Access to Finance for

PHOTO: WILL BOASE

Small and Medium Enterprises

Financial access is critical for the growth of small and medium-size enterprises (SMEs). It allows entrepreneurs to
innovate, improve efficiency, expand to new markets, and provide millions of jobs. Yet, in developing countries,
the majority of SMEs are unable to acquire the financing they need to reach their potential. Financing SMEs in the
developing world can be risky and expensive for lenders, leading to an estimated financing gap of one trillion USD
(International Finance Corporation, 2011).

To reduce the credit gap, financial institutions, governments, and donors invest in lending products and policies
designed to provide SMEs with the financing they need to grow and innovate. However, the extent to which such
programs effectively reduce the barriers to SME financing has generally not been rigorously measured. The SME
Program at Innovations for Poverty Action (IPA) rigorously evaluates potential solutions and promotes the
most efficient and cost-effective ways to expand access to finance for SMEs.

THE SME CREDIT GAP

Credit Gap:
Unserved &
Underserved (percent)
>70 50-60 <40

60-70 40-50 NO DATA

IFC Enterprise Finance Gap Database (2011)

 The SME Program addresses challenges throughout the SME lending cycle

SME LOAN Bank screens Bank requires Client invests loan in Client repays loan
loan client collateral to secure loan business
PROCESS:

High default rates on

KEY CHALLENGES Reliable historical Loan applicant lacks Client does not have
SME loans increase
data on SMEs is qualified collateral the financial and
IN SME LENDING unavailable or managerial knowledge risk, resulting in
CYCLE: expensive to collect to successfully reduced SME lending
invest loan

CLIENT SCREENING
In developed countries, financial institutions assess SME loan applicants using information supplied by credit bureaus. In emerging
markets, however, strong credit bureaus and other financial infrastructure often do not exist. Instead, banks rely on time-consuming
methods to obtain credit histories directly from loan applicants. Incomplete financial records and unverifiable client information
further increase the cost of assessing SME loan applications, making banks reluctant or unable to lend to SMEs. However, the SME
sector in many developing countries is large and represents a very promising frontier for lenders. To capitalize on this, some banks
have begun implementing innovative screening mechanisms to reduce the cost of lending.

CREDIT SCORES CAN IMPROVE LENDING DECISIONS

Colombia | Daniel Paravisini and Antoinette Schoar
IPA partnered with Bancamía, a bank focused on SME lending, to evaluate whether a computer-generated credit scoring system
reduced the cost and improved the quality of the bank’s loan review process. Usually, Bancamía’s credit committee approves or
rejects loan applications, or refers them to a regional manager. Researchers tested whether the committee’s behavior changed
when the credit score was available during the decision process. They also tested whether the additional transparency provided
by the score incentivized committee members to improve their performance.

Results
Existence of a credit score, whether it was included in the initial loan review or not, encouraged the committee to spend
more effort on difficult-to-evaluate applications. The improvement even when the score was not used suggests that
the committee might already have had the necessary information to make decisions on difficult applications,
but lacked the incentives to use the information efficiently. The committee’s enhanced decision-making lowered
the number of loan applications referred to the regional managers, which in turn reduced the overall cost of the
decision-making process. Additionally, when the credit score was included in the loan review, the committee was able
to better allocate loans, extending larger loans to less risky borrowers and smaller loans to riskier borrowers.

CAN LOAN OFFICERS IDENTIFY CLIENTS CAPABLE OF GROWING THEIR FIRMS?

Egypt | Gharad Bryan, Dean Karlan, and Adam Osman
Many microfinance institutions (MFIs) aspire to “graduate” their clients to larger loans as their businesses grow, but often lack
the ability to successfully screen SME-level loans. Harnessing MFI loan officers’ knowledge of their clients’ borrowing potential
could provide an innovative and cost-effective screening mechanism. IPA researchers are partnering with the Alexandria Business
Association to develop and test a model that combines quantitative data with loan officers’ knowledge of their clients in order to
identify the microenterprises most likely to succeed with larger loan amounts. By randomly assigning a portion of the qualified
clients to receive an SME-sized loan, researchers will be able to evaluate whether loan officers can accurately identify high-potential
clients. The study will also measure the impact of the significantly larger loans on job creation and firm growth.

Access to Finance for Small and Medium Enterprises innovations for poverty action 2
 COLLATERAL
Banks traditionally require that clients provide collateral such as land or real estate to secure their loans. However,
many creditworthy SMEs do not have the type of collateral required by commercial lenders and therefore have
trouble accessing needed financing. To remove this barrier, some governments and financial institutions are
relaxing collateral requirements or eliminating them altogether.

DO FLEXIBLE COLLATERAL REQUIREMENTS IMPROVE CREDIT ACCESS?

Colombia | Marcela Eslava and Antoinette Schoar
The Colombian government, with support from the International Finance Corporation, recently introduced a new Secured
Transactions Reform that provides a legal framework for accepting movable collateral such as vehicles, machinery, accounts
receivable, and inventory. The reform has two main pieces. First, it establishes a unified online registry for all movable assets used
as collateral, so that potential creditors can verify whether assets offered as collateral are subject to other obligations. Second, the
law improves enforcement in cases of default. By reducing banks’ risk in accepting alternative forms of collateral, the reform is
expected to increase access to credit for SMEs. IPA is measuring the impact of the reform on lenders’ provision of credit to SMEs
as well as business growth indicators such as employment and sales.

FINANCIAL CAPABILITIES
Entrepreneurs’ financial management skills can determine their ability to access credit and grow their firms. In
developing countries, business owners often have received no formal financial training. Financial literacy programs
are a popular approach to improving financial management and decision-making, but the evidence on whether
these training programs actually promote business growth is mixed.

TRAINING WITH ‘RULES OF THUMB’ IS MORE EFFECTIVE THAN TRADITIONAL FINANCIAL TRAINING
Dominican Republic | Alejandro Drexler, Greg Fischer, and Antoinette Schoar
IPA researchers partnered with ADOPEM, a bank serving small businesses, to compare two methods of financial literacy training:
one which emphasized classic accounting principles and another which focused on simple “rules of thumb.” The more complex
training covered topics such as inventory management and daily record keeping. The “rules of thumb” training focused on simple
guidelines for financial decision-making, such as separating business and personal expenditures, paying oneself a fixed salary, and
estimating profits from changes in cash on hand.

Results
The “rules of thumb” training resulted in significant improvements in firms’ financial practices and revenues,
while the standard accounting program had no effect. Relative to those who received no training, “rules of thumb“
trainees were 6 to 12 percentage points more likely to separate business and personal cash and accounts, keep
accounting records, and formally calculate revenues. “Rules of thumb” trainees also reported higher revenues overall
but particularly in bad weeks, suggesting that the simplified training content equipped them to better cope with slower
periods. The impact of the “rules of thumb” training was particularly positive for clients with poor management practices
before the training.

CAN FINANCIAL “RULES OF THUMB” BE TAUGHT THROUGH SMS MESSAGES?

India | Shawn Cole and Antoinette Schoar
Mobile platforms have the potential to affordably reach thousands of small business owners. In this study, IPA researchers evaluate
whether the success of a “rules of thumb” training program using a simple, heuristics-based financial education curriculum can
be replicated when the training is delivered via SMS messages. Carefully designed messages containing basic rules that are easy
to implement will be sent to a randomly selected group of small businesses. The study will measure the impact of this training
approach on the financial management and growth of small firms.

Access to Finance for Small and Medium Enterprises innovations for poverty action 3
 LOAN REPAYMENT
SMEs tend to have higher default rates than larger firms, making SME lending riskier. Better screening
mechanisms can identify creditworthy SME clients, but innovations to banks’ client management practices and
contract terms can improve portfolio performance even after loans have been disbursed. The SME Program assesses a range of
programs aimed at improving SME loan performance.

PERSONAL RELATIONSHIPS CAN IMPROVE REPAYMENT

India | Antoinette Schoar
This study evaluates whether personalized attention from bank officers improves loan repayment. SME loan clients of ICICI Bank
were randomly assigned to one of four groups that involved different levels of interaction with the bank. The first group received
phone calls every two weeks from the same relationship manager; the second received calls but from rotating relationship
managers; the third group received only reminder calls for upcoming payments due; and the fourth group followed the usual bank
protocol of receiving only SMS reminders before payment due dates.

Results
Building a relationship between bank officers and clients reduced late loan payments and, in particular, reduced
the likelihood of repeated late payments. Borrowers in groups one and two had on average about 0.1 fewer late
payments than those in group four, a significant reduction. Among borrowers who had at least one late payment,
those in groups one and two were more than 20 percentage points less likely to have a second late payment relative
to those who only received SMS reminders. The reduction in late payments for groups one and two outweighed
the additional cost of the phone calls and bank staff time, making the program cost effective for the bank. Better
repayment among borrowers also helped small business owners secure more favorable terms with the bank for
subsequent loans.

ALTERING THE TRADITIONAL REPAYMENT TIMEFRAME BENEFITS CLIENTS

India | Erica Field, Rohini Pande, and Natalia Rigol
Traditional microfinance contracts require clients to repay loans in weekly installments beginning shortly after disbursement.
In a 2007 study, a randomly selected group of business owners received a grace period of two months before starting to repay
their loans. The goal was to test whether the grace period would allow businesses to invest more of the loan in their business and
thereby promote growth.

Results
Clients who received the loans with grace period invested approximately six percent more in their businesses,
were more than twice as likely to start a new business, and had 41 percent higher profits after nearly three
years. In addition, 13 percent of businesses receiving the grace period grew from microenterprises into SMEs
within five years of obtaining the loan. However, grace period clients were also more than three times as likely to default
on their loans. IPA researchers are currently conducting follow-up surveys to determine the long-term effects of the
contract modification on business growth.

The SME Program discovers and promotes effective solutions to the constraints affecting SME growth and
entrepreneurship in developing countries.
Build the body of evidence Promote evidence-based decision-making

The SME Program brings together leading researchers and Producing evidence is not enough to achieve policy impact: results
innovative organizations to test new ideas and evaluate must reach those with the power to enact change. The SME
existing SME development approaches. Relying on IPA’s research Program works closely with its partner organizations to ensure
management expertise, these partnerships lead to high-quality, that research findings inform programmatic and operational
HEADQUARTERS
cutting-edge research that informs SME policy design. The SME decisions. The Program also shares evidence with multilateral
101 Whitney
Program Avenue
also directly supports new studies through its Competitive organizations, nonprofits, governments, donors, and the private
New Haven, CT 06510 USA
Research Fund on Entrepreneurship and SME Growth. sector through international events.
poverty-action.org
+1 203.772.2216
contact@poverty-action.org
CONTACT sme@poverty-action.org |www.poverty-action.org/sme