SMEs’ economic contribution can be dramatically boosted by access to finance in 2022
Small and Medium Enterprises (SMEs) are extremely important for creating jobs and raising GDP all around the world. According to World Bank data, almost 50% of all jobs globally are supported by SME enterprises, which account for around 90% of all companies. When informal SMEs are taken into account, the contribution of formal SMEs to national income (GDP) in emerging economies rises to as much as 40%.
As a result, SMEs are the foundation of every economy, and they frequently assume even more importance in the wake of significant socio-political events like the 2008 financial crisis or the Covid-19 outbreak. SMEs in emerging markets and developing nations frequently experience limited development possibilities as a result of a lack of access to financing for expanding their enterprises while making a sizable contribution to the economy.
The International Finance Corporation (IFC) has estimated that roughly 65 million businesses, or 40% of formal micro, small, and medium-sized companies (MSMEs) in developing nations, struggle to obtain financing. Just formal SMEs have an annual unmet requirement of $5.2 trillion. This sum is almost 1.4 times the level of worldwide MSME financing at the moment.
Despite the fact that the issue of SMEs’ low access to financing has been debated for more than 25 years, there are a number of reasons why the credit gap still exists. The fact that SMEs are frequently unorganized is one of the main reasons why banks are reluctant to credit them. These tiny businesses frequently are not subject to the official tax rates. Most don’t even need to register themselves. They don’t have to register employees or give provident funds because they have a tiny crew.
The main phases in the life of a business include existence, survival, success, take-off, and resource maturity if we examine the normal lifecycle of a firm by drawing comparisons with Maslow’s hierarchy of requirements.
Most companies fail even before they get through the existence and survival stages. For instance, within the first six months of operation, restaurants have a mortality rate of roughly 90%. Similar success rates also exist in a number of other business industries.
Access to financing becomes essential for businesses that are able to stand out from the competition and manage their working cash to maintain operations. When companies reach the point of success, they must consider growth over the long term, which also necessitates a sizable influx of funds to construct the necessary infrastructure and invest in technology, among other things.
These businesses are unfortunately forced to seek Non-Banking Financial Companies (NBFCs) and accept loans at higher interest rates as a result of the credit gap from regular banking channels, which puts more strain on their resources. Because they lack the necessary paperwork, they are unable to rely on other methods like FDI, bonds or debentures, or IPOs.
The hesitation of banks to lend
The perceived risk considerations are what the banks attribute to their reluctance to lend to small firms. Since proprietors of small enterprises sometimes lack the necessary design abilities, they frequently lack defined policies, planning, and strategy. Third parties like valuers or analysts do not support or evaluate their business models.
These companies frequently lack the funds, time, and resources necessary to get those endorsements or approvals for their strategic path.
Additionally, a lot of small firms are family-run, and the lines separating personal and corporate accounts are often blurry. Family members frequently receive compensation for their efforts that is excessive rather than consistent with accepted business norms. Additionally, the majority of small enterprises lack effective succession planning.
SMEs’ credit deficit to be filled
Government-owned banks, like the Small Industries Development Bank of India (SIDBI) or the IDBI, are charged in places like India with helping SMEs get financing at lower interest rates so they may overcome their first challenges and succeed.
NITI Aayog, the planning arm of the Indian government, published a discussion paper in 2021 proposing the establishment of an Indian digital-only bank to serve SMBs. These banks have a lower capital requirement than ordinary banks and might possibly be launched by both people and organizations.
Additionally, they won’t be constrained by intricate rules like the need to establish actual branches in remote areas or onerous reporting requirements, etc. These can present a chance for fresh business people to enter the loan market. In turn, this will assist SMEs in flourishing, which will be advantageous.
SME development will also be aided by government programs like Open Network for Digital Commerce (ONDC), a nonprofit organization whose goal is to level the playing field for e-commerce platforms.
In order to encourage them to invest in digital tools and develop their technological capacity, ONDC might increase loans to unbanked and underbanked businesses.
From the perspective of ESG and as a method to contribute to economic growth, traditional banks have a huge opportunity to expand access to financing for small enterprises. They may create a successful and long-lasting strategy to accelerate the growth of SMEs by researching the SME ecosystem, finding viable sectors, and spotting visionary entrepreneurs. In addition to providing loans, banks may invest in educating their SME clients and raising their level of awareness in order to strengthen their bonds with them and help them succeed.
Banks, governments, and other institutions must work together to promote SMEs’ development and success through favourable legislation and proper assistance, given the significant role that they play in the economy.
Most economies, especially those in emerging countries, rely heavily on small and medium-sized businesses (SMEs). Globally, SMEs make up the majority of businesses and play a significant role in creating jobs and expanding the economy. Approximately 90% of all enterprises and more than 50% of all jobs are created by them. It is possible for formal SMEs to contribute as much as 40% to the GDP of emerging economies. When informal SMEs are taken into account, these figures are substantially higher.
Our projections show that 600 million jobs would be required by 2030 to accommodate the expanding global workforce, making SME growth a top priority for many governments worldwide. In emerging markets, SMEs account for 7 out of every 10 formal employment created. The second most-often stated barrier to SMEs’ expansion in emerging markets and developing nations, access to finance, is a major impediment to SME growth.
SMEs rely on internal finances or cash from friends and family to begin and initially manage their businesses because they are less likely to be able to secure bank loans than large companies.
IFC estimates that 65 million businesses, or 40% of formal micro, small, and medium-sized companies (MSMEs) in developing countries, have an annual unmet funding demand of $5.2 trillion, which is equal to 1.4 times the amount of global MSME lending at present. East Asia and the Pacific make for the majority of the global financial gap (46 per cent), followed by Latin America and the Caribbean (23 per cent), Europe, and Central Asia (15 per cent).
From region to region, the gap volume varies significantly. For example, Latin America, the Caribbean, the Middle East, and North Africa have the largest ratios of the funding gap to potential demand, at 87 and 88 per cent, respectively. A little over half of legally recognized SMEs lack access to formal loans. When micro and informal businesses are taken into account, the financial gap becomes even more.
edited and proofread nikita sharma