonae Kim, Presentation for “Expanding Microfinance in Central Asia” conference, April 2003
Ibid
Sarah Forster , et. al., “Microfinance in Central and Eastern Europe and the New Independent States”,
Microfinance Center, 2002 (mimeo)
45
46
34
virtually impossible for the rural populations to develop small-scale economic activities
for increased incomes, and improved living standards and quality of life.
MFIs have: (a) limited source of funds and high dependence on a single source
(mostly donor grants); (b) uncertainty about legal status and tax and other regulations;
(c) low sustainability due to high costs, high risks, limited risk mitigating ability; (d)
there is little product diversification; and (e) interest rates are quite high to reflect high
administrative cost burdens.
There is also the need to strengthen weak licensing, regulatory and supervisory
capacity with respect to MFIs.48 In order to meet the needs of microenterprises in the
region, there will have to be a parallel effort to consolidate the sector and also scale-up.
On April 2-4, 2003 in Almaty, a regional Microfinance conference “ Expanding
Access to Microfinance in Central Asia”, was attended by representatives of MFIs,
government officials, donors and outside experts. . The near term priorities, key results
and recommendations for different actors (ie. Donors, governments and MFIs) came out
from the reports of national focus group presentations and at the plenary session. These
presentations identified priorities, major barriers and recommendations for future
development of microfinance sector. These are presented in Table__ below:
48
World Bank MF Study Group, Presentation, April 2, 2003.
35
Summary of Key Recommendations
Priorities to Scale Up Microfinance









Establish a crisis management team with the necessary organizational
capabilities
Develop a strategy and vision with clear roles for governments and
private sector
Focus on rural microfinance
Create a supportive, flexible, policy environment and eliminate interest
rate ceilings!
Establish an enabling legal environment for business
Improve institutional and management capacity (MFI, Government)
Strive for better donor communication and coordination
Provide more grant funds ( esp TA); private investors and new funding
mechanisms
Create more trust and open communication channels - donors,
government, population.
Recommendations for Donors









coordinate better understand each others’ priorities
Provide more $$! needs-driven support, with appropriate instruments,
not politically driven
Influence creation of enabling policy framework
Insist on MFIs adopting reporting standards, ratings, audit
Allow MFIs to use unified standard reporting
Provide training exposure for government officials about MF
Encourage competition and links to commercial sources
Don’t undermine each other, create unfair competition for MFIs
Use EBRD conference to highlight importance of MF
Recommendation for MFIs





Develop different mechanisms for providing financial services
Develop more diverse products
Prepare transparent, standard high quality reporting
Focus on rural populations
Create MFI Association/Working Group
RECOMMENDATION FOR GOVERNMENTS








Develop coherent strategy for MF with input from private sector, govt
and NGOs
Develop MF law , regulatory framework Remove interest rate ceilings
Simplify supervision requirements, tax and regulatory framework for
MFIs
Simplify tax and regulatory framework for small business
Encourage training of government officials ( eg Central Bank, tax
officials)
Eliminate contradictions in laws and regulations
Eliminate corruption
Governments should introduce action plans at EBRD conference
36
Table____ below includes data on Central Asia’s Microcredit/Microfinance
Portfolio (Kazakhstan, Kyrgyz Republic, Tajikistan and Uzbekistan).
Table___
illustrates the Microcredit portfolio of a number of commercial banks surveyed in Kyrgyz
Republic, Tajikistan and Uzbekistan.
Table ___ Central Asia Microcredit/Microfinance Portfolio
Type of
Institution
Outstanding
Loan
Portfolio
(million
38 USD)
Active
Borrowers
(,000)
Average
Loan Size
(USD)
Depth of
Outreach
(%)
137
278
39
Commercial
Banks
143
24
5,912
832
Credit Unions
11
30
369
52
TOTAL
192
191
1,005
141
NGO MFIs
Source: Hoonae Kim, Presentation for “Expanding Microfinance in Central Asia” Conference
Table ___ Commercial Banks in Kyrgystan, Tajikistan and Uzbekistan
Country
(# of banks
surveyed)
Total Loan
Portfolio
(million USD)
Outstanding
Microcredit
Portfolio
(million USD)
MC % of
Total
Portfolio
# of MC
Borrowers
Average
MC loan
(USD)
KG (4)
16
2
10
715
2,338
TJ (5)
142
0.3
0.2
271
1,050
UZ (7)
2,864
38.4
1
15,430
2,493
Total (16)
3,022
40.7
2
16, 416
5,912
Source: Hoonae Kim, Presentation for “Expanding Microfinance in Central Asia” Conference
E.
Vision of a Scaled-up Industry.49 In order to become more commercialized and
scale-up MF a new vision for the industry will be needed within the CIS-7 countries:
49
These principles have been adapted and expanded from Editors: Maria Otero and Elizabeth Rhyne, The
New World of Microfinance, Kumarian Press, 1994, pp. 11-26; also see Robert Peck Christen,
Commercialization and Mission Drift, opus cited, pp. 6-7
37

A Pluralistic Approach to Microfinance. MFIs will need to offer products and
services that their clients need and demand. They will also need to change and
adapt as their client needs change. That requires moving beyond financial NGOs
to institutions with the infrastructure to reach millions of people—savings banks,
postal banks, commercial banks, small business banks, agricultural banks and
agricultural cooperatives, housing cooperatives, etc.50;

Financially Sound MFIs. MFIs will need to become financially sound in order to
scale-up. That is MFIs that want to become financially sustainable will need to
have the characteristics of other successful financial institutions. They will need
to improve the quality of their governance as they grow and evolve, adopt good
MIS and accounting systems, focus on the quality of their portfolio, improve
their productivity and operating efficiency through the adoption of new
technologies and adapt and change their strategies as the industry changes. Above
all MFIs will need to charge high real rates of interest to cover the high costs that
offering small loans and absorbing small deposits entail.51

Provision of external support to the MF industry. To keep rates affordable to
its clients the MF industry will require external support/ resources following two
parallel tracks: (i) rapid growth of financially sound MFIs supported by equity
investors serving as “incubators’ who will assist in all aspects of MFI
development; and simultaneously (ii) improvements in the institutional structure
of the industry, which will need to come form of resources provided by donors.
See Robert Peck Christen, “Microfinance Policy Issues,” CGAP, October 2002 (mimeo) for a more
complete discussion on the need to increase retail distribution capacity in MF
50
51
It is the most counterintuitive and politically charged issue surrounding MF, that MFIs need to charge
higher rates of interest to their generally poor micro clients than commercial banks charge, for example, to
prime customers or even medium size businesses. But a better way to view this issue is that micro clients
do not normally receive credit from commercial banks and often their only alternative is to receive credit
from money lenders or pawnbrokers at much higher rates of interest. For an interesting discussion on
money lenders and other financing alternatives for micro borrowers see Robinson, The Microfinance
Revolution.
38
The sector simply cannot scale-up fast enough without substantial external
resources.
The Microfinance Industry will have to support growth in existing MFIs in:
 Number of customers
 Size and types of loan and savings products available to their clients
 Types of services offered
 Number of branches/ units
All of which assumes a significant increase in institutional capacity

MFIs will need to attract financial resources including deposits, medium and
long-term debt and equity and increasingly from direct private investors and
capital markets.

MF will have to emphasize the importance of savings in addition to loans.
The industry developed initially through NGOs has a bias towards credit. But the
poor need institutions that offers them both a safe haven and convenience for their
savings. In addition, if they are also offered a return on their savings, it has been
proven that the working poor will flock to such institutions; and finally many
MFIs as they expand will need to attract savings to broaden and deepen their
capital base.

Create new MFIs. New commercially sustainable MFIS should be created
through commercial and other banks “scaling down” or through the establishment
of micro/SME banks.
39
E.
Institutional Obstacles to Growth. There are a number of institutional obstacles
to growth that will need to be overcome. Growing institutional capacity may take a
decade or more to overcome these obstacles which include, inter alia, the following:

MFIs will need to be licensed and regulated. A great deal has been written
recently about the regulation of MFIs, but the facts are implementation is difficult.
MF represents a challenge to existing regulations and often weak regulators in
developing and transition economies. Central Banks or independent regulatory
agencies are often reluctant to deal with MFIs as financial institutions that need
somewhat unique regulatory treatment. However, it is clear that institutional
capacity will need to be created within existing regulatory institutions to supervise
MFIs and that will take time and considerable effort;52

Credit guarantees. In order to attract private sources of medium to long-term
debt from the inter-bank or the capital market in the case of bonds, some form of
guarantee or partial guarantee facility will need to be established. This could be
created as an insurance product that covers its costs. There have been a number
of such schemes established in support of commercial bank loans to SMEs.

Financial discipline/ rating agencies. As private investors are drawn into the
sector, and many more MFIs become licensed financial institutions, financial
discipline will become essential. This discipline will potentially come from many
quarters--- commercial banks who lend to MFIs through the interbank markets or
directly, equity investors through direct investment ( mostly IFIs initially) or
through equity funds, a number of which are in the process of being established
modeled after PROFUND, a debt/equity fund focused on commercialized Latin
American MFIs. Governance will need to improve in most MFIs and independent
Boards of Directors will need to play a more important role as MFIs increasingly
formalize. Moreover, there is a need for independent assessments of the
See CGAP, “Microfinance Consensus Guidelines: Guiding Principles on Regulation and Supervision of
Microfinance,” September 2002;
52
40
performance of MFIs that seek to raise funds from the market through rating
agencies and independent auditors.53.

Currency and foreign exchange risks. MFIs operate in CIS-7 markets that have
inconvertible and/ or unstable exchange rate regimes. If external investors are to
be attracted to the industry, there will need to be some type of facility to address
the volatility and the foreign exchange risks.

High Transaction Costs. Micro-finance has to date implied high transaction
costs. Through improvements in technology, using branch facilities of existing
commercial or savings banks or infrastructure of other distribution networks will
need to increase operational efficiency to improve profitability and returns on
equity and assets employed.

Managerial training/capacity building. Perhaps the greatest constraint to
scaling-up is the need to develop future management for MFIs in a changing
environment that balances the social needs of reaching poor entrepreneurs with
the need to develop financially sustainable MFIs. Therefore, the MF industry in
the CIS-7 countries will need to expand available training and capacity building
efforts in the industry.
53
The MF industry has developed incipient financial infrastructure such as a rating agency, MicroRate, and
a service to evaluate MFIs versus their peer group, The MicroBanking Bulletin. There also exists wholesale
institutions, almost all NGOs, such as Accion, Women’s World banking, FINCA, Opportunities
International, Grameen Trust, CARE, VITA, etc. all of whom mobilize donor funds, charitable
contributions and other sources of funding for the MFIs they represent. There are a handful of investment
funds providing equity and/ or loans to MFIs, the most established of which is PROFUND, having invested
some $ 20 million in MFIs in Latin America. While these institutions have played a very important role
pioneered development of the industry, the problem is that there are relatively few such financial
infrastructure institutions at present, the wholesalers are very dependent on donor support and the
investment funds are relatively small and cover only a fraction of the industry’s need for real equity. Also,
none of these institutions are fully private, with a mix of institutional investors such as the IFC and other
IFIs as investors in partnership with small scale entrepreneurs.
41
VIII. Banking Credit to SMEs
A.
Availability of Credit to SMEs. Financial intermediation by banks in the CIS-7
countries has been weak by any standard. Financial markets and financial intermediaries
in the CIS-7 countries are substantially under-developed. The level of financial
intermediation in five of
these countries was just 10 percent of GDP in 2000,
approximately 25 percent of the level of other developing countries with similar GDP per
capita and less than 10 percent of the average of financial development in high income
countries.54 Interest rate spreads have remained very high largely to cover banking
inefficiencies, but also as a reflection of the risks or the quality of the potential
borrowers. In 2000, the average spread for high income countries was 4 percent, 15
percent for low income countries and 20 percent for the CIS-7 countries.55 Banks in
countries such as Armenia, Georgia and Moldova have shown great reluctance to lend to
the enterprise sector, given the perceived risks. Not only are interest spreads high, but
most loans are dollarised and collateral requirements are also high 56. When made, loans
are invariably short-term. The only term-lending available to SMEs appears to be based
on donor credit lines. All of these conditions—reluctance to lend, high interest rate
spreads, high collateral requirements, and dollarisation of loans, have an asymmetric and
adverse impact on potential borrowing by SMEs.
For example in Armenia although the banks are liquid, the largest bank in the
country lends less than 5 percent of its liabilities to the private sector. The primary
source of funds for the private sector are donor supported credit lines in a total amount of
US$80 million as of end 2001. The World Bank is the largest of these donors with three
separate credit programs that have allocated some US$21.5 million. To put these credit
lines in perspective, the largest bank in Armenia has total private sector lending of
US$6million, although it had the capacity to lend far greater amounts. The effect of these
credit lines appears to have segmented the credit market. Loans using donor funds require
The Enterprise Research Institute, “Private Sector Development in the CIS7 Countries,” Washington,
D.C., 2002, p. 48; see also Financial and private Sector Development Department, Europe and Central
Asia, “Financial Sector development Strategy,” 2003, p.18
55
The Enterprise Research Institute, Opus Cited, p.49
56
Ibid, p.50
54
42
weaker collateral, less well developed business plans and are made on more favorable
terms than local sources of funds. The excess supply of deposits has resulted in deposit
rates declining, while the spreads between borrowing and lending rates remains high. In
addition, collateral requirements are very demanding, with banks demanding gold as
collateral in many cases.57
Banks in Moldova require collateral amounting to three times the value of the loan. In
Georgia, loans are likewise restrained by very high collateral requirements, while in
Tajikistan a private bank ceased lending and used its resources to establish a trading
house to trade goods with Afghanistan58. In the Kyrgyz Republic, as yet another example,
both the World Bank and the EBRD were forced to convert credit lines for term lending
for SMEs to working capital lines focused on micro-enterprises because of the lack of
bankable projects submitted by the primary commercial banks to the project
implementation unit.59
In Uzbekistan, on the other hand, there has been a substantial effort by the
Government to have its state-owned banks lend to SMEs60. According to official data, the
2001 loan portfolio to SMEs totaled almost US$ 442 million. Of this amount commercial
banks provided US$ 341 million. Most of this was provided by the state-owned or
partially state-owned banks --69 percent.. Private banks captured just 8 percent of the
SME loan market. Credit lines of IFIs made up 18 percent of available credit. So called
non-budget funds make up 5 percent of lending on a highly concessional or subsidized
basis. In addition, the Government has made two other subsidized financing vehicles
available for SMEs. The first is known as the “fund for preferential credits”. To create it
the banks set aside 25 percent of their profits to be used for these purposes. In turn, the
banks receive tax breaks and other benefits from the Government. A second vehicle is for
micro credits. Despite efforts of the Government to direct credit to the SME sector, only
57
World Bank, Armenia Trade Study, Opus Cited, pp.94-95
The Enterprise Research Institute, Opus Cited, p. 50.
59
The author was the Sector Manager when this line was converted to a working capital line.
60
IFC and State Secretariat for Economic Affairs (SECO), “Business Environment in Uzbekistan as Seen
by Small and Medium Enterprises,” March 2002, This section of the paper is based on an IFC survey of
some 1500 MSMEs in Uzbekistan. pp. 35-39
58
43
14 percent of surveyed SME account holders have obtained bank loans. Some 22 percent
of firms surveyed indicated the need for external credit, but did not apply for bank credit.
Reasons for not applying included in priority order—high interest rates (91 %), collateral
requirements (48 %), bank bureaucracy (38 %), no long-term credit (30 %) and loan not
available in cash (22%). These reasons are in line with the problems SMEs face in
borrowing in other CIS-7 countries.
Table ___ Loan Statistics 2000-2001
Figure___ Money is Scarce in the Three of the Four Subject Countries
Source: Khaled Sherif, Michael Borish and George Carke, Edited by Paul J. Siegelbaum, Structural
Adjustmnet in the Transition: Case Studies from Albania,Azerbaijan, Kyrgyz Republic and Moldova
44
B.
The Banking Business in the CIS-7 Countries. 61 The business of banking in
the CIS-7 countries has been severely constrained by both external and internal,
institutional, factors. Factors over which banks have had little control include low levels
of monetization resulting in high levels of non-cash transaction in these countries, a large
informal economy in each of the countries, low lending demand resulting from wide
spread enterprise distress and lack of demand for fee generating corporate services.
Other constraining factors such as excessive fixed cost structures, the failure to resist
political pressures to make imprudent loans, and a reluctance to move more aggressively
to resolve and/ or adequately provision for non-performing loans (NPLs) are largely
internal issues that could be resolved by better banking management.
Non-performing loans. NPLs
have been a particularly acute problem. In
Azerbaijan at the end of 1999 they represented 67 percent of total loans and in the
Kyrgyz Republic, NPLs peaked in 1999 at 36 percent. These are levels comparable to the
East Asian crisis countries or to the banks during the recent Turkish crisis. In Moldova
NPLS were at just 20 percent , but consumed tow-thirds of net interest income. In
Uzbekistan directed credits has resulted in a high level of non-performing loans, but a
high percentage of these loans are guaranteed by the Government, so they are still carried
on the books of these banks at face value.
Quality of firms seeking loans. The distressed condition of the enterprise sector
presents limited incentives for banks to lend to the real sector. Large enterprises, their
preferred customer targets, are for the most part struggling state owned enterprises or
newly privatized firms, many of which have yet to restructure. De novo firms are
primarily micro and small firms and represent high costs of doing business on a client or
transaction basis. Inefficient banks in the region can not easily down scale into micro and
small-scale lending without effectively learning how to bank at this level, i.e. the
techniques of MSME banking.
61
This section of the paper is largely taken from Khaled Sherif, Michael Borish and George Carke, Edited
by Paul J. Siegelbaum, Structural Adjustmnet in the Transition: Case Studies from Albania,Azerbaijan,
Kyrgyz Republic and Moldova. World Bank,ECSPF, January 2002 , Note that this paper by Sherif, et. al.
presents a quite detailed explanation for the problems of banks in these countries which would seem apply
to all of the CIS-7 countries.
45
Deposit mobilization. These banks also have great difficulty in mobilizing
deposits or savings. Deposits are constrained by limited confidence in the banks and low
levels of enterprise liquidity. There is much greater reliance on borrowing from the
central bank There has been little access to foreign capital through syndicated loans or
foreign investment in the banking sector, as in the accession countries where foreign
banks largely dominate the sector (Slovenia as a major exception for the moment).
Poverty has also made it difficult for the banks to develop a broad funding base. Some of
this relates to the rural nature of some of these countries, where poverty is widespread
and extensive branch banking would likely prove non-viable. This is true for example in
the Kyrgyz Republic and in Moldova as examples.
Figure___ Per capita bank deposits are extremely low by global and regional
standards
Source: Khaled Sherif, Michael Borish and George Carke, Edited by Paul J. Siegelbaum, Structural
Adjustmnet in the Transition: Case Studies from Albania,Azerbaijan, Kyrgyz Republic and Moldova
46
Figure____ Year-to-year Deposit Growth
Source: Khaled Sherif, Michael Borish and George Carke, Edited by Paul J. Siegelbaum, Structural
Adjustmnet in the Transition: Case Studies from Albania,Azerbaijan, Kyrgyz Republic and Moldova
Bank ownership. Until recently, the banking sector in the CIS-7 countries was
state owned. Presently, bank ownership is now majority private (see Table _ on Bank
Ownership in the CIS-7), with Uzbekistan a major exception, where all of the major
commercial banks remain state owned. The Government of Uzbekistan has adopted an
explicit industrial policy of directed credits to industry, for example, for the cotton sector
or for auto assembly and auto-parts manufacturing. These banks have sectorally
concentrated loans that are most often state guaranteed. The Kyrgyz Republic also has
several state-owned banks. These banks were intervened as a result of the Russian crisis,
large-scale fraud in a couple of the banks and weak banking supervision. . The intention
is to re-privatize these banks in the near future.
47
Table ___ Statistics on public sector banks in CIS-7, 2000
Number of State
Banks as of end1992
Number of State
Banks as of end2001
State bank % of
assets (end2000)
State bank %
deposits (end2000)
State bank %
capital
(end-2000)
State bank %
credit
(end-2000)
CIS-7
Armenia
Azerbaijan
Georgia
Kyrgyz Republic
Moldova
Tajikistan
Uzbekistán
5
4
4
4
5
5
8
0
2
0
3
1
1
16
2.6
64.7
0.0
9.4
10.8
6.8
100.0
5.4
88.8
0.0
10.3
15.3
N/A
100.0
0.0
13.0
0.0
12.9
4.5
N/A
100.0
1.3
93.6
0.0
10.0
12.8
N/A
77.5
Memo item
Poland
Czech Republic
Hungary
Estonia
Latvia
Lithuania
16
4
10
3
5
3
4
4
2
0
2
1
26.6
25.9
7.8
0.0
9.2
13.8
31.7
30.2
7.4
0.0
19.4
16.5
14.6
21.4
21.0
0.0
6.9
10.4
32.1
36.0
9.1
0.0
18.3
14.8
Source: ECSPF Strategy Paper on the Financial Sector
Weak capital base. The problem is not state ownership, therefore, but weak
capitalization and the relative lack of experience in banking by recently privatized banks.
There was simply no formal banking tradition in the region. Most banks in the region that
have failed or have been intervened, have experienced insider or connected lending, mismanagement, poor systems and bad governance. Unlike, the EU accession countries,
there has been almost no entry of international banks into the sector to establish high
banking standards.. It is notable just how small the banking sector is in most of these
countries with capital and liabilities of EU accession country banks approximately 60
times the average of the CIS-7 banks. Although these countries maintain minimum
capital standards, system wide capital and per bank capital remains very low by global
standards. In Azerbaijan, for example, as of end 2000 system-wide capital was US$ 269
million or US$ 4 million per bank. In the Kyrgyz Republic, banks are very small and
system wide capital at the end of 2000, was US$ 8 million. By contrast the EU accession
countries had an average per bank capital of US$ 108 million per bank.
Poor Earnings.
Given a legacy of state ownership, weak capital base, a
problematic enterprise sector and lack of fee based products and services to offer
prospective clients, it is not surprising that bank earnings have been weak to negative
over the last several years.
48
The Russian crisis (1998-1999) had an adverse impact on a number of banks in
the region.62
Table___ Adjusted Profit and Loss after Provisioning: 1999-2000
Provisions for Losses
After- tax Profits/Losses
ROA
ROE
Azerbaijan
322 million
- $266 million
-36.7%
-245.7%
Kyrgyz Republic
$ 13 million
-$ 13 million
-14.2%
-1.5%
Notes: based on figures in Azerbaijan from 1999 and Kyrgyz Republic from March 2000
Sources: Central banks; World Bank calculations
Source: Khaled Sherif, Michael Borish and George Carke, Edited by Paul J. Siegelbaum, Structural
Adjustmnet in the Transition: Case Studies from Albania,Azerbaijan, Kyrgyz Republic and Moldova
Since the end of the crisis and the strong recovery of the Russian economy, as
well as the CIS-7, economies, the banks have shown signs of recovery and strengthening
Limits to bank lending to SMEs. The lack of capital and poor earnings results,
puts a limit on how much support the banks can give to the SME sector, even if they
were to determine that every firm that applied for working capital or other loans merited
receiving these loans. In several of these countries there has been a major effort to
restructure and to re-capitalize the banking sector. While this is necessary and important
long-term, during restructuring and re-capitalization it is unlikely that these banks will
make a push to extend loans to SMEs. Therefore, necessary and at times urgent financial
sector reforms actually have an adverse impact on SME lending, at least in the shortterm.
Yibin Mu, “Review Report of the Financial Sector Reform and Development Strategies in ECA
Countries,” World Bank, ECA, Private and Financial Sector Department, August 2000, pp.3-4
62
49
Figure___Difficulties encountered by Uzbek SMEs operating a bank account
Difficulties encountered by Uzbek SMEs operating a bank account
Long term/duration of bank
transactions
High commission fee
Numerous bank requirements to
be met at clearing transactions
Episodic shortage of cash in the
Bank
Bank bureaucracy
Limitation of cash withdrawal in
local currency
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
Source: Business Environment in Uzbekistan as Seen by Small and Medium Enterprises, IFC, 2002;
The BEEPS survey reinforced the concept that most of the financing for small
businesses in the CIS-7 is done through the usage of retained earnings as working capital.
Loans from family and friends appear to be the second most used form of financing,
while there are sometimes financing through credit arrangement with customers and/or
suppliers. Local private commercial banks account for very little financing, with the
exception of Moldova, whose banks apparently account on average about 11 per cent of
the share of working capital for the firms interviewed.
50
Figure___Source of working capital for Small Enterprises in CIS7
Origin of Working Capital for Small Enterprises in CIS7
Armenia
Countries
Azerbaijan
Georgia
Kyrgyzstan
Moldova
Tajikistan
Uzbekistan
0%
20%
60%
40%
80%
100%
Source of Working Capital (%)
Internal funds/Retained earnings
Borrowing from local private commercial banks
Loans from family/friends
Trade credit from suppliers
Trade credit from customers
Others
Source: Business Environment and Enterprise Performance Survey (BEEPS), World Bank and the
European Bank for Reconstruction and Development, 2002;
C.
Specialized Banks. Given the problems in the general, commercial, banking
sector in the CIS-7 countries, there will always be the temptation to seek a solution in
specialized or dedicated banks. Going beyond the discussion of microfinance and the
need to scale-up this sector, including the role of credit unions, dedicated MSME banks
or eventual down-scaling of commercial banks in these countries into MSME lending, the
question remains what can and should be done to fill gaps in small business lending, for
example, the role of dedicated agricultural banks or postal banks? Traditionally stateowned agricultural banks have not performed well due to the generalized problems of
politicized and directed lending through such institutions. But also due to the special
nature and problems associated with financing of state-owned farms, the kolkhozes, and
commercialized crop production under state production, for example cotton production in
a number of Central Asian countries. As the sector is increasingly privatized, the question
remains is there a need for privately owned and operated agricultural cooperatives to
support small private farms and agri-processing operations?
51
Postal Banks are another potential opportunity to be explored in the region. As a
result of former soviet planning each of the CIS-7 countries is endowed with an extensive
state owned postal network, which reaches the most remote rural areas. This existing
network can be utilized to provide financial services to rural areas that are not served by
commercial banks. But again not a reversion to state-owned banking, but the more
commercialized approach taken by the Dutch in the form of Post bank, owned by ING, or
the recently privatized Deutsche Post Bank. There is a long tradition of successful postal
banking in Europe and Japan, as examples, first to effect payments for social securities
and other purposes, second to mobilize savings from individual family units and
eventually as a source of small loans. The obvious advantages of postal banking is that
the postal system infrastructure bears part of the overhead costs and the need for a postal
system throughout the country can help justify banking windows in all of the postal
branches. For Governments the clear advantage, should be the reduction of the fiscal
demands that operating the postal systems represents. Problems associated with postal
banks have been non-specialization of staff who remain primarily postal employees,
non-computerized accounting systems making it difficult to determine the performance of
the banking functions, as opposed to postal operations, lack of adequate systems and
controls, leading to potential theft and the initial investment or start-up costs of such
operations.63 The Georgian Postbank was established in 1995 with special tasks in the
field of pension payments and tax collection through the post offices. It is the 5th largest
bank in the country. Postal savings have been recently introduced to post offices in
Uzbekistan and Kyrgyz Republic but little progress has been made to-date in this area64..
D.
Non-Bank Financial Institutions. This area of the financial sector development
is at best in its incipient stage of development in the CIS-7 countries. It is clear that nonbank financial services such as leasing and factoring could make a large difference to
SME access to finance. Since most available finance is working capital finance, on a
short-term basis, the availablility of leasing could improve access to term financing for
equipment and machinery. Support by IFIs, for example, the IFC who has often
63
Ibid, pp.38-39 for a discussion of postal banking.
Universal Postal Union, “Guiding Principles for the Reform of Postal Financial services”, Draft 2, 2002,
Universal Postal Union, Switzerland
64
52
supported the entry of leasing in developing countries, could potentially catalyze
development of non-bank financial institutions in the CIS-7 countries, which in turn
could have an important impact on SME access to specialized financial services.
VI. Supporting Infrastructure
In order to improve access of MSMEs to finance, it is clear that the supporting
infrastructure for the financial sector will need to be improved in CIS-7 countries.
Progress has already been made in some of these areas, but the need remains to continue
such reforms. These include: (i) improving the legal infrastructure—company and
contract law, protection of property rights and timely enforcement of these rights
through the courts or other means of dispute resolution. An important legal reform for
SMEs is the adoption of a law on floating collateral covering accounts receivable,
inventory and equipment and the development of a central collateral registry within the
country to register floating liens. This would lower the collateral requirements for SMEs
and, over time, substantially improve their access to finance; (ii) the adoption of
international accounting standards, improving standards of reporting and disclosure, and
use of independent auditors; (iii) improving bank and non-bank financial institutions’
governance; and (iv) strengthening regulation and supervision. Adopting licensing,
supervisory and regulatory standards for MFIs is important for the sound development of
microfinance in these countries. While these areas go beyond the scope of this paper, they
remain critical if the financial sector is to improve its performance and specifically its
support for MSMEs.
VII.
Conclusions: How to Improve Access to Finance for MSMEs
For growth to be sustainable and dynamic in the CIS-7 countries new entry is
important. Overall growth levels in these countries in recent years has led to
strengthening both the SME sector and the financial sectors. Improvement in the business
environment, including simplifying taxes, eliminating ad hoc inspections by officials that
are rent seeking and simplifying registration and licensing requirements, is the single
most important issue that governments need to address in order to provide incentives for
53
MSMEs to move out of the informal sector and to begin to invest in their future. Another
important longer-term reform would be movement towards regional integration, starting
with trade reforms in the form of a customs union to increase the market for SME goods
and services.
But in order to sustain growth, MSMEs need financing beyond the levels they can
obtain from internally generated funds, from their owners own savings, their friends and
family, as is presently the case for most MSMEs in these countries. In many respects
access to finance will depend on the quality of the firms themselves—the market demand
for their products, their management, their degree of transparency in terms of good
accounting and reporting, and their planning in the form of a business plan and/or
strategy. For micro-entrepreneurs and small businesses this will be a standard that is
difficult to achieve and, therefore, they will benefit most by the development of
microfinance, including credit unions, cooperative banks, dedicated MSME banks and
banks downscaling.
But SMEs, as opposed to micro-entrepreneurs, need a heterogeneous mix of
financing, presently unavailable in the financial sectors in the CIS-7 countries. Focusing
on a few key products—working capital finance, trade finance for exporters, and leasing
for equipment would meet most SME needs. This means that commercial banks in the
region need to continue their efforts at re-capitalization and
restructuring, with an
additional emphasis on good banking practices, good management practices and
improved governance. The work, for example, of the EBRD in introducing MSME
lending to commercial banks should support these efforts. But the infrastructure—laws,
accounting and reporting standards, supervision and regulation, in the sector will also
need to be addressed and this work is on-going in virtually all of the CIS-7 countries.
This will all take time to achieve, but MSMEs , especially new entry, represents the
future for the the CIS-7 countries and its important that these issues be supported by both
the countries themselves and the donor community.
54
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