MSME Finance Gap: Assessment of the Shortfalls and Opportunities in Financing Micro, Small and Medium Enterprises in Emerging Markets

30 January, 2018

Original source: SME FINANCE FORUM

This report appraised empirical research regarding the existence and size of the micro, small and medium (MSME) enterprise finance gap in developing countries. A theoretical and empirical framework is presented to articulate and measure this gap at the country level, based on the interaction between supply and demand of finance for MSMEs. This research estimates that there are 65 million formal micro, small and medium enterprises that are credit constrained, representing 40 percent of all enterprises in the 128 reviewed countries. Of these developing economies surveyed, the potential demand for MSME finance is estimated at US$ 8.9 trillion, as compared to the current credit supply of $3.7 trillion. The finance gap attributed to formal MSMEs in developing countries is valued at $ 5.2 trillion, which is equivalent to 19 percent of the gross domestic product (GDP) of the 128 countries. This in turn amounts to 1.4 times the current level of MSME lending to these countries.

The finance gap in the informal MSME market is another important aspect of this study. In this context, there is an estimated $ 2.9 trillion in potential demand for finance from informal enterprises in developing countries. This figure is indeed sizeable, and is equivalent to 10 percent of the GDP in these countries.

In addition to contributing to the limited, but growing literature which tries to measure the size of the enterprise finance gap for emerging markets, this study introduces a new and a more systemic methodology to measure the gap. This revised methodology examines the gap from both a demand and supply constraint perspective. Many MSMEs may have a higher “potential” demand for financing. However, this demand often goes unacknowledged because the owner of the enterprise knows that is not likely to be met. Similarly, the supply of credit in these markets is a constraint. Financial institutions prefer to lend money to enterprises with better documentation, and an established track record. In other words, financial institutions prefer to supply credit to low-risk enterprises.

The results of this report also raise some pertinent questions: Has the enterprise finance gap increased in recent years? Can there be a dynamic measure of this gap which can be regularly updated so that interventions toward reducing the gap can be measured? Throughout this study, the authors have tried to pre-empt and address these concerns. First, the findings indicate that the increase in the estimate of the finance gap from the 2011 measure is primarily driven by changes in the methodology. This should be interpreted as a holistic recalculation of the gap from both the supply and demand perspectives. Second, this robust methodology has the added benefit of being easier to update in future years. Thus, for the first time, the evolution of the gap can be captured, and the dynamic changes to the gap over time can be more accurately assessed. 

This study highlighted the key market-enabling policies that governments might pursue to close the MSME finance gap. The public sector has an important role in reforming the institutional environment, providing regulatory frameworks, and fostering competition and other market-oriented policy actions. Policy recommendations to support a more diverse financial landscape encompass improving competition within the financial system, as well as allowing a variety of financial institutions to operate. In addition, bothdirected lending programs and risk-sharing arrangements can have positive effects on MSME access to finance and growth. However, it can be a challenge to effectively design and manage them. Lastly, mounting evidence suggests that solid credit information systems, movable collateral frameworks and registries, and efficient insolvency regimes can increase lending to MSMEs.Governments are encouraged to continue developing and improving the financial infrastructure to enable greater MSME lending.

The private sector benefits from market-enabling policies set by the public sector, and is able to directly intervene and promote financial inclusion. Private sector initiatives focusing on building the capacity of traditional financial institutions — such as banks, non-bank FIs, credit unions, savings and loan associations among others — can help them to better serve the MSME segment. The implementation of a targeted MSME strategy, coupled with capacity building of staff and management, are crucial for successful penetration to these underserved markets. A targeted MSME strategy could include the design of directed business models, sales and customer management policies, specialized credit risk models, and tailored products and services.

In addition to the traditional financial institutions, technology and digital financial services providers can play a significant role in providing finance and payment services to the MSME market segment. A variety of fintech players, such as marketplace lenders, payment and supply chain finance platforms, among others, can significantly contribute to closing the finance gap either by operating on their own or by partnering with the larger, traditional financial institutions.

You can download the full report from here.

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