Do financial services lead to SME growth? It depends…

Around the world, most businesspeople identify lack of access to finance as the major inhibitor to growth. Typically, poor access to finance is, on its own, symptomatic of a number of problems businesses experience. Poor business management, weak or crowded markets, a lack of a track record in business, and the lack of collateral are often contributors to this problem. However, in other cases, the financial markets simply don’t work very well. This is common in Low and Medium Income Countries.

Earlier this year, I was commissioned to lead a Rapid Evidence Assessment of the literature on Financial Services and Small and Medium-sized Enterprise Growth and Development. The UK Department for International Development (DFID) sponsored the study, which Landell Mills managed. My coauthors were William Steel and Aurelie Larquemin.

DFID have recently published the report, which can be found here.

This rapid evidence assessment examines the existing evidence on the effectiveness of programme interventions designed to ignite the growth of small firms and their transition into medium‐sized enterprises. It considers the evidence on the question: What financing support interventions have been effective and ineffective in supporting the sustainable transition from small firms to medium‐sized firms in Low and Medium Income Countries, how and why?

Thus, the interest is in how programme interventions have been used to support enterprise growth––specifically, so that firms grow from one size class into the next.

The study was particularly focused on Ghana, but evidence was drawn from a much broader canvass. We identified 62 studies on this topic published between 2007 and 2017. Of these, 21 produced evidence from Ghana and West Africa, 13 from elsewhere in Africa and 28 from other Low and Medium Income Countries.

Overall, the results of this review suggest there is no strong evidence on the sustained effect of financial services on small enterprise growth.

Despite this, the literature reviewed provides leads on what could work, for whom and in what circumstances.

For example, improving access to finance generally enhances small and medium-sized enterprise (SME) growth. However, while it is commonly argued that the high cost of finance and the eligibility requirements of commercial finance providers are major obstacles, the evidence from this review reveals a more complex picture. The high cost of finance and the limited access SMEs have to it is only one constraint to enterprise growth.

Other factors inhibiting business growth include poor business environments, inadequate infrastructure, corruption, and inexperienced business owners with poor management skills.

While there is evidence to show how stronger linkages between the enterprises and financial institutions can improve access to financial services and induce growth, it is important not to isolate access to finance as a single constraint to growth, but to consider it as part of a more holistic approach.

Small business grants were found to create short‐term firm‐level effects and stimulate market development. While increasing the capital stock of SMEs can have a positive effect on some firm‐level indicators, changes in employment resulting from this type of intervention are smaller.

Grant funds improve the performance of enterprises of all sizes, but the evidence indicates that the sustained impact of these interventions over, say, three to five years, is minimal.

Grants have been used successfully to stimulate the demand among SMEs for business development services, which can contribute to enterprise growth and transition.

Some studies have shown how business plan competitions are a means of focusing grants for maximum likely impact.

Well‐designed banking sector reforms were also found to stimulate competition, develop financial markets and increase credit flows into SMEs. However, if these reforms are to lead to SME growth, they requires a clear understanding of how SMEs can manage risk and growth.

Within the commercial banking sector, there are emerging opportunities for new SME financing instruments, such as leasing and factoring. However, this takes time and requires the right incentive structures for broad institutional change.

Overall, there is a general need for better evidence on the impact of policy and programme interventions on small enterprise growth. Development agencies should invest more in robust evaluations and assessment methods, which isolate and test intervention variables. This includes the use of experimental methods and enterprise panels. Stronger links between policy and programme interventions and the SME research community would be particularly helpful.