HOW ARE SMES FINANCED IN DEVELOPING COUNTRIES ?

HOW ARE SMES FINANCED IN DEVELOPING COUNTRIES ?

By: Fernando Cárdenas E.

Economists have long agreed on the critical role of SMEs in developing countries. These companies help economic growth, job creation and the reduction of inequality problems. However, SMEs have various problems in financing their operations and growth. In an article from April 2023, Cuenca, Ceular-Villamandos, and Navajas-Romero study the behavioral factors that impact the financing decisions of small businesses in Ecuador. Next, I present its main conclusions applicable to our developing countries. 

SMEs have problems of scale, and in many cases they are family businesses, with few technological capabilities and limited resources and structure. These characteristics are largely due to little access to financing. Difficulties in obtaining financing affect their competitiveness, profitability and growth. 

Public policies that aim to develop financial markets, to develop credit alternatives and to prepare SMEs to improve their access to financing, can have important effects on their performance and productivity. Improving knowledge about the types of entrepreneurs and their financing options enriches the construction of these public policies. 

In Latin American and Caribbean countries, according to the authors' analysis and other research, an important source of financing for SMEs is informal credit (family, friends and acquaintances). These can also be formally financed with banks, cooperatives and other credit institutions, but generally the requirements are higher and in some cases difficult to meet.   

The main objective of the aforementioned research is to analyze the behavior patterns of SMEs that affect their financing decisions from both formal and informal sources. The literature distinguishes four different groups of companies based on individual, organizational and context factors. 1. Companies that do not use external financing, 2. Those that only use informal financing, 3. Those that only use formal financing, and 4. Companies that use both. The main difficulty for entrepreneurs to obtain external financing is the lack of transparency in information (information asymmetry). There is a big difference between the information that entrepreneurs have about their businesses and what the financier manages to obtain.  

In this study, the researchers delve into the subject and identify five groups of entrepreneurs based on their financing decisions:      

1. “The skeptics” (43% of the entrepreneurs analyzed in the study) They are entrepreneurs who are afraid of the requirements and regulations associated with financing and who prefer to reinvest their profits instead of getting into debt with high interest rates or undergoing procedures strict with their funders. Personal savings is his main source of financing.

2. The "indifferent" (29% of the sample). They are those who, despite knowing the financing options available in the market, do not agree with them and prefer not to use them. They also rely solely on their personal savings.

3. The "bold" (11%). Those with a profile that is more willing to take risks find options to boost the growth of their businesses with credit and development institutions.

4. The "improvisers" (9%). Those who start their businesses with limited own resources and despite understanding little about the financial world, are not interested in learning. They show little growth and their main focus is day to day.

5. The "weak" (8%). They know they are not eligible for credit and view banks as a far off option due to their inability to meet the myriad requirements needed to access credit. They hope that the situation will improve and that, as they mature, they can increase their chances of accessing credit. 

MAIN CONCLUSIONS

This study validates that SMEs mainly depend on their own funds as a source of financing. A large proportion of the businesses in the study groups depend on informal loans, and a large number of these loans are related to personal savings. The results also highlight the importance of improving entrepreneurs' knowledge of basic finance and personal finance. Also, they show the need to develop public policies that promote the development of appropriate financing mechanisms for SMEs that replace or complement informal credits. On the other hand, it is necessary to develop practical and simple business training programs focused on management skills, risk management and collaboration between businessmen.