MSMEs: Big Opportunity In Small Lending | CGAP
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MSMEs: Big Opportunity In Small
Lending
03 May 2013 3 comments
Bailey Klinger
There is significant evidence that Micro,Small and Medium sized Enterprises (MSMEs) in
emerging markets have insufficient access to finance. In the World Bank enterprise
surveys, access to finance is rated as the most significant obstacle to business growth
globally (16.2%) and Stein, Goland & Schiff (2010) estimate that there are 310 to 380
million enterprises that need more credit but can’t access it, with collective needs
totaling $2.1 to $2.5 trillion. Studies of the business enterprises themselves
demonstrate that if they had more access to capital, they could do very productive
things with it and earn rates of return far higher than the interest rates banks typically
charge.
On the other side of the potential lending transactions are the commercial banks.
Despite the recent credit crunch, banks remain well capitalized in most emerging
markets. Moreover, there is increased competition in traditional segments such as
consumer and corporate lending that is forcing banks to look for new sources of growth.
Why then aren't banks taking advantage of the big opportunity in small business
lending?
Photo Credit: Anjali Banthia
If you speak with the banks, it is clear that it's not because of a lack of awareness of or
interest in the sector. For example, in a 2011 survey by FOMIN 93% of banks in Latin
America & the Caribbean considered small and medium-sized enterprises as 'strategic to
their business' and 89% of them had a specialized unit focused exclusively on this
segment. Banks want to lend more to MSEs; it’s just that it’s difficult to do.
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MSMEs: Big Opportunity In Small Lending | CGAP
http://www.cgap.org/blog/msmes-big-opportunity-small-lending
When lending to consumers, banks assess risk by verifying the monthly income of the
applicant--do they have a job with a regular income and is that income sufficient to
meet the consumer’s other obligations plus the amount of the loan? Verifying this
income can be done rather easily as long as the individual has formal employment,
which has the benefit of formal and verifiable evidence such as pay stubs and
employment tax records. Moreover, such wage income is relatively stable.
Small business owners, on the other hand, often lack a stable or verifiable paycheck.
Their income can change significantly from month to month and, even more importantly,
it is extremely difficult to verify. In emerging markets many transactions are done in
cash and generally MSEs do not have up-to-date audited financial statements.
Larger corporations can also have unstable income, but for larger businesses sales
transactions and financials are more easily projected. Added to this is the issue of
transaction costs. Large companies take out large loans, and a bank earns its money on
the ‘spread’ (difference between the interest paid on the loan and the cost of capital). So
even though interest rates and spreads are typically smaller for lending to large
corporations compared to MSEs, the large loan size to which the spread is applied can
support relatively high costs of loan origination.
Moreover, sending skilled loan officers to examine a large business’s financial records
and business plan is worthwhile for a $500,000 loan to a large corporate borrower.
However, the smaller loan amounts sought by small- and medium-sized enterprises
cannot support very large transaction costs: the loan size is simply too small.
As a result, a bank has less information to evaluate risk for MSEs compared to
consumers and corporations; and compared to corporations it can spend less money to
gather and analyze information. Typically, they rely on rules like guarantors and
collateral, which results in creating the above-mentioned $2.5 trillion dollar MSE
financing gap as well as harming economic growth and poverty reduction.
New tools are needed to solve this problem--one of which will be proposed in the next
post in this series.
--------- The author is the CEO & co-founder of the Entrepreneurial Finance Lab.
Topics: Market Research Funding Landscape
Countries: Latin America and Caribbean
SERIES: MICRO- AND SMALL ENTERPRISES
COMMENTS
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MSMEs: Big Opportunity In Small Lending | CGAP
http://www.cgap.org/blog/msmes-big-opportunity-small-lending
Lending to SME has many
Submitted by tsewele john on Wed, 2013-06-12 02:44
Lending to SME has many advantages than could do commercial banks, when
thinking about improving on the living standards of the masses, which is of great
interest and concern to every development practitioner. outreach and impacts are
very wide and tangible. my case is a small lending initiative put in place under a
common initiative group. This work mostly within urban markets where vendors are
identified on daily basis on the same spot, they are sensitized on services offered and
they make their choices. Choices range from house rents, njangui, loans repay, plot
and building financing, school resumption preparation, normal savings etc Everyday
they make contributions (savings) so as to meet up with their monthly demands.
sometimes they request for very small loans raging from FCFA 10000 to 200000,
which reflect their business size. securities here include, the savings choice, the spot
they occupy in the market which the market master and the the suppliers recognize
very well (suppliers in meat, tomatoes, fresh and dry fish, palm oil)etc. Cash
contribution by these very SMEs for just a sinle group in one market per monthly
basis is estimated at USD 28000. In a market, about ten different groups execute
such activities including some formal MFIs. These MFIs use this to improve on their
running capital, while the others use the funds collected to generate interest as
deposits in banks. since they are mostly school graduates with no job, they earn
income raging from USD250 upwards which help improve on their living standards.
many female collectors and men as well have received marriage blessings with some
of the vendors in the markets and as this provides interest free cash to the business
and a share in household expenses. Default rates here are very low, raging from 1 to
2 % per month, for those who failed to honour all their monthly payment.Very often,
over USD 50000 is given out as loans per month to these very small vendors. Are the
multiplier effects not seeming encouraging or the impacts not very great. All i intend
to say is that, micro lending to SMEs has wide impacts not only to those that benefit,
but also to those that offer. it is best for governments to promote this initiative so as
to assure a participatory and sustainable growth in every nation economy. Confidence
remains here the key to lending, not collateral and good financial statements. 'small
lending is a promising future for development'
reply
Great job, Bailey !
Submitted by Rodrigo Baluk on Wed, 2013-05-08 16:02
Great job, Bailey ! Keep pushing ! To reach MSME` segments efficently, we need to
develop new and innovative tools. I truly believe that one of them is what EFL is
doing. Our industry no longer resist traditional methods (tremendously expensive and
unefficient) that waste money, time and precious resources (what at the end comes
to abort tons of projects) I strongly believe in psycometrics, as it was succesfully
used for years in other fields. Sincerely yours. Rodrigo Baluk ARGENTINA
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reply
In Small Business Corporation
Submitted by victor m hernandez on Sat, 2013-05-04 10:52
In Small Business Corporation, the company I worked with, we use a risk based
credit technology for lending to MSMEs. It has scoring and credit risk rating outcome
and is quite effective and reliable. We have experienced abvout 2% to 3% default
rate on our loan portfolio.
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