How to Expand Credit to SMEs
Access to and cost of credit are some of the major hurdles for SMEs to do business, compete and grow.
Latin American countries have recently made significant strides in economic policy, especially in management and oversight of financial systems. First, systems have been revamped with new financial and capital market instruments. In addition, capitalization, liquidity, default and other indicators show that banks in general are comfortable with prudent limits, which shows resilience and security in the system in face of crises.
However, the benefits of this greater sophistication and strength have not yet reached all, as the region still shows major deficiencies in access to credit and other financial services. In fact, domestic credit to the private sector accounts for only 50% of GDP, substantially below that of other emerging regions, and access to services is highly unequal depending on the size of the business.
Access to and cost of credit are some of the major hurdles for SMEs to do business, compete and grow. In the case of Argentina, Brazil and Mexico, which generate 65% of the region’s GDP, only 40% of small formal enterprises have access to a line of credit, while more than 95% of large companies boast this and other financial services.
Since SMEs represent a disproportionately high share of formal enterprises in the region, they are part of virtually all production chains and contribute significantly to household consumption; thus, in addition to being slow job and income generators, they actually hinder these. Access to financial services has detrimental implications for investment, productivity and competitiveness of these companies, which “intoxicate” virtually the entire economy.
Interestingly, research conducted by the Latin American Federation of Banks shows that financial institutions have a great interest in the SME lending market and that 90% of banks have active financial policies and focus especially on these companies. So, if there is such an interest from banks, why are SMEs so poorly served?
There are many explanations, especially limitations on guarantees and information, including financial, accounting and operational limitations, which reportedly encumber conventional credit analysis. These limitations help explain a well-known vicious cycle of poor credit history, high interest rates, and short credit terms. International banking regulations, which prompt banks to move their portfolios to lower-risk assets, along with the region’s high banking concentration, are exacerbating that vicious cycle. In addition, the high fixed cost ofcredit analysis and monitoring, combined with a high heterogeneity of SMEs, would lead to another—also well known—pattern of credit denial for companies with innovation and growth potential.
This context leads to the adoption of new solutions and options for access to financial services. These solutions already exist and are available to policy makers. One is to encourage new stakeholders, including Fintech companies, to use more agile, lighter and less expensive credit analysis technologies, to better address the heterogeneity of SMEs, and to design differentiated strategies. In addition, Fintech companies offer low-cost non-financial services to SMEs, such as customer, accounting and inventory management, which help improve the quality of business management information.
Open banking, i.e. the exchange of customer data, also promotes credit analysis and competition. Brazil’s experience with Cadastro Positivo, which is now implemented with individual information from tens of millions of customers of financial and non-financial companies, will prove a valuable laboratory for testing risk analysis solutions and differentiated credit conditions.
Another solution is the expansion of guarantee funds for credit portfolios. Guarantee funds and operations aim to share risks and reduce capital exposure and encourage banks to expand their loan portfolios, improve financing conditions, and create opportunities for new customers. Guarantee funds for SMEs are still under-developed in the region, have low capitalization and are very heterogeneous, and therefore, there is great room for growth. Mexico and Colombia boast the most developed guarantee funds, but even there coverage remains limited. In addition to promoting credit expansion in good times, this instrument may be especially relevant in times of credit crunch.
