BOOSTING SME FINANCE FOR GROWTH The Case for more Effective Support Policies Ana Fiorella Carvajal Tatiana Didier BOOSTING SME FINANCE FOR GROWTH The Case for more Effective Support Policies BOOSTING SME FINANCE FOR GROWTH The Case for more Effective Support Policies SEPTEMBER 2024 Ana Fiorella Carvajal Tatiana Didier © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. The boundaries, colors, denominations, links/footnotes and other information shown in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The citation of works authored by others does not mean the World Bank endorses the views expressed by those authors or the content of their works. Nothing herein shall constitute or be construed or considered to be a limitation upon or waiver of the privileges and immunities of The World Bank, all of which are specifically reserved. Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. Cover design: Diego Catto Val Layout: Good News Resources Sdn Bhd/www.gnrsb.com CONTENTS Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Acknowledgments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiv Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xv CHAPTER 1 The Enabling Role of Access to Finance for Productivity, Growth, and Resilience . . . . . . . 1 CHAPTER 2 The Evolution of SME Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.1 Debt Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.1.1 Bank Lending for SMEs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.1.2 Fintech Lenders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.1.3 Asset-Based Financing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.1.4 Capital Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.2 Equity Financing for SMEs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.2.1 Equity Financing for Innovative Firms . . . . . . . . . . . . . . . . . . . . . . . 7 2.2.2 Equity Financing for Mature SMEs. . . . . . . . . . . . . . . . . . . . . . . . . 8 2.3 Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 CHAPTER 3 A Road Map for Enabling SME Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 3.1 Action 1. Continue Enhancing the Availability of SME Credit Information . . . . . . . . 10 3.2 Action 2. Complete the Enabling Environment for Asset-Based Financing, Including the Implementation of Movable Collateral Registries. . . . . . . . . . . . . . 11 3.3 Action 3. Overhaul Insolvency Regimes. . . . . . . . . . . . . . . . . . . . . . . . . . 12 3.4 Action 4. Complete the Enabling Environment for Alternative Sources of Financing. . . 12 3.5 Action 5. Foster Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 3.6 Action 6. Develop the Enabling Environment for Equity Financing. . . . . . . . . . . . 15 3.7 Action 7. Enhance Consumer and Investor Protection . . . . . . . . . . . . . . . . . . 17 3.8 Action 8. Establish Robust Foundational Infrastructure . . . . . . . . . . . . . . . . . . 18 BOOSTING SME FINANCE FOR GROWTH vii CHAPTER 4 Toward a More Effective Use of Targeted Public Interventions. . . . . . . . . . . . . . . . 19 4.1 Action 1. Enhance Data Availability and Diagnostic Analyses to Ensure Outreach to Underserved SMEs. . . . . . . . . . . . . . . . . . . . . . . . . . 21 4.2 Action 2. Emphasize Financial Additionality and Private Capital Mobilization as Clear Objectives of Targeted Interventions. . . . . . . . . . . . . . . . . . . . . . . 22 4.3 Action 3. Deploy Concessional Financing Sparingly . . . . . . . . . . . . . . . . . . . 23 4.4 Action 4. Leverage Developmental Finance from Donors for Private Capital Mobilization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 4.5 Action 5. Complement Targeted Interventions with Non-financial Support. . . . . . . . 24 4.6 Action 6. Improve the Evaluation of Targeted Interventions . . . . . . . . . . . . . . . 25 4.7 Action 7. Improve Coordination, Including by Better Leveraging Existing DFIs, and Ensure Proper Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 4.8 Additional Recommendations for the Design of Debt Interventions. . . . . . . . . . . 26 4.9 Additional Recommendations for the Design of Equity Interventions. . . . . . . . . . 28 CHAPTER 5 Selected Topics. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 5.1 Women-Led SMEs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 5.2 Financing Investments in Mitigation and Adaptation to Climate Change for SMEs . . . 33 5.3 Financing Agri-SMEs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 5.4 SMEs in FCV countries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 CHAPTER 6 Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Appendix A. Misallocation of Firm Financing. . . . . . . . . . . . . . . . . . . . . . . . . 45 Appendix B. Microenterprises. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Appendix C. Selected Experiences. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Appendix D. Firm Capability and the Connection to Access to Finance . . . . . . . . . . . . 56 Appendix E. The Principles for Public Credit Guarantees. . . . . . . . . . . . . . . . . . . 58 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Notes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 viii BOOSTING SME FINANCE FOR GROWTH LIST OF FIGURES 2.1 Sources of Financing for SMEs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.2 Composition of Debt Financing for SMEs around the World . . . . . . . . . . . . . . . 4 2.3 Composition of Equity Financing around the World . . . . . . . . . . . . . . . . . . . . 8 5.1 GHG Emissions around the World . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36 C.1 Number of Listed Companies at the KOSDAQ in Early Days of Development . . . . . .50 LIST OF TABLES 3.1 Key Sources of Alternative Finance in EMDEs . . . . . . . . . . . . . . . . . . . . . . .13 3.2 Key Sources of Equity Financing in EMDEs . . . . . . . . . . . . . . . . . . . . . . . . 16 4.1 Targeted Interventions Supporting SME Finance . . . . . . . . . . . . . . . . . . . . . 20 C.1 VC-Backed IPOs at the KOSDAQ . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50 D.1 Selected Types of Access to Finance Related Capacity Building Interventions . . . . . .56 E.1 Coverage Ratios and Pricing Policies around the World . . . . . . . . . . . . . . . . . .59 LIST OF BOX 4.1 Lessons Learned from Efficient National Development Financial Institutions (NDFIs) . . . 26 BOOSTING SME FINANCE FOR GROWTH ix Foreword Small and medium enterprises (SMEs), which account for about half of employment worldwide, provide livelihoods for billions of people and their families. Hit hard by the pandemic, SMEs needed public financing-support to remain afloat. As the crisis response shifts to recovery, the international development community is renewing focus on the fundamental question of how to help SMEs flourish. Removing the obstacles to their growth and productivity is at the heart of efforts to create more and better jobs and to eliminate poverty. Access to financing is essential for growth, productivity, and resilience. For decades, governments in emerging market and developing economies (EMDEs) have implemented programs to improve SME access to finance, often at a large budget cost. Yet, the SME financing gap remains large, especially in the least developed countries, and public budgets are tight. How can governments in EMDEs enhance the effectiveness of support policies for SME finance? This new World Bank report, “Boosting SME Finance for Growth: The Case for More Effective Support Policies,” looks at this topic afresh and provides concrete, practical guidance to policy makers. The report draws insights from the experiences of both high- income countries and EMDEs while considering new developments that are changing the landscape of SME financing— such as the rapid emergence of new financial technologies (fintech). The report calls for governments to prioritize improvements in the enabling environment, such as building the core infrastructure for both debt and equity financing. They should encourage the use of fintech and ensure a level playing field for alternative lenders, including fintech lenders, factoring and leasing companies, and microfinance institutions. These actions carry limited fiscal costs but could bring sizeable benefits. Public financing programs are still needed. But governments must adopt a more evidence-driven approach for the design and implementation of support to ensure it reaches the SMEs facing the most critical financial constraints. Robust diagnostics are also essential to tailor interventions to conditions in individual countries, so that they can effectively address the challenges that limit the ability and capacity of financial institutions to reach SMEs. SME finance-support programs should also crowd in private capital. Policy makers must carefully monitor programs for the potential to displace commercial financing, especially programs that provide financing to SMEs at better terms than those available in the marketplace. Such programs can distort incentives for SMEs and for financial providers, limiting market development and availability of financing over the long term. Within this framework, we offer advice for designing and implementing programs to improve both debt and equity financing, through interventions such as lines of credit and public guarantee schemes on the debt side, and investments in equity funds to spur the financing of innovation. Finally, the report also highlights four cases in which the challenges for SME financing have unique features that require a tailored policy approach: the financing of climate change adaptation and mitigation investments by SMEs, the financing of SMEs in the agriculture sector, the financing of women-owned businesses, and the financing of SMEs in countries affected by fragility, conflict, and violence. The recommendations in this report should help policy makers ensure that their SME finance programs promote a thriving SME segment, thereby boosting overall economic growth, productivity, and job creation. Jean Pesme Global Director, Finance Finance, Competitiveness and Innovation Global Practice BOOSTING SME FINANCE FOR GROWTH xi Acknowledgments This report was written by Ana Fiorella Carvajal and Tatiana Didier. The authors are grateful for contributions from the following: Lucero Burga, Pietro Calice, Fatou Fadika, Eva Gutierrez, Justin Hill, Jose Ernesto Lopez Cordova, Andres Federico Martinez, Anica Nerlich, Toshiaki Ono, John Luke Plevin, Alexander Giorgios Sotiriou, John Wilson, Ricardo Bebczuk, and Carlos A. Brutomeso Panizzo. The work was carried out under the guidance of Pablo Saavedra (Prosperity Vice President) and Jean Pesme (Global Director, Finance, Competitiveness, and Innovation Global Practice). For reviewing various sections and providing peer review comments at different stages of the report, we especially thank the following: Mohamed Hassan Abdulkader, Randa Akeel, Irina Astrakhan, Nabila Assaf, Fadwa Bennani, Gian Boeddu, Julian Casal, Leyla Castillo, Loic Chiquier, Shanthi Divakaran, Mary Hallward-Driemeier, Thomas Kenyon, Mona Haddad, Alexandre Hugo Laure, Collen Masunda, Sergio Jose de Mesquita, Thilasoni Benjamin Musuku, Harish Natarajan, Laila Nordine, Bujana Perolli, Aun Ali Rahman, Consolate Rusagara, Matthew Saal, Luz Maria Salamina, Asli Senkal, Sophie Sirtaine, Fiona Elizabeth Stewart, Francesco Strobbe, Ivor Stuck, Ahmed Mohamed Tawfick Rostom, Ghada Teima, Martien Van Nieuwkoop, Niraj Verma, Pedro Xavier Faz de los Santos, and Wei Zhang. This report was supported by the Finance for Development (F4D) Umbrella Program, administered by the World Bank. F4D is a global partnership platform aimed at building deep, inclusive, resilient and efficient financial systems in low- and middle-income countries. Find out more: finance4development.org. Production and design of this report was superbly managed by Eunice Ng and her team at Good News Resources Sdn. Bhd. Cover design was done by Diego Catto Val. Marcy Gessel provided editing assistance. Communications and outreach were led by Youjin Choi, Elizabeth Price, and Nandita Roy. BOOSTING SME FINANCE FOR GROWTH xiii Abbreviations ADB Asian Development Bank IPO initial public offering agri-SMEs agriculture SMEs KOSDAQ Korean Securities Dealers Automated agritech agricultural technology Quotations AML/CFT anti-money laundering and combating the KONEX Korea New Exchange financing of terrorism KOSPI Korea Exchange Main Board ASEAN Association of Southeast Asian Nations KRX Korea Exchange BIS Bank for International Settlements LIC low-income country CBA/NCBA Vodafone and Commercial Bank of Kenya LoC line of credit CCAF Cambridge Center for Alternative Finance M&E monitoring and evaluation CDD customer due diligence MFI microfinance institution CGAP Consultative Group to Assist the Poor MIC middle-income country CRA credit rating agency MSMEs micro, small and medium enterprises DFI development financial institution NAFIN Nacional Financiera DFS digital financial services NBFI non-bank financial institution EBA European Banking Authority NDFI national development financial institution EBRD European Bank for Reconstruction and NGF National Guarantee Fund (Colombia) Development OECD Organisation for Economic Co-operation EIB European Investment Bank and Development EMDEs emerging market and developing PCG partial credit guarantee economies PCGS public credit guarantee schemes EU European Union PE private equity FCV fragile, conflict, and violence R&D research and development fintech financial technology RXIL Receivables Exchange of India Ltd GCF Green Climate Fund S&P Standard and Poor’s GDP gross domestic product SAFE simple agreement for future equity GHG greenhouse gas SMEs small and medium enterprises GPFI G20 Global Partnership for Financial UMIC upper-middle income country Inclusion UNEP United Nations Environment Programme HIC high-income country USAID US Agency for International Development ICCR International Committee on Credit UNSGSA United Nations Secretary-General Special Reporting Advocate for Inclusive Finance for IDFC International Development Finance Club Development IFC International Finance Corporation VC venture capital ILO International Labour Organization WSMEs women-owned (and led) SMEs IMF International Monetary Fund IPCC Intergovernmental Panel on Climate Change xiv BOOSTING SME FINANCE FOR GROWTH Executive Summary New research by the World Bank demonstrates that the lack of competition in the banking sector, missing markets removing debt and equity financing constraints for small and (for example, the lack of equity markets in some countries), medium enterprises (SMEs) can lead to significant gains and inadequate enabling environments that underlie private in productivity, growth, and resilience.1 SMEs in emerging financing to SMEs. As a result, governments have deployed a market and developing economies (EMDEs) often consider wide set of interventions to support the enabling environment the constraints in access to finance one of the top obstacles (for example, development of credit-reporting systems, for business operations and growth. Indeed, smaller private secured transactions and collateral registries, and insolvency firms face the largest financing constraints in middle-income regimes) as well as targeted interventions to directly affect countries (MICs). Removing financial frictions and distortions, the supply of financing with fiscal costs (for example, lines of thereby relaxing access to finance constraints for firms, could credit, partial credit guarantee schemes, and, increasingly, result in large productivity gains of up to 86 percent in MICs, investment programs in venture capital funds). Yet, the credit with the largest gains observed among MICs with lower gap for SMEs in EMDEs persists. The most recent estimates levels of gross domestic product (GDP) per capita. Financial for the formal micro, small, and medium enterprises (MSMEs) constraints hinder not only the productive growth of SMEs, sector as a whole place this gap at 19 percent of GDP as of but also their ability to cope with adverse shocks. World Bank 2020 (about US$5.7 trillion).2 Similarly, the private markets research shows that, during the pandemic, firms with access to for equity financing have remained underdeveloped. external financing were better able to maintain employment levels and avoid falling into arrears. Smaller private firms had Thus, the case for government support remains compelling. the highest probability of being financially constrained during The need for further progress in closing the financing the pandemic. gaps, heightened by recent global developments that are changing the landscape of SME financing—such as the Governments have implemented different types of rapid emergence of new financial technologies (fintech) interventions to address the constraints hampering SME and the growing challenges posed by climate change— access to finance, but huge financing gaps remain. These require governments to review their toolkit of interventions constraints stem from the characteristics of SMEs (high credit to maximize the effectiveness of support policies. This risk, opacity, and lack of suitable collateral). In addition, report supports such review by building on the experiences lending to SMEs is marked by higher transaction costs when of both high-income countries (HICs) and EMDEs to draw compared to large corporates, partly because of the smaller insights and lessons to inform the range of interventions transaction size. These challenges are often heightened in that governments in EMDEs should pursue to close the SME EMDEs given additional supply-side shortcomings, such as financing gap. The Evolution of SME Financing Banks in EMDEs remain by far the main providers of around 0.01 percent of GDP or less in EMDEs, and only a financing for SMEs. But the SME loan portfolios of banks handful of countries have markets with greater depth.3 The in EMDEs remain significantly smaller than those of banks bulk of equity investments in private markets in EMDEs is in HICs. Although SME loans have expanded in real terms concentrated in larger firms, more so than in HICs. Even then, between 2010 and 2020, they have declined as a share of the financing of mature SMEs remains underdeveloped. GDP in MICs and HICs. For example, estimates in this report Including buy-out funds and growth equity, private equity show that SME loans in HICs amounted to 12 percent of (PE) funds represented 0.03 percent of GDP in MICs in 2020 GDP in 2020, compared to 7 percent for MICs and 3 percent versus 0.3 percent in HICs.4 in low-income countries (LICs). Similarly, private markets for equity financing, which are critical to spur innovation, remain While fintech is helping financial intermediaries reach SMEs small in most EMDEs. Venture capital (VC) investments stood and alternative sources of financing are expanding in select EXECUTIVE SUMMARY xv EMDEs, the aggregate impact remains unclear. Case studies lenders are providing working capital to SMEs (for example, and anecdotal evidence suggest that some banks in selected through factoring) and financing for investments (for example, HICs and EMDEs have improved their outreach to SMEs via leasing). Capital markets solutions have also helped via the use of fintech—directly or via partnerships—such as diversify the range of funding sources for SMEs, which can embedded finance. Nonetheless, research is still inconclusive be important in turbulent times, supporting firm resiliency, as regarding the full scope of this increased outreach. Progress well as in normal times, supporting better financing conditions has been made toward expanding the range of alternative for SMEs. Specialized SME exchanges have emerged in some lenders. Some of these new lenders—especially, fintech EMDEs, enabling SMEs to access financing from a wider lenders (digital banks and fintech lending platforms in range of investors for SMEs. Yet all these alternative sources particular)—have reached underserved SMEs, albeit mostly of financing remain small in most EMDEs and are mostly for short-term financing thus far. In addition, asset-based concentrated in large, more developed EMDEs. A Road Map for Enabling SME Finance Governments should prioritize the implementation of an procedures and to simplify in-court insolvency enabling environment to support SME financing. This agenda proceedings to reduce their cost and complexity. carries very limited fiscal costs, while the benefits could be • Action 4. Complete the enabling environment for sizeable. Many EMDEs have embarked on this work, but it is alternative sources of financing. Governments should time to deepen and expand it. Policy makers should aim at support the development of a wide set of alternative lenders building the core market infrastructure, fostering increased use that can foster greater outreach to SMEs. Depending on of fintech, ensuring that an enabling environment for alternative country context, especially the level of financial sector lenders and for equity financing is in place, promoting market development, the enabling environment policy agenda competition, and addressing concerns related to consumer should include proportionate licensing regimes for protection. The following road map, which is consistent microfinance institutions (MFIs), cooperatives, and fintech with the 2022 Updated G20/OECD High-Level Principles on lending platforms; adjustments to bank licensing regimes SME Financing, outlines a list of key actions EMDEs should to allow the entrance of digital banks; and, in MICs with implement urgently, with due consideration to country contexts. more developed capital markets, an enabling environment • Action 1. Continue enhancing the availability of SME for capital markets solutions supporting financing to SMEs. credit information. Governments should continue to • Action 5. Foster competition. Fintech and alternative actively promote the development of credit-reporting lenders can change market structure and competition systems, paying special attention to expanding their dynamics in a way that would hinder SME financing. Key coverage to include alternative lenders and leveraging areas to monitor include market entry requirements and alternative data. coverage of credit reporting systems, with consideration • Action 2. Complete the enabling environment for given to the implementation of open finance programs. asset-based financing, including the implementation Governments can also explore innovative interventions, of movable collateral registries. The adoption of such as platforms to bring multiple financial providers modern secured transactions laws, covering, for example, together and foster competition. factoring and leasing, along with the implementation of • Action 6. Develop the enabling environment for movable collateral registries that formalize and provide equity financing. Focus on private markets and allowing transparency to lenders’ claims, are critical to expanding SMEs to raise funding directly, without triggering the asset-based financing. Lessons indicate the importance of disclosure and governance requirements of a public expanding the range of assets that can be given as collateral, offering. Depending on country context, governments adopting notice-filing, online centralized (or interoperable) should develop the enabling environment for private movable collateral registries, and effective out-of-court funds and equity crowdfunding. In EMDEs with more mechanisms to execute collateral. Other government developed equity markets, governments should initiatives, such as e-invoicing, should be leveraged to strengthen the enabling environment for SME listings. further the development of markets for receivables. • Action 7. Enhance consumer and investor protection. • Action 3. Overhaul insolvency programs. Specialized Governments should ensure that their frameworks SME insolvency regimes should be implemented to lower against deceptive and fraudulent practices apply to barriers and improve access to out-of-court restructuring new providers of financing, and across all types of xvi BOOSTING SME FINANCE FOR GROWTH delivery channels. For capital markets, there is a need essential to leverage fintech for SME financing. Online to balance easing SME access to retail investors with business registration as well as broader digitalization of investor protection. business operations can also support access to finance • Action 8. Establish robust foundational infrastructure. by helping SMEs build “reputational collateral” and thus Digital connectivity and digital payment services are a more robust credit footprint. Toward a More Effective Use of Targeted Public Interventions Enabling environment interventions are necessary, but they • Action 1. Enhance data availability and diagnostic are not always sufficient. Targeted financial interventions— analyses to ensure outreach to underserved SMEs. which carry fiscal costs but can mobilize private investment— There is no universal model of interventions for all may still be needed. In practice, in most EMDEs, a EMDEs to apply. Interventions need to be selected multipronged approach to public intervention is necessary to and designed using rigorous data-driven diagnostics address the debt and equity financing gaps. But policy makers of financing gaps and their underlying causes. Most must be cognizant of the trade-offs in allocating resources EMDEs would need substantial improvements in to support each type of financing, especially when fiscal data collection, reporting, and accessibility to ensure resources are scarce. Debt financing is the most important effective targeting of underserved segments and source of external financing for SMEs in EMDEs, with intermediaries serving them. government support programs exhibiting widespread reach. • Action 2. Emphasize financial additionality and In contrast, schemes supporting equity financing typically private capital mobilization as clear objectives of have a more limited reach, covering a smaller set of SMEs due targeted interventions. Targeted interventions in to their high costs. Policy makers should be realistic about not EMDEs should mitigate key market failures hindering only the desirability of interventions, but also their feasibility private financing to SMEs, while making more strategic and impact, based on their own country contexts. While there use of public funds. To this end, governments need to is no rigid sequencing in the implementation of interventions, improve the design of interventions so that programs governments need to be mindful of the state of preconditions reach their intended beneficiaries, as defined in specific for different financial instruments. The implementation of well- program objectives. Critically, public funds should designed targeted interventions, coupled with improvements be used to leverage additional private financing. in the enabling environment, should enhance SME access to Governments thus need to carefully evaluate the finance. However, without further progress in addressing the sustainability of crowding-in effects, while avoiding underlying causes of the underdevelopment of the financial crowding-out effects. sector more broadly, the effectiveness of such interventions might suffer. Targeted interventions might help push the • Action 3. Deploy concessional financing sparingly. frontiers of the financial sector, but they cannot do all the Concessional financing should be used only in heavy lifting. exceptional circumstances—for example, when it is critical for private capital mobilization—and should Going forward, governments in EMDEs need to substantially include an exit plan. Governments should thoroughly improve the design of their targeted interventions to increase assess (a) whether market failures justify concessionality their effectiveness. Governments must adopt stronger, and determine the objectives to be achieved with evidence-driven approaches to ensure that interventions its use; (b) the extent of potential market distortions, benefit underserved SMEs and focus on addressing the including crowding-out effects for private capital; and key market failures and identified gaps. Furthermore, (c) the need to deploy mechanisms to mitigate such interventions should be designed and deployed in a way risks. Interventions should also embed graduation that fosters financial additionality and mobilizes additional targets (for both SMEs and financial institutions). private financing, thereby promoting the creation of financial • Action 4. Leverage developmental finance markets and reducing the need for public sector support over provided by donors for private capital mobilization. time. The seven recommended actions that follow outline Governments should systematically map the global the agenda to improve the design and implementation of developmental financing available in the SME space targeted interventions. and leverage it through blended finance structures EXECUTIVE SUMMARY xvii to mobilize additional private capital and reduce the • Action 7. Improve coordination, including by need for public financing. better leveraging existing development financial • Action 5. Complement targeted interventions with institutions (DFIs) while ensuring proper governance. non-financial support. Programs to enhance firm Governments should better leverage existing DFIs. capabilities are critical to building a healthy pipeline of For example, governments can ensure that any new SMEs for lending or investing. Depending on country program aimed at implementing targeted financial context, programs to enhance the capabilities of financial interventions is fully coordinated with existing DFI intermediaries and investors might also be needed. programs. This requires stepping up efforts to improve the effectiveness of DFIs, develop a holistic strategy for • Action 6. Improve the evaluation of targeted SME financing, and enhance day-to-day coordination interventions. Governments should establish robust arrangements. Finally, robust governance arrangements and independent monitoring and evaluation (M&E) should be in place to (a) mitigate political interference frameworks aimed at better measuring impact, going in technical decisions; (b) ensure that political interests beyond the typical statistics monitored across EMDEs, do not outweigh long-term program objectives; and (c) such as the number of SMEs and the volume of ensure proper oversight and accountability. financing. M&E systems could also guide the design and implementation of policy interventions. Debt Interventions Governments should more deliberately use targeted to address problems stemming from the high riskiness interventions to foster the development of alternative (perceived and real) of SMEs, which is heightened lenders while continuing to strengthen bank financing for by their opacity, lack of collateral, and limited credit SMEs. Banks have been the key delivery partners for targeted histories. The implementation of PCGs, however, is public support. Yet while banks will remain a key funding complex and requires a certain level of maturity within source for SMEs, they are not sufficient to address the SME institutions to ensure their effectiveness. credit gap. Alternative lenders are critical to closing this gap. • Lines of credit (LoCs) should be used more selectively Thus, governments need to use interventions to foster their to address gaps in the funding markets that affect the development. Three consequences of this requirement are ability of different intermediaries to serve the SME the need for governments to (a) reduce the use of direct segment. In exceptional circumstances, concessional lending; (b) remove requirements that create undue barriers lines of credit could be used to make lending to SMEs for alternative lenders to access interventions by relying more (or a particular segment of SMEs) commercially viable for on proportionate requirements; and (c) consider the use of private lenders and provide better lending conditions to targeted interventions to address the constraints faced by SMEs. alternative lenders. The type of interventions to deploy will • Other interventions: Depending on the country vary depending on country context and could include the context, governments could consider interventions to following. foster the development of capital markets solutions • Capitalization of partial credit guarantee (PCG) that can be used by both SMEs and SME lenders, such schemes: Governments should continue to expand as investment programs and credit risk guarantees (or the implementation of PCGs as the key intervention other risk-sharing arrangements). Equity Interventions Public interventions supporting equity finance in private regulatory environment for equity financing. The economic markets have faced challenges in mobilizing private additionality that these interventions could bring for investors in many EMDEs, especially in LICs. This limited innovation and growth might lead some governments to impact is largely the result of challenges with preconditions, pursue them, irrespective of the challenges. This could be an which relate to uncertainty in the macroeconomic and acceptable choice; however, in such context, governments financial environment, the limited development of an should recalibrate the objectives of their interventions, investor base, and missing components of the legal and understanding that they need to focus on “market creation” xviii BOOSTING SME FINANCE FOR GROWTH and that mobilizing private investors would likely require a including equity as well as other forms of risk capital, such as greater level of financial support across the whole ecosystem mezzanine financing. for a long period of time. Moreover, governments would need to address the structural problems that have hindered In addition, governments need to consider a holistic approach the development of equity financing. In any event, equity to developing the overall landscape for equity financing, interventions, even in MICs, require a longer time horizon entrepreneurship, and innovation to improve the prospects for to reach sustained impact, with governments being ready to effective policy interventions. The scope of support programs provide patient capital. would depend on country context. These programs would likely include technical assistance for SMEs as well as support Overall, in supporting equity financing through private for the creation of other entities that can play an instrumental markets, governments need to apply private sector practices role in building the deal flow, such as incubators and to improve the mobilization of private capital. In practice, accelerators. Capacity building to support the development this means relying on private sector structures—in particular, of the investor base might also be needed. Governments funds—to achieve scale and diversification. The management in EMDEs should focus on interventions for equity financing of funds should be professional and independent, free of in private markets, but for a select set of EMDEs with more government interference. Such an approach would ensure developed public equity markets, governments could that public investments follow the market. There should carefully assess the feasibility and potential impact of other also be flexibility in the type of financial instruments used, interventions, such as to support SME listings. The Need for a Tailored Approach for SMEs in Select Cases Evidence suggests that SMEs face additional challenges attention to climate adaptation investments. Thus far, both to access financing in select cases that require a tailored policies supporting the enabling environment as well as approach to public support interventions. While there is a targeted interventions have emphasized climate mitigation need for more data, research, and systematic evaluations that efforts. Second, access to finance for SME adaptation requires can better guide the design of effective interventions, some a bottom-up approach that prioritizes localized solutions with relevant cases follow here. widespread reach across SMEs vulnerable to physical risks (such as extreme climate events). In contrast, a top-down approach Women-owned (and led) SMEs (WSMEs). Addressing gender could be a more effective way of supporting mitigation for gaps in SME financing requires strong commitment from SMEs. That is, government decarbonization efforts should focus policy makers, starting with the integration of a gender lens in on large businesses, but greater emphasis and support should the design of SME access-to-finance interventions. World Bank be given to SMEs that are part of large businesses’ global supply experiences supporting governments in closing the gender chains or those SMEs for which decarbonization efforts might finance gap highlight the importance of earmarking resources be needed to ensure competitiveness, such as those directly for WSMEs and relying on a wider range of financial providers exporting to countries with high sustainability standards. Third, for the deployment of targeted financial interventions. the public good feature underlying adaptation and mitigation Governments should also place increased attention on the investments, which is often perceived as lack of a business development of customized financial offerings for women case for such investments by individual SMEs, justifies the entrepreneurs, including alternative delivery channels (that is provision of concessional financing to SMEs. Fourth, the high digital channels), staff training on how to engage with women uncertainty surrounding these investments tends to increase entrepreneurs, and the provision of tailored non-financial their risk versus conventional investments. Hence, policy services for WSMEs to complement core financial services. makers could place greater emphasis on de-risking adaptation These efforts should be anchored in the collection of gender and mitigation financing. disaggregated data. Financing SME investments in adaptation and mitigation Financing adaptation and mitigation efforts by SMEs. requires efforts to complete the enabling environment, Addressing the impact of climate change on SMEs requires but governments should pay close attention to a recalibration of government efforts. First, policy support unintended consequences. Taxonomies and climate-related for SME finance needs to be rebalanced to provide greater disclosure requirements are essential building blocks of the EXECUTIVE SUMMARY xix enabling environment for the financing of sustainable and partnerships may be needed. Finally, governments should climate-resilient projects; but they may have unintended consider demand-side interventions to improve agri-SMEs’ consequences and negatively affect financing to SMEs. integration into value chains, their access to markets, and their For instance, financial institutions may reallocate their loan business performance. portfolios away from SMEs highly exposed to physical and transition risks. They may also retrench from borrowers that SMEs in countries affected by fragility, conflict, and violence are unable to provide information on climate-related risks. (FCV). Governments should prioritize the development of For SMEs, the need for additional information, and even the enabling environment, with emphasis on basic credit certification in some instances, would also increase transaction infrastructure and the infrastructure necessary to leverage costs and may discourage some SMEs from seeking financing fintech. Targeted interventions should focus on unlocking in the first place. Akin to such challenges, if alternative lenders debt financing, especially interventions that address the high are not able to track climate-related risks in their own lending riskiness of SMEs, such as PCGs, combined with enhanced portfolios, they may face constrained access to funding, non-financial support to SMEs and financial intermediaries. hindering their ability to serve their SME clients effectively. Concessional financing might be warranted, but its use needs to be carefully assessed to mitigate unintended Agriculture SMEs (agri-SMEs). Governments need to place consequences, including to overall financial market increased emphasis on scaling up commercial financing for development. Equity interventions should also be carefully agri-SMEs through greater use of risk-sharing mechanisms, assessed, given the greater challenges that FCV countries such as PCGs, while deploying LoCs conditioned to private face in mobilizing private capital and creating financial capital mobilization. In addition, a wider set of financial markets. Capacity constraints and security concerns might providers should be included in these interventions, along require adjustments in the design and implementation of with strengthened use of technical assistance. A key additional interventions, such as the simplification of eligibility criteria consideration is the need to incorporate mechanisms to and delivery and evaluation through third parties. Finally, strengthen the resiliency of agri-SMEs to shocks, including a holistic approach to the business enabling environment through insurance markets, for which public-private agenda is warranted. xx BOOSTING SME FINANCE FOR GROWTH CHAPTER 1 The Enabling Role of Access to Finance for Productivity, Growth, and Resilience Small and medium enterprises (SMEs) are the backbone years. For 2019, the gap was estimated to be about US$5.7 of the economy in most emerging market and developing trillion, equivalent to 19 percent of GDP and 20 percent of economies (EMDEs), but they face critical challenges the overall private sector credit issued by banks in EMDEs.8 in access to finance. SMEs represent roughly 9 out of 10 These percentages are roughly at the same level as they were businesses globally, account for more than 50 percent of in 2015.9 Similarly, the private markets for equity financing employment in EMDEs, and contribute to 40 percent of gross remain underdeveloped in most EMDEs. domestic product (GDP).5 Disruptions caused by the recent COVID-19 pandemic have raised global awareness about the Addressing the financial distortions that hinder SME access importance of SME resilience for countries’ overall economic to finance could yield significant gains in economic growth prospects. Yet, a complex set of challenges constrains SME and productivity and could also bolster private sector resilience, growth, and productivity and thus hinders their resilience.10 World Bank research shows that smaller private potential to create more and better jobs. SMEs in EMDEs often firms face the largest financing constraints in MICs. Removing consider access to finance (or the lack thereof) a critical obstacle financial frictions and distortions, thereby relaxing firms’ for business operations and growth.6 Indeed, there are sizeable financial constraints, could boost MICs’ productivity by up differences in access to debt and equity financing for SMEs in to 86 percent. Moreover, the estimations show that larger EMDEs compared to SMEs in high-income countries (HICs). For productivity gains would accrue for smaller firms than for larger example, Didier and Cusolito (2024) show that smaller private firms. Importantly, these gains diminish as income levels rise. firms, especially those with fewer than 100 employees, face the As such, countries with lower GDP per capita would benefit largest financing gaps in middle-income countries (MICs).7 more from a more efficient allocation of finance toward smaller firms. Financial constraints not only hinder the productive Despite widespread public support programs in EMDEs, growth of SMEs, but they also hamper their ability to cope with SMEs continue to face a sizeable financing gap. Government adverse shocks. World Bank research shows that, during the support in EMDEs has consisted of interventions to pandemic, firms with access to external financing were better develop the enabling environment, with efforts focused on able to maintain employment levels and avoid falling into strengthening critical financial infrastructure (for example, arrears. Smaller private firms had the highest probability of credit information systems, secured transaction frameworks, being financially constrained during the pandemic. Countries and insolvency regimes) and targeted interventions aimed at with higher GDP per capita and with more developed financial increasing the supply of financing for SMEs (for example, via markets had less financially constrained firms. Appendix A the provision of lines of credit [LoCs], partial credit guarantee provides a detailed summary of this research. [PCGs] schemes, and the implementation of investment programs in venture capital funds). Thus far, there is limited Governments should thus focus on mitigating the key market evidence that government support programs have been failures and frictions that hinder SME access to finance.11 widely successful in fostering SME financing. The most These market failures relate to the inherent characteristics recent estimates focus on the micro, small, and medium of SMEs, namely (a) their greater opacity (SMEs often lack enterprise (MSME) financing gap and show that the credit credible financial statements); (b) their relatively high riskiness gap for formal MSMEs has remained fairly constant in recent (this is partly a reflection of lower capabilities and financial 1. THE ENABLING ROLE OF ACCESS TO FINANCE FOR PRODUCTIVITY, GROWTH, AND RESILIENCE 1 literacy); and (c) their lack of suitable assets for debt financing, sector are typically composed of new reporting and disclosure in particular immovable assets that could be used as collateral requirements for regulated financial institutions related to the and could also mitigate the challenges associated with (a) climate risk exposures of their portfolio. These additional and (b). Due to information asymmetries and a lack of tools reporting requirements may hinder SME financing precisely to overcome them, lenders face great difficulties in assessing because of the opacity of small firms and their limited capacity SME creditworthiness, monitoring their actions, and enforcing to provide data on environmental performance. These repayment, which negatively affect lending to these firms. issues can be particularly challenging when firms’ capabilities Lending to SMEs is also marked by higher transaction costs and financial literacy are already in need of strengthening. compared to large corporations due in part to the smaller Authorities thus need to support SMEs in their journey to adapt transaction size. Furthermore, additional challenges emerge to new climate conditions by adding new targeted interventions from the structure and level of development of the financial that facilitate access to sustainable financing options. sector, which are more pronounced in EMDEs. A low degree of bank competition hinders bank lending to SMEs.12 The more At this critical juncture, this report will assist policy makers limited development of financial markets in EMDEs can also in EMDEs in reviewing and strengthening their access to constrain the role of financial intermediaries and investors in finance support programs by providing a strategic view of SME financing. Finally, EMDEs typically have underdeveloped the key issues involved in SME financing. This report builds financial infrastructures, especially credit information systems, on the experiences of both HICs and EMDEs, drawing on as well as deficient enabling environments supporting private the lessons learned, to help EMDEs deploy more effective investors, such as limited property rights, low contract interventions. This report focuses exclusively on SMEs and enforcement, and an inefficient judiciary system.13 does not cover microenterprises because of their unique characteristics, such as their high level of informality and sole The increased use of financial technology (fintech) in SME proprietorship, which require a dedicated policy agenda. financing has brought additional benefits and risks that Appendix B briefly explains the key differences between SMEs require governments to adjust their interventions.14 Fintech and microenterprises and the impact on the policy agenda. has the potential to address some of the critical challenges hindering access to finance for SMEs. For instance, the use This report is organized into five additional chapters: of alternative data and new credit-scoring methods seems • Chapter 2 provides evidence on the evolution of external to effectively mitigate the frictions related to information sources of financing for SMEs, contrasting EMDEs versus asymmetries and to some extent also the lack of acceptable HICs, considering both bank and non-bank financing, collateral. Moreover, fintech solutions have the potential to and whether and how fintech is changing the landscape reduce the high transaction costs and enable scalability in for SME financing. Such a diagnostic is crucial for the SME financing by increasing digitalization and automation. assessment of an adequate set of policy options. However, fintech solutions do not tackle all the constraints of • Chapter 3 provides a road map for EMDEs to tackle access to finance for underserved SMEs. The higher riskiness the core enabling environment necessary to foster the (perceived and real) of the SME segment remains largely development of debt and equity financing for SMEs. unresolved by fintech solutions. While financial institutions • Chapter 4 delves into targeted interventions to affect have leveraged the predictive powers of big data and artificial the supply of both debt and equity financing to SMEs, intelligence for short-term, working capital loans, they have focusing on key recommendations to improve their yet to explore those tools for longer-term loans.15 Importantly, effectiveness. fintech’s use also raises new obstacles that can constrain access to finance. For example, fintech may exacerbate • Chapter 5 discusses four selected cases that require a risks to competition, consumer protection, and data privacy tailored approach to policy support: access to finance and cybersecurity. Thus, governments need to adapt their (a) to women-owned (and led) business (WSMEs); (b) interventions to this new environment, fostering the use of to support climate change mitigation and adaptation fintech while ensuring that risks are adequately mitigated. efforts by SMEs; (c) to agriculture SMEs; and (d) to SMEs in fragility, conflict, and violence (FCV) countries. The Furthermore, climate change has added another set of chapter addresses two main questions: (a) whether and challenges to SME financing that requires a different how the factors that constrain access to finance for SMEs set of interventions. On one hand, SMEs will need access in each of these cases are different from those outlined in to finance to undertake climate mitigation and adaptation chapter 3, and (b) whether and how public interventions efforts that can support their competitiveness and resilience. should differ from those described in chapters 3 and 4. On the other hand, the financial sector’s increased adoption • Chapter 6 brings the landscape of SME financing of sustainability practices may pose additional challenges for and government support together, highlighting key SME financing. The additional levers of policy for the financial messages and recommendations. 2 BOOSTING SME FINANCE FOR GROWTH CHAPTER 2 The Evolution of SME Financing SMEs rely on different forms of funding, both internal does this evolution of financing options mean for SMEs? Has and external, to support their activities and growth.16 financing become less of a constraint? Are banks less relevant This report focuses on external financing options, which vary today? Should governments rethink their support to ease the according to SME size, financing needs, and risk profile (figure constraints hindering access to finance for SMEs? This chapter 2.1). The range of financing options has evolved over time aims to shed light on these questions by offering an updated in EMDEs, with fintech offering new opportunities. But what view of the SME financing landscape. 2.1 Debt Financing 2.1.1 Bank Lending for SMEs Globally, banks remain the main source of external debt For example, the volume of SME loans is smaller in MICs financing for SMEs in both developed and developing than in HICs when measured as a share of GDP. In 2020, countries (figure 2.2). In HICs, SMEs have access to other SME loan volume represented 7.4 percent of GDP for MICs sources of debt financing outside of banks, as these sources versus 11.9 percent for HICs. Although comprehensive (for example, receivables financing, leasing) are relatively data for LICs are limited, evidence from a small subset of well-developed. However, this is not the case in MICs and countries indicates that SME bank loans represented an even low-income countries (LICs). In most EMDEs, bank loans smaller share of GDP, estimated at 2.6 percent for the median account for the bulk of the debt financing for SMEs. Such country.17 SME loans expanded in real terms between 2010 dominance by the banks arguably reflects the competitive and 2020, but they have declined as a share of GDP in MICs advantages of their business model, for instance, their access and HICs. The MIC-HIC differential has remained relatively to relatively cheap funding from deposits and their ability to stable over time. The small size of the banking sector in cross-sell and bundle products. EMDEs explains, at least in part, the underdevelopment of bank financing to SMEs. Research also shows that economic Despite being the main source of debt financing, bank and financial development is positively correlated with SME lending to SMEs is still relatively underdeveloped in EMDEs. loans from banks.18 2. THE EVOLUTION OF SME FINANCING 3 FIGURE 2.1 Sources of Financing for SMEs Financing Needs: Capital Long term Markets Private Equity Markets Medium term Crowdfunding Leasing Platforms SME Exchanges Lending Platforms Banks Short term Microfinance Factoring Micro Small Medium Large Source: Original figure for this publication. FIGURE 2.2 Composition of Debt Financing for SMEs around the World Total Outstanding Debt Volume, 2020 HIC MIC 14 12 10 8 % GDP 6 4 2 0 Bank loans Receivables Leasing Fintechs Minibonds financing Source: Original calculations for this publication based on data from International Monetary Fund, Organisation for Economic Co-operation and Development, Asian Development Bank, World Bank, Factoring International, World Leasing Yearbook, Cambridge Centre for Alternative Finance, Moody’s, Bank for International Settlements, and Standard and Poor’s (S&P). Note: The figure shows the median across countries within income groups. The data in the figure are as of 2020, except for digital banks (within fintech) which are as of 2019. Fintech debt includes only SME loans from digital banks, big tech, and digital lending platforms. SME bank loan data cover 78 countries (31 HICs, 47 MICs), receivables financing data cover 83 countries (HICs: 44, MICs: 39), leasing data cover 49 countries (HICs: 31, MICs: 18), digital banks data cover 10 countries (HICs: 7, MICs: 3), big tech data cover 28 countries (HICs: 6, MICs: 22), and digital platforms data cover 61 countries (HICs: 34, MICs: 27). Existing evidence suggests that banks are leveraging Growing evidence indicates that some banks in selected fintech for SME financing; however, the specific impact HICs and EMDEs have expanded their outreach to SMEs— of such change has not yet been quantified. Globally, see appendix C for selected examples. Nonetheless, more banks have started to adopt fintech solutions through various research is needed to reveal the true scope of the evolving means, including in-house initiatives; acquisition of fintech landscape. firms; and strategic partnerships, such as embedded finance.19 4 BOOSTING SME FINANCE FOR GROWTH 2.1.2 Fintech Lenders New financial providers leveraging fintech solutions under an embedded finance model.28 Estimates indicate (“fintech lenders”) have emerged, but they remain that big tech had facilitated about US$700 billion in loans relatively small players and have a more active presence as of 2020, 10 percent of which went to SMEs.29 in select HICs and MICs. Digital banks represent the largest segment for SMEs among these new financial Growing evidence indicates that fintech lenders have been providers, although their lending volumes remain small when reaching underserved SMEs. For example, compared to compared to the incumbent banking sector. As of 2020, the banks, digital lending platforms have financed riskier SMEs, total portfolio of digital banks amounted to US$660 billion according to studies conducted in Germany, the United worldwide, with SME loans estimated at about 10 percent Kingdom, and the United States. These studies also show of the total.20 Thus, compared to the overall size of banks’ that the lending volumes of digital lenders have been larger portfolios, their importance in SME financing is still limited.21 where bank coverage has been lower.30 In China, more than Digital banks in HICs account for 60 percent of digital bank three-quarters of SMEs served by digital banks were first- assets worldwide, those in China for another 30 percent, time borrowers.31 Similarly, evidence from a recent World and the rest in a few large MICs.22 In some countries, digital Bank survey shows that fintech lenders across HICs and banks have become large players in the SME segment. EMDEs have targeted underserved segments, including For example, in the United Kingdom, digital banks have SMEs.32 Case studies highlight the use of alternative data established themselves as a dominant force in SME lending and enhanced credit-scoring methods as key factors for since starting operations in 2015.23 Likewise, in China, fintech lenders’ greater outreach to SMEs.33 Mybank has served over 45 million SMEs, which is about one-third of SMEs in China.24 Digital lending platforms have Despite their outreach to underserved SMEs, fintech also gained prominence in the SMEs space.25 As of 2020, lenders face marked challenges in scaling up operations. digital lending platforms had facilitated US$44 billion in debt Fintech lenders that do not take deposits, such as digital financing to SMEs globally.26 Akin to trends in digital banks, lending platforms, have difficulty accessing funding at lending platforms are operating across many EMDEs, but competitive rates. Digital banks have struggled to create volume-wise, their importance is concentrated in HICs and revenue sources that extend beyond transaction fees. Big selected EMDEs.27 While big tech firms are growing players tech companies have yet to settle on the extent to which in SME financing, the bulk of their financing is channeled their financial activities belong to their core business model through digital banks or through traditional banks, often and are deployed at scale. 2.1.3 Asset-Based Financing Asset-based financing can be particularly attractive for are subject to high information asymmetries, and are thus SMEs as it can mitigate their lack of immovable assets perceived by lenders as posing a higher credit risk, are more and heightened credit risk by working with alternative likely to finance investments with leasing.35 SMEs in construction sources of collateral.34 Receivables financing, also referred and manufacturing, in particular, have benefited from access to to as factoring, can be an important source of short-term, leasing.36 working capital financing for SMEs. Long payment periods have been a recurring challenge for SME operations. Factoring Fintech solutions have given a boost to receivables allows SMEs to use the invoices originated from the sale of their financing, but financing volumes are relatively small in goods and services to secure short-term financing. Moreover, EMDEs. Different types of factoring platforms have emerged, for financiers, the risk of these transactions is largely based on some based on traditional factoring, and others based on the credit risk of the (higher quality) buyer, not the credit risk reverse factoring.37 Some platforms are on-balance-sheet of the SMEs. Another asset-based financial product is leasing, lenders, akin to a lending institution; other platforms are which significantly lowers the credit risk of a borrower, as the closer to capital markets and simply connect SMEs and risk for leasing providers is limited to the value of the leased investors, thus providing off-balance-sheet financing. These asset itself, whose ownership tends to remain with them until platforms can reduce transaction costs, increase the speed the end of the contract. Leasing provides financing for longer- of transactions, and facilitate access to finance for SMEs in term, capital investments for SMEs. Research has shown remote areas. Platforms, especially in countries that have that, indeed, SMEs with limited immovable collateral, who implemented e-invoicing, can also reduce the risk of fraud 2. THE EVOLUTION OF SME FINANCING 5 and facilitate enforcement as transactions are recorded in a of-court enforcement mechanisms, and robust financial centralized system. Finally, online platforms allow SMEs to infrastructures, especially credit information systems.39 build a credit history, which can facilitate access to other Asset-based financing requires modern secured transaction forms of financing. These fintech platforms for receivables laws that can provide efficient mechanisms to constitute financing remain relatively small in EMDEs, with financing security interest. In addition, it requires well-functioning volumes estimated at US$686 million in MICs in 2020. The collateral registries, offering cost effective usage and easy global fintech market for receivables financing is currently accessibility (for example, online registries). Recent evidence estimated at US$4.2 billion, which equals about 1 percent of indicates that robust credit information systems have also the total receivables financing market as of 2020.38 played a role in asset-based financing. These markets are thus typically more developed in HICs and a select set of MICs. Fintech has also facilitated leasing, for instance by providing Receivables financing is particularly well-developed in HICs, better risk management tools. Digital technologies, such as which account for almost 80 percent of global volumes.40 global positioning systems and machine learning solutions, Upper-middle-income countries (UMICs) account for the bulk can make it easier to track and evaluate the state of a leased of the remaining 20 percent. Factoring volumes for the total asset. The emergence of online market auctioneers for used market (that is, not just SMEs) surpassed 5 percent of GDP for products has improved the liquidity of secondary markets for the median HIC in the sample but were only about 0.8 percent movable assets in HICs, which allows leasing companies to for the median MIC in 2020. Similar patterns are observed in better manage risks. leasing markets: financing volumes for the total market were 2 percent of GDP for the median HIC and 0.65 percent for the Asset-based financing is more developed in countries with median MIC in 2020.41 supportive legal and regulatory frameworks, effective out- 2.1.4 Capital Markets Capital markets solutions, such as minibonds and debt Beyond stable macrofinancial conditions, the development funds, allow SMEs to tap into a different set of financiers.42 of capital market solutions for SMEs typically occurs Access to capital markets not only brings diversification of when certain preconditions are in place. For example, funding sources to SMEs but also may provide additional minibond markets often emerge in countries with relatively benefits. For example, minibond issuers have been able to well-developed corporate bond markets, whereas debt funds obtain lower interest rates on their subsequent bank loans.43 often require a strong asset management industry. Both Bonds have mostly been issued by medium companies types of instruments also require a strong base of investors, (owing to a de jure or de facto minimum issuance size), especially institutional investors. Moreover, their development whereas debt funds have supported a wider range of usually requires the implementation of specialized legal and SMEs, as these funds can invest in a range of assets (from regulatory regimes. Overall, capital market solutions for SMEs receivables to SME loans and minibonds).44 Some of are more readily available in HICs and a few large, financially these debt funds buy the assets from SME lenders, others developed, EMDEs. For example, minibond issuances have originate the assets themselves. been concentrated in Europe, and only a few other countries, such as Argentina, China, Peru, and the Republic of Korea have Capital markets have also provided SME lenders with developed the segment at a more limited scale. Debt funds indirect mechanisms to support SME financing. Specifically, have grown rapidly over the past 10 years, especially in HICs capital markets solutions have been used by SME lenders to and some MICs, such as Brazil and Mexico, but only a small improve their funding structure, allowing them to compete fraction of the funds have targeted SMEs. In contrast, plain more effectively in credit markets, which in turn can result in vanilla issuances by SME lenders can be found across a wider an expansion of financing to SMEs, improvements in lending range of EMDEs, as they only require basic corporate bond conditions, or both. In many countries, banks (and other markets. Other instruments, such as SME loan securitization, SME lenders, to a lesser degree) use capital markets to raise remain niche products, even in HICs.45 long-term funding through relatively simple instruments, such as plain vanilla bonds. In more sophisticated capital markets, both banks and other SME lenders have also resorted to instruments more directly tied to their SME portfolios, such as the securitization of their SME loans. 6 BOOSTING SME FINANCE FOR GROWTH 2.2 Equity Financing for SMEs 2.2.1 Equity Financing for Innovative Firms Although the majority of SMEs rely on debt as their main with the top-five segments for global VC investments during source of external financing, equity financing can be 2010–19 being technology, media, and telecommunications; powerful in spurring innovation.46 Innovative activities are mobile; software as a service; artificial intelligence and inherently risky and generally entail investments in intangible machine learning; and e-commerce.54 These top-five assets, such as research and development (R&D), that provide segments accounted for more than 70 percent of the value of limited collateral value. Consequently, these investments can VC investments and more than 70 percent of the number of be hard to finance with debt. While equity can fund any type firms that received VC investments, not only in HICs, but also of investment, it often disproportionately benefits firms with in MICs. investments in such innovative activities. Fintech has started to play a role in the financing of Private markets, especially venture capital (VC), are the innovative firms through crowdfunding platforms, but main source of equity financing for SMEs; however, they these platforms remain markedly small in most EMDEs. remain small in most EMDEs.47 While the median HIC While VC funds are dominated by professional investors, country has VC investments at around 0.3 percent of GDP per crowdfunding platforms have enabled retail investors to fund year, such investments stand at about 0.01 percent of GDP SMEs directly through equity and quasi-equity instruments.55 (or less) in MICs, and only a handful of EMDEs have markets Research in HICs suggests that crowdfunding platforms are with greater depth (figure 2.3).48 Moreover, fewer firms obtain more likely to fund highly innovative, high-risk companies financing from VC in EMDEs compared to HICs. For example, that may otherwise fail to raise capital from VC funds.56 VC investments did not reach more than 10 companies per However, whether those companies are able to obtain follow- million people in a given year in any EMDE country during on funding from other sources and thrive in the long term 2010–19, whereas among HICs, VC investments often remains an open question. These platforms have developed reached more than 80 companies per million people. mostly in HICs and a few MICs (for example, Brazil, India, Malaysia, and South Africa). According to Cambridge Center VC investments in EMDEs are concentrated in relatively for Alternative Finance (CCAF) data, equity crowdfunding large and mature firms.49 Contrary to popular perception, VC reached US$2 billion globally in 2020, which represents less investments have limited reach to startups and young firms, not than 0.1 percent of the VC industry.57 only in EMDEs, but even in HICs.50 VC arguably plays a more prominent role in funding the next stage of the innovation The limited institutional investor base and the small cycle, when companies commercialize their innovation.51 scale of private markets for equity financing explain, In fact, the bulk of VC investments is concentrated in firms at least in part, the focus of VC investments on larger that are five years old or older in both UMICs and HICs.52 In and more mature firms in EMDEs.58 With a limited range addition, VC investments in MICs are concentrated in relatively of investment opportunities in smaller markets, the stakes larger firms than VC investments in HICs. For example, during are higher for each individual transaction. Thus, equity 2010–19, firms with more than 350 employees accounted for investors have incentives to be more risk averse and about 70 percent of the volume of VC investments in MICs focus on larger and more mature firms whose viability compared to 35 percent in HICs. and credibility are likely to be well established. These credentials also enhance investor exit options. The lack VC investments have focused on a narrow set of high-tech of a robust domestic investor base is another important sectors in both HICs and EMDEs. Historically, VC funds have factor. Although foreign investors can play an important typically funded segments in which the uncertainty about the role for market development, research shows that these viability and commercialization of ideas can be resolved within investors tend to be less informed about local markets the time frame of VC financing cycles (typically between 8 and and are more risk averse than domestic investors. Hence, 10 years).53 Overall industry size and performance may also they favor larger and more mature firms.59 For example, VC play a role, as they affect not only the risk-return profile of investments in MIC companies with investor participation the VC transactions, but also the exit options for investors. from HICs were almost double the size of VC investments Over the recent past, the focus has been on high-tech sectors, with only domestic investors.60 2. THE EVOLUTION OF SME FINANCING 7 FIGURE 2.3 Composition of Equity Financing around the World a. Capital invested b. SME exchanges 0.5 HIC MIC Market capitalization % GDP (2021, median country) 0.4 0.30 Capital invested % GDP (2020, median country) 0.3 0.20 0.2 0.10 0.1 0.00 0.0 Private Venture Crowdfunding HIC MIC equity capital Source: Original calculations for this publication based on McKinsey, Datastream, and CCAF. 2.2.2 Equity Financing for Mature SMEs Private equity (PE) funds have reached only a few larger SMEs, SME exchanges have emerged and are often grounded on and thus have not been a consistent source of financing lighter listing requirements than those of the traditional for mature SMEs. PE financing, including financing through public equity markets. Their strategies have varied. Some buy-out and growth equity funds, represented about 0.03 SME exchanges target mature, profitable SMEs (for example, percent of GDP in MICs in 2020, compared to 0.3 percent the Alternative Investment Market in the United Kingdom, of GDP in HICs (figure 2.3). While the volume of PE financing Alternext in France, and the National Stock Exchange and the is larger than the volume of VC financing, PE has funded BSE in India), while others brand themselves as hubs for high- fewer SMEs as transactions are significantly larger. In 2020, tech companies (for example, KOSDAQ in Korea and Mothers the median transaction size for VC investments in MICs was Exchange in Japan). Some of the latter set seem to have estimated at US$300,000, while the amount climbed to US$6 created positive spillovers for the VC industry, arguably by million for PE investments.61 Hence, PE financing is typically enhancing the exit options for investors.63 (See appendix C.) only a viable source of funds for larger SMEs, which often There are currently 90 SME exchanges worldwide, although benefit from equity funding to turn their companies around only about 40 percent of them, in HICs and large MICs (such and improve profitability. as China, in particular), are active. Over the last 20 years, SME exchanges have emerged However, a more complex set of challenges affects equity in a wide range of economies, but less than half of these financing in EMDEs. The underdevelopment of both private exchanges remain active. The traditional public equity and public equity markets in EMDEs points to challenges in markets have not successfully attracted SMEs.62 Disclosure and expanding equity markets more broadly.64 Such challenges corporate governance requirements are costly, compliance is include a thin pipeline of companies ready to invest; a shallow difficult, and in many cases, SMEs are reluctant to open their investor base; and deficiencies in the enabling environment capital to third parties. Furthermore, the limited liquidity of for equity financing, including inadequate investor protection SMEs, the lack of research coverage, and the small ticket (for example, for minority shareholders) and corporate size hamper investor interest. Consequently, specialized governance issues.65 8 BOOSTING SME FINANCE FOR GROWTH 2.3 Summary SMEs continue to face both debt and equity financing financing and the role of equity financing for innovation gaps; addressing these gaps will require deliberate and growth. It should also reflect the new environment in government intervention. While progress has bridged which SME financing is taking place, especially regarding the some of these challenges, especially in certain MICs, increased use of technology. Furthermore, when determining substantial gaps remain particularly marked in LICs. Against the range of interventions to deploy, governments should be this backdrop, governments in EMDEs should continue to mindful of the preconditions necessary to develop specific prioritize access to finance for SMEs. However, the evidence types of financing solutions. Governments should also presented in this chapter highlights the need to revisit the consider the role that a stable macroeconomic environment toolkit of interventions, both for the enabling environment and robust institutions play in fostering the development of and for targeted interventions. This revised toolkit should a vibrant financial sector. These issues will be covered in the place increased emphasis on alternative sources of debt next chapters. 2. THE EVOLUTION OF SME FINANCING 9 CHAPTER 3 A Road Map for Enabling SME Finance As a starting point, governments should focus on urgently financing, in particular their opacity (that is, lack of reliable completing a core enabling environment agenda to support financial information), their lack of “suitable” collateral, and SME financing. While empirical research highlights the their higher credit risk (perceived and real). Lessons learned importance of a wide range of issues for SME financing, from from policy implementation in HICs and EMDEs reinforce the economic fundamentals to solid institutions, governments relevance of these components, but also reaffirm the need to should continue to prioritize components of the enabling deepen reforms. In addition, new areas should be brought environment that can materially impact SME financing.66 to the core agenda, focusing on the development of an Implementing this agenda carries very limited fiscal costs, yet enabling environment for alternative lenders and for equity the benefits could be sizeable. financing. For purposes of this report, alternative lenders are any lender that is not a traditional bank.67 As these reforms are The core agenda pursued by many EMDEs for the last 20 implemented, other areas will require updating, including a years remains highly relevant, but enhancements should greater focus on consumer protection and competition. Finally, be pursued, and new areas of attention added. The core the enabling environment to leverage financial technology policy agenda has focused on three main components: constitutes a cross-cutting issue. The following road map, (a) the development of credit-reporting systems; (b) the which is consistent with the 2022 Updated G20/OECD implementation of frameworks for secured transactions High-Level Principles on SME Financing, provides guidance along with collateral registries; and (c) the implementation of specific to EMDEs regarding key actions needed to urgently effective insolvency frameworks. These core components aim implement this extended core agenda while recognizing that to mitigate key market failures and challenges that affect SME country context matters. 3.1 Action 1. Continue Enhancing the Availability of SME Credit Information Credit reporting systems can mitigate critical market Governments in EMDEs should continue to actively promote failures that affect SME financing, especially information the development of effective credit reporting systems. asymmetries between lenders and SMEs, by providing Removing legal obstacles for the exchange of credit objective information that lenders can use in their credit information is the first step toward developing these systems. risk assessment processes. These systems also allow SMEs Still, experiences in EMDEs indicate that, in many cases, to build a credit history that they can use as “reputational governments need to establish the necessary incentives for collateral” to access formal credit outside established lending such information exchange to take place. Depending on relationships. Existing evidence has positively linked credit country context, such incentives could include mandatory reporting systems with SME lending.68 reporting. In countries where credit reporting systems do not 10 BOOSTING SME FINANCE FOR GROWTH develop organically, governments should actively engage in access to utility data; in Kenya, they have access to mobile supporting their creation, as many EMDEs have done.69 In payments data; and in the United Kingdom, they have access addition, governments have a key regulatory role: (a) ensuring to information on house rents. The use of such data, however, a level playing field in information access for new entrants; (b) raises concerns about data privacy and data protection when ensuring open and equal access to credit reporting systems individuals’ personal information is involved.72 Governments for regulated and unregulated lenders; (c) identifying and should thus foster the responsible use of alternative data by eliminating anticompetitive pricing policies; and (d) preventing enacting the necessary regulations and guidance. 73 the formation of closed user groups.70 Governments should also explore expanding access to Once credit reporting systems are established, governments government data to lenders. Government agencies hold a should focus on ensuring the inclusion of alternative lenders wide range of data relevant for SME financing, including data and on enhancing the availability of alternative data. on business registration, tax, and land records. Accessing Regarding the former, banks are often reluctant to extend such data can be time-consuming and costly. Improving information sharing arrangements to alternative lenders. access in an efficient manner, such as via automated, online In addition, these lenders may need technology upgrades interfaces, while supporting their inclusion in credit-reporting to fulfill reporting obligations. Thus, governments can play systems (for example, in credit bureaus), could substantially a critical role in expanding the participation of alternative enhance the information environment for SME financing. lenders in credit reporting systems via regulation and capacity For example, in India, automated access to government building initiatives. Regarding the latter, research indicates data platforms has enabled banks to approve MSME and that alternative information, such as information on payments personal loans online in under an hour, down from 20 to 25 (for example, from utility bills and other financial transactions) days in the past.74 In Argentina, the Ministry of Production and information on internet usage, can help capture the is implementing a digital platform that will consolidate footprint of underserved SMEs, allowing them to establish financial and economic information on SMEs, including their creditworthiness versus potential lenders.71 Specific financial information from the tax authorities. SMEs will elements of alternative data to be covered vary depending on control who has access to this information, and they will be country context. For example, in Guyana, credit bureaus have able to provide it to regulated financial institutions. 3.2 Action 2. Complete the Enabling Environment for Asset-Based Financing, Including the Implementation of Movable Collateral Registries Asset-based financing remains limited in EMDEs, despite intellectual property, reliable asset valuation and secondary legal reforms aimed at facilitating its use. As summarized market liquidity are harder to assure. Other key challenges in chapter 2, asset-based financing brings distinctive benefits hindering the development of asset-based financing to SMEs, as it addresses critical challenges that affect their include a lack of intermediaries familiar with this type of financing, including the lack of “suitable” collateral and instrument, and thus, a corresponding lack of appropriate credit history. This is why, during the last two decades, risk management mechanisms. Finally, in many countries, governments in EMDEs have worked on implementing legal the legal frameworks and the institutional arrangements frameworks for secured transactions (for example, factoring supporting such transactions are still incomplete. The latter and leasing), along with the implementation of collateral type of challenges is more profound in jurisdictions with civil registries, especially for movable assets, that formalize and law systems, which have been more reluctant to embrace provide transparency to lender’s claims thus helping to a number of fundamental approaches of modern secured lower the cost of defaults and the risk of fraud.75 However, transactions legislation, such as notice-based registries several challenges continue to affect the use of asset- and extrajudicial enforcement.76 Furthermore, in some based financing. There are obvious benefits of real-estate EMDEs there are still limitations in the type of assets that collateral—titled property—which include stable pricing can be used as collateral for debt financing. In addition, in and deep secondary markets. For other assets, such as some EMDEs, collateral registries operate with obsolete 3. A ROAD MAP FOR ENABLING SME FINANCE 11 information technology systems or are paper-based, making moving to online centralized (or interoperable) collateral it costly for potential lenders to obtain information. In some registries and covering movable assets, which can help EMDEs, there are separate registries for different types of lower transaction costs and speed up the constitution of assets, and the lack of interoperability makes more difficult liens. Governments should also consider enhancing capacity for potential lenders to conduct complete searches of the building for financial intermediaries. status of SME assets. Finally, cross-country experiences highlight the benefits Governments should review the progress and challenges of coordinating this agenda with other government in their respective countries in completing the initiatives. Two notable areas for policy support are (a) enabling environment for asset-based financing. The the implementation of electronic receipts, which can implementation of modern secured transactions laws is support deeper markets for receivables financing, and (b) particularly important, especially the inclusion of a wide government procurement initiatives, which can further the range of assets as acceptable collateral, and the adoption development of both receivables financing and purchase of notice-based registries and effective out-of-court order financing. Appendix C provides examples of how mechanisms to execute collateral. As explained above, some countries in Latin America have effectively leveraged for some EMDEs, other important measures might include e-invoicing to foster receivables financing. 3.3 Action 3. Overhaul Insolvency Regimes Effective and efficient insolvency regimes can improve experience of HICs and EMDEs is that “ordinary” regimes SME access to finance. A robust insolvency regime is do not usually work for SMEs, as such regimes usually focus essential for both the financial and private sectors. Growing on the challenges of insolvency for large corporations.79 evidence indicates that insolvency regimes provide lenders The COVID-19 pandemic has provided impetus to reforms with greater certainty and predictability in the recovery aimed at developing specialized regimes for SMEs. In of defaulted loans, thus allowing them to price the risk addition, the World Bank Insolvency and Creditor Debtor of defaults more efficiently. Similarly, entrepreneurs are Regimes Principles, revised in 2021, provides updated more willing to enter the market when they are not putting global guidance. The principles encourage countries to (a) their entire personal fortunes at risk.77 Moreover, effective lower the barriers to access and encourage early utilization of insolvency systems enable the reorganization of viable out-of-court restructuring procedures and hybrid procedures businesses78 and ensure that non-viable businesses can (that is, those conducted largely out of court, with minimal quickly exit the market, allowing the reallocation of assets to court intervention) and (b) simplify in-court insolvency more productive firms. proceedings to reduce cost and limit complexity, including cutting procedural steps. Jurisdictions such as Australia, Yet, globally, the development of insolvency regimes still Chile, Spain, and the United States have implemented these requires significant progress. A key lesson learned from the types of frameworks. 3.4 Action 4. Complete the Enabling Environment for Alternative Sources of Financing Banks will remain a key source of external financing EMDEs can apply. Research has not found evidence of for SMEs; therefore, their regulation remains a critical persistent material negative impact of this framework on element of the enabling environment for SME financing. SME lending, albeit the impact differs across SMEs and Prudential regulation introduced with the Basel III reforms countries (see appendix C). In light of the lessons learned increased the capital requirements for banks on their from previous crises about the importance of prudential SME loan portfolios, although the final version contains regulation for the overall health of the banking sector, a favorable treatment for specific sets of SME loans that EMDEs are encouraged to pursue the implementation of 12 BOOSTING SME FINANCE FOR GROWTH regulatory frameworks that are consistent with the Basel example, asset-based financing for SMEs that lack adequate standards. collateral or credit history), or (c) they adopt different credit assessment methodologies (for example, fintech lenders But banks alone cannot address the SME credit gap. leveraging big data). Thus, it is critical for EMDEs to ensure As summarized in chapter 2, alternative lenders can fulfill that the enabling environment supports the development of important gaps in the SME financing space because (a) their alternative lenders. Table 3.1 provides a stylized view of the business models are directly oriented toward underserved necessary elements of the enabling environment for different segments (for example, microfinance institutions; MFIs), (b) alternative lending sources, along with the preconditions for the type of financing they offer is more accessible to SMEs (for their scalability. TABLE 3.1 Key Sources of Alternative Finance in EMDEs Where alternative Key preconditions for Type Key enabling environment lenders are likely scalability to develop Factoring and LICs and MICs, • Availability of long-term • Modern secured transactions law, leasing but more likely to financing that supports the including notice-filing collateral registries develop in MICs funding of financial providers and effective out-of-court enforcement Microfinance LICs and MICs • Availability of long-term • Differentiated regime for deposit- institutions and financing that supports the taking versus non-deposit-taking cooperatives funding of financial providers financial institutions, with proportionate requirements Digital banks LICs and MICs, • Enabling environment for • Reforms to banking licensing but more likely to digital financial services (DFS) requirements (mainly to eliminate the develop in MICs need for physical presence) On-balance-sheet LICs and MICs • Enabling environment for • No additional framework beyond the fintech lending DFS existing one for consumer lending platforms • Availability of long-term institutions financing that supports the funding of financial providers Off-balance- LICs and MICs, • Enabling environment for • Exclusion of lending and debt-based sheet fintech but more likely to DFS crowdfunding from the requirements lending platforms develop in MICs • Availability of a robust imposed in public offering regulations and debt-based investor base (retail and under specific circumstances platforms overtime institutional) • Specialized licensing regime for the platforms, with proportionate requirements Bond issuances MICs, and to a • “Basic” corporate bond • No additional specialized framework by SME lenders lesser extent, markets; credit rating • Issuances rely on the basic regime for financially services; robust institutional public and private offers, including the developed LICs investor base regulatory framework for CRAs SME loan MICs • Well-developed corporate • Legal structures that ensure bankruptcy securitization bonds markets remoteness • Robust credit rating services • Regulatory framework for securitization • Robust institutional investor (emphasis on standardization, disclosure, base and retention requirements) • Regulatory framework for CRAs 3. A ROAD MAP FOR ENABLING SME FINANCE 13 Where alternative Key preconditions for Type Key enabling environment lenders are likely scalability to develop Minibonds issued MICs • Well-developed corporate • Proportionate regime for SME issuances by SMEs bonds markets (that is, simplified offering documents, • Robust credit rating services less frequent periodic reporting, and a • Robust base of high-net- discrete list of material events) worth individuals • Proportionate listing requirements • Vehicles to pool bonds and • Potential reforms needed to institutional make them attractive to investors regulations (especially if issued institutional investors under private offering) • Regulatory framework for CRAs SME debt funds MICs • Well-developed mutual fund • Specialized regime for debt funds, industry allowing investments in alternative assets, • Established pipeline of SME including loans and receivables assets (minibonds, loans, • Greater flexibility to funds available only receivables) to professional investors • Mainly focused on sophisticated investors (professional and institutional investors) Source: Original table for this publication. For many EMDEs, strengthening the regulation of MFIs are being created to allow these new entities to provide (and cooperatives) should be a priority. As will be discussed such services under proportionate requirements, in addition in chapter 5, microfinance institutions and cooperatives are to traditional securities intermediaries and exchanges.83 key intermediaries that provide financing to underserved Research indicates that many platforms operate in more sectors, including agriculture SMEs (agri-SMEs) and WSMEs. than one jurisdiction, which also highlights the importance However, in some EMDEs, they are not subject to financial of international coordination and cooperation. The set of regulation, whereas in others they are subject to very specific reforms for a given country will depend, in particular, stringent requirements. Thus, for many EMDEs, ensuring that on the level of development of the respective country’s MFIs and cooperatives that are deposit-taking institutions financial sector. For instance, factors such as the existence are subject to financial regulation, under a proportionate of a robust base of retail and institutional investors plays a regime, should be a priority.80 role in the development of these platforms. Therefore, they are more likely to thrive and scale up in MICs, where the Selective reforms based on country context are needed broader enabling conditions for their operation are likely to to ensure that specialized fintech lenders can operate on be more developed. Thus, governments should be mindful a level playing field.81 A key reform pertains to potential of their own country contexts in prioritizing these reforms. changes to the licensing regime of banks to allow the entrance of digital banks. This might entail, for example, MICs with relatively well-developed capital markets should adaptations to physical presence requirements. Economies consider the implementation of an enabling environment to like Brazil; Hong Kong SAR, China; Malaysia; Mexico; foster capital markets solutions for SME financing. Capital Singapore; and Thailand have revised and provided markets solutions can help SME lenders obtain long-term guidance on the application of the licensing regime of funding, allow SMEs to diversify their funding sources, and banks to digital banks.82 In addition, governments should can also lead to additional benefits in terms of improved consider the creation of licenses for new types of financial lending conditions. However, as discussed in chapter 2 intermediaries. Notable examples include the lending and summarized in table 3.1, capital markets solutions platforms discussed in chapter 2, whereby such platforms require a range of additional preconditions to develop. function as intermediaries bringing together SMEs, and Authorities need to be cognizant of such preconditions investors. Approaches have varied across countries, but in the when determining how to prioritize the development of the European Union and the United States, specialized licenses enabling environment for these solutions. 14 BOOSTING SME FINANCE FOR GROWTH 3.5 Action 5. Foster Competition Increased fintech adoption and the emergence of information held by financial institutions and initiate alternative lenders could bring changes in market transactions.88 Open finance has the potential to deepen structure and competition dynamics that negatively financial services and foster innovation and competition in the impact SME financing.84 For banks, leveraging fintech can financial sector by allowing the development of new business lower the outreach costs to SMEs and expand the banking models as well as new service providers. Governments have sector’s appetite for the SME segment.85 In the absence started to acknowledge this potential, while recognizing the of new entrants, technology-driven economies of scale opportunities that open finance creates to streamline access and scope could lead to increased market concentration. to finance for SMEs and promoting financial inclusion. Several External competition from challenger digital banks and jurisdictions have implemented, or are in the process of other specialized fintech lenders (including big tech firms) implementing, open finance frameworks. The United Kingdom could alter market structure. As summarized in chapter 2, and European Union are at the forefront of this agenda, with in some countries these non-bank financial players are larger EMDEs, like India, Mexico, and Türkiye, following suit. partnering with banks rather than competing with them, which could exacerbate market concentration effects.86 In Governments in both LICs and MICs should consider turn, this could result in the benefits of fintech accruing to additional innovative interventions that foster competition financial institutions, rather than leading to a material impact and can potentially improve SME access to financing. An on SME financing. Hence, it is critical to foster competition, example of an innovative intervention is the development of ensuring a level playing field across the different providers electronic platforms to bring financial intermediaries together of financing to SMEs.87 Important aspects to watch are the to compete for SME credit. Development financial institutions following: entry requirements, which should be proportionate (DFIs) in Colombia, India, and Mexico have developed and to the undertaken risks, and thus should not constitute an operated such platforms. While the financial institutions could entry barrier for alternative lenders; accessibility to credit create such platforms themselves, active participation by DFIs information, whereby coverage should be extended to may be necessary to overcome coordination failures among alternative lenders; and extension of the framework for financial institutions. Other types of innovative measures consumer protection to new types of lenders. that do not require public funding could also be considered. The British Business Bank provides one such example, as it Depending on country context, governments should requires the largest banks to provide information on rejected consider “open finance” reforms aimed at allowing third SME loans to alternative platforms for the consideration of parties, acting on behalf of customers, to directly access alternative lenders. Appendix C provides additional details. 3.6 Action 6. Develop the Enabling Environment for Equity Financing As discussed in chapter 2, equity financing is critical for professional investors or the amount raised is limited).89 In innovation and growth. Table 3.2 summarizes the important addition, governments should develop a framework for the features of the enabling environment needed for specific private fund industry. In countries with a well-developed equity financing solutions as well as key preconditions. domestic institutional investor base, governments should also determine if changes are needed to their investment As a first step, governments in EMDEs must ensure that regulations, such as pension funds, to allow them to invest in the legal and regulatory framework for capital markets this type of asset.90 In tandem, governments should consider provides space for SMEs to raise funding in the private initiatives aimed at enhancing their capacity to make these markets. This can be achieved through exemptions that investments. Countries with a strong foreign investor base allow companies to tap equity investors without triggering also need to ensure that their foreign direct investment laws the obligations of disclosure and corporate governance do not create barriers or cumbersome procedures that stifle associated with public markets under specific circumstances financing from foreign investors. Finally, taxation can become (for example, where capital raising is largely confined to a competitive issue versus other jurisdictions. 3. A ROAD MAP FOR ENABLING SME FINANCE 15 Depending on country context, governments should elements in the enabling environment are proportionate consider developing the enabling environment for equity disclosure and corporate governance requirements for SME crowdfunding. Equity crowdfunding platforms provide offerings.92 But actions by the exchanges to support SME SMEs access to retail investors under a streamlined listings are also needed. Such actions include streamlining disclosure regime. The challenge for EMDEs is to strike a performance, disclosure, and governance listing requirements balance between easing SME access to a wider range of and lowering listing costs. Some of the more successful SME investors while also providing adequate investor protection. exchanges have implemented a wider range of measures Many countries have addressed this tradeoff through a that seek to address investors’ concerns about the quality of combination of measures that include limits to the amount SME listings, the availability of information, and secondary companies can raise along with limits to the amount that market liquidity. Among the adopted measures are the investors can fund, as well as due diligence obligations for following: requirements for the participation of specialized the platforms. Nonetheless, existing evidence suggests that intermediaries to support companies’ compliance with listing equity crowdfunding is more likely to thrive and scale up in obligations; support to research coverage, in some cases with countries that already have relatively well-developed equity subsidies for a number of years; and adoption of market- markets.91 Thus, governments need to be mindful of country making requirements. Finally, cross-country experience context in prioritizing the development of these frameworks. indicates collective investment vehicles that can pool SME assets (such as small cap funds) can make SME listings more EMDEs with well-developed equity markets should develop attractive to institutional investors. the enabling environment to support SME listing. The key TABLE 3.2 Key Sources of Equity Financing in EMDEs Where equity Key preconditions for Type financing solutions Key enabling environment scalability are likely to develop Coinvestment with LICs and MICs • Pipeline of companies • Exemptions to public offering (maximum angel investors • Existence of angel number of investors, maximum amount investors raised, type of investors targeted) VC, SME growth MICs, and to a lesser • Robust pipeline of • Licensing framework for fund managers funds and, private extent, some LICs companies • Regime for private funds that exempts equity funds • Robust set of them from authorization or subjects them professional investors to “simple” registration • Depending on investor base, changes to the investment regulations of pension funds to allow them to invest in PE/VC • Regime for foreign direct investments that provides efficient procedures for registration and exit • Tax regime that provides for tax neutrality Equity MICs • Relatively well- • A streamlined disclosure regime for crowdfunding developed equity SMEs, exempting their offerings from platforms markets authorization by the securities regulator • Robust base of retail • Limits to the amount companies can raise investors through platforms and to the amount that retail investors can invest in platforms and in one single company • Licensing regime for crowdfunding platforms, with proportionate requirements 16 BOOSTING SME FINANCE FOR GROWTH Where equity Key preconditions for Type financing solutions Key enabling environment scalability are likely to develop SME offerings, MICs • Relatively well- • Proportionate system for SME offerings including through developed equity (that is, simplified offering document, SME exchanges markets; High net-worth less frequent periodic reporting, and a individuals discrete list of material events • Collective investment • Less stringent corporate governance schemes to pool equity requirements) offerings and attract • Proportionate listing requirements institutional investors • Specialized SME exchange to support liquidity Source: Original table for this publication. 3.7 Action 7. Enhance Consumer and Investor Protection The increased use of fintech in the SME financing space regulators should ensure that operational requirements poses new risks to SMEs. Fintech has facilitated the entry of imposed on financial intermediaries remain robust. Finally, new financial providers who are spurring the development financial supervisors should adapt their supervision to capture of new financing products and new delivery mechanisms. the risks brought by fintech, new financial intermediaries, However, the conditions of such financing, and of the and new business models. roles of different participants in the transactions (such as in embedded financed), are not always clearly explained to Similarly, increased reliance on capital markets solutions, SME borrowers.93 Thus, governments and financial regulators whether traditional- or fintech-based ones, carries investor need to ensure that the legal and regulatory frameworks protection risks. Many of the capital markets solutions for against deceptive and fraudulent practices apply to financing SME financing have a higher level of risk than traditional providers (incumbent or new) and across all types of delivery products (that is, corporate bonds and equity). This is channels.94 In addition, consumer protection laws should apply why, in practice, many of these products are only offered to individuals as users of financial services, for both personal through private placements, which limits the possibility and business purposes.95 Considering the country context, of retail investor access. However, lending and equity governments should carefully assess whether to expand the crowdfunding platforms provide retail investors with direct scope of consumer protection frameworks toward small firms. access to SME offerings. In these cases, governments and When expanding consumer protection obligations to cover financial regulators have used a combination of mechanisms small firms, governments must strike a balance between to mitigate investor protection risks, including limits on maximizing the potential benefits and limiting the unintended the amount that retail investors can invest in this type of consequences (from associated costs and restrictions) to ensure offering and warnings about the risks associated with these these obligations do not negatively impact access to finance. investments, in addition to the imposition of disclosure Currently, approaches vary significantly across jurisdictions, requirements regarding the role of the platforms and the with some jurisdictions extending some consumer protection conditions under which companies are obtaining financing elements (though not all) beyond private individuals to from investors.97 Countries have also required platforms to a subset of firms.96 The use of fintech exacerbates other assess how well investors understand these products prior to operational risks, such as cybersecurity. Therefore, financial allowing investments.98 3. A ROAD MAP FOR ENABLING SME FINANCE 17 3.8 Action 8. Establish Robust Foundational Infrastructure Robust basic digital infrastructure and digital financial especially for business customers located in remote areas. The infrastructure are key components of the ecosystem that experience of several EMDEs (for example, Brazil and some enables the adoption of fintech and the development of EMDEs in East Africa) demonstrate how interoperable mobile alternative fintech lenders.99 Digital connectivity underpins money, faster payments, and other systemic interventions in the provision of digital financial services (DFS). Overall, it the digital payment space can improve access to finance. includes the following: (a) ensuring the smooth functioning of an information, communication, technology network with Other public and private digitalization initiatives, such broad coverage throughout the country and a reliable power as online registration of SMEs, and digitalization of supply; (b) access to basic mobile telephony services—voice, SME processes can further support access to finance. text, and special system messaging services; and (c) access Online SME registration can support SME access to finance to data services (3G and above), which can improve the user by increasing the efficiency of customer due diligence (CDD) experience through application based delivery of DFS services. processes while enabling a more robust digital footprint Application based DFS services, with detailed information for SMEs.101 Similarly, digitalization of SME processes can on the users’ digital footprint and behavioral characteristics, help SMEs build their alternative data. Most SMEs lack the also enable more tailored products and credit assessments scale to develop their own unique digital platforms and thus for SMEs. Similarly, digital public infrastructure is crucial.100 need to partner with large digital platforms. Such platforms For example, digital payment infrastructure is the gateway could include e-commerce platforms for goods (for example, to financial access and can play a role in access to finance Amazon and Lazada), service platforms (for example, Grab as well. Digitizing payments generates alternative data, and Food Panda), and providers of broader digital tools to which can be helpful for SME financing, as outlined above; enhance businesses operations (for example, Microsoft or reduces transaction costs; and increases transaction efficiency, Amazon Web Services). 18 BOOSTING SME FINANCE FOR GROWTH CHAPTER 4 Toward a More Effective Use of Targeted Public Interventions Governments around the world have resorted to targeted Increasingly, EMDEs have also deployed interventions interventions to affect the supply of financing to SMEs. to expand access to equity financing for SMEs. In most There is no globally accepted typology for targeted cases, equity interventions have largely focused on financing interventions.102 In this report, targeted interventions are startups, given the lack of active VC markets to support the defined as public interventions that aim to directly affect the financing of innovation. However, governments in some supply of financing available to SMEs, but also carry fiscal EMDEs have also supported equity financing for growth costs. Table 4.1 provides a stylized view of the interventions SMEs. Financing SMEs through VC funds has been the main deployed in EMDEs along with the market failures such type of intervention deployed by governments around the interventions seek to address. world. These schemes typically rely on a single dedicated fund in EMDEs with less developed capital markets, and There is no consolidated information on the size nor the on a fund-of-funds approach in larger and more developed scope of targeted support in EMDEs, but World Bank EMDEs, whereby the government invests in a plurality of experience indicates that governments in EMDEs have existing funds. In many cases, support programs have also often prioritized interventions aimed at addressing the included a small allocation to direct coinvestments alongside SME credit gap. Many EMDEs have relied on a combination angel investors. To different degrees, governments in EMDEs of direct lending to SMEs (mostly via DFIs, such as have adopted other types of support programs to build the development banks) and intermediated interventions (that is, entrepreneurial ecosystem. A limited number of EMDEs have the government, in many cases via a DFI, provides a line of implemented targeted interventions aimed at supporting credit to financial intermediaries, so that in turn they provide SME listings in equity markets. These programs have usually the financing to SMEs).103 In most EMDEs, banks have been focused on subsidies to their listing in SME exchanges and tax the main intermediary through which these interventions benefits to attract investors. have been deployed. More recently, governments have increasingly contributed to the capitalization of PCG Overall, governments need to substantially improve the schemes, which provide protection to lenders against design and implementation of targeted interventions to credit losses arising from their SME lending portfolio.104 enhance their effectiveness. This impetus is particularly In a few larger EMDEs, public interventions (for example, important at the current juncture when governments are investment programs and de-risking tools) have also been facing tight fiscal space due to the economic impact of the used to mobilize investors to SME financing via capital COVID-19 pandemic. The rest of this chapter draws on the markets solutions. See appendix D for an example of the lessons learned from the targeted interventions in both HICs type of interventions deployed. and EMDEs to shape guidance for policy makers in EMDEs. 4. TOWARD A MORE EFFECTIVE USE OF TARGETED PUBLIC INTERVENTIONS 19 TABLE 4.1 Targeted Interventions Supporting SME Finance Type of intervention Problem that they seek to address Differences in use between EMDEs and HICs Debt interventions Direct lending • Provides flexibility in the range of • Many DFIs in EMDEs use direct lending for SMEs, challenges to be addressed, but does either as their solo approach or in addition to an not mobilize private capital on-lending approach. Lines of credit (LoCs) • Address the funding challenges of • In HICs, LoCs have been deployed through a wide financial intermediaries (for example, range of lenders, including not only banks but lack of long-term financing) that hinder also alternative lenders, such as digital banks and their ability to lend to SMEs asset-based lenders. In EMDEs, the main channel • De-risks SMEs by altering their risk- for deployment has been banks. return profiles, when provided at concessional terms Partial credit • Mitigate constraints from high credit • Globally, the main users of these schemes have guarantee schemes risk, limited collateral, and limited been banks; but depending on the country, information in SME financing by other alternative lenders have had access. Some providing a guarantee against credit countries have separate funds/windows for some losses generated by SME loans (or the types of non-alternative lenders. SME portfolio), for a fee • Can trigger capital “savings,” for regulated entities Other credit • Mitigate credit risk, by providing a • These types of guarantees are used more guarantees used guarantee against losses generated by frequently in HICs, covering different capital with capital market SME-related assets markets solutions (for example, minibonds, SME solutions funds, SME securitization). • Some larger EMDEs have programs for some of these solutions. Investments in • Provide scale via signaling effect • Investment programs are used more frequently in different capital • Can also have demonstration effects HICs, mainly in connection with different types of markets solutions debt funds and lending platforms. Equity interventions Investments in funds • Provide scale via signaling effects • In HICs, they support both innovation and growth. • Can have demonstration effects • In EMDEs, the focus has been on VC funds. • When provided at concessional terms, can also de-risk SMEs by altering their risk-return profile Direct coinvestment • Support the development of angel • These are used in both HICs and EMDEs. investors • Address specific gaps in the marketplace that funds are not fulfilling Equity guarantees • De-risk SMEs by altering SME risk- • Use of equity guarantees is limited across both return profiles via reduction of EMDEs and HICs, likely because a similar effect potential for losses can be obtained through asymmetric return arrangements. Tax incentives to • De-risk SMEs by altering SME risk- • These are available in a wide range of HICs, and investors return profiles via improvement of some EMDEs. Scope varies by country, but in many returns cases, they cover a wide range of SME investments (that is, not only for investments in VC funds, but for investments in SMEs more broadly as long as not listed in public markets). Source: Original table for this publication. 20 BOOSTING SME FINANCE FOR GROWTH No comprehensive cross-country evaluation of targeted The recommended actions below provide a framework interventions programs in EMDEs has been conducted to tackle these challenges. They are applicable to to date; however, indirect evidence suggests that design any government or public entity that deploys targeted challenges have impacted program effectiveness.105 The interventions, as defined in this report, to support access to existing evidence and World Bank experience supporting finance for SMEs.106 countries in deploying these types of interventions point to three interrelated challenges in program design across While targeted interventions might help push the EMDEs: (a) lack of clarity in the objectives of the interventions; frontiers of the financial sector toward improving SME (b) problems with targeting, both in terms of the eligibility for access to finance, such interventions cannot do all the SMEs as well as the financial intermediaries used as delivery heavy lifting. World Bank experience supporting EMDEs partners; and (c) deficiencies in monitoring and evaluation in implementing targeted interventions suggests that the (M&E) frameworks. Addressing these three dimensions effectiveness of targeted interventions in EMDEs has been should create a positive feedback loop, in which assessments hindered by incomplete enabling environments as well as based on M&E frameworks would not only reveal the impact by challenges emerging from the level of development of support policies, but also identify lessons that could form and structure of the financial sector in EMDEs. The the basis of revisions to the design and implementation implementation of both the enabling environment actions, for these programs in the future. M&E frameworks would summarized in chapter 3, along with the implementation thus allow for evidence-based course-correction in public of well-designed targeted interventions should lead to support programs. An additional challenge relates to the improvements in SME access to finance. But without fragmentation of interventions across multiple government further progress in addressing the underlying causes of the departments and public entities, including DFIs, which could underdevelopment of the financial sector more broadly, the potentially create gaps in support, or even duplication of effectiveness of targeted interventions in EMDEs might still efforts that can lead to an inefficient use of public resources. suffer and waste public resources. 4.1 Action 1. Enhance Data Availability and Diagnostic Analyses to Ensure Outreach to Underserved SMEs There is no such thing as a typical SME, nor are they all consistent definition of SMEs at the country level can help similarly constrained in accessing financing. SMEs range enhance the effectiveness of the broader support agenda from mom-and-pop operations to high-technology firms on for SMEs. For example, the adoption of such definitions the verge of a public offering, some may be high-growth firms, can facilitate data collection and analyses, can mitigate while others are low-growth SMEs, and so on. Admittedly, coordination failures by establishing a focal point for policy SMEs do share some common critical features that hinder their action, and even signal policy priorities. Many countries access to finance, yet not all SMEs are equally constrained, nor have indeed adopted such definitions for policy purposes. do they need the same type of financing. The composition However, such definitions should constitute the starting of SMEs and the extent to which they are constrained varies point to select the set of firms that should benefit from across countries. Thus, country-specific conditions matter, targeted financial support. Rigorous country diagnostics namely, the demand side (that is, SMEs themselves), the supply are necessary to understand which SMEs segments face side, and the broader financial and economic environment. the largest financing gaps and can thus help policy makers For instance, the level of development of the financial sector better define (and possibly narrow down) the universe of (that is, market concentration, degree of diversification of potential beneficiaries of targeted financial interventions. funding sources, availability of long-term funding markets) can disproportionately impact the availability of financing for Furthermore, there is no set of standardized interventions some SME segments or the availability of certain financing that all EMDEs can apply, as country context matters. instruments. Determining which interventions to deploy, as well as their specific design, should also be driven by such country Accordingly, the set of SMEs that benefit from targeted diagnostics. Governments should strive to target the SMEs interventions should vary across countries. A unique and that would benefit the most from interventions (that is, 4. TOWARD A MORE EFFECTIVE USE OF TARGETED PUBLIC INTERVENTIONS 21 first-time borrowers), and consider, as appropriate, specific can affect the scalability and impact of the interventions. As “windows” for the most underserved SMEs. The diagnostics discussed below, a careful balancing of the different objectives should also inform the choice of intermediaries to deploy pursued with different interventions might be needed. the needed interventions, ensuring they are delivered through financial intermediaries that can effectively reach Most EMDEs would need to substantially improve the underserved segments. For example, the inclusion of availability and access to firm-level data to support robust alternative lenders might be critical to reach underserved country diagnostics and ensure adequate targeting of their segments. Thus, eligibility criteria should not be limited interventions. In many EMDEs, there are huge data gaps to banks. Similarly, in the context of equity financing, relevant for an assessment of the landscape for SME financing. the eligibility criteria could point to fund managers with There is a major gap in standardized, accurate, granular, and experience in strategies that are in line with the identified frequent data on firm financing, especially for smaller private financing gap. firms. While several countries have taken important actions to expand their statistical capacity, EMDEs still need to step In practice, a multipronged approach is likely needed in most up efforts to develop and improve the building blocks for EMDEs to address the debt and equity financing gaps. While effective and comprehensive data collection, including the equity and debt financing play important, but distinct, roles in adoption of regular firm-level surveys and financial institution supporting SMEs along their life cycles, policy makers must be surveys. Policy makers must therefore prioritize data collection, cognizant of the trade-offs in allocating resources to support reporting, and accessibility, especially firm-level financial data equity versus debt financing, especially when fiscal resources and analysis, to foster evidence-based policies in tackling are scarce. Debt financing is the most important source of the challenges of the SME financing gap. In the short term, external financing for SMEs, and support programs can have governments should complement existing information with widespread reach. In contrast, given the scarcity and cost of qualitative assessments, including ad-hoc surveys. In tandem, equity financing, equity interventions should be deployed governments should develop and enhance their SME more selectively, reaching a smaller set of firms, typically (finance) data frameworks at the national level. They should innovative SMEs and SMEs with high growth potential, also consider measures that can help consolidate existing especially when other long-term funding sources have not data from different public entities and enhance governments’ fully developed. Policy makers should also be realistic about understanding of the SME sector. One example of such an not only the desirability of these interventions but also their initiative is SME observatories, which have been implemented feasibility and impact, based on the realities in their own in countries such as France and Morocco with the objective countries, especially the existence of preconditions that of creating a hub of information and knowledge on SMEs.107 4.2 Action 2. Emphasize Financial Additionality and Private Capital Mobilization as Clear Objectives of Targeted Interventions Targeted interventions in EMDEs should mitigate key capital is critical for the long-term development of SME market failures hindering SME finance, while making more financing. strategic use of public funds. In many EMDEs, interventions supporting access to finance have been used too broadly, Important corollaries can be drawn from the emphasis including to support social protection goals. Going forward, on private capital mobilization. First, it places a higher bar it is essential for governments to reassess the role of these on direct interventions (that is, interventions made directly interventions and focus their programs on addressing key by a government entity or public institution without the market failures that prevent viable SMEs from accessing participation of private financial intermediaries) as this financing. Governments should place greater emphasis on type of interventions is unlikely to mobilize private capital. improving financial additionality and crowding in private Second, care must be taken that interventions mobilize capital, while minimizing distortions and outright avoiding “new” private funding, and do not lead to crowd-out a crowding-out effect. The direct engagement of private effects, although measuring additionality is complex.108 22 BOOSTING SME FINANCE FOR GROWTH That is, policy makers need to emphasize the role of public given the structural problems that affect the development of support programs in crowding-in private financing, rather the financial sector. In this context, government interventions than displacing it. To this end, at a minimum, governments would need to fulfill a role of market creation, which would should conduct a market analysis to understand the existing likely require interventions over a longer period of time. At level of financing by the private sector and estimate the the same time, policy makers would need to work to address potential crowding-in impacts of the public intervention, the structural challenges that hinder private financing. including conducting simulations, as appropriate. Third, Without such additional actions, public support might not in some EMDEs, especially LICs, achieving private capital effectively mobilize private sector financing and develop mobilization, and in particular achieving sustainable financial markets in a sustainable manner, regardless of the participation of the private sector, might be challenging amount of financial resources deployed. 4.3 Action 3. Deploy Concessional Financing Sparingly Concessional financing carries high risks.109 Both EMDEs Thus, concessional financing should be used sparingly and HICs have used concessional financing to alter the risk- and deliberately to achieve a specific benefit in the return profile of a loan or an investment, and thus make SME financing space. In deciding about the provision of commercially viable the financing of a specific underserved concessional financing, governments should thoroughly sector (for example, agri-SMEs), a specific type of financing assess (a) whether market failures justify the use of (for example, long-term loans), or allow intermediaries to concessionality in the first place and the objectives to be provide financing at below market rates. While justified in achieved with such interventions, as explained above; (b) the some instances, such as in cases of clear positive externalities extent of the potential distortions that it could bring; and (c) (for example, financing SMEs’ investments in adaptation whether mechanisms can be put in place to mitigate such or mitigation to address the impact of climate in their risks. The recurrent use of concessional financing should operations), concessional financing can negatively impact prompt an assessment of whether additional policy actions, overall private market development. Concessionality carries for example, in the enabling environment, are needed. the risk of reducing the incentives for financial intermediaries However, identifying the degree of concessionality needed or investors to commit their own funding. This is the case involves a counterfactual assessment that is difficult to when interventions provide concessional financing to SMEs, make in practice. Drawing a line between concessional and as doing so may reduce their demand for financing at market commercial financing is also difficult, as in some instances, rates. Private financial institutions are then unable to compete “commercial” pricing might not exist. Overall, the use with support programs. Such use of concessionality can lead of concessional financing should constitute a temporary to crowding-out effects. Similarly, concessionality deployed via measure. Authorities should explicitly develop an exit cheaper funding to financial intermediaries to incentivize their strategy and graduation targets, as appropriate. To this end, engagement with the SME segment (which does not always at the design stage, authorities should assess the additional translate to lower interest rates or longer-term financing for policy actions that might be needed to support the removal SMEs) can lead to moral hazard, as intermediaries or investors of concessional financing at a later stage, including actions may lower their selection standards. in the enabling environment. 4. TOWARD A MORE EFFECTIVE USE OF TARGETED PUBLIC INTERVENTIONS 23 4.4 Action 4. Leverage Developmental Finance from Donors for Private Capital Mobilization Some EMDEs have had access to concessional financing systematically map the global developmental financing from public and private donors in connection with SME available in the SME space and maximize their use via financing programs. In many cases, this support has been blended finance structures to increase private capital associated with underserved segments, such as WSMEs and mobilization and potentially lower the need for public agri-SMEs, and more recently to green financing. The scope funding. A key example is the Green Climate Fund that has varied from grants for capacity building to financing supports the financing of climate change adaptation and risk-sharing arrangements (for example, to establish a PCG mitigation investments in EMDEs.111 National development facility). Yet, in many cases, this support has not been directly banks in some EMDEs, such as Nacional Financiera linked to the objective of mobilization of private capital for (NAFIN) in Mexico, are going through the accreditation complex reasons—from the fact that many donors have not process that will allow them to tap fund resources for their yet prioritized such mobilization to the complexities that a own SME programs. In addition, global private sector blended finance structure might bring. initiatives providing blended finance for private financial intermediaries exist for segments such as agri-SMEs112 Going forward, governments should better link development and WSMEs.113 Thus, it is important that governments also financing with their own private capital mobilization goals map these initiatives to systematically assess where public in a blended finance approach.110 Governments should funding is most needed. 4.5 Action 5. Complement Targeted Interventions with Non-financial Support Cross-country experience indicates that programs to capabilities of financial intermediaries and investors. enhance SME capabilities are critical to improve the Programs for financial intermediaries could be instrumental effectiveness of targeted interventions. For example, in expanding and diversifying funding sources. For instance, financial intermediaries in many EMDEs frequently point to training for alternative lenders in key operational areas (for the lack of a healthy pipeline of SMEs as a key constraint example, risk management) or for new products (for example, for lending or investing. Governments in EMDEs have asset-based financing) can help them expand their reach increasingly linked their financial interventions to technical to SMEs. These programs can also benefit smaller banks assistance programs for SMEs, both for debt and equity and foster competition. While existing programs are more financing. Appendix D provides an overview of the different prevalent in connection with debt financing, they can also types of complementary programs that EMDEs can be beneficial in the context of equity financing, especially implement. These programs are a critical addition to the where support programs aim at developing a domestic financial education programs that many EMDEs have in place fund management industry. In the context of capital market and that in some cases identified SMEs as a target group.114 solutions for SMEs, World Bank experience indicates the need to consider capacity building for institutional investors, In addition, depending on country needs, governments such as pension funds, to help increase their awareness and may also consider deploying programs to enhance the understanding of the new instruments and their risks. 24 BOOSTING SME FINANCE FOR GROWTH 4.6 Action 6. Improve the Evaluation of Targeted Interventions Establishing programs to assess the impact of targeted governments in EMDEs should focus on setting up clear interventions is key to ensuring accountability and enabling objectives for their interventions and transforming such the fine tuning of interventions. Accountability through objectives into timebound targets that can be monitored increased transparency is paramount in an environment and adjusted as needed. In the medium term, governments of limited fiscal space. It is critical for governments to should establish independent M&E frameworks, anchored on evaluate interventions to demonstrate that public resources robust data frameworks and the adoption of well-established are being used effectively. Such evaluations can also techniques (for example, the use of control groups) for support the effectiveness of interventions by enabling the the evaluation of program impacts, especially in terms of implementation of adjustments when interventions do not additionality and private capital mobilization.116 In addition, reach their intended objectives. This is an area where there governments should leverage different types of public is much room for improvement in both HICs and EMDEs, institutions and private stakeholders, such as statistical and although progress has been made in selected HICs.115 auditor general offices, as well as universities and think tanks, Based on World Bank experience supporting EMDEs in to promote and institutionalize independent evaluations as implementing targeted interventions, in the short term, an accountability tool. 4.7 Action 7. Improve Coordination, Including by Better Leveraging Existing DFIs, and Ensure Proper Governance In many EMDEs, multiple government departments or effectiveness of DFIs. A recent World Bank report provides public agencies are often involved in the design and nine recommendations to improve the effectiveness of DFIs, implementation of targeted interventions supporting which are all consistent with the recommendations included SME finance. For example, interventions targeting specific in this report (see box 4.1). Second, efforts to enhance underserved segments might be under the responsibility coordination. This should include the development of a of different ministries (for example, finance, agriculture, holistic strategy for SME financing that considers all entities innovation), which might lead to the existence of separate involved in this space, as well as appropriate arrangements vehicles and arrangements to deploy them (for example, the for day-to-day coordination (for example, coordination creation of separate interventions under different ministries committees). with specific objectives in the SME space, such as programs to expand financing for agri-SMEs or programs to expand Finally, strong governance arrangements should be in financing for innovation). In tandem, there might also be DFIs, place to ensure that the objectives of public interventions including development banks, with a mandate to deploy are achieved.118 While specific governance structures might targeted interventions on the SME finance space.117 The vary depending on the legal nature and structure of the dispersion in the deployment of public sector support for implementing agencies,119 the overriding lesson from the improving SME financing creates the potential for gaps and World Bank experience supporting EMDEs in implementing overlaps that can lead to an inefficient use of public resources. targeted interventions is that governance arrangements need to be robust to (a) mitigate the potential for political In this context, governments should ensure that they interference in technical decisions, especially regarding the adequately leverage existing DFIs, for example by ensuring selection of the intermediaries to deploy the corresponding that any additional program that is created is fully interventions and the SMEs to receive support; (b) ensure coordinated with existing DFI programs. This in turn requires that political interests do not outweigh long-term project two distinct sets of efforts. First, efforts to improve the objectives; and (c) ensure proper oversight and accountability. 4. TOWARD A MORE EFFECTIVE USE OF TARGETED PUBLIC INTERVENTIONS 25 BOX 4.1 Lessons Learned from Efficient National Development Financial Institutions (NDFIs) Lesson 1. Identify the unmet needs and factors preventing when subsidies are necessary, they are channeled in a private sector involvement, and consider all public policy transparent and non-distortionary way. interventions available, beyond provision of public sector Lesson 6. Operate the institution as a financial sector funding, to address the problem. company not a public agency. Lesson 2. Set up a mandate or mission statement for NDFIs Lesson 7. Ensure that the institution is effectively managed, focused on complementing private sector and crowding in and the incentives of management and staff are aligned with private investors to provide financial solutions to identified the objectives of the institution through effective corporate underserved segments or projects while preserving governance, risk management, and mechanisms to evaluate financial sustainability. the performance of NDFIs. Lesson 3. Design NDFI facilities focused on servicing credit- Lesson 8. Ensure that NDFIs are properly supervised by constrained borrowers to ensure additionality. the financial supervisory agency and that the institution Lesson 4. Develop a range of instruments to leverage operates on a level playing field. private sector funding. Lesson 9. When the environment is not conducive to NDFI Lesson 5. Use preferential lending sparingly when large effectiveness, operate in second tier and raise funds in externalities can be justified. NDFIs need to ensure that international capital markets. Source: Gutierrez and Kliatskova (2021). Note: NDFI = national development financial institutions. 4.8 Additional Recommendations for the Design of Debt Interventions Governments should more deliberately use targeted governance arrangements to mitigate potential government interventions to support alternative lenders. In many interference and to ensure proper risk management. Such EMDEs, banks have been the main intermediary through conditions are difficult to attain in EMDEs. Moreover, this which interventions have been deployed. While banks remain type of intervention does not address the underlying market the key funding source for SMEs, as indicated in chapter failures in SME financing. Hence, it does not help create 2, alternative lenders can fulfill important gaps in SME the conditions to unlock commercial lending, nor does it financing. Hence, governments in EMDEs should use targeted leverage private financing in any way. Direct lending should interventions to foster the development of alternative lenders. be used sparingly, for a limited period of time, when sizeable Appendix C discusses the example of how the British Business externalities justify its use. Bank incorporated the diversification of funding sources as a core objective of its interventions. Governments should avoid barriers in access to support programs for alternative lenders by reviewing the To this end, governments should first focus on reducing eligibility criteria for financial intermediaries. For example, their use of direct lending. As indicated earlier, many EMDEs in many EMDEs, PCGs can only be accessed by banks or the still rely on direct lending to affect the supply of SME financing. requirements for access to PGCs are skewed toward banks. Direct lending can be an effective mechanism to address Such design gives banks the upper hand in dealing with key financing constraints affecting SMEs, as it supports the quick risks when serving SMEs. Adopting requirements to access delivery of financing to underserved segments. Nonetheless, support programs related to the soundness of financial its use has raised concerns. Effective deployment of direct intermediaries is necessary to ensure proper risk management. lending requires a high level of institutional maturity and robust However, governments should establish proportionate 26 BOOSTING SME FINANCE FOR GROWTH requirements that foster accessibility by financial institutions • LoCs. LoCs have been used frequently in EMDEs to other than incumbent banks. Depending on country context support SME financing in different contexts, due to their and the objective of interventions, such institutions might relative simplicity and flexibility compared to PCGs.122 include MFIs, asset-based lenders, and on-balance-sheet However, they often do not address the fundamental fintech lenders. challenges hindering SME financing in EMDEs, such as those related to the characteristics of SMEs themselves. Governments should deploy interventions aimed at tackling Therefore, without additional policy actions, the the specific challenges faced by alternative lenders. For potential for graduation from these interventions example, funding is a key challenge for many alternative is limited. Furthermore, when LoCs are offered at lenders, as it affects their ability to expand their portfolios concessional terms for SMEs, the risk of crowding-out and deepen their engagement with underserved SMEs. private capital increases, as borrowing at commercial Unlike banks, most alternative lenders do not have access to rates becomes unattractive for SMEs. In addition, deposits. In fact, many rely on funding from banks. In addition, LoCs potentially require a greater amount of public other sources of long-term funding, such as capital market resources compared to PCGs. As EMDEs implement financing, might not be available to them. Governments can PCGs, LoCs should be used more selectively, with their thus support alternative lenders using targeted interventions, use focusing mainly on addressing gaps in the funding such as LoCs, or creating refinancing facilities to improve markets that affect financial intermediaries’ ability to access to (long-term) funding. Such measures can enable the serve the SME segment. Country circumstances—such expansion of alternative lenders’ SME portfolios and improve as the specific role that different intermediaries play in financing conditions for SMEs. financing specific underserved SMEs—would determine the types of intermediaries that should benefit from these interventions. For example, for many EMDEs, Mix of Interventions Supporting Debt Financing LoCs could be targeted to MFIs, asset-based lenders, and, for a smaller set of EMDEs, also fintech lenders. For most EMDEs, LoCs and PCGs remain the main types of In exceptional circumstances (for example, when there deployed intermediated interventions. However, depending are significant positive externalities), concessional on country context, governments may need to recalibrate LoCs could be used to make commercially viable the their use. financing for SMEs, and to improve lending conditions (for example, longer maturity, lower interest rates). In • Capitalization of PCGs. PCGs should constitute the key practice, in many EMDEs the dividing lines between targeted intervention to address, on a permanent basis, LoCs at market prices or LoCs at concessional terms are problems stemming from the high riskiness (perceived blurred. For instance, LoCs are in many cases given to and real) of SMEs, which is heightened by their opacity, enable credit at longer maturities for which there might lack of collateral, and limited credit histories.120 Still, not be any market price. Thus, it is critical that authorities the implementation of PCGs is complex and requires monitor whether LoCs (at concessional terms or simply a certain level of institutional maturity. A set of core provided at favorable conditions) do in fact translate principles, summarized in appendix E, should guide into benefits for SMEs (for example, in the form of new their development.121 These principles call for the products or improved terms such as better maturities or establishment of PCGs via separate legal entities, with more favorable interest rates).123 strong governance and risk management arrangements and highlight the need for robust oversight to ensure • Other interventions. Based on country context, the credibility of the schemes. In practice, PCGs around governments could consider other types of the world differ in their design—specifically in elements interventions, such as creating refinancing facilities for such as management structure, operating rules, and the regulated alternative lenders to address, on a more characteristics of guarantees, including the coverage permanent basis, their funding constraints. In any case, ratio and pricing. These design choices can be critical their deployment typically requires a certain institutional to the effectiveness and financial sustainability of maturity. Governments should also consider the the schemes, as they affect administrative costs and competitive implications of such alternative arrangements influence the participation of financial institutions and to ensure a level playing field across the range of SMEs and can even impact loan default rates. In fact, financial providers actively engaging with SMEs. a key challenge for PCGs in many EMDEs is the limited uptake by financial intermediaries, which should call MICs with more developed capital markets should for a review of their design, especially of the incentives consider deploying interventions designed specifically for financial institutions and SMEs embedded in the to foster capital markets solutions for debt financing schemes. for SMEs. There are four main types of such interventions: 4. TOWARD A MORE EFFECTIVE USE OF TARGETED PUBLIC INTERVENTIONS 27 investment programs, credit risk guarantees, tax incentives, specific types of investors, thus making additional and subsidies. Country context should determine the specific interventions necessary. One such intervention is credit set of capital market solutions to develop (whether plain risk guarantees. Cross-country experience, especially vanilla issuances by SME lenders, SME loan securitization, from EMDEs, suggests it is effective in attracting minibonds, debt funds, or lending and bond-based institutional investors toward riskier instruments, as this platforms that operate off balance sheet) and the type of set of investors tend to have conservative risk appetites intervention to deploy. Such decisions should also depend (dictated by regulation in some cases, restricting their on an assessment of the viability, sustainability, and potential investments to high-rated securities). There is, however, benefits of further developing each of these solutions to a delicate balance between such credit enhancements deepen SME financing. Chapter 2 provided a stylized view and the economics of the instruments themselves. of the key preconditions and the enabling environment While credit enhancements might bring instruments to necessary for each of these capital market solutions to guide a desired rating, in practice, their pricing might render governments’ choices. Cross-country experience indicates them financially unviable.124 that, in many cases, more than one intervention would be needed to mobilize private investors, as highlighted in the • Tax incentives: Although tax incentives are used to examples of Colombia and Italy, discussed in appendix C. alter the risk-return profile of SME investments, their use Overall, governments should be guided by the principle of should be carefully assessed against the market failures using the minimum amount of public resources necessary to hindering access to finance for SMEs. Some investors crowd-in private capital. may already enjoy favorable tax treatments, which • Investment programs: This is the most basic type limits the impact of separate tax incentives for SME of intervention that can be deployed. It is aimed at investments. Similarly, for some institutional investors, providing scale to a specific capital markets solution like pension funds, addressing credit risk concerns might through signaling effects associated with government be critical to align SME investments with their own risk investments. This intervention could also be associated appetite. with demonstration effects, although it does not alter • Subsidies: Subsidies have been used to foster the direct the risk-return profile of SME investments. use of capital markets, especially by medium companies. They aim to lower the costs of accessing the markets • Credit risk guarantees: For many jurisdictions, and include, for example, benefits in connection with investment programs might not be sufficient to mobilize specific issuance or listing costs. 4.9 Additional Recommendations for the Design of Equity Interventions Although public support is considered critical to crowd-in environment; the lack of a robust pipeline of companies; the private investors to equity financing, such interventions limited development of a domestic institutional investor base; have had limited impact in many EMDEs, especially in the lack of consistent exit options for investors; and in some LICs.125 The empirical evidence on the effectiveness of cases, the lack of some basic components of the legal and interventions remains scarce, as many schemes supporting regulatory environment for equity financing, among other equity financing in EMDEs are relatively recent. However, challenges. Some of the challenges could be addressed qualitative assessments point to significant differences through parallel interventions; but other challenges are between larger EMDEs and smaller jurisdictions. In smaller structural in nature and are thus more complex and would jurisdictions, especially within LICs, the ability of public require more time to resolve. interventions to unlock private investor participation in an impactful and sustainable manner remains an open question. In this context, governments (especially governments in This difference in the impact of interventions across countries LICs) that wish to pursue this type of intervention should is largely the result of challenges with preconditions, which recalibrate their objectives to place greater focus on market relate to uncertainty in the macroeconomic and financial creation. Focusing on the role of market creation implies 28 BOOSTING SME FINANCE FOR GROWTH that governments must be willing to initially accept a limited market gaps should dictate the selection of SMEs to target level of private capital mobilization, which in some cases, can and, consequently, the type of funds in which the government only be achieved with concessionality. It would also likely should invest (for example, early stage, growth, late stage). In require more widespread and prolonged financial support addition, an understanding of the investor base should guide across the entire ecosystem of entrepreneurship, innovation, design decisions, such as the domicile of the funds. Appendix and equity financing. Governments might accept this level C provides insights regarding the types of flexibilities that of support, given the potential economic additionality of some countries have introduced in their programs to address these interventions for innovation and economic growth. the needs and preferences of foreign and domestic investors. But governments must be mindful of the implications of this For instance, some EMDEs have allowed investments in recalibration of objectives, including the potentially large foreign funds provided that a percentage of their assets are fiscal costs of these interventions. Governments would also invested in domestic companies. World Bank experience need to work on complementary interventions to address the supporting EMDEs in implementing targeted interventions structural challenges affecting private sector participation in indicates the need to incorporate flexibility in the financial the market to increase the probabilities of graduation from arrangements and the instruments, allowing coverage of not these interventions. In any event, equity interventions, even in only equity but also other instruments, such as convertible MICs, require a longer time horizon to reach sustained impact, bonds and mezzanine and subordinated debt. The latter can and governments should be ready to provide patient capital. still provide risk capital, while mitigating some of the concerns that have hampered the interest of SMEs for equity financing, particularly those associated with SMEs’ reluctance to open Mix of Interventions Deployed to Support Private their capital to third parties. Equity As a result of the nascent state of their equity markets, Governments should apply private sector practices to LICs that have implemented investment programs have improve the mobilization of private capital, relying on a not been able to apply a fund-of-funds approach and have fund-of-funds approach whenever possible. Private sector instead relied on investing in a single dedicated fund. The structures, in particular funds, are critical to achieve scale and fund is structured by the government, with the expectation diversification. Early lessons from HICs and EMDEs indicate that it will bring private sector investors to it; thus, it is that investment, through a fund of funds, should be the sometimes called a hybrid fund. This approach is unlikely preferred approach. Under this approach the government to close the existing financing gaps of SMEs, nor is it likely invests in companies indirectly, via the structuring of a fund, to meet the follow-on needs of companies that are able to which in turn invests in a plurality of other funds structured by obtain financing from the fund. It is also unlikely to mobilize private sector fund managers, and in which private investors private capital at scale. In this case, the choice of a single also invest. This approach was initially adopted by countries hybrid fund is driven by country context. Small countries that members of the Organisation for Economic Co-operation are not regionally well integrated would not be able to resort and Development (OECD), with increased adoption coming to a fund-of-funds approach, as there would not be enough from larger EMDEs over time. This approach provides scale fund managers locally or regionally interested in supporting and mitigates the risk of concentration in one fund (and SMEs in these markets, even though there could be SMEs fund manager), thus ensuring diversification of investment in need of equity financing. Governments that choose to strategies. Compared to private investors, this approach pursue this type of intervention should thus be realistic about ensures that government investments follow the market. what can be accomplished and as stated earlier, should focus However, early lessons indicate that governments should on market creation, working in parallel to address structural retain the flexibility to use direct coinvestments alongside challenges that limit their ability to mobilize private capital in private investors that would conduct their own due diligence, a sustainable manner. thus allowing governments to also follow the market. For example, direct coinvestments in companies alongside angel Governance arrangements are key in mobilizing private investors could foster the development of a network of angel investors, irrespective of specific intervention designs. investors that could support early-stage financing. It could Governance arrangements are meant to instill confidence in also help address specific market gaps not fulfilled through a investors by ensuring that fund management is professional fund-of-funds approach. and that decisions are based on market and business opportunities. In practice, this means using professional An in-depth market analysis should be the basis for fund managers and investment committees integrated by identifying the type of funds in which to invest, determining independent experts who can make investment decisions the type of instruments to deploy, and informing other without government interference. Government oversight design elements of the program. The identification of the key is still necessary to ensure the achievement of program 4. TOWARD A MORE EFFECTIVE USE OF TARGETED PUBLIC INTERVENTIONS 29 objectives, for example, in terms of outreach to specific Governments should use tax incentives carefully. Tax SME segments and financial additionality. But oversight incentives to investors have been deployed in many should not take place through direct participation of the countries, including most of the countries with well- government in investment decisions, but rather through developed VC industries.126 Nonetheless, the effect of such other mechanisms, including strong M&E frameworks, as incentives in attracting private equity financing remains discussed in the previous section. unclear. Research has not found a relationship between tax incentives and the level of equity financing.127 The use of tax To limit market distortions and ensure sustainability, incentives by many countries to make investments in SMEs financing should be provided on commercial terms; however, more attractive to foreign investors, might lead some EMDEs EMDE experience indicates that some level of concessionality to provide similar incentives; however, in doing so it is critical may be necessary to crowd-in private investors, particularly that EMDEs evaluate their fiscal cost and effectiveness in for riskier investments. This recommendation is relevant, for mobilizing private capital and, more generally, in bringing example, for EMDEs attempting to attract foreign investors. In financial additionality. In addition, governments should this case, governments may use concessionality to offer returns holistically assess whether concessional financing is already comparable to the returns that these investors would obtain being provided and the potential impact of combining it through investments in other countries, including in HICs. In with tax incentives. practice, the type of concessionality has varied. In many cases, it has involved asymmetric returns (for example, the government Finally, equity guarantee programs could be explored. caps its returns, or it accepts a larger share of the losses, akin Guarantees can be used as an alternative to investment to a guarantee); in other cases, it has involved the government programs when SMEs and investors have strong concerns bearing certain costs of the fund (such as, paying part of the about government interference. In practice, there has been fund management fees). limited use of equity guarantees globally as governments have deployed other instruments with a similar overall Cross-country experience indicates the need for broader objective of changing the risk-return profile of SMEs for support programs for more impactful investment investors, while acting through different levers (for example, interventions. The scope of these programs depends on tax incentives). An in-depth understanding of country context country context. is needed to assess which instrument can best address the • Technical assistance, grants, and performance-based needs in the marketplace. financing to support the development of the deal flow: As highlighted above, the lack of a robust pipeline Mix of Interventions Deployed to Support SME of companies to invest in is often mentioned as a key Listings constraint for private investors in EMDEs. Governments have increasingly combined their financing support with Governments should assess the feasibility and potential technical assistance programs aimed at enhancing firms’ impact of interventions to support SME listings. Globally, capabilities and providing investment readiness grants. few countries have implemented interventions beyond Other types of grants to SMEs should be used under equity financing interventions in private markets. Moreover, limited circumstances, for example, when they are needed qualitative evidence raises questions about the long-term to support innovation but are unlikely to distort private impact of such interventions on SME listings. Below is a list of financing. Public support can also foster the development the interventions that have been deployed. of other entities that play an instrumental role in building • Non-financial support to build the pipeline of SMEs the deal flow, such as incubators and accelerators. coming to market. Some countries have established This type of support has varied, from launch grants to support programs, akin to investment readiness performance-based financing to align incentives. programs for private equity financing, but, in this case, • Capacity building to support the development of support is aimed at helping SMEs prepare for public the investor base: In some EMDEs, there is a need to listings. further develop the base of angel investors, which can • Financial support to SMEs. Some countries have be a source of early-stage equity capital and expertise. reduced specific fees, such as listing fees, to attract Governments have been instrumental in developing SMEs listings. Other countries (for example, Jamaica, angel networks and providing capacity building. In Kenya, and Thailand) have used tax exemptions.128 addition, in countries where domestic institutional investors (such as pension funds and insurance • Tax benefits for investors in SME listings. In some companies) are mobilized, capacity building programs countries, tax benefits for investing in SMEs have been to increase understanding of these investments have extended beyond equity financing in private markets to proven to be valuable. also cover SMEs listed in SME exchanges. 30 BOOSTING SME FINANCE FOR GROWTH CHAPTER 5 Selected Topics 5.1 Women-Led SMEs Globally, only one in three businesses are owned by affecting WSMEs access to finance: structural differences, women.129 Female participation in business ownership is supply-side discrimination, and demand-side aversion to positively correlated with countries’ income level, but only external sources of financing.133 to a small extent. In LICs, about 25 percent of businesses have a female owner, whereas in MICs and HICs, the rates There are structural differences in WSMEs compared to are slightly higher at around 33 percent. This rate also male operated businesses. WSMEs tend to concentrate in varies across and within regions, from a low of 18 percent in less productive sectors, have lower levels of business capital South Asia to a high of 50 percent in Latin America and the and labor, fewer tangible assets to offer as collateral, and Caribbean.130 are less willing to compete and to adopt advanced business practices; all of which affect the evaluation that lenders and Financial exclusion is a significant challenge for women investors made of their businesses. Such differences are entrepreneurs attempting to start, operate, or expand largely the result of gender-specific constraints that emerge their businesses. More than 1 billion women do not use or do from the context in which women operate, their endowments, not have access to the financial system.131 The International and household-related factors. These constraints ultimately Finance Corporation (IFC) estimated that worldwide, a affect the decisions women make as entrepreneurs.134 In US$300 billion gap in financing exists for formal women- this regard, women are heavily influenced by social norms owned small businesses, and more than 70 percent of WSMEs surrounding education, permissible economic activities, have inadequate or no access to financial services. Women in and interactions with buyers and suppliers, especially in less EMDEs also face more challenges to accessing DFS, as they developed countries, all of which affect women’s ability to have less access to mobile technology. Estimates indicate conduct business. For example, social norms may prevent that EMDEs have 200 million more male than female cell many women in some EMDEs from accessing safe and phone owners.132 reliable transportation (limiting their mobility), access to information (including informal communication networks), and participation in training. Women’s disproportionate Are the challenges affecting WSMEs access to responsibility for child- and eldercare constitutes another finance the same as those affecting men-led social norm that influences their economic participation by businesses? limiting their personal time. Moreover, women often lack authority over the allocation of household assets and face WSMEs suffer additional constraints to access financing pressures to share their own resources. A cultural environment than male operated businesses. While there is consensus that favoring male dominance and decision making limits women’s WSMEs face a larger financing gap relative to male operated ability to control the revenue generated by their businesses. businesses, the empirical evidence on the root causes of Legal and regulatory constraints in family law and inheritance this gap is mixed. Overall, it points to three types of factors also play a role in women’s ability to own property and access 5. SELECTED TOPICS 31 collateral. According to World Bank’s Women, Business, and commercial banks. However, for the vast majority of WSMEs, the Law 2024, to this day, nearly 25 percent of economies limit especially smaller businesses and first-time borrowers, NBFIs, women’s property rights.135 Lastly, women also lack access to notably MFIs, represent their primary lender. As mentioned legal identification and credit histories more often than men. earlier in this chapter, women’s access to venture capital funds Overall, these underlying social norms and legal constraints is very limited.140 directly affect business growth and performance. Experiences with recent innovations highlight fintech’s In addition to these structural differences, there are other potential in expanding WSME access to finance, while constraints, including behavioral ones, emerging from also revealing some specific challenges for a greater take both the demand and the supply side. On the demand side, up of fintech lending solutions by WSMEs. See appendix many women entrepreneurs do not even apply for financing, C for selected examples. Although robust evidence is not thus self-selecting out of financial markets. Empirical yet available, alternative credit scoring is showing promise evidence points to low financial literacy, high risk aversion, in addressing the drawbacks of lack of collateral and reliance or fear of rejection (or a combination of these factors).136 On on traditional credit information for WSME access to finance. the supply side, there is research backing the existence of For example, the use of psychometric tests in Ethiopia has gender biases from lenders and investors.137 While some of supported the development of loans with reduced collateral these biases relate to discrimination, others emerge in the requirements.141 Credit scoring also holds potential to mitigate context of imperfect information, where data on indicators gender bias in credit origination, if properly designed.142 In such as creditworthiness are difficult and costly to obtain by addition, tailored products that rely on technology to reduce financial providers. the time to obtain a loan and provide convenient access to funds, such as automatic and on-tap disbursement of funds, These barriers have a tangible impact on access to both can be particularly useful to women. At the same time, the debt and equity financing. World Bank experience in Consultative Group to Assist the Poor’s (CGAP’s) research with the field, along with several country studies, shows that 400 micro and small enterprises in India, Kenya, and Peru in addition to being less likely to have a loan, women found widespread lack of trust in fintech providers, particularly entrepreneurs are more likely to face higher interest rates, among the smallest, poorest, and women-owned businesses. stand a greater chance of being required to collateralize The limited number of recourse mechanisms users have to a higher share of the loan, and more often must rely on enforce their rights and the lack of transparency on the use shorter-term loans compared to male entrepreneurs. of customer data were identified as key sources of concern.143 Regarding equity financing, businesses founded by women receive only a fraction of the overall funding from investors. In 2020, only 2.3 percent of global VC investments went to Should public interventions that support WSMEs businesses with female founders.138 This pattern holds in differ from standard SME financing interventions? spite of the fact that businesses owned by women tend to deliver higher returns on investment—more than twice as The trends and innovations highlighted above confirm much per dollar invested—and stronger cumulative revenues the relevance of an extended core enabling environment (nearly 10 percent more) over a five-year period compared for the policy agenda for WSMEs. The examples illustrate to businesses led by men.139 In the case of startups, most the importance of alternative lenders and the potential entrepreneurs identify lack of investors and shortage of role of fintech to expand WSME access to finance; thus, funding as a barrier. For women entrepreneurs attempting to substantiating the appropriateness of strengthening the build startups, these barriers are further aggravated by two enabling environment for fintech and for alternative lenders. factors: (a) women have lower access to networks of investors The examples also highlight the importance of a robust compared to men, and (b) investors perceive women-led consumer protection framework to mitigate mistrust in enterprises as riskier than other investments. fintech lenders. A tailored approach to targeted interventions is needed. Which intermediaries serve WSMEs? Are recent Existing research shows that gender-neutral programs that developments changing the landscape of their seek to support entrepreneurs are not sufficient to address financing? the constraints faced by WSMEs, and in some instances, may instead widen existing gaps. Therefore, governments need to The sources of finance for women entrepreneurs differ integrate a gender lens into the design and implementation of greatly by segment, with alternative lenders playing a SME financing interventions, for which the collection of gender critical role for smaller businesses. Women with established, disaggregated data is critical. In practice, a tailored approach mature businesses are most likely to access financing through is needed, one that explicitly tackles the specific constraints 32 BOOSTING SME FINANCE FOR GROWTH affecting WSMEs access to finance, be they structural Customized financial offerings for WSMEs are essential. differences in the women-led businesses, women’s aversion These include (a) developing alternative delivery channels to to seek external financing, or lender or investor biases. women entrepreneurs who are unable or unwilling to come While acknowledging that WSMEs in different segments may to a branch; (b) training staff on how to engage with women require different approaches,144 the interventions145 listed entrepreneurs; and (c) delivering non-financial services to below seem to have a greater impact on WSMEs compared complement financial services. Existing evidence suggests to SMEs more broadly. that there are combined benefits of training and credit and grants for female entrepreneurs.146 In addition, research Governments should include a wider set of finance providers shows that certain types of training have a greater impact in their interventions. Interventions should be accessible for on WSMEs. Training programs addressing socioemotional alternative lenders more broadly, including MFIs, cooperative skills and gender-specific content—as opposed to standard financial institutions, and fintech lenders, in addition to managerial training programs—have proved to have an commercial banks. These alternative financial providers tend to impact in numerous contexts and pay for themselves through have a wider network and better outreach among WSMEs. increased profits over the long term.147 Governments should also consider earmarking public funds for WSMEs. Governments can increase the availability Finally, a multipronged approach is necessary to effectively of funds for WSMEs either by imposing targets or by offering close the financing gaps for WSMEs. Notably, addressing additional incentives for financial institutions to lend to foundational aspects related to the business environment, women entrepreneurs. This approach is more common for such as legal and regulatory constraints, as well as restrictive LoCs and PCGs. In the case of support for equity finance, for social and cultural norms, is key when focusing on WSMEs. all the reasons noted in this section, such programs face the Only by tackling such issues, would governments be able to risk of lack of WSMEs that can attract private investors in a way mitigate the structural differences between WSMEs and male that allows appropriate disbursements of funds. operated businesses. 5.2 Financing Investments in Mitigation and Adaptation to Climate Change for SMEs Climate change is affecting SMEs by increasing their Are the challenges of access to finance for SMEs’ vulnerability to physical risks and transition risks.148 adaptation and mitigation investments different Regarding physical risks, the increased frequency and intensity than those affecting SMEs more generally? of natural disasters pose critical challenges for SMEs due to The landscape for adaptation and mitigation financing their limited coping mechanisms. Regarding transition risks, is marked by financial market failures that can lead to the environmental footprint of the vast majority of SMEs is marked underinvestment, by both SMEs and financiers relatively small and, at first glance, suggests a limited need alike. While the traditional barriers of SME access to finance, for investments in mitigation. However, SMEs at the aggregate as discussed earlier in this report, still apply, a number of arguably have a sizeable impact. But estimates for EMDEs are additional challenges further constrain the undertaking and rare.149 Importantly, there are also transition risks associated financing of adaptation and mitigation investments by SMEs. with the global shift toward a low-carbon economy. A subset of SMEs has increasingly faced pressures to act and adopt Externalities and lack of pricing mechanisms lead to mitigation strategies to comply with more stringent regulations misaligned incentives to invest. One critical market failure and taxes as well as well as with growing client demands for relates to externalities and the public-good nature of climate environmental sustainability in global markets.150 That is, SMEs change related investments, which leads to mispricing of would need to act to remain competitive in the marketplace benefits, costs, and risks. For example, green investments or risk being left behind.151 Constraints in access to finance, often generate positive externalities—for example, reduced both ex ante and ex post in case risks materialize, render SMEs greenhouse gas (GHG) emissions and reduced air pollution— vulnerable to these risks brought on by climate change. Policy that are not fully internalized by individual SMEs.152 There interventions must play a pivotal role in addressing the barriers can also be externalities in adaptation investments—for that hinder investments in more resilient and sustainable example, technology spillovers that can benefit a wider set practices for SMEs, while also fostering private financing. of businesses. Moreover, adaptation investments by individual 5. SELECTED TOPICS 33 SMEs can contribute to sector-wide resilience and stability. players tend to introduce their own, resulting in a lack of Carbon pricing mechanisms are starting to be used around comparability, reliability, and accountability, leading to the world to price some of these externalities—namely, higher transaction costs and increasing greenwashing the negative externalities associated with GHG emissions. risks, which in turn can reduce the attractiveness of these However, carbon credit markets are still in their nascent investments. The international sustainability standards stage in most EMDEs, and there are marked challenges in recently issued by the International Sustainability Standards leveraging these markets for SMEs, at least in the short term. Board will partially mitigate this problem. Yet, EMDEs will For instance, the limited capabilities of SMEs can be a major likely face challenges in implementing them. Furthermore, barrier as the use of carbon markets is administratively costly information challenges can be more constraining for SMEs and requires significant measurement efforts—including data due to their opacity, as information on environmental validation of the project design, accurate data gathering performance is even more scarce. and reporting, and responsiveness to third party verifiers during on-site inspections. In the absence of effective pricing mechanisms for these externalities in EMDEs, there are What is the role of financial sector policies in misaligned incentives to invest. supporting SME adaptation and mitigation investments? Mismatched time horizons and high uncertainty discourage investments. Although investments in mitigation can increase Thus far, support to the enabling environment for firm the operational efficiency of SMEs, they often require large financing has predominantly focused on climate mitigation upfront expenditures, and returns have long payback periods. efforts rather than adaptation.154 Taxonomies, along with In the case of adaptation investments, benefits usually take climate-related and environmental disclosure standards, are the form of lower expected losses associated with climate- essential elements in building the enabling environment for related risks, which are not only hard to quantify, but also financing sustainable and climate-resilient projects. Existing may not be material to SMEs in the short term. Furthermore, standards have focused primarily on climate change mitigation the high uncertainty regarding the magnitude and frequency efforts rather than adaptation, with emphasis placed largely of extreme weather events weakens the business case for on the management of GHG emissions. For example, existing such investments.153 The uncertainty about the magnitude taxonomies tend to focus on defining sectors and activities and timing of financial returns can discourage financing, that can be classified as “green,” with the aim of making as lenders favor short-term returns, partly due to the high them more attractive to lenders and investors. In fact, many riskiness of SMEs. taxonomies do not make explicit reference to how financing can support climate change adaptation or resilience in the There are also marked informational inefficiencies that face of climate shocks.155 Similar observations can be made in exacerbate uncertainties and perceptions of risk. The the case of disclosure and reporting requirements. high uncertainty surrounding mitigation and adaptation investments is amplified by data gaps on climate-related Targeted interventions have also placed greater emphasis information, posing challenges for SMEs, financiers, and on climate mitigation efforts, rather than on adaptation policy makers alike. Limited knowledge and capabilities efforts. A survey of DFIs, which are leading players in climate intensify the challenges from climate data gaps and can finance in EMDEs, shows that they strongly favor mitigation hinder effective risk management practices, especially investments.156 While support to SME financing has mainly for “new risks”—for example, greenwashing risks and been offered through direct lending, governments have also transition risks. Limited awareness and capabilities can be supported SMEs with equity and grants, largely for clean and particularly constraining because of the economic and climate technologies.157 PCGs are being adapted to support financial complexities and the rapidly evolving nature of the the financing of green initiatives of SMEs in a small but landscape for climate-related investments and finance. expanding set of countries, typically through the adoption of “green” windows.158 These windows should be aligned The underdevelopment of the financial infrastructure with taxonomies and disclosure frameworks to ensure that for climate-related investments further complicates this the schemes themselves can manage climate-related risks already intricate informational environment. Globally, while facilitating sustainable finance to SMEs.159 The links standards to classify sustainable activities (along with non- among PCGs and taxonomies and disclosure frameworks sustainable activities, in some cases) are lacking. There is also exacerbates existing biases in policy frameworks toward limited harmonization in disclosure and reporting of climate- climate mitigation investments. related investments, including standardized metrics and reporting frameworks for environmental impact evaluation. Financial sector policies aimed at supporting SME finance In the absence of formally agreed-upon standards, market need to be rebalanced to provide greater attention 34 BOOSTING SME FINANCE FOR GROWTH to adaptation, with emphasis placed on improving the In contrast, a top-down approach could be more effective effectiveness of government support to mobilize private in supporting SMEs facing high transition risks associated capital. Addressing the imbalance in policies requires a with the global shift toward low-carbon economies. While shift in the understanding of the importance of adaptation individual SMEs have a low carbon footprint, some SMEs investments for SMEs while recognizing the distinct face pressures to improve their carbon footprint to remain challenges of fostering adaptation investments, such as the competitive, ensuring access to markets and participation lack of clear metrics for assessing adaptation outcomes.160 in global value chains. Support to mitigate the impact The rebalancing in public policy approach is particularly of such transition risks should thus be deployed in a top- important because global climate finance is heavily focused down approach, whereby efforts focus on large companies on mitigation, with estimates showing that more than 90 active in global markets, but greater emphasis is placed percent of total financing went toward mitigation efforts on supporting SMEs that are part of their value chains or during 2017–20.161 Estimates indicate that private capital SMEs for which decarbonizations efforts might be needed to accounts for 54 percent of mitigation finance, whereas the ensure competitiveness, such as those directly exporting to public sector provides almost all of the adaptation financing. countries with high sustainability standards. In some EMDEs, These statistics characterize not only the more advanced complementary support might also be needed for SMEs state of development of private markets for mitigation operating in specific, high-emitting sectors, for which their investments, but also a sizeable gap in adaptation financing, decarbonization can lead to a material contribution to the with limited private capital mobilization associated with countries’ nationally determined contributions. Finally, it is public support. important to bear in mind that mitigation efforts focused on firms more broadly (that is, the demand for energy) may not Such a rebalancing is particularly relevant for SMEs in be as impactful as those focused on greening the energy EMDEs. While mitigation investments are essential to avoid supply (that is, power generation and distribution). global catastrophic scenarios, in the context of SME financing in EMDEs, individual SMEs contribute little to global It is critical that targeted interventions be aligned with and emissions, and transition risks primarily affect a relatively supportive of countries’ broader climate change mitigation small subset of SMEs, notably those involved in global value and adaptation strategies, hence policy support needs chains and exposed to global market pressures. In contrast, to reflect country context. Consider climate finance for physical risks seem to affect a wider set of SMEs, especially mitigation: energy broadly accounts for almost 75 percent in light of the limited penetration of insurance within the of global GHG emissions, but zooming in on EMDEs shows segment, leaving them potentially exposed to large losses. a markedly different picture (figure 5.1). GHG emissions from SMEs in EMDEs are particularly exposed to climate-related energy account for around 5 percent of the total in LICs, but hazards, such as cyclones, floods, droughts, sea level rise, they are more than 60 percent in UMICs, largely reflecting and coastal erosion, due to these countries’ geographic differences in economic structures. Transport accounts for location and extensive coastlines. There is also a greater 30 percent of GHG emissions in HICs, but significantly less share of SMEs in climate-sensitive sectors, like agriculture in EMDEs. In contrast, agriculture, land use, and forestry and fisheries. Additionally, inadequate infrastructure and activities play a much larger role in EMDEs. A similar limited capacity for early warning systems in many EMDEs argument applies for adaptation investments. can amplify the impacts of natural disasters. How can targeted interventions better support SMEs’ adaptation and mitigation efforts? Supporting access to finance for SME adaptation requires a bottom-up approach with widespread reach that goes beyond size-based targeting. Vulnerabilities to physical risks depend, to a large extent, on SMEs’ geographical location, their sector of operations, their existing risk management strategies, and of course, on the type of climate shocks they are vulnerable to. Effective support thus requires localized solutions with broad outreach across SMEs, specifically designed to help SMEs enhance physical risk management strategies.162 5. SELECTED TOPICS 35 Waste, 3% Industrial Processes 60% 84.5% (Cement, Chemical Other industry, 11.0% Chemicals, 3% 50% 13% Energy Use in Trans Cement, 3% 40% Others, 1% Other Fuel Combus Shipping, 2% 30% 60.3% 51.8% 20% 39.7% FIGURE 5.1 Aviation, 2% Residential buildings, 12% Fugitive Emissions 10% 3.4% GHG Emissions around the World 5.0% 0% Energy: Electricity, Road transport, 13% Heat, Buildings a. Global GHG emissions by sector, 2019 b. GHG emissions by High sector across income Upper countries, Lower 2019 Low income Commercial middle middle Crop Energy in agriculture buildings, 7% income income burning, 1% and fishing, 2% Fugitive Unallocated fuel Iron and steel, 6% 100% Land use change emissions, 7% combustion, 7% 3.9% Rice cultivation, 1% 7.7% Agriculture, Land Use, and forestry, 3% 90% and Forestry Agr. soils, 4% Chemicals and 32.7% petrochemicals, 6% 80% Waste Livestock and manure, 6% 11.5% 30.3% 70% Waste, 3% Industrial Processes 60% 84.5% (Cement, Chemicals) Other industry, 11.0% Chemicals, 3% 50% 13% Energy Use in Transport Cement, 3% 40% Others, 1% Other Fuel Combustion Shipping, 2% 30% 60.3% 51.8% Aviation, 2% Residential 20% 39.7% Fugitive Emissions buildings, 12% 10% 3.4% 5.0% Energy: Electricity, Road transport, 13% 0% Heat, Buildings High income Upper Lower Low income Commercial middle middle Energy in agriculture buildings, 7% income income and fishing, 2% Fugitive Unallocated fuel emissions, 7% combustion, 7% Source: Original calculations for this publication based on data from Climate Watch and from World Resources Institute (2023). While there is limited information on the extent to which Governments can leverage DFIs to play a catalytic role in governments are providing concessional financing to SMEs, fostering change in the financial sector.166 In EMDEs, DFIs externalities justify their use.163 Such support should not often have the scale and the ability to catalyze private be aimed at providing liquidity to financial institutions, but capital, as well as the necessary tools to provide long- rather at providing incentives to SMEs so that they make term funding and support riskier projects, key features the needed investments to address the challenges posed for financing mitigation and adaptation investments. For by climate change, fostering access to cheaper sources instance, DFIs can support private capital mobilization of funding, thereby enhancing the business case for these through the design of innovative financial instruments by investments. Concessional financing may also be appropriate acting as first movers and setting standards and through for emergency financing, after SMEs are hit by natural demonstration effects, among other innovations. DFIs disasters or extreme weather events. Access to finance can support capacity building efforts, for example, by can be particularly challenging, as SMEs may have lost the providing technical assistance to SMEs and lenders on assets that formed the collateral basis for debt financing, and the management of physical and transition risks. Building their business viability may come into question. But policy capabilities and raising awareness should be an integral makers should be careful in the design of policies to avoid part of the policy agenda more broadly. disincentives for adaptation investments. The higher risks of climate-related investments highlight What is the potential for unintended consequences the need for risk-sharing support, for instance, through from the “new” financial regulation? PCGs.164 This high riskiness, perceived and real, of both adaptation and mitigation investments in comparison The new levers of policy to support greater sustainability to conventional investments is explained in part by the and resiliency in the financial sector may have unintended marked uncertainties, mismatched time horizons, and consequences that negatively impact financing to SMEs. inefficiencies in the informational environment. The main Taxonomies and climate-related disclosure requirements are objective of de-risking interventions, such as PCGs, is to essential building blocks of the enabling environment for adjust the risk-return profile of investments for lenders, the financing of sustainable and climate-resilient projects. thereby fostering capital mobilization.165 PCGs can also be Harnessing investment opportunities should go closely with leveraged to provide emergency finance to viable SMEs. risk management. That is, the financial sector can only mobilize The design of PCG schemes must carefully monitor for finance for climate change if financial intermediaries can unintended consequences. For example, favoring “green” effectively manage climate risks in their own portfolios. Thus, or penalizing “brown” SMEs may exacerbate barriers in the importance that financial supervisors require banks and access to finance. other financial intermediaries to imbed climate risk into their 36 BOOSTING SME FINANCE FOR GROWTH risk management frameworks. At this stage, the empirical into capital assessments induced large banks to reallocate evidence remains limited, but policy makers should carefully their lending portfolio away from exposed sectors.167 This monitor the implementation of these new frameworks and negative spillover effect of financial regulation would apply requirements to avoid unintended consequences. not only to SMEs highly exposed to physical risks but also to those exposed to transition risks (that is, SMEs operating in First, financial institutions may retrench from borrowers high-emitting segments). that are unable to provide information on climate-related risks. To the extent that SMEs may be unable to provide Third, non-bank financial institutions (NBFIs) could also be such information, precisely because of their opacity, financial adversely impacted by climate-related financial regulation. institutions may be unable to assess climate risks for these Some of these financial institutions, such as MFIs, are SMEs and may limit financing. Transaction costs would also important providers of financing for SMEs in EMDEs. To a increase for financial institutions (for example, due to additional large extent, they tend to rely on funding from commercial due diligence processes) and may render smaller transactions banks. Akin to the challenges faced by SMEs themselves, simply not cost effective. For SMEs, the need for additional if NBFIs are not able to track climate-related risks in their information, and even certification in some instances, would own lending portfolios, they may face constrained access also increase transaction costs and may discourage some to funding, hindering their ability to serve their SME clients SMEs from seeking financing in the first place. effectively. In fact, this unintended consequence of the new financial infrastructure could affect the broad set of Second, financial institutions may reallocate their lending alternative lenders borrowing from banks. In addition, the portfolio away from clients that are highly exposed to adoption of climate-related financial regulation for NBFIs climate-related risks. For example, Miguel, Pedraza, and themselves could increase their operational costs, which Ruiz-Ortega (2022) show that a micro-prudential policy in would be particularly challenging for smaller NBFIs with Brazil requiring banks to incorporate environmental risks limited resources and capacity. 5.3 Financing Agri-SMEs Are the challenges affecting access to finance for The agri-financing gap and its rippling effects on food agri-SMEs the same as those faced by other SMEs? security, food price inflation, and ultimately on countries’ economic growth expose the urgent need to improve access Agri-SMEs tend to have higher risk profiles and are subject to finance. Three quarters of the developing world lives in to greater uncertainty than other types of SMEs, thus agri- rural areas, and about 9 out of 10 people depend directly or SMEs face greater challenges in access to finance.168 First, indirectly upon agriculture for their livelihoods. While the lack agri-SMEs are highly exposed to climate-related risks, both of access to finance has a profound impact on the growth of directly, for example, when an extreme weather event affects agri-SMEs themselves, it also affects countries’ productivity, production, and indirectly, for example, through commodity competitiveness, and economic growth. Estimates show an price volatility. Second, their business model is highly seasonal. annual formal financing gap of about US$106 billion.169 The This constrains their cashflow and puts a premium on risk multiple shocks of the COVID pandemic, Russia’s invasion of management capabilities, which is often lacking among agri- Ukraine, and food price inflation have intensified the needs SMEs in many EMDEs. Third, in many EMDEs, agri-SMEs are of agri-SMEs to access finance to improve productivity and marked by a high degree of informality in business operations, strengthen food systems. Furthermore, the escalating impacts which leads to inadequate financial records. Fourth, the of climate change underscore the need to strengthen the limited enforceability of the assets of agri-SMEs, including the resilience of SMEs, as well as bolster their competitiveness, traditional land tenure systems in some EMDEs, aggravates the thus adding another layer of urgency to improve access to aforementioned challenges. Female farmers and entrepreneurs, finance (see section 5.2).170 whose presence in the agriculture sector is more prominent than in other sectors, are particularly vulnerable, as they are rarely landowners and do not have assets to be pledged as Which intermediaries serve agri-SMEs? Are recent collateral (see section 4.8). Overall, these unique features developments changing the landscape of their create a high level of opaqueness and uncertainty that adds financing? complexity to the provision of financing to the segment. In addition, serving agri-SMEs can be costly for financial providers, The landscape of agri-SMEs lenders includes a wide range of as agri-SMEs tend to be spread out over remote, rural areas. players, with alternative lenders playing an important role 5. SELECTED TOPICS 37 for smaller agri-SMEs. While banks continue to represent connections between participants in a value chain and their a large share of the value of formal external financing for connections with lenders to facilitate access to finance and agri-SMEs, they tend to focus on more mature, less risky, encourage investments in procedures, tools, and machinery larger borrowers. These borrowers are typically traders and that can reduce greenhouse gas emissions and encourage processors in cash crop value chains. At the other end of climate-smart practices. These mechanisms have been the size distribution of agri-SMEs, non-banking institutions, developed by food and beverage suppliers. For example, such as MFIs and cooperative financial institutions, tend the Unilever Sustainable Living program provides access to to provide financing to commercial farmers, cooperatives, sustainable finance to over 500,000 smallholder farmers and and microenterprises as an extension of their traditional 5 million agriculture retailers. Similar approaches have been retail business. Depending on country context, factoring observed in several countries and with other large suppliers. and leasing providers also engage with agri-SMEs, with the Fintech is also improving value chain financing, especially latter typically supporting the purchase of equipment and through the use of blockchain technology. Its benefits of machinery. Despite the uniqueness of agri-SME borrowers, allowing the traceability and verifiability of product flows, the offering of tailored products, backed by specialized staff, to include practices used for farming and harvesting all the remains limited. Many agri-SMEs sitting in between these way to consumers and payments flows, are highly effective two ends of the distribution of enterprises remain largely features to unlock financing. unserved by the formal financial sector as they are too small and too risky for banks and too large for NBFI financing.171 However, value chain financing has developed around In addition, equity financing has funded a select set of strong and well-organized value chains, where agriculture agri-SMEs, such as SMEs leveraging the use of technology productions are transferred from farms to downstream (agritechs) or large, established agri-SMEs such as local food processors and traders efficiently. Value chain finance and beverage manufacturers.172 In practice, agri-SMEs often solutions often require a holistic approach consisting of rely more on internal and informal financing sources than on building trust and business relations among the main value formal financing. chain actors and strengthening farmer organizations for greater volume and quality of produce while facilitating Similar to the trends for SMEs in other sectors, digital finance along the flow of agriculture goods. For products financial solutions are helping agri-SMEs increase their such as export commodities and perishable products, this access to finance. The adoption of mobile finance has allowed model can be effective and scalable, but for products with the digitalization of payments across agriculture value chains, weaker value chain links, such a solution may not be feasible. which in turn has paved the way for the provision of credit, For example, staple commodity value chains, such as wheat, especially for smaller, more informal agri-SMEs thanks to the maize, and rice, are often difficult to organize given the traceability and transparency of financial flows along these high volume of transactions outside of contracts between chains. Other emerging solutions include financing based producers and off-takers. on agriculture credit scoring leveraging alternative data (for example, farming yields and geo-localization information to track climate risks) as well as digital e-commerce marketplaces Should public interventions that support agri-SMEs and platforms that offer financial and non-financial services. differ from standard SME financing interventions? For example, Digi Farm (a division of Vodaphone) in Kenya offers digital payments and credit solutions to agri-SMEs The trends and innovations highlighted above confirm along with non-financial support, such as access to agriculture the relevance of an extended core enabling environment. inputs and markets. Amazon Fresh in the United States, The above examples illustrate the importance of fintech in Pinduodo in China, and Jumia operating in 14 countries are improving agri-SME access to finance, and thus the need offering short-term finance to agri-SMEs on their platforms for a robust enabling environment, from digital connectivity through partnerships with financial institutions. and digital payment services to a supporting enabling environment for the entrance of new fintech players. They Another source of financing for agri-SMEs is value also show the importance of supporting the enabling chain financing, which is anchored in steady business environment for alternative lenders more broadly. transactions between producers and off-takers in the value chains. Furthermore, as resilience of individual producers to In EMDEs, targeted interventions in the agri-SME space have climate change is becoming increasingly critical for stronger extensively relied on direct subsidies, matching grants, and value chains and risk management in financing, examples donor funding, especially for commercial farms and producer of climate-linked value chain finance models are on the rise. cooperatives, based on their high socioeconomic importance These include sustainable payable finance and loans for as well as food security concerns. Purely commercial finance sustainable agriculture. These financial solutions leverage the for agri-SMEs remains relatively small and limited to the 38 BOOSTING SME FINANCE FOR GROWTH small set of agri-SMEs that are well-known to local financial capabilities of firms and financial providers. On the supply institutions. The vast majority of public support programs in side, in addition to basic agriculture finance training, support EMDEs have provided some form of concessional funding for financial product innovation tailored to the needs of the (subsidies and grants), with limited links (if any) to the segment, leveraging value chain finance and DFS, could be development of private markets at commercial terms. In fact, impactful. On the demand side, small farmers, especially concessionality to either agri-SMEs or to financial providers, women and cooperatives, often require basic financial and in many instances, discourages financing at commercial terms business training. (see discussion in section 4.3). Overall, these interventions have not addressed key market failures underlying access Agricultural insurance can play an important role in to finance to agri-SMEs. Hence, most agri-SMEs remain facilitating investment and access to finance as well constrained in access to formal sources of finance. as increasing resilience to shocks. Evidence shows that insurance, alongside credit and other financial services, can Going forward, governments should strengthen their help farmers better manage climate shocks and prepare efforts to scale up commercial financing, leveraging for, and recover from, such shocks. In addition to the blended finance and more market-based mechanisms for provision of timely funding after the occurrence of shocks, interventions as part of a coherent policy to support the insurance supports access to credit by reducing the credit sector. Increasingly, in many EMDEs, LoCs, first-loss schemes, risk to lenders.173 It can also positively influence investment and PCGs have been developed with a targeted allocation behaviors, increasing expenditures into productive inputs, incentivizing financing to agri-SMEs for investments in activities, and technologies.174 Across EMDEs, there is a agriculture equipment, logistics, warehouses, irrigation growing range of products to de-risk agri-SME production systems, and climate technologies, but on conditions that from climate shocks and facilitate access to finance. Such require financial institutions to add their own funding. In some products include weather index and area yield insurance countries, governments also support agri-SMEs lenders’ targeted at producers, meso insurance to protect the agri- access to capital markets. However, at the same time that portfolio of lenders, and contingent credit instruments, which these market-based mechanisms are being implemented, provide finance to agri-SMEs in the case of a predefined heavily subsidized interventions are also being deployed production shock akin to an insurance mechanism. in both the agriculture and financial sectors. Therefore, it is critical that governments adopt coherent policies that are However, cross-country experience demonstrates that conducive to more private sector participation. strong partnerships between the public and private sectors are required to develop effective and sustainable agriculture In supporting scaling up of commercial financing, insurance markets. Many initiatives for insurance and other governments should consider the inclusion of a wide set financial risk management tools have failed to achieve scale of finance providers in support programs. In addition to and sustainability in EMDEs due to a variety of obstacles, commercial banks, these include MFIs, cooperative financial including low trust, weak enabling environment, and limited institutions, and new digital financial providers (including technical capacity, among other design features that did not alternative lenders, such as digital agriculture marketplace consider incentives to agri-SMEs and insurance providers. platforms), among others. These alternative lenders would Alongside private risk capital, expertise, and networks, expand the outreach to a greater set of agri-SMEs, as there is a critical need for public investments in areas many may already be providing financial services to these such as premium subsidies to build experience and trust companies. In practice, this means that PCGs and LoCs in insurance; data gathering, distribution, technology and may require targeted awareness-raising campaigns and analytics; institutional and governance frameworks; financial special provisions in their design, which are catered to education; and institutional capacity building. these institutions. Depending on country context, this could also mean supporting access to capital markets for a wide The interventions discussed above are just one part range of agri-SME lenders. This might require government of the solution to closing the agri-SME financing gap. guarantees or de-risking support. Agri-SME lenders in some Exposure to the segment will continue to be limited if the EMDEs, such as India, Thailand, and Vietnam, are frequent agriculture sector remains largely informal, unprofitable, issuers of corporate bonds (see discussion in section 4.8). and vulnerable to external shocks. Therefore, governments need to deploy complementary interventions to tackle In addition, governments should complement financial structural characteristics that render the segment risky, interventions with mechanisms to address the low capacity prone to uncertainty, and vulnerable to shocks. Such of both agri-SMEs and financing providers. In practice, this interventions would improve the competitiveness and means that financial sector interventions may need to embed overall business performance of the agriculture sector, a technical assistance component to address the limited including value chains. 5. SELECTED TOPICS 39 5.4 SMEs in FCV countries Are the challenges affecting access to finance Marked supply-side challenges further limit SME access for SMEs in fragility, conflict, and violence (FCV) to finance. Financial markets are often underdeveloped in countries the same as those affecting SMEs in non- FCV countries, with fewer sources of financing. In fact, missing FCV countries? or incomplete markets are common financial market failures in FCV situations. While banks tend to be the main providers While FCV countries should not be treated as one of financing in most FCV countries, they tend to serve a homogenous group, these countries share common factors relatively small share of private enterprises, despite evidence that acutely constrain SME financing and broadly restrict of strong demand. Other lenders, such as MFIs, may exist, SME operations. FCV country context covers a wide range but they typically face greater challenges serving SMEs in FCV of challenging situations, ranging from weak institutions situations than in non-FCV contexts. This is due to the higher and social fragility to high risk of conflict and actual violent risk of SMEs and the more challenging environment in which events or war.175 Admittedly, the underlying causes for each these lenders operate, which includes less opportunities to FCV country’s situation can differ widely. Yet, World Bank access stable long-term financing. In small island fragile states, experience suggests that the three elements—fragility, the lack of size of these markets is an important constraining conflict, and violence—are often interrelated and mutually factor, as it limits the scope for gains from economies of scale, reinforcing, creating a common set of challenges for SMEs, which is an important feature for the financing of SMEs. In albeit with different intensities based on country context. some countries, there are also marked gaps in the enabling environment for SME financing, which are compounded by FCV countries are typically characterized by weak, highly the general weaknesses in the rule of law and institutions. For unpredictable business environments that impose marked example, information asymmetries in credit markets may be constraints on SMEs, making them riskier investments more pronounced due to a lack of functioning credit-reporting than SMEs in non-FCV countries. In general, FCV countries systems, while lenders are not able to rely on the judiciary exhibit high levels of political and economic volatility, often to enforce contracts and deal with defaults. Furthermore, the accompanied by weak legal frameworks and institutions. penetration of digital infrastructure is lower in FCV countries, Altogether, these factors create an unstable environment for thus affecting the development of innovative solutions based doing business. To different degrees, corruption, rent seeking on fintech.177 Government ownership of banks and financial behavior, and lack of trust, especially trust in the government, intermediaries, in addition to political influence in credit further exacerbate unpredictability, and weaken the rule of allocation decisions may distort credit markets and build law. Depending on country context, critical public services inefficiencies into the banking system. Various forms of market and infrastructure necessary for businesses to operate might control through regulation may also hinder competition and not be provided by the government on satisfactory terms, outreach to SMEs. Survey data show that overall access to including basic services, such as transport networks, utilities, finance is a major obstacle to SME business operations in FCV and even security. In response, companies tend to develop countries. While, on average, 38 percent of SMEs have a bank coping mechanisms that, in turn, can negatively affect their loan or line of credit in non-FCV countries, only 19 percent profitability. Such is the case for security, which is chronically of SMEs have such credit in FCV countries. Similarly, both lacking in FCV countries. Unsafe operating conditions the share of SMEs in FCV countries using banks to finance can undermine business safety, threatening staff, assets, working capital and investments and the share of working and infrastructure, and can lead to significant operational capital and investments financed by banks are at about half challenges, such as those associated with supply chains and the levels observed in non-FCV countries.178 logistics. Ultimately, businesses may incur additional costs from having to pay for security. In addition, SMEs might face Limited capacity among SMEs, the financial sector, hurdles to access the global market—for instance, some FCV and policy makers is a key overriding constraint in FCV countries are not part of the global financial infrastructures countries. Many actors (for example, multilateral development (for example, the International Bank Account Number system), banks and donors) embed limited capacity in their own which can constrain the ability of SMEs to import and export. definitions of FCV. For example, the OECD states that “fragility Survey data show that, in this environment, businesses tend is the combination of exposure to risk and insufficient coping to display a higher degree of informality compared to non- capacity of the state, systems and/or communities to manage, FCV countries. Overall, SMEs tend to be less productive and absorb or mitigate those risks.”179 Limited capabilities hinder more vulnerable to shocks, partly because of the constraints SMEs’ growth and their ability to adequately manage risks imposed by this challenging environment.176 and withstand shocks. Limited capabilities can also constrain 40 BOOSTING SME FINANCE FOR GROWTH policy design and implementation, thus thwarting the ability digitalization could go a long way in minimizing these risks, of countries to develop realistic transition plans out of their as well as security concerns. For the same reasons, policy own FCV situations. makers should place strong emphasis on M&E frameworks through third parties. Policy makers could also consider the use of iterative approaches that continuously assess the situation on the ground, adapting existing interventions and Should public interventions that support SME innovating new ones as the situation changes. finance in FCV countries differ from standard SME financing interventions? Governments should emphasize policies to unlock debt financing, paying particular attention to the high In FCV countries, understanding the best types of riskiness of SMEs. As indicated above, SMEs in FCV interventions for SME access to finance is an ongoing situations are often riskier. Not only do they face more endeavor. World Bank support has produced some volatile and uncertain operating conditions, but their level preliminary lessons discussed below. of informality is higher, which results in a more challenging Completing the enabling environment for SME financing information environment, marked by limited availability of should be at the forefront of the policy agenda for financial information. In this context, risk-sharing instruments many FCV countries. Depending on country context, that seek to mitigate these challenges, such as PCGs, can governments, especially in LICs, should prioritize a policy be particularly effective. Evidence suggests that PCGs have agenda focused on ensuring that both the basic financial been impactful in a number of FCV countries. Afghanistan infrastructure, including credit information systems, and the serves as one example, where a recently implemented credit basic digital infrastructure to support fintech solutions are in guarantee facility has made important strides in expanding place. Digital payments have developed in some of the most SME financing, including for women-owned businesses. challenging FCV environments, suggesting that fintech could However, policy makers need to be cautious when designing play an important role in FCV countries more broadly.180 such schemes, as capacity constraints can limit deployment because of their inherent complexity. In some FCV economies, The need for diagnostics to identify and tailor targeted such as West Bank and Gaza, international donors have set interventions is even more critical in FCV countries. The up credit guarantee facilities directly available to lenders.182 FCV context is often thought of as a continuum rather If the adoption of PCGs is not feasible due to capacity than a binary concept, where a common set of challenges constraints, greater reliance on LoCs might be warranted. exist, albeit at different degrees or intensities, even within countries.181 However, differences in the degree to While adopting concessional financing might be which challenges apply can materially impact the choice, beneficial, it is critical to carefully assess its need. design, and implementation of interventions. For example, Governments should seek to use concessional financing, implementing targeted interventions might require entirely including donors’ funding, in a manner that fosters private different approaches based on the extent to which public capital mobilization and financial additionality more institutions are either generally weak or completely generally. Examples of concessionality include (a) support ineffective. Further, such diagnostics can be particularly of the establishment and expansion of PCGs to increase challenging in FCV settings owing to constraints in data lending by financial intermediaries, (b) support of more availability and accessibility. For example, in some FCV affordable and longer-term financing to SMEs by financial countries, even aggregate data on lending to SMEs are intermediaries, and (c) use of grants to foster innovation not available. Hence, depending on country context, when in product design by private financial intermediaries. In quantitative diagnostics are not feasible, policy makers may some circumstances, concessionality may also be called need to rely on qualitative assessments. for to support the continued provision of services by lenders whose operations might be affected by the weak Capacity constraints may warrant adjustments to the and uncertain business environment of FCV countries. design and implementation of interventions. For example, For example, grants were important in Yemen to support limitations in institutional and financial sector capabilities the operations of the microfinance industry after the might lead to simplified eligibility criteria for financial war, when the industry found itself with portfolios at risk institutions and SMEs, along with streamlined compliance soaring into the double digits.183 Grants to SMEs have and due diligence processes. In some contexts, policy been frequently used in FCV countries. In many cases, makers should also consider deploying interventions through governments argued that these grants were justified third party implementing agencies to overcome limited by the role that SMEs play in building socioeconomic institutional capabilities in the government and mitigate stability and resilience via the provision of jobs as well the risks of capture due to corruption. Automation and as goods and services, including food, water, health, 5. SELECTED TOPICS 41 education, and transportation, all of which contribute to While equity financing programs have also been adopted the resilience of communities. This latter role is particularly in FCV contexts, their deployment requires a more careful prominent where the state may be absent or too weak to assessment than in non-FCV countries, as the conditions be effective. Even so, similar to the recommendations for for private capital mobilization tend to be even more non-FCV countries discussed above, it is critical to assess challenging. Examples of programs that have achieved potential distortions caused by concessional financing to some of their objectives include the equity investment mitigate unintended consequences. Such considerations program implemented in Lebanon by Kafalat (iSME). This are particularly important in the case of grants to support program was able to support the growth of innovative SMEs financial intermediaries and SMEs that may be needed in through a combination of grants for concept development some FCV contexts. Their indiscriminate use can hinder and coinvestments with VC funds and other institutional the development of private financing at commercial terms. investors. Still, the program had limited reach and was not Hence, governments need to strike a difficult balance. renewed. Other FCV countries, such as Iraq, are currently When needed, governments should consider relying more implementing similar types of programs. In line with the on matching grants that can mitigate the risks of supporting discussion in chapter 4, the ability of these programs to unviable firms, while leaving pure grants to more limited or mobilize private financing at scale and in a sustainable exceptional circumstances. This was the case, for example, manner seems limited given the overall macroeconomic and when pure grants were used to support SMEs in Lebanon financial conditions of these countries. While the economic right after the explosion in the Port of Beirut in 2021. additionality that these interventions can bring might justify Similarly, emergency resilience grants were provided in their use, the situation of FCV countries calls for a more Yemen to farmers and fishermen to support food production careful assessment of their costs and sustainability. and jobs within conflict affected communities. To the extent that many of the most pressing challenges The provision of non-financial support, particularly for SME financing in FCV countries stem from a weaker technical assistance to both lenders and SMEs, appears business environment that affects both SMEs and more critical for FCV countries than for non-FCV countries. financial intermediaries alike, the impact of enabling Lenders might require enhanced support due to the relatively environment and targeted interventions in SME access low level of financial sector development and the challenging to finance might be limited. This does not mean that operating environment. Depending on the country, technical governments should not undertake interventions focused assistance could cover support to different types of SME on SME access to finance. Instead, governments should lenders to enhance their governance and risk management adopt a holistic approach to tackling the various elements practices as well as support the development of an enabling of SME business environment challenges. Early lessons infrastructure. For example, in Burkina Faso, Burundi, and indicate the importance of actions to (a) support political and the Democratic Republic of Congo, governments have macroeconomic stability, (b) strengthen legal and institutional been supporting the digital transformation of non-bank frameworks as well as governance,185 and (c) improve access financial intermediaries (for example, MFIs and savings to basic infrastructure (for example, transportation networks and credit cooperative societies) through the creation of and utilities), among others. shared information and management systems. Technical assistance could also support the development of tailored products for SMEs, including leveraging fintech via the use of pilot programs. For example, with technical support from different programs, including from international donors, banks in countries such as Libya and Yemen have opened SME units.184 This technical support has included the development of tailored loan products, along with cash flow analysis techniques to assess the credit worthiness of SMEs (replacing high collateral requirements) and other analytical and client outreach tools to address the particular financing concerns and challenges of SMEs. Banks have adapted the tools to the local capacities and cultural practices—for example, adapting them to the principles of Islamic Ijara. SMEs are also likely to need enhanced support, for instance, to strengthen managerial capabilities. 42 BOOSTING SME FINANCE FOR GROWTH CHAPTER 6 Conclusion The case for governments to support SME financing makers should be realistic about not only the desirability of remains compelling. In spite of progress made in particular policy interventions but also their feasibility and impact, countries, the financing gap for the whole MSME sector based on their own country contexts. remains wide, at about 19 percent of GDP for EMDEs as of 2019. At the same time, the case for government support Going forward, governments must improve the programs to expand SME financing remains strong, as novel effectiveness of their interventions by adopting a stronger, research shows that addressing constraints in access to evidence-driven impetus in their design. This report has finance can lead to significant productivity gains and increase provided a set of seven actions to improve the design and the resilience of SMEs. implementation of interventions. The overriding messages are the need for governments to improve their analysis of The starting point for governments should be urgently the financing gaps and their underlying causes to better completing the enabling environment. This agenda carries target interventions and deploy them in a manner that very limited fiscal costs, while the benefits of expanding fosters financial additionality, including sustainable private SME financing could be large. Many countries have started capital mobilization. All this requires a significant data this work, but it is time to deepen and expand it. This upgrade. The implementation of well-designed targeted report has provided a road map with eight actions aimed interventions, coupled with a more supportive enabling at building critical financial market infrastructure that can environment, should bolster improvements in SME access to mitigate the challenges hindering SME financing, including finance. Nevertheless, without further progress in addressing those deriving from SME characteristics (information opacity, the underlying causes of the underdevelopment of financial high risk, and lack of collateral). This set of core actions also systems, the effectiveness of interventions might still suffer. aims to ensure that the legal and regulatory frameworks to Targeted interventions might help to push the frontiers of foster the use of fintech and to support the development the financial sector, but they cannot do all the heavy lifting. of alternative lenders and equity financing is in place, while mitigating competition and consumer protection concerns. For debt interventions, the key overriding message is that governments need to use them more deliberately to foster However, targeted interventions, which carry important the development of alternative lenders while continuing fiscal costs, are also needed. This report has highlighted the to strengthen bank financing for SMEs. Banks have been important, but distinct, roles of debt and equity financing, the main delivery partners for public interventions. Yet, while and thus the potential need for targeted interventions across banks will remain a key source of funding for SMEs, they will both types of financing. However, policy makers must be not be sufficient to close the credit gap. Alternative lenders cognizant of the trade-offs, especially when fiscal resources are critical to closing such gaps. Hence, governments need to are scarce. Debt financing remains the most important source use interventions to foster their development. Consequently, of external financing for SMEs, and support programs can governments must (a) reduce their direct lending; (b) remove have widespread reach, whereas due to the scarcity and cost requirements that create undue barriers for alternative of equity financing, programs to support it would typically lenders to access interventions, for instance, by relying more have a more limited reach, covering a small set of firms. Policy on proportionate requirements; and (c) consider the use of 6. CONCLUSION 43 targeted interventions to address the constraints faced by to actively monitor the implementation of policies that alternative lenders. The type of interventions to deploy will seek to embed climate-change related risks in the risk vary based on country context, whereby larger and more management frameworks of financial intermediaries, to developed EMDEs should consider additional interventions mitigate the possibility of unintended consequences for aimed at further developing capital markets solutions. SME financing. • In the case of agri-SMEs, governments should For equity interventions, the key overriding message is strengthen their efforts to promote the development of that governments need to apply private sector practices commercial financing, for instance, through greater use to improve the mobilization of private capital. In practice, of risk-sharing interventions and the inclusion of a wider this means relying on private sector structures, in particular range of financial intermediaries for their deployment. A funds, to achieve scale and diversification. The management key additional consideration is the need to incorporate of funds should be professional and independent, free of mechanisms to strengthen the resiliency of agri-SMEs to government interference. Government oversight is key for shocks, including through insurance markets, for which the achievement of government objectives (for example, in public-private partnerships may be needed. terms of additionality), but this should be done through other bodies and mechanisms, including a strong M&E framework. • In the case of SMEs in FCV countries, governments This report has acknowledged the challenges that EMDEs, should rely on a fully customized approach that in particular LICs, face in mobilizing private capital to equity takes into consideration the intensity of the different financing. LICs that may want to pursue these interventions challenges affecting these countries. Governments might need to focus on market creation, which would likely should emphasize policies to unlock debt financing, require interventions over a longer period of time, while paying particular attention to interventions to address working in parallel to address the structural challenges that the high riskiness of SMEs, such as PCGs. Concessional prevent further participation of private investors. financing might be needed to support the operation of lenders and SMEs, but its implementation needs to Governments need to take a tailored approach to tackle be carefully assessed to mitigate potential unintended the challenges affecting specific subsets of SMEs, in consequences. Capacity constraints might call for particular agri-SMEs, WSMEs, SMEs in FCV countries, and simplifications in the design and implementation of financing SMEs for adaptation and mitigation to climate interventions, which can affect the range of feasible change. This report has provided guidance to this effect. interventions in these countries. • In the case of WSMEs, governments should integrate a Finally, access to finance is only one factor underlying SME gender lens in the design of SME interventions. Potential productivity and growth. Beyond the broad macroeconomic tailored measures include earmarking programs factors, SME productivity is also affected by a broader set explicitly to these firms and including a wider range of micro factors, including the business environment, SME of financial intermediaries for their deployment, with capabilities, and access to markets. This report has already special attention paid to the development of financial highlighted the importance of providing non-financial products tailored to women entrepreneurs. support to SMEs, jointly with financial support, as a key factor • Governments should recalibrate the support they are to improve the effectiveness of support policies. It is critical providing to SMEs to tackle climate change challenges that governments develop a holistic approach to their SME by undertaking a risk-based approach, whereby the support agenda. relative merits of two risks are considered: physical risks and transition risks. A wider range of SMEs are vulnerable to the former, hence, governments should place greater emphasis on adaptation efforts, through a bottom up approach. Financing mitigation efforts should continue to be focused on large businesses, but greater emphasis should be placed on the trickle-down effects to SMEs in their value chains, through a top-down approach. Such an approach places greater emphasis on the SMEs that are most vulnerable to transition risks. Efforts to complete the enabling environment, including developing and implementing effective taxonomies and disclosure requirements, along with improving availability and access to data, are essential. Governments also need 44 BOOSTING SME FINANCE FOR GROWTH Appendix A. Misallocation of Firm Financing Novel empirical evidence quantifies the SME financing capital investments in MICs during 2010–19, compared to 35 gap and its sizeable negative impact on aggregate percent in HICs. outcomes, such as productivity and growth.186 This has been an elusive feature in discussions of firms’ access to Debt is a crucial source of financing for SMEs, but equity finance, especially in EMDEs. SMEs are considered the financing can be powerful in promoting innovation. backbone of the economy in most EMDEs, but they face Although the estimations show that the misallocation of critical challenges in access to finance that hinder their finance across firms stems in large part from a level effect (an potential to create more and better jobs. Drawing from inefficient allocation of the total amount of finance to firms), a newly constructed data set of 2.5 million firms across the results also indicate that countries with more knowledge- MICs and HICs, the research shows that financial market and technology-related outputs, and thus arguably a larger inefficiencies—namely, financial frictions and market share of firms engaging in innovative activities, would benefit failures—constrain financial flows to these firms. In turn, the most from improvement in the financing mix (the allocation this misallocation of finance hinders firms’ ability to invest of capital between debt and equity). That is, countries with and even use inputs efficiently, thus negatively impacting more innovative activities could obtain sizeable productivity their performance, and ultimately aggregate productivity gains from rebalancing the composition of financing to firms and growth. Novel estimates show that mitigating these and improving their access to equity finance. These results inefficiencies, thereby relaxing the constraints on firms’ highlight that firms’ capital structure matters for aggregate access to debt and equity financing, can lead to aggregate productivity, at least in part because of the value of equity productivity gains of up to 86 percent in MICs, with the financing for innovative firms. Yet, venture capital financing is largest gains observed among less developed MICs. These skewed toward a narrow set of high-tech sectors, suggesting gains stem from a reallocation of financial resources toward that equity financing might play a limited role in advancing financially constrained yet productive firms. technological change in EMDEs. Costly misallocation of finance is very detrimental to Financial constraints not only hinder firms’ performance, SMEs, particularly those with fewer than 100 employees but also constrain their ability to cope with adverse that tend to face the largest financing gaps in MICs. The shocks. The results of World Bank’s data show that during estimates show that smaller firms would benefit the most the COVID-19 pandemic, many firms in EMDEs were unable from a more efficient allocation of capital across firms, to mitigate the effects of the shock, partly because their especially those in less developed countries. These firms access to external sources of financing was limited. Firms typically face a substantial financing gap in both debt and that had access to external financing were better able to equity. On average, the smallest private firms in the sample maintain employment levels and avoid falling into arrears. have debt-to-assets (leverage) ratios of around 65 percent Moreover, access to diversified sources of financing can help in HICs, whereas similarly sized firms in MICs have leverage firms weather shocks. For example, the results show that ratios averaging 40 percent. The smallest private firms in capital market financing can replace bank lending during MICs have even lower leverage ratios, around 20 percent, banking crises, allowing firms to mitigate the adverse effects indicating a much more limited use of debt financing. The of the crisis on performance and employment. Hence, firms differential in leverage ratios between firms in MICs and HICs with limited access to multiple sources of financing are more declines with firm size, with virtually no differences observed exposed to the effects of negative shocks. For smaller firms among the largest private firms and publicly listed firms. in EMDEs, which are often dependent on banks for external Smaller, innovative private firms in MICs make limited use of finance, small fluctuations in bank credit can have sizeable not only debt financing, but also external equity financing. effects on their investments and growth. Private markets for equity financing in EMDEs are shallow and concentrated, financing relatively large firms, which The original findings in the report provide strong constrains the availability of equity financing for smaller, analytical underpinnings for existing, practical knowledge innovative firms. For example, private firms with more than in supporting SME financing and highlight important 350 employees accounted for roughly 70 percent of venture implications for financial sector policies that address APPENDIX A. MISALLOCATION OF FIRM FINANCING 45 financing gaps for firms in EMDEs. Debt constitutes the A supportive enabling environment is the backbone of largest and most important source of external finance for firm financing. While not directly targeting smaller private a vast majority of private firms around the world. Hence, firms, policies fostering the enabling environment for the core focus of policy initiatives aimed at fostering firm debt and equity financing tend to entail disproportionate financing should be on supporting widespread and efficient benefits for this set of firms, thereby complementing more access to debt financing for SMEs. That is, the targeting of targeted interventions. This is the case for policies aimed policy support should reflect the more acute financing gaps at strengthening the financial infrastructure, such as credit for smaller firms in a country. Targeted interventions should information systems and insolvency frameworks. On the intentionally focus on improving information on SMEs; de- latter, estimates show that deficiencies in insolvency systems risking SMEs and creating missing markets. The goal should can distort incentives—for example, by supporting inefficient always be graduation, in which market-based financing loan evergreening—that increase the likelihood and prolong for SMEs develops. Importantly, this size-based targeting the survival of zombie firms. The findings show that weak in policies should not translate into unconditional support insolvency systems lock up not only capital, but also labor in to firms simply based on their size. The viability of firms is low-productivity uses. To the extent that labor released from critical, for instance, to avoid supporting the proliferation of exiting firms is absorbed by more productive firms, there zombie firms. could be significant gains in aggregate output. Policy support needs to take a differentiated approach In supporting access to finance for firms, policy makers for debt and equity financing. Targeting is a more complex need to consider the unique circumstances of each country yet even more important imperative for equity financing, and prioritize evidence-based policies that address the due in large part to the scarcity of this financing source challenges of the SME financing gap. A rigorous, data- in EMDEs. The targeting of programs for equity financing driven assessment of the key constraints on firm financing should go beyond a size-based approach, recognizing that and their underlying causes within the context of individual for a subset of SMEs—notably, innovative ones—balanced countries is important not only for the design of policies (for access to debt and equity financing would be invaluable. example, to enhance the effectiveness of targeted support The results suggest that policy interventions to support policies), but also for policy implementation (for example, equity market development are more likely to succeed when by enabling the implementation of effective monitoring and certain preconditions are in place, such as the existence evaluation frameworks). However, there is a generalized lack of a strong institutional investor base and a supportive of data on the financing of private firms across the developing entrepreneurial environment. These conditions are more world, which is particularly marked in countries where data likely to be observed among the more developed MICs, are most needed, such as those with underdeveloped raising questions about the effectiveness of interventions financial systems, where financial inefficiencies can be more in less developed countries. Policy makers must thus be constraining. Improving the availability of and access to data cognizant of the trade-offs in allocating resources to support is thus crucial for a more effective policy agenda supporting equity financing versus debt financing, especially when fiscal firm financing in EMDEs. resources are scarce. 46 BOOSTING SME FINANCE FOR GROWTH Appendix B. Microenterprises Microenterprises play a pivotal role in supporting the • Credit risk uncertainty. Partially because of the livelihoods of low-income workers in EMDEs. There is informality, as well as challenges related to literacy and no unique definition of microenterprises. For this report, accounting competencies, credit providers are unable microenterprises are defined as firms with less than 10 to access reliable financial information or to assess the employees. It is estimated that the majority of enterprises credit risk of microenterprises the way they would for in EMDEs are microenterprises, although there is no reliable a larger enterprise. Microenterprises and their owners and consistent cross-country data for EMDEs. In OECD are unlikely to have information in credit bureaus or countries, microenterprises comprise between 70 and 90 reliable financial statements. This uncertainty regarding percent of the enterprises and these employ, on average, the business cash flows is compounded by the fact 29 percent of the workforce.187 In EMDEs, these figures are that most microentrepreneurs comingle business and likely to be higher, and the proportion of lower-income and personal finances. Microenterprise loans often go vulnerable populations relying on microenterprises for their toward consumption, and consumer loans are often livelihoods is likely to be higher still. used for microenterprise finance. • Lack of collateral. Creditors often seek to mitigate Microenterprises are not a monolith. Sawhney et al. (2022) risk with collateral requirements, but low-income highlight the significance of five dimensions of enterprise microentrepreneurs are unlikely to have the right kinds segmentation: (a) the sectors in which they operate, (b) the and quantities of assets. And if they do, they will be entrepreneurial mindset, (c) the growth stage in which they less likely to put those assets at risk. are, (d) the entrepreneur’s gender, and (e) the size of the enterprise. • High operating expenses and low transaction sizes. Even if able to overcome the informality and credit Despite the heterogeneity of microenterprises and their risk uncertainty, the marginal costs of originating and non-financial needs, there are some commonalities managing microfinance loans are extremely high relative when it comes to the need for financial services. Most to the small ticket sizes involved. These fundamental microenterprises rely on some form of credit to support their business-model dynamics are the primary driver of growth and sustainability at some point in their lifecycle. relatively high interest rates in the microfinance sector. Yet, according to IFC estimates, a gap of US$4.9 trillion for • Distrust. Customers often distrust formal financial microenterprises alone, equivalent to 8 percent of the GDP service providers, sometimes with good reason, and of EMDEs, remains. prefer to rely on informal financial service providers (especially friends and family). Are the challenges affecting microenterprises’ access to finance the same as those affecting SMEs? Have the external sources of finance for microenterprises been the same as for SMEs? Many of the challenges that hinder microenterprises’ access to finance are similar to those affecting SMEs; however, Overall, microenterprises have relied less on banking some features are more prevalent in microenterprises. financing than SMEs. Similar to SMEs, most microenterprises rely first on informal and quasi-formal sources of finance, • Informality. Most microenterprises, especially those run especially social networks of family and friends, as well by people with low incomes, operate in an environment as informal money lenders and small-scale community where the costs of formality (for example, taxes, financing initiatives like village saving and loan associations regulatory requirements, reduced competitiveness, and rotating savings and credit associations. As with SMEs, literacy, and numeracy) exceed the benefits to their suppliers often provide microenterprises with credit in the businesses. This informality of microenterprises makes form of payment terms to buy their products. Among formal traditional financial institutions leery of the regulatory financial service providers, MFIs play a more important role and financial risks of working with them. in their financing than banks, as do financial cooperatives. APPENDIX B. MICROENTERPRISES 47 Banks have been an important provider of financing, but At the very basic level, this means implementing four mostly through consumer loans and credit cards. regulatory enablers of DFS: (a) regulation of e-money, (b) risk-based requirements for anti-money laundering and These financial service providers have employed a variety combating the financing of terrorism (AML/CFT; that is, of strategies to overcome the barriers of microenterprise proportionate customer due diligence; CDD), (c) regulation finance. In the case of the well-known group loan method of agent networks that allows financial service providers of microfinance pioneered by Grameen Bank and others, to use third-party agents as their distribution channel, and credit groups reduce the risk of default through the cross (d) financial consumer protection tailored to the full range guarantees group members provide each other, and they of financial service providers and products—providing a decrease the cost of providing small ticket loans by bundling necessary margin of safety and confidence. them. In the individual model of microfinance, loan officers are trained to develop estimated financial statements for In addition, as summarized in chapter 3, policy makers microenterprises and use those estimates as the basis for must ensure that financial markets can reap the benefits of lending decisions. fintech and innovation while ensuring consumer protection. Newcomers such as fintech platforms and digital banks see Similar to SMEs, a new generation of solutions to potential in serving the microenterprise segment as they overcome the same barriers and to provide improved believe they can address many of the financing challenges financial services to microenterprises is taking shape via through technology (for example, collaborative CDD, fintech. Reduced reliance on brick-and-mortar branches and alternative credit scoring) and partnerships (for example, increased reliance on digital payments infrastructure, like embedded finance, open finance).188 If they succeed, it mobile money, lowers the expense of providing small ticket would send a strong signal to incumbents to follow suit. And financial services. Digital data trails, especially those that if they fail because of some of the same regulatory limits are close proxies to cash flows, like inventory or payments that arguably hinder the engagement of incumbents with the data, enable more efficient and accurate risk assessments. segment, it would send a signal to regulators to reconsider The ability of companies to leverage application programing their approach. interfaces to make connections within their own technology stacks, and with those of other partners, makes solutions more agile and effective. Hommes et al. (2022) highlight how these trends are enabling different fintech business models to serve microenterprises. As summarized in chapter 2, these business models or channels are important also for SME financing. Is the nature of policy interventions needed for microenterprises the same as for SMEs? Given the higher presence of informality and sole proprietorship, policy interventions for access to finance of microenterprises should focus first on the financial inclusion of the individuals. From a policy perspective, informality has multifaceted consequences ranging from the risk of criminal tax evasion (possibly reaching the volume of money laundering) to the lack of official financial reports and documents required for onboarding formal businesses (for example, business license and registration). For formal businesses, the relevant policy element that many (if not most) microenterprises share is that they operate as sole proprietors. Because of these two characteristics (informality and sole proprietorship), policy makers should first focus on policies supporting financial inclusion of individuals, as their benefits are likely to extend to microenterprises. 48 BOOSTING SME FINANCE FOR GROWTH Appendix C. Selected Experiences Fintech Innovation in the Banking Sector: Global SMEs. Many have partnered with commercial banks. Examples189 One example is Safaricom in Kenya. In 2012, Safaricom launched M-Shwari (short-term digital loans) and Fuliza Much of the innovation taking place through increased (digital overdraft) with Vodafone and Commercial adoption of fintech for SME lending has been centered on Bank of Kenya (CBA/NCBA). Later, they also partnered banks themselves. While there is scarce evidence on whether with KCB bank. CBA/NCBA and KCB have disbursed these developments have changed the landscape for SME about US$2.5 billion in SME credit as of August 2022 financing, case studies can offer a glimpse into the potential through these two products. In South Africa, JUMO for synergies to expand lending to SMEs. has partnered with MANSA Bank to roll out its lending services in Côte d’Ivoire. Fawry in the Arab Republic of • In Asia, big techs (such as Alibaba, Grab, and Kakao) Egypt has registered as a microfinance institution to be have spearheaded digital credit to SMEs. While they able to provide credit products. can leverage the large volumes of customer data, which • In North America, there is a greater mix in the SME has been invaluable for credit decisions, they often have credit segment of big tech, digital payment providers, lacked the know-how, access to financial infrastructure, digital lenders, and digital banks. But, as in Asia and regulatory backing or access to cheap sources of funding Europe, many non-bank players have looked toward to lend to SMEs at large scale. Consequently, they have banks and incumbent financial institutions to develop either partnered with commercial banks or set up their their SME lending business. For example, Amazon own bank. For example, Alibaba in China has set up has partnered with Goldman Sachs, while PayPal has Mybank, Kakao in Korea launched Kakao bank, and Grab partnered with Wells Fargo. has obtained a digital banking license in Malaysia. A few • In Latin America, digital banks, such as Nubank and digital lending platforms have followed a similar path— C6 in Brazil and MACH in Chile, have been actively examples are Paytm, Lendingkart, KoinWork, and Xendit. engaging in the SME credit market. • In Europe, digital lending platforms—such as Funding Circle, LendingClub, and October—have stood out The partnership of these new fintech players and banks has in the SME segment. Albeit they were often set up as often brought benefits to both parties. Non-bank financial independent platforms, many have partnered with providers, such as digital lending platforms, typically face banks to foster growth. In some cases, revenues from higher funding costs than banks and their expansion is often banking-as-a-service provided by these platforms have hindered by funding availability. A fintech-bank partnership surpassed revenues from direct loan intermediation. allows these new players to overcome the funding One relevant example is October in Europe. In 2020, constraints in a cost-effective manner. In addition, they gain it launched a new service, offering technology-based access to a large customer base, leveraging the reputation credit assessment tools, fraud detection, and customer of the partner bank. Banks can increase their outreach via interface solutions to commercial banks and other the product innovation brought by fintech. However, these financial intermediaries against a fee. A number of banks partnerships can also add risks. For example, “lax” credit adopted October technologies—such as BPI France, origination standards on the side of the fintech player could Solution Bank, and Engie—and leverage the technology lead to higher than expected losses for the banks. to enhance their own digital offerings to SMEs. • In Africa, telecoms and e-payment providers have Linking VC with SME Exchanges: The Experience of become the dominant fintech players. Initially, they the Republic of Korea190 expanded the payment infrastructure to the unbanked population, and in a second phase, they have started Over the past 30 years, Korea has developed three distinct to offer lending products, targeting both retail and boards on the Korea Exchange (KRX) which cater toward the APPENDIX C. SELECTED EXPERIENCES 49 different life stages of a company. The Korea Exchange Main companies, in raising capital. Initially, the number of Board (KOSPI) is the main board and is reserved for large listings on the new KOSDAQ market did not increase and profitable companies; listing requirements are high. In much, but with the introduction of a special track in 1999 addition, the Korea Securities Dealers Automation Quotation that simplified the listing process for government-certified (KOSDAQ) and the Korea New Exchange (KONEX) were technology companies, the number of new listings almost set up as IPO markets for SMEs, with a focus on technology doubled. Before 1999, about 85 percent of the listed startups. In contrast with the KOSPI, the KOSDAQ and companies were ordinary SMEs, and only about 15 percent the KONEX emphasize the possibility of future growth; were startups. After 1999, the share of startups among the and listing requirements such as firm size, firm age, and listed companies grew rapidly, reaching 50 percent in 2021 profitability are lighter and more flexible than those in the (figure C.1). Particularly, tech ventures were attracted to the KOSPI. Altogether, the three boards have been set up to KOSDAQ. With the transition toward a technology, venture- function as growth ladders. focused board, the KOSDAQ has become a popular route for VC funds to exit their investments. As of 2019, over 50 The KOSDAQ has developed into an important exit route percent of IPOs were backed by VC funds (table C.1). As of for VC funds. The KOSDAQ was first introduced in 1996 June 2021, the KOSDAQ had a market capitalization of 427 to support venture companies, particularly technology trillion won (US$379 billion), and 1,506 listed companies. FIGURE C.1 Number of Listed Companies at the KOSDAQ in Early Days of Development 400 350 300 250 200 150 100 50 0 1996 1997 1998 1999 2000 2001 ordinary companies startups Source: Nomura Foundation. TABLE C.1 VC-Backed IPOs at the KOSDAQ 2014 2015 2016 2017 2018 2019 Number of IPOs 67 109 70 78 90 97 Number of VC-backed IPOs 33 60 36 40 47 53 % VC-backed IPOs 49.3% 55% 51.4% 51.2% 52.2% 54.6% Source: Korean Distribution Science Cooperation. 50 BOOSTING SME FINANCE FOR GROWTH The KONEX was introduced in 2013 in response to timeframe has expired, the receipt becomes an “executive increasingly stricter listing requirements at the KOSDAQ and title” (in Chile) or a “security” (in Peru), which means that the subsequently higher barriers for startups to list and VC funds owner of the receipt can request its payment in an abbreviated to exit their investments. With the burst of the information judicial process, similar to a check. technology bubble in the early 2000s and several breaches of investor trust throughout the decade, the capital markets Together, these features have improved the factoring industry regulator gradually tightened listing requirements. As a in these jurisdictions. For example, in Chile factoring has result, the average age for companies to list on the KOSDAQ increased since it was made mandatory in 2014, growing by increased from 9 years in 2004 to 13 years in 2011. The 50 percent on average and reaching US$29 billion in 2021— size of the listed companies also increased, with the typical equivalent to over 8 percent of GDP. Different business KOSDAQ firm reaching an average sales volume of about models coexist—including banking factoring, specialized US$100 million. Owing to these stricter requirements, the factoring companies, and digital platforms that act as government chose to establish the KONEX, which has fewer marketplaces for the sale of receivables—bringing together listing requirements. In contrast to the KOSDAQ, the KONEX companies in need of liquidity with investors. The experience is a market exclusively for professional investors. Many small of Peru is following a similar path: the implementation of enterprises and startups tend to list in the KONEX first and mandatory electronic invoices has boosted the industry. As then list on the KOSDAQ or KOSPI after growing large. Thus, per information provided by the Ministry of Production, the the KONEX has developed into one possible springboard bulk of the entities selling receipts are MSMEs. for listings at the two other boards: on average, eight companies moved up to the two other boards each year. For many VC funds and founders, the KONEX has become an alternative means to recover their investments; they initially Basel III Impact on SME Financing: Summary of Key list their companies at the KONEX and then sell their shares to Empirical Research other investors later. Therefore, besides being a springboard The impact of prudential regulation on SME financing for the KOSDAQ and the KOSPI, the KONEX also promotes has been the subject of debate particularly in the context secondary trade among VC and PE funds. As of June 2021, of the discussions and the implementation of the Basel III the KONEX had a market capitalization of 7 trillion won, with framework. As approved, the Basel III framework provides 137 listed companies. Thus, the KONEX remains significantly for two sets of treatments (both preferential compared to smaller than the KOSDAQ. the treatment of unrated corporates) for exposures to SMEs depending on their characteristics: (a) retail SMEs receive a flat 75 percent risk weight on all their exposures and (b) Deepening Asset-Based Lending through E-Invoicing unrated corporate SMEs receive a flat 85 percent risk weight Implementation and Selected Reforms to Factoring on all their exposures. Laws: The Experience of Chile and Peru191 In Latin America, the process of digitization of commercial Financial Stability Board Evaluation for G-20 Jurisdictions192 receipts has been triggered by the need to tackle business informality and improve tax collection. However, electronic In 2018, the Financial Stability Board conducted a qualitative receipts can minimize key operational risks involved in and quantitative analysis of the impact of the capital and factoring, such as the risk of fraud (for example, due to the liquidity requirements on SME financing, focusing on G-20 double sale of receipts), and thus help achieve scale. In this jurisdictions. The evaluation did not find material and context, in tandem with the implementation of e-invoicing, persistent negative effects on SME financing in general. countries such as Chile and Peru have introduced targeted However, it highlighted that more stringent risk-based reforms to their factoring laws to make the sale of receipts capital requirements under Basel III may have temporarily more efficient and foster the creation of marketplaces for affected growth and tightened the conditions of SME receivables. Key reforms included the establishment of lending in some jurisdictions for the least capitalized a maximum period for buyers to reject a receipt and the banks. But these effects were not homogeneous across availability of abbreviated judicial procedures for the recovery jurisdictions. The evaluation also provided some evidence of unpaid debt connected to receipts. Regarding the first type of reallocation of bank lending toward more creditworthy of reform, in both Chile and Peru, the respective laws now firms after the introduction of reforms, but it highlighted that establish that if a receipt is not rejected within the specified this effect was not specific to SMEs. Finally, feedback from timeframe, the receipt is considered accepted for all legal stakeholders suggested that macroeconomic conditions purposes, which in practice means that the seller can now and factors other than financial regulation were the most use it with confidence for factoring. On the latter, once this important drivers of SME financing trends. APPENDIX C. SELECTED EXPERIENCES 51 World Bank Analysis for Emerging Markets193 have access to external financing before, relying on trade credit and internal funds to finance their activities. In recent In 2019, World Bank staff conducted additional research years, the program’s growth has slowed down because focusing on the impact of the implementation of Basel III private banks developed their own SME products, including on the access to finance of SMEs in 32 EMDEs. The authors proprietary electronic platforms for factoring. In other words, found that for EMDEs, Basel III had a moderately negative the government’s support has become less relevant as the effect on SME access to finance. The results suggested industry has matured. However, NAFIN’s role was crucial in that SMEs that already had a banking loan prior to Basel the industry’s development. As of December 2020, NAFIN III implementation could have been affected less than supported over 390 chains with over 14,000 suppliers. those that only had a bank account. This in turn reaffirmed practitioners’ view that once SMEs have an established relationship with a bank, they typically do not face problems India: Development of a Factoring Platform196 in renewing credit. The Receivables Exchange of India Ltd (RXIL), is a joint venture between the Small Industries Development Bank of Zooming in on the implementation of Basel III in the EU194 India, a national development bank in India, and the National Stock Exchange of India. It started its operations in 2017, The Basel III framework has provided room for jurisdictions offering an online platform where companies can auction to include a favorable treatment for SME loans into their their invoices at competitive prices to banks and non-bank national regimes. The EU introduced the “supporting factor” financial institutions. To initiate a transaction, either the in 2014—a reduction of capital requirements associated seller (factoring) or the buyer (reverse factoring) uploads an with SME loans of 23.81 percent, which provides an incentive invoice to the online platform. The respective counterparty, for banks to lend to eligible SMEs. the buyer or the seller must accept the invoice before it can be factored. Once accepted, the invoice is posted on the The existing evidence on the impact of the supporting factor website and is open to financial institutions to post their is mixed. The initial evaluations of the European Banking interest rates and bid on the invoice. Authority failed to identify any increase in access to finance for SMEs, relative to large firms. More recent evaluations As of June 2022, the RXIL platform had reached over 11,000 have found positive effects. However, some of this research MSME suppliers, working with 53 factors and over 800 has found that the positive effects were not consistent across buyers. On average, the monthly factoring and reverse all SME segments, and that they have not benefitted micro factoring volumes are the equivalent of US$213 million. and small firms. Although those numbers are significant in absolute terms, they remain marginal compared to the size of India’s economy. The lack of a broad network of large, credit- Selected Examples of Interventions to Foster worthy buyers is one of the key challenges that seems to Competition in the Lending Industry be hindering RXIL from growing faster. The reasons seem to be multiple, such as the fear of exposing their supply chain Mexico: Development of a Factoring Platform195 to competitors, the reluctance to relinquish any rights to dispute the services and goods delivered after the invoice In 2001, NAFIN, Mexico’s national development bank, has been accepted, or the competition from banks who created an online platform (Cadenas Productivas, or already provide large corporates with similar offers. Productive Chains) to facilitate factoring transactions. The program was anchored in the notion of supply chains, whereby it is the buyers who invite their suppliers, very For those MSMEs already benefiting from RXIL’s factoring often SMEs, to the platform. Suppliers choose the invoice platform, interest rates have come down significantly, they want to have factored and open it up for auction to standing at 4–6 percent compared to the 12–15 percent the participating institutions, which in the case of NAFINs’ available through banks directly. platform are banks. All factoring transactions are done without recourse. Colombia: Development of a Platform for Microcredit197 The program experienced a significant expansion between In January of 2022, Bancoldex, the SME development 2001 and 2010, with over 11 million factoring transactions bank of Colombia launched Neocredito, an electronic amounting to more than US$90 billion completed during platform that is bringing together different types of this period—equivalent to about 1 percent of Mexico’s GDP financial intermediaries to compete in the microcredit annually. Many suppliers participating in the program did not market. The platform allows microentrepreneurs to connect 52 BOOSTING SME FINANCE FOR GROWTH with several financial partners simultaneously to receive partners, which are financial services providers for smaller competitive financing offers. The platform simplified the businesses (such as banks, non-bank lenders, equity funds, documentation for the application of loans of less than and private debt funds). For most of its programs, this indirect US$10 million by natural persons, thus expediting approval approach enables it to leverage in third-party funding in and disbursement. As of March 2023, about US$2 billion addition to its own funding, maximizing the impact of its in loans to microentrepreneurs had been disbursed, and interventions. about 10,000 microenterprises had registered with the platform. Specific performance indicators that are associated with the diversification objective include the number of new delivery partners; the value of commitments to new delivery partners; United Kingdom: Creation of a Finance Referral Program198 the stock of finance through non-Big Five banks; and new In 2016, the United Kingdom created a finance referral commitments to non-bank and challenger bank lenders program. The program requires nine of the biggest banks through its Investment Program. to pass on the details of small businesses they have turned down for financing to government designated alternative platforms. These platforms are in turn required to share Selected Examples of the Use of Interventions to the details, in anonymous form, with alternative finance Foster Capital Markets Solutions for Debt Financing providers. Italy200 Since it was launched in November 2016 until 2019, nearly 19,000 small businesses who were rejected for finance from In 2012, Italy made important changes to its legal one of the big banks have been referred under the scheme. framework, through the Development Decree, to allow Over 900 businesses had secured more than 15 million unlisted medium companies to issue minibonds, under a pounds. Since the Q4 2017 the conversion rate for SMEs proportionate disclosure plan. Reforms were made to the who had contact with the platform has been over 10 percent, legal and regulatory framework applicable to institutional in line with market expectations. investors to foster their investment in these bonds, and, in parallel, targeted interventions were deployed to align their risk return appetite. In particular, minibonds and funds that invest in them can access the guarantees provided by the The Inclusion of Diversification of Funding Sources SME Central Fund. In addition, tax benefits were granted as a Key Objective of Government Interventions: to both the companies issuing minibonds and the investors. The Case of the British Business Bank199 As of December 2022, there were 1,016 companies with minibonds issued, of which 663 were SMEs as per the The British Business Bank was created in 2014 to address European definition, or 65.3 percent. For 2022 alone, there market weaknesses in the provision of finance to SMEs in were 254 issuers of which 178 were SMEs, amounting to 70.1 the United Kingdom. It initially set four market-oriented percent, compared to 66.5 percent in 2021. objectives focused on improving the finance marketplace for smaller businesses: (a) increase the supply of finance, (b) help increase the diversity of finance, (c) address regional Colombia201 imbalances in access to finance, and (d) encourage and enable SMEs to find appropriate finance. In 2019, A2censo, the first debt crowdfunding platform of Colombia, started operations. As part of the strategy The inclusion of diversification of funding sources as a to promote the development of this type of alternative separate objective rests on the premise that continuing financing, the National Guarantee Fund (NGF) entered to widen the range of finance options available to smaller into an agreement with A2censo to provide it with access businesses—by supporting increases in the number, type, to it, whereby individual companies using the platform to and capabilities of finance providers and platforms—helps raise funding can request a guarantee from the NGF, with ensure that smaller businesses can access finance on terms the NGF covering losses up to 50 percent of the amount that best suit their business challenges. lent to a company by investors in the platform. In parallel, Bancoldex, the SME development bank, committed to To deliver on its objectives, the British Business Bank coinvest in each issuance, up to 20 percent of the total undertakes a range of finance programs and non-financial amount raised. As of December 2022, more than 9,800 activities for smaller businesses across the United Kingdom, investors have participated in the platforms, and more than at all stages of development. For their finance programs, its 120 issues have been backed with guarantees from the main business model is to work indirectly through delivery NGF, with a disbursement amount of US$57 billion. Of the APPENDIX C. SELECTED EXPERIENCES 53 amount disbursed, 10 percent went to microenterprises, 47 Selected Examples of Innovation in Women’s Access percent to small companies, and the remaining 43 percent to Finance to medium enterprises. Use of Alternative Scoring: The Experience of Ethiopia204 The Impact of the Investor Base in the Design of In environments where women are less likely than men to Interventions to Expand Equity Financing202 own fixed assets that can serve as loan collateral, alternative credit scoring can be a powerful tool to expand lending. A deep understanding of the overall country context For example, the Women Entrepreneurship Development and of the potential investor base is key to ensuring that Project in Ethiopia has worked on the implementation the design of interventions maximizes the mobilization of an alternative credit scoring technology, based on of external capital. One key design aspect refers to the psychometrics, to enhance a financial institution’s ability to domicile of the funds. lend to female entrepreneurs. The choice of a psychometrics test responds to country context. Financial technologies From a political perspective, governments are pressured dependent on mobile phones or internet access are less to invest in domestically domiciled funds. Domestic viable in a market like Ethiopia, where only 16 percent of institutional investors might also prefer domestic funds, as the population uses the internet and 51 out of 100 people they might offer domestic investors greater legal certainty have mobile phone subscriptions. Thus, psychometrics and, potentially, tax benefits that they might not enjoy in has emerged as a promising option for creating a better investments abroad. In some countries, institutional investors picture of Ethiopian borrowers. Unlike other fintech data might also face limitations on investing in foreign vehicles. solutions, psychometrics could create data on borrowers In contrast, many foreign investors have strong preferences that did not exist before. In the context of Ethiopia, the for vehicles constituted in foreign jurisdictions with tried psychometric test has been adapted to include more visual and tested legal and tax frameworks.203 Furthermore, many and interactive exercises for members of the population foreign investors prefer to invest in regional funds, which with low literacy levels and limited familiarity with digital offer them country diversification. technology. As of October 2019, more than 14,000 women entrepreneurs took out loans, and 66 percent of clients were Balancing these interests is not easy. Some EMDEs have first-time borrowers. As a result of the project, participating chosen to invest only in local vehicles. In some cases, MFIs increased the average loan size by 870 percent and this choice might not hinder their ability to attract foreign reduced the collateral requirements from an average of 200 investors. This has been the case of larger EMDEs, with a percent of the value of the loan to 125 percent. The average strong pipeline of companies. However, some EMDEs might project loan has resulted in an increase of over 40 percent in not have the leverage with foreign investors to persuade annual profits and nearly 56 percent in net employment for them to invest via local funds. Countries such as Egypt, Ethiopian women entrepreneurs. Jordan, and Saudi Arabia have included investments in regional funds, domiciled in foreign plazas, in their fund- Use of Tailored Training: The Experience of Mexico205 of-funds approach, conditioned to meeting a particular leverage ratio. Furthermore, some of these jurisdictions have In Mexico, a program provided business training and established lower leverage ratios for these regional funds specialized services to female entrepreneurs in marginalized than what is targeted for domestically domiciled funds as communities. The program offered a combination of training part of their efforts to attract foreign investors. on hard skills (for example, traditional managerial skills) and soft skills (for example, training on emotional intelligence). Flexibilities are also starting to be implemented in connection It trained 2,500 female entrepreneurs in five different states. with the legal domicile of SMEs. Increasingly, startups from Women who completed the hard and soft skills training had EMDEs with global ambitions are choosing to establish their higher weekly profits, spent more on inputs and salaries, had legal domicile in foreign plazas with strong venture capital higher access to financing opportunities such as buying or markets. Some EMDEs are broadening eligibility criteria to selling with credit, and had increased the number of paid enable them to support these SMEs, so long as they keep workers more than those who completed only the hard skills their basis of operations in their countries. training. 54 BOOSTING SME FINANCE FOR GROWTH Developing Gender Differentiated Digital Credit Products: flexible repayment terms, including digital payments through The Experience of India206 a QR code. In India, CGAP is currently working with Aye Finance, a Similarly, Kinara Capital in India offers unsecured business fintech organization focused on microenterprises to develop loans without property collateral to registered MSMEs a gender differentiated digital credit product. The product from the manufacturing, trading, and services sectors. The provides a working capital loan for WSMEs and tailors its approach to women at every step of the service chain. HerVikas Program is a business loan specially designed for This includes adjusting the loan size, relaxing eligibility women-owned businesses. MSME women entrepreneurs requirements for collateral and firm location, or getting can get a 1 percent discount on the interest rate on their approval from a male relative, as well as designing a gender loans without submitting any additional documents. Women inclusive application process that minimizes visits to the entrepreneurs can apply for a HerVikas loan online and get branch and adding a separate call center. In addition, it the loan disbursed in the applicant’s bank account within 24 reviews the credit scorecard for gender bias and allows for hours. APPENDIX D. FIRM CAPABILITY AND THE CONNECTION TO ACCESS TO FINANCE 55 Appendix D. Firm Capability and the Connection to Access to Finance Finance is a key input to the ability of firms to improve their Although general business conditions are beyond the productivity, grow, and generate sustainable jobs. How (and influence of any one firm, their internal capabilities regulate how well) finance is utilized by these firms depends on a how well they navigate these broad conditions and their number of factors including general business conditions, immediate markets (for example, existing and new clients, the firm’s specific market conditions, and their internal channels to markets, competitors), and how effectively they capabilities. manage the types of changes in their own operations that can improve productivity and create jobs. This applies to all These internal capabilities include the ability to develop SMEs, from new microbusinesses to established medium and effectively implement a coherent strategy and business manufacturers,207 as the management capabilities of firms are planning; the effective recruitment and management of staff; increasingly recognized by economists as being a direct driver the development and maintenance of formal systems; the of firm performance and of firm survival. capacity to enter new markets and obtain new clients; and the ability to incorporate new technologies and develop new There are various interventions aimed at improving firm products. Lastly, it also includes the capacity to generate capability that complement access to finance interventions.208 and manage internal financial resources (management These instruments generally involve advice and training, but accounting, financial planning, costing) and, where necessary, vary in their intensity, focus, and sophistication according to the access external finance. type of SME being targeted, as different SME segments have different capability issues. Table D.1 provides some examples. TABLE D.1 Selected Types of Access to Finance Related Capacity Building Interventions Set of SMEs Examples of type of finance Examples of capability improvement instruments Micro-firms Micro-finance • Business training/mentoring/coaching • Finance specific—financial management training High-tech startups Equity (early-stage VC) • Accelerators, incubators, mentoring • Finance specific—investment readiness for early-stage VC Established SMEs Bank financing, factoring • Business planning, management improvement advice • Finance specific—financial training, business advice Growth SMEs Early-stage PE, lending • Growth company programs, networks • Finance investment readiness for early-stage PE Source: Original table for this publication. As can be seen from the table, there are various types of • Business training—the provision of training to interventions: founders, owners, and chief executive officers of SMEs on various aspects of SME management can be • Diagnostics—tools to help SMEs understand their narrowly focused on one area (for example, financial financial performance, can include benchmarking data management) or more general. Delivery model is so firms can be compared to peers. Delivery model generally “one to many” with set curricula and can be includes face to face and online. online. Effectiveness relies on the quality of trainer and implementation support. 56 BOOSTING SME FINANCE FOR GROWTH • Mentoring and coaching—advice by experienced capacity improvement. Many SME chief executive officers businesspeople and entrepreneurs may be about a and managers are not aware of their relative operational, specific topic (for example, finance) or general support. financial, and management performance versus peers. Delivery model is one to one; effectiveness relies on They often lack sources of formal advice (few have boards quality of mentor and whether there is rapport with SME. or use management consultants), so the process of seeking external funding can be a trigger to seek external help • Management improvement advice—typically provided because their finance request was unsuccessful, because the by consultants. the advice can be narrowly focused finance provider suggested they would benefit, or because on one issue or more broadly structured support involving diagnostics (of issues) and support for management support was part of an integrated finance- the implementation of changes and improvements. advice package.209 Delivery model is tailored to SME; effectiveness relies on the quality of advisor and motivation and capacity However, despite its potential impacts, SME capacity of SME to engage in improvement processes. building support often needs to be subsidized because SMEs will rarely be able to fund it themselves, and although • Incubation and acceleration—structured 3-to-6- finance providers may be able to provide some support to month programs for young firms, generally offered in improve their potential pipeline, it is often insufficient. This cohorts involving a mix of training, coaching, and peer type of support may be less relevant with initiatives that activities. Effectiveness relies on quality and rigor of are designed to inject liquidity into the market and provide training and quality of support network. working capital (for example, COVID or natural disaster • Investment readiness—training and coaching to support) to SMEs. address impediments in SMEs to attracting external financing. Tailored to specifics of firm. Effectiveness Similar to access to finance interventions, those setting relies on the quality of provider, capacity of SME to up programs need to measure the effectiveness of these improve, and alignment with investor requirements. programs by evaluating their impact, costs, and scalability. Furthermore, establishing a strong governance framework is Firm-level interventions can combine the provision of access critical to ensuring that firms in the applicable underserved to finance and firm capability improvement services— sector (that is, WSMEs, agri-SMEs, startups) have equal incubators and accelerators typically combine both. access to these services and that the programs are phased Seeking access to finance can act as a trigger for firm-level out if ineffective. APPENDIX E. THE PRINCIPLES FOR PUBLIC CREDIT GUARANTEES 57 Appendix E. The Principles for Public Credit Guarantees Public credit guarantees have become a popular tool used to prudently manage their capital structure. PCGS by governments around the world to channel credit to should be independently and effectively supervised MSMEs. Although public credit guarantee schemes (PCGS) based on risk-proportionate regulation. could emerge and develop privately, in many cases, • Corporate governance and risk management. The governments participate in these schemes, often directly. PCGS should have a clearly defined mandate supported A survey of credit guarantee schemes around the world by strategies and operational goals consistent with shows that over 30 percent of these schemes have some policy objectives, sound internal controls, and solid risk form of state ownership, with governments playing a bigger management framework. The mandate of PCGS should role in funding and management than in risk assessment be set in the legislation that establishes the scheme and and recovery.210 The median scheme around the world has include, at minimum, the target MSMEs and the main outstanding guarantees equivalent to 0.11 percent of GDP lines or lines of business of the scheme. The PCGS and focuses on firms with fewer than 100 employees.211 should have a sound corporate governance structure However, the size, outreach, costs, and performance of these with an independent and competent board of directors, schemes vary widely across countries.212 The largest and appointed according to clearly defined technical criteria, more established guarantee schemes operate in developed to ensure that business decisions respond to economic countries, including Canada, Japan, the United States, and and financial considerations and are free of political several European countries. influence and interference. An effective and strong system of internal controls, including internal audit and In response to the widespread state involvement in credit compliance functions, is recommended to safeguard guarantee schemes around the world, the World Bank has the integrity and efficiency of PCGS operations and issued a set of principles for the design of public guarantees governance. A robust risk management framework that that are efficient and financially sustainable.213 The World allows PCGS to accurately identify, measure, assess, Bank principles cover four key areas: and manage the risks they face (credit risk, liquidity and • Legal and regulatory frameworks. PCGS should be market risk, and operational risk) in a timely manner— established as independent legal entities on the basis and to determine that they hold adequate capital of a sound and clearly defined legal and regulatory against those risks—is a critical component of the overall framework to support the effective implementation corporate governance framework. of its operations and the achievement of its policy • Operational framework. PCGS should adopt clearly objectives, thereby enhancing its credibility and defined eligibility and qualification criteria for MSMEs, reputation. The legal and regulatory framework lenders, and credit instruments. These criteria should should also promote public-private mixed ownership, be publicly communicated and periodically reviewed which has the advantage of reducing moral hazard to ensure adequate targeting. Typical eligibility criteria on the part of the scheme itself, lenders, and MSME for borrowers include a combination of firm size (based borrowers by introducing peer pressure, shared on the number of employees, total revenues, or loan responsibility, and transparency in the decision- size), subsector, geographical location, and age. The making process. The PCGS should have adequate eligibility criteria may also consider firm performance, funding, with clearly identified sources. PCGS should including viability and profitability. Credit instruments be primarily funded out of equity endowments, which covered by a PCGS typically include working capital and can be complemented by long-term concessionary investment finance. Whereas working capital finance loans either from government sources or from may be important for sustaining jobs in MSMEs that multilateral and bilateral institutions. The PCGS are vulnerable to insolvency because of insufficient should not borrow from public or private debt markets short-term credit, investment finance is essential for 58 BOOSTING SME FINANCE FOR GROWTH job creation and long-term economic growth. Overall, example, coverage ratios (measured as the fraction of the eligibility criteria and application requirements the loan value that is guaranteed) need to leave enough should be simple, unified, and available electronically, risk for lenders to motivate them to properly assess and to facilitate adoption by both lenders and borrowers. monitor borrowers, while covering credit risk and moral The online system should also include the processes hazard to promote lender participation. The appropriate of information update, claim submission, and payment coverage ratio should be determined based on the of fees and commissions. In addition, establishing MSME target sectors. For example, higher coverage efficient, transparent, and simple claim procedures can may be granted to MSMEs operating in sectors with increase credibility and encourage participation. The higher potential for job creation or job preservation, or trigger conditions for claim submission should specify to early-stage firms. Coverage ratios around the world the maximum period allowed after a missed payment are typically higher than 50 percent, though they vary or payments and should not be conditional on initiating across countries (table E.1). But higher coverage should legal action against the MSME borrower, although entail higher fees. That is, the PCGS should charge fees lenders should proactively continue their efforts to on the basis of the riskiness of the underlying loan, recover the debt. In well-designed systems, claim which is reflected in the combination of the coverage settlement should not take place after the conclusion ratio, exposure at default, and loss given default. The of the debt recovery process, as these processes can fees charged by PCGS around the world vary between be lengthy and may discourage lender participation. 0.5 and 4 percent of the guaranteed amount per year. Evidence from schemes around the world indicate that • Monitoring and evaluation. PCGS should be subject to such an approach has not led to greater claim rates or rigorous financial reporting requirements, should have greater risk-taking behavior, with losses hovering around their financial statements audited externally, and should 2 percent. also periodically and publicly disclose non-financial information related to their operations, such as social • Credit risk must be shared appropriately among and economic commitments made and outcome. The the PCGS, lenders, and borrowers, to avoid moral performance of PCGS—in particular their outreach, hazard on the part of lenders and MSMEs. Sharing additionality, and financial sustainability—should be credit risk ensures that the right incentives are in place systematically and periodically evaluated, and the to keep default and claim rates as low as possible. For findings from the evaluations publicly disclosed. TABLE E.1 Coverage Ratios and Pricing Policies around the World Coverage ratio Economies Min. Max. Avg. Variations in coverage ratio Commission fees Canada 85% 85% 85% 2% of total loan value + 1.25% p.y. of outstanding loan value Chile 50% 80% 65% 80% for small firms (loans up to 1% to 2% p.y. of guaranteed amount; higher US$100,000); 50% for medium fees for banks with greater risk firms (loans up to US$400,000) France 40% 70% 55% 40%–50% on average; 60% for 0.6% p.y. (for 40% coverage) to 0.9% p.y. (for innovative firs; 70% for startups 70% coverage) Malaysia 30% 100% 65% Depends on type of borrower 0.5% to 3.6% p.y., varying with the riskiness and instrument of the borrower Republic of Korea 50% 90% 70% 90% for high-risk borrowers; 50% 0.5% to 3% p.y., varying with the riskiness of for low-risk borrowers the borrower and the size of the loan United States of 75% 85% 80% 75% for loans greater than 2% to 3.5% of loan value + 0.55% of America US$150,000; 85% for smaller loans outstanding amount; higher fees for larger loans Source: Original table for this publication based on World Bank staff assessments conducted before the COVID19 pandemic. Note: Avg. = average; max. = maximum; min. = minimum; p.y. = per year REFERENCES 59 References Abouzahr, K., M. Krentz, J. Harthorne, and F. B. Taplett. Ayyagari, M., A. Demirgüç-Kunt, and V. Maksimovic. 2018. 2018. “Why Women-Owned Startups Are a Better “Financing SMEs and Economic Development.” In Bet.” Boston Consulting Group, June 6, 2018. https:// Handbook of Finance and Development, edited by T. www.bcg.com/publications/2018/why-women-owned- Beck and R. Levine, 503–33. Cheltenham, UK: Edward startups-are-better-bet. Elgar. Agoraki, M., M. Delis, and F. Pasiourasc. 2011. “Regulations, Ayyagari, M., P. F. Juarros, M. S. Martínez Pería, and S. Competition and Bank Risk-Taking in Transition Sandeep. 2016. “Access to Finance and Job Growth: Countries.” Journal of Financial Stability 7: 38–48. Firm-Level Evidence across Developing Countries.” Agostino, M., and F. Trivieri. 2010. “Is Banking Competition World Bank Policy Research Working Paper Series 7604, Beneficial to SMEs? An Empirical Study Based on Italian World Bank, Washington, DC. Data.” Small Business Economics 35: 335–55. Bai, J., S. Bernstein, A. Dev, and J. Lerner. 2021. “The Dance Alderman, H., and T. Haque. 2007. “Insurance against between Government and Private Investors: Public Covariate Shocks: The Role of Index-Based Insurance Entrepreneurial Finance around the Globe.” NBER in Social Protection in Low-Income Countries of Africa.” Working Paper 28744, National Bureau of Economic World Bank Working Paper 95, World Bank, Washington, Research, Cambridge, MA. DC. Bancel, F., and U. Mittoo. 2002. “The Determinants of Alibhai, S., A. Donald, M. Goldstein, A. A. Oguz, A. Pankov, Capital Structure Choice: A Survey of European Firms.” and F. Strobbe. 2019. “Gender Bias in SME Lending: University of Manitoba working paper, University of Experimental Evidence from Turkey.” Policy Research Manitoba, Manitoba, Canada. Working Paper 9100, World Bank, Washington, DC. Bartz-Zuccala, W., Ö. Taskin, T. Hos, C. Sangaré, R. Schwarz, Alonso Gispert, T., P. L. Chatain, K. J. T. Driessen, D. Queiroz and P. Horrocks. 2022. Scaling Up Blended Finance in Palermo, A. I. Plaitakis, A. F. Carvajal, and M. Dohotaru. Developing Countries. OECD, Paris. 2022. “Regulation and Supervision of Fintech: Basel Committee on Banking Supervision. 2010. Considerations for EMDE Policymakers.” World Bank, “Microfinance Activities and the Core Principles Washington, DC. for Effective Banking Supervision.” BCBS, Basel, Amamou, R., A. Gereben, and M. Wolski. 2020. “Making a Switzerland. Difference: Assessing the Impact of the EIB’s Funding Beck, T., A. Demirgüç-Kunt, L. Laeven, and R. Levine. 2008. to SMEs.” EIB Working Papers 2020/04N 978-92-861- “Finance, Firm Size, and Growth.” Journal of Money, 4583-4, European Investment Bank (EIB), Luxembourg. Credit, and Banking 40: 1379–405. Antoniou, A., Y. Guney, and K. Paudyal. 2008. “The Beck, T., A. Demirgüç-Kunt, and V. Maksimovic. 2005. Determinants of Capital Structure: Capital Market- “Financial and Legal Constraints to Growth: Does Firm Oriented versus Bank-Oriented Institutions.” Journal of Size Matter?” Journal of Finance 60 (1): 137–77. Financial and Quantitative Analysis 43 (1): 59–92. Beck, T., A. Demirgüç-Kunt, and V. Maksimovic, 2008. Assaf, N., M. Engman, A. Ragoussis, and S. Agrawalabila. “Financing Patterns around the World: Are Small Firms 2021. “The Private Sector in Fragile Situations.” In Different?” Journal of Financial Economics 89 (3): 467– Macroeconomic Policy in Fragile States, edited by R. 87. Chami, R. Espinoza, and P.J. Montiel, 127–85. Oxford, Beck, T., A. Demirgüç-Kunt, and M. S. Martínez Pería. 2011. UK: Oxford University Press. “Bank Financing for SMEs: Evidence across Countries Atkinson, A. 2017. “Financial Education for MSMEs and and Bank Ownership Types.” Journal of Financial Potential Entrepreneurs.” OECD Working Papers on Services Research 39: 35–54. Finance, Insurance and Private Pensions 43, OECD, Paris. Beck, T., L. Klapper, and J. C. Mendoza. 2010. “The Typology Ayyagari, M., T. Beck, and A. Demirgüç-Kunt. 2007. “Small of Partial Credit Guarantee Funds around the World.” and Medium Enterprises across the Globe.” Small Journal of Financial Stability 6: 10–25. Business Economics 29 (4): 415–34. Berger, A. N., and G. F. Udell. 2006. “A More Complete Ayyagari, M., A. Demirgüç-Kunt, and V. Maksimovic. 2013. Conceptual Framework for SME Finance.” Journal of “Financing in Developing Countries.” In Handbook of Banking and Finance 30: 2945–66. the Economics of Finance, vol. 2, part A, edited by G. Berhane, G., S. Dercon, R. V. Hill, and A. Seyoum Taffesse. M. Constantinides, M. Harris, and R. M. Stulz, 683–757. 2014. “Formal and Informal Insurance: Experimental Amsterdam: Elsevier. Evidence from Ethiopia.” Paper presented at the 29th Ayyagari, M., A. Demirgüç-Kunt, and V. Maksimovic. 2014. International Conference of Agricultural Economists, “Who Creates Jobs in Developing Countries?” Small Milan, Italy, August 8–14, 2015. Business Economics 43: 75–99. Binh, K. B., H. Jhang, P. Daehyeon, and D. RYU. 2020. 60 BOOSTING SME FINANCE FOR GROWTH “Capital Markets for Small- and Medium-Sized Campello, M., and M. Larrain. 2016. “Enlarging the Enterprises and Startups in Korea.” The Journal of Asian Contracting Space: Collateral Menus, Access to Credit, Finance, Economics and Business 7 (12): 195–210. and Economic Activity.” Review of Financial Studies 29 Bloom, N., and J. Van Reenen. 2010. “Why Do Management (2): 349–83. Practices Differ across Firms and Countries?” Journal of Campos, F. M. L., R. Dawn Coleman, A. Conconi, A. A. Economic Perspectives 24 (1): 203–24.Boden, R., and A. Donald, M. Gassier, M. P. Goldstein, Z. L. Chavez. 2019. R. Nucci. 2000. “On the Survival Prospects of Men’s and Profiting from Parity: Unlocking the Potential of Women’s Women’s New Business Ventures.” Journal of Business Business in Africa. Washington, DC: World Bank Group. Venturing 15 (4): 347–62. Campos, F., M. Frese, M. Goldstein, L. Iacovone, H. C. Booth, L., A. Aivazian, A. Demirgüç-Kunt, and V. Maksimovic. Johnson, D. McKenzie, and M. Mensmann. 2018. “Is 2001. “Capital Structures in Developing Countries.” Personal Initiative Training a Substitute or Complement Journal of Finance 56 (1): 87–130. to the Existing Human Capital of Women? Results from a Brown, J. R., S. M. Fazzari, and B. C. Petersen. 2009. Randomized Trial in Togo.” American Economic Review “Financing Innovation and Growth: Cash Flow, External Papers and Proceedings 108: 256–61. Equity, and the 1990s R&D Boom.” Journal of Finance Caprio, G., and A. Demirgüç-Kunt. 1998. “The Role of 64 (1): 151–85. Long-Term Finance: Theory and Evidence.” World Bank Brown, J. R., G. Martinsson, and B. C. Petersen. 2013. “Law, Research Observer 13 (2): 171–89. Stock Markets, and Innovation.” Journal of Finance 68 Carpenter. R. E., and B. C. Petersen. 2002. “Capital Market (4): 1517–49. Imperfections, High-Tech Investment, and New Equity Brown, J. R., G. Martinsson, and B. C. Peterson. 2017. “Stock Financing.” Economic Journal 112 (477): 54–72. Markets, Credit Markets, and Technology-Led Growth.” Carter, M., L. Cheng, and L. Sarris. 2016. “Where and How Journal of Financial Intermediation 32: 45–59. Index Insurance Can Boost the Adoption of Improved Brown, J. R., and B. C. Petersen. 2009. “Why Has the Agricultural Technologies.” Journal of Development Investment-Cash Flow Sensitivity Declined So Sharply? Economics 118: 59–71. Rising R&D and Equity Market Developments.” Journal Carter, M. R., F. Galarza, and S. Boucher. 2007. “Underwriting of Banking and Finance 33 (5): 971–84. Area-Based Yield Insurance to Crowd-In Credit Supply Brown, M., T. Jappelli, and M. Pagano. 2009. “Information and Demand.” MPRA Paper 24326, University Library of Sharing and Credit: Firm-Level Evidence from Transition Munich, Germany. Countries.” Journal of Financial Intermediation 18: 151– Carvajal, A. F., R. M. Davis, S. Divakaran, and T. Konidaris. 72. 2020. Capital Markets and SMEs in Emerging Markets Buchner, B., B. Naran, P. de Aragão Fernandes, R. and Developing Economies: Can They Go the Distance? Padmanabhi, P. Rosane, M. Solomon, S. Stout et al. Washington, DC: World Bank. 2021. “Global Landscape of Climate Finance 2021.” Carvajal, A. F., and T. Didier. 2024. Financing Mitigation and Climate Policy Initiative, December 14, 2021. Adaptation to Climate Change for SMEs. Washington, Burga, L., N. Gimelli, S. Muradyan, A. Robakowski, M. Miller, DC: World Bank. M. Rawlins, and G. Snyder. 2021. “Using Digital Solutions CCAF, World Bank, and World Economic Forum. 2022. The to Address Barriers to Female Entrepreneurship: A Global Covid-19 Fintech Market Impact and Industry Toolkit.” Washington, DC: World Bank. Resilience Report. University of Cambridge, World Business Wire. 2022. “MYbank Makes Financing More Bank, and World Economic Forum. Accessible for 45 Million SME Clients by Leveraging Cetorelli, N. 2004. “Bank Concentration and Competition Digital Technology.” April 29, 2022. in Europe.” Journal of Money, Credit, and Banking 36: Buvinic, M., R. Furst-Nichols, and E. C. Pryor. 2013. A Roadmap 543–58. for Promoting Women’s Economic Empowerment. New CGAP. 2022. “CGAP Pilots Innovative Digital Credit Models York: United Nations Foundation. for MSEs.” Press release, July 28, 2022. Cai, J. 2015. “The Impact of Insurance Provision on Chemmanur, T. J., K. Krishnan, and D. K. Nandy. 2011. “How Household Production and Financial Decisions.” Does Venture Capital Financing Improve Efficiency in American Economic Journal: Economic Policy 8 (2): Private Firms? A Look beneath the Surface.” Review of 44–88. Financial Studies 24: 4037–90. Calice, P. 2016. “Assessing Implementation of the Principles Chigurupati, V. R., and S. P. Hegde. 2010. “Capital Market for Public Credit Guarantees for SMEs: A Global Frictions, Leasing and Investment.” Unpublished report. Survey.” Policy Research Working Paper 7753, World Cirera, X., and Q. Qasim. 2014. “Supporting Growth- Bank, Washington, DC. Oriented Women Entrepreneurs: A Review of the Calice, P. 2023. “Unlocking SME Finance in Fragile and Evidence and Key Challenges.” Innovation, Technology Conflict Affected Situations,” Policy Research Working and Entrepreneurship Policy Note 5. World Bank, Paper Series 10363, World Bank, Washington, DC. Washington, DC. Calomiris, C., M. Larrain, J. Liberti, and J. Sturgess. 2017. Cole, S. A., and W. Xiong. 2017. “Agricultural Insurance and “How Collateral Laws Shape Lending and Sectoral Economic Development.” Annual Review of Economics Activity.” Journal of Financial Economics 123 (1): 163–88. 9: 235–62. REFERENCES 61 Cucagna, E., L. Iacovone, and E. Rubiano-Matulevich. 2020. Compound-Risk Aversion: Evidence from a WTP “Women Entrepreneurs in Mexico: Breaking Sectoral Experiment in Mali.” Paper presented at the Agricultural Segmentation and Increasing Profits.” World Bank LAC and Applied Economics Association Annual Meeting, Gender Innovation Lab Policy Brief, October. August 4–6, 2013, Washington, DC. Da Rin, M., T. Hellmann, and M. Puri. 2013. “A Survey of European Commission. 2018. Effectiveness of Tax Incentives Venture Capital Research” In Handbook of the Economics for Venture Capital and Business Angels to Foster the of Finance, edited by George M. Constantinides, Investment of SMEs and Start-Ups. Working Paper 68– Milton Harris, and Rene M. Stulz, 573–648. Amsterdam: 2017, Luxembourg: European Commission. Elsevier. EIB. 2022. “Small and Medium Enterprises Overview.” Dalhuijsen, E., E. Gutierrez, T. Kliatskova, R. Mok, and M. Gert Luxembourg: European Investment Bank. Jan Regelin. 2023. “Greening National Development EIB. 2023a. Evaluation of the EIB Group Equity and Quasi- Financial Institutions: Trends, Lessons Learned, and Equity Support for Small Businesses and Mid-Caps. Ways Forward.” World Bank Group, Washington, DC. Luxembourg, European Investment Bank. de Jong, A., R. Kabir, and T. T. Nguyen. 2008. “Capital EIB. 2023b. “Impact Assessment of the EIB’s Intermediated Structure around the World: The Roles of Firm- and Lending to Businesses.” Impact study. Luxembourg, Country-Specific Determinants.” Journal of Banking and European Investment Bank. Finance 32: 1954–69. Ewens, M., and J. Farre-Mensa. 2022. “Private or Public de la Torre, A., J. C. Gozzi, and S. Schmukler. 2017. “Innovative Equity? The Evolving Entrepreneurial Finance Experiences in Access to Finance: Market Friendly Roles Landscape.” Annual Review of Financial Economics 14: for the Visible Hand?” World Bank Policy Research 271–93. Working Paper 4326, World Bank, Washington, DC. Feyen, E., J. Frost, L. Gambacorta, H. Natarajan, and M. Saal. Demirgüç-Kunt, A., M.S. Martínez Pería, and T. Tressel, 2020. 2022. “Fintech and Digital Transformation of Financial “The Global Financial Crisis and the Capital Structure of Services: Implications for Market Structure and Public Firms: Was the Impact More Severe among SMEs and Policy.” World Bank, Washington, DC. Non-Listed Firms?” Journal of Corporate Finance 60. Financial Stability Board. 2019. Evaluation of the Effects of Demirgüç-Kunt, A., and V. Maksimovic. 1998. “Law, Finance, Financial Regulatory Reforms on Small and Medium- and Firm Growth.” Journal of Finance 53 (6): 2107–37. Sized Enterprise (SME) Financing. Basel, Switzerland: Demirgüç-Kunt, A., and V. Makismovic. 1999. “Institutions, Financial Stability Board. Financial Markets, and Firm Debt Maturity.” Journal of Fisera, B., R. Horváth, and M. Melecký. 2019. “Basel III Financial Economics 54 (3): 295–336. Implementation and SME Financing: Evidence for Demirgüç-Kunt, A., and V. Maksimovic. 2002. “Funding Emerging Markets and Developing Economies.” World Growth in Bank-Based and Market-Based Financial Bank Policy Research Working Paper 9069, World Bank, Washington, DC. Systems: Evidence from Firm-Level Data.” Journal of Financial Economics 65: 337–63. Fouejieu, A., R. Sahay, M. Cihak, and S. Chen. 2020. “Financial Inclusion and Inequality: A Cross-Country De Roure, C., L. Pelizzon, and A. Thakor. 2022. “P2P Lenders Analysis.” Journal of International Trade and Economic versus Banks: Cream Skimming or Bottom Fishing?” Development 29 (8): 1018–48. Review of Corporate Finance Studies 11 (2): 213–62. Frame, W. S., A. Srinivasan, and L. Woosley. 2001. “The Didier, T., and A. P. Cusolito. 2024. Unleashing Productivity Effect of Credit Scoring on Small-Business Lending,” through Firm Financing. Washington, DC: World Bank. Journal of Money, Credit and Banking 33 (3): 813–25. Didier, T., E. Feyen, R. Llovet Montanes, and O. P. Ardic Frost, J., L. Gambacorta, Y. Huang, H. Shin, and P. Zbinden. Alper. 2022. “Global Patterns of Fintech Activity and 2019. “BigTech and the Changing Structure of Financial Enabling Factors.” Fintech and the Future of Finance Intermediation.” Economic Policy 34 (100): 761–99. Flagship Technical Note, World Bank, Washington, DC. GPFI. 2023. “G20 Policy Recommendations for Advancing Dietsch, M., M. L. Henri Fraisse, and S. Lecarpentier. 2019. Financial Inclusion and Productivity Gains through “Lower Bank Capital Requirements as a Policy Tool Digital Public Infrastructure.” to Support Credit to SMEs: Evidence from a Policy Experiment.” EconomiX Working Paper 2019-12, Gambacorta, L., Y. Huang, H. Qiu, and J. Wang. 2019. “How EconomiX, University of Paris Nanterre. Do Machine Learning and Non-traditional Data Affect Credit Scoring? New Evidence from a Chinese Fintech Divakaran, S., H. Halland, G. Lorenzato, P. Rose, and Firm.” BIS Working Paper 834, Bank for International S. Sarmiento-Saher. 2022. “Strategic Investment Settlements, Basel, Switzerland. Funds: Establishment and Operations.” International Development in Focus, World Bank, Washington, DC. Gambacorta, L., F. Khalil, and B. M. Parigi. 2022. “Big Tech vs. Banks,” BIS Working Paper 10378, Bank for EBA. 2016. EBA Report on SMEs and the SME Supporting International Settlements, Basel, Switzerland. Factor. EBA/OP/2016, European Banking Authority. Giannetti, M. 2003. “Do Better Institutions Mitigate Agency EBRD. 2018. “Special Study: Credit Lines-Lending through Problems? Evidence from Corporate Finance Choices.” Financial Intermediaries.” London: ERBD. Journal of Financial and Quantitative Analysis 38 (1): Elabed, G., and M. R. Carter. 2013. “Basis Risk and 185–212. 62 BOOSTING SME FINANCE FOR GROWTH Goffe, V., J. Hammersley, and E. Rustom. 2021. “Best IPCC. 2023. “Climate Change 2023: Synthesis Report. Practices in the Operation of Partial Credit Guarantee Contribution of Working Groups I, II and III to the Sixth Schemes: Guide for Policy Makers.” World Bank, Assessment Report of the Intergovernmental Panel on Washington, DC. Climate Change.” IPCC, Geneva. Goldstein, I., J. Jagtiani, and A. Klein. 2019. “Fintech and the ISF Advisors. 2019. “Rural and Agricultural Finance: State of New Financial Landscape” BPI Banking Perspectives, the Sector Report.” ISF Advisors, Washington, DC. Volume 7, Q1 (March). ISF Advisors. 2022. “The State of the Agri-SME Sector: Graña-Alvarez, R., E. Lopez-Valeiras, M. Gonzalez-Loureiro, Bridging the Finance Gap.” Edinburgh, Scotland: and F. Coronado. 2024. “Financial Literacy in SMEs: Commercial Agriculture for Smallholders and A Systematic Literature Review and a Framework for Agribusiness (CASA). Further Inquiry.” Journal of Small Business Management Jagtiani, J., and C. Lemieux. 2017. “Fintech Lending: 62: 331–80. Financial Inclusion, Risk Pricing, and Alternative GSMA. 2020. “Reaching 50 Million Women with Mobile: A Information.” Monetary Economics: Financial System & Practical Guide.” London: GSMA. Institutions eJournal, December 26, 2017. Gutierrez, E., and T. Kliatskova. 2021. “National Development Jappelli, T., and M. Pagano. 2002. “Information Sharing, Financial Institutions: Trends, Crisis Response, Activities, Lending, and Defaults: Cross-Country Evidence.” and Lessons Learned,” World Bank, Washington, DC. Journal of Banking and Finance 26 (10): 2017–45. Hill, R. V., N. Kumar, N. Magnan, S. Makhija, F. de Nicola, Jenik, I., and P. Zetterli. 2021. “Digital Banks: How Can They D. J. Spielman, and P. S. Ward. 2019. “Ex Ante and Ex Be Regulated to Deepen Financial Inclusion?” Working Post Effects of Hybrid Index Insurance in Bangladesh.” paper, CGAP, Washington, DC. Journal of Development Economics 136: 1–17. Jensen, N., and C. Barrett. 2017. “Agricultural Index Insurance Hommes, M., A. Sotiriou, S. Kruijff, S. Sawhney, S. K. for Development.” Applied Economic Perspectives and Kumaraswamy, and E. Kiamba. 2022. The Promise of Policy 39 (2): 199–219. Fintech for Micro and Small Enterprises. Washington, Kallberg, J. G., and G. Udell. 2003. “The Value of Private DC: Consultative Group to Assist the Poor. Sector Business Credit Information Sharing: The US Honohan, P. 2010. “Partial Credit Guarantees: Principles and Case.” Journal of Banking and Finance 27(3): 449–69. Practice.” Journal of Financial Stability 6: 1–9. Karlan, D., R. D. Osei, I. Osei-Akoto, and C. Udry. 2014. ICCR. 2018. “Use of Alternative Data to Enhance Credit “Agricultural Decisions after Relaxing Credit and Risk Reporting to Enable Access to Digital Financial Services Constraints.” Quarterly Journal of Economics 129 (2): by Individuals and SMEs Operating in the Informal 597–652. Economy: Guidance Note.” Global Partnership for Kelly, S., and M. Mirpourian. 2021. “Algorithmic Bias, Financial Inclusion. Financial Inclusion, and Gender.” Women’s World IDFC. 2021. IDFC Green Finance Mapping Report 2021. Banking, New York. Paris: IDFC. Khanna, M. , J. S. Wimpey, M. Bruhn, S. Singh, M. Hommes, Inclusive Green Finance Working Group and Alliance for and A. Sorokina. 2017. “MSME Finance Gap Report.” Financial Inclusion. 2022. “Green Credit Guarantee World Bank, Washington, DC. Schemes for MSMEs.” Special report, Alliance for Klapper, L. 2006. “The Role of Factoring for Financing Small Financial Inclusion, Kuala Lumpur, Malaysia. and Medium Enterprises.” Journal of Banking and Independent Development Evaluation. 2020. “Evaluation Finance 30 (11): 3111–30. of the AfDB’s Role in Increasing Access to Finance in Koreen, M., A. Laboul, and N. Smaini. 2018. “G20/OECD Africa.” Project Cluster Evaluation, Africa Development Bank Group, Abidjan, Côte d’Ivoire. Effective Approaches for Implementing the G20/OECD High-Level Principles on SME Financing.” OECD SME Independent Evaluation. 2018. Support for Small and and Entrepreneurship Papers 9, OECD Publishing, Paris. Medium-Sized Enterprises, 2005–2017: Business Environment, Access to Finance, Value Chains, and Kwaak, T., M. Clarke, J. de Kok, J. Snijders, S. Tollenaar, S. Women in Business. Thematic evaluation, Asian Galesloot, and M. L. Oliveira Sadilek. 2021. “Survey on Development Bank, Manila. the Access to Finance of Enterprises (SAFE): Analytical Report 2021.” European Commission, Luxembourg. IFC. Forthcoming. “MSME Finance Gap: An Updated Estimation and Evolution of the MSME Finance Gap Leon, F. 2014. “Measuring Competition in Banking: A Critical in Emerging Markets and Developing Economies.” Review of Methods.” Serie Etudes et documents du Washington, DC: World Bank. CERDI. ILO. 2019. “The Power of Small: Unlocking the Potential of Leon, F. 2015. “Does Bank Competition Alleviate Credit SMEs.” InfoStories, October 21, 2019. Constraints in Developing Countries?” Journal of Banking and Finance 57: 130–42. IPCC. 2014. Climate Change 2014: Mitigation of Climate Change. Contribution of Working Group III to the Fifth Lerner, J. 2013. “The Boulevard of Broken Dreams: Innovation Assessment Report of the Intergovernmental Panel on Policy and Entrepreneurship.” Innovation Policy and the Climate Change. Cambridge, UK: Cambridge University Economy 13 (1): 61–82. Press. Lerner, J., and R. Nanda. 2020. “Venture Capital’s Role in REFERENCES 63 Financing Innovation: What We Know and How Much We OECD. 2022a. “Financing SMEs and Entrepreneurs 2022: An Still Need to Learn.” Journal of Economic Perspectives OECD Scoreboard.” OECD Publishing, Paris. 34 (3): 237–61. OECD. 2022b. “Financing SMEs for Sustainability: Lerner, J., and A. Schoar. 2005. “Does Legal Enforcement Drivers, Constraints and Policies.” OECD SME and Affect Financial Transactions? The Contractual Channel Entrepreneurship Papers 35, OECD Publishing, Paris. in Private Equity.” Quarterly Journal of Economics 120: OECD. 2022c. States of Fragility 2022. Paris: OECD 223–46. Publishing. Love, I., and M. S. Martínez Pería. 2015. “How Bank OECD. 2023. “Framework for the Evaluation of SME and Competition Affects Firms’ Access to Finance.” World Entrepreneurship Policies and Programmes 2023.” Bank Economic Review 29 (3): 413–48. OECD Studies on SMEs and Entrepreneurship, OECD Love, I., M. S. Martínez Pería, and S. Singh. 2014. “Collateral Publishing, Paris. Registries for Movable Assets: Does Their Introduction OECD and ASEAN. 2021. “Facilitating the Green Transition Spur Firms’ Access to Bank Finance?” Working Papers for ASEAN SMEs: A Toolkit for Policymakers.” OECD 201422, University of Hawaii at Manoa. Publishing, Paris. Love, I., and N. Mylenko. 2003. “Credit Reporting and Ongena, S., and A. Popov. 2015. “Gender Bias and Credit Financing Constraints.” World Bank Policy Research Access.” Working paper series, European Central Bank, Working Paper No. 3142, World Bank, Washington, DC. 1822, European Central Bank, Frankfurt. Lu, L. 2018. “How a Little Ant Challenges Giant Banks? Pavlova, E., and S. Gvetadze. 2023. “Female Access to The Rise of Ant Financial (Alipay)’s Fintech Empire and Finance: A Survey of Literature.” EIF Research and Relevant Regulatory Concerns.” International Company Market Analysis Working Paper 2023/87, European and Commercial Law Review 28: 12–30. Investment Fund, Luxembourg. Lyman, T., L. de Koker, C. Martin Meier, and M. Kerse. 2019. Pazarbasioglu, C., A. Garcia Mora, M. Uttamchandani, H. “Beyond KYC Utilities: Collaborative Customer Due Natarajan, E. Feyen, and M. Saal. 2020. “Digital Financial Diligence.” Working paper, CGAP, Washington, DC. Services.” World Bank Group, Washington, DC. Martínez Pería, M. S., and S. Singh. 2014. “The Impact of Plaitakis, A., and S. Staschen. 2020. “Open Banking: How to Credit Information Sharing Reforms on Firm Financing?” Design for Financial Inclusion.” Working paper, CGAP, World Bank Policy Research Working Paper Series 7013, Washington, DC. World Bank, Washington, DC. Proparco Group AFD. 2023. “Proparco and the European Mayordomo, S., and M. Rodriguez-Moreno. 2017. “Support Union Support Bank of Palestine in Financing High Is Appreciated: On the Effectiveness of the SME Impact SMEs.” Press release, February 13, 2023. Supporting Factor,” Banco de Espana, Madrid. Saal, M. 2021. “What Are Key Regulatory and Policy Miguel, F., A. Pedraza, and C. Ruiz-Ortega. 2022. “Climate Considerations for Embedded Finance?” Salzburg Change Regulations: Bank Lending and Real Effects.” Questions for the Future of Finance, Salzburg Global World Bank Policy Research Working Paper 10270, Finance Forum, Saltzburg, Austria. World Bank, Washington, DC. Santos, P., and C. B. Barrett. 2011. “Persistent Poverty and Moody’s Investors Service. 2022. “Rapid Growth of Virtual Informal Credit.” Journal of Development Economics 96 Banks Puts New Verve into Old Banking Systems.” (2): 337–47. February 15, 2022. Sawhney, S., S. Krishna Kumaraswamy, N. Singh, E. Morsy, H. 2020. “Access to Finance: Mind the Gender Gap.” Kiamba, and A. Sotiriou. 2022. “No Small Business: A Quarterly Review of Economics and Finance 78: 12–21. Segmented Approach to Better Finance for Micro and Murcia, J. F., E. Cuestas, R. Michelitsch, and A. Soriano. 2016. Small Enterprises.” Focus note, CGAP, Washington, DC. “Evaluation of the IDB’s Group Work through Financial Schammo, P. 2019. “Undisruption in the SME Funding Intermediaries: SME Finance Background Report.” Inter- Market: Information Sharing, Finance Platforms and the American Development Bank, Washington, DC. UK Referral Scheme.” European Business Organization Naran, B., J. Connolly, P. Rosane, D. Wignarajah, G. Wakaba, Law Review 20: 29–53. and B. Buchner. 2022. “Global Landscape of Climate Sharpe, S. A., and H. H. Nguyen. 1995. “Capital Market Finance: A Decade of Data.” Climate Policy Initiative. Imperfections and the Incentive to Lease.” Journal of October 27, 2022. Financial Economics 39 (2–3): 271–94. OECD. 2015. New Approaches to SME and Entrepreneurship Slotty, C. 2009. “Financial Constraints and the Decision to Financing: Broadening the Range of Instruments. OECD Lease: Evidence from German SME.” Working Paper Publishing, Paris. Series: Finance & Accounting No. 205, Johann Wolfgang OECD. 2017. Entrepreneurship at a Glance 2017. Paris: Goethe-Universität, Frankfurt am Main. OECD Publishing. Staschen, S., and P. Meagher. 2022. “3 Regulatory OECD. 2020. “Evolution and Trends in SME Finance Policies Challenges Posed by Platform-Based Finance.” CGAP since the Global Financial Crisis.” OECD Publishing, Paris. Blog, February 23, 2022. OECD. 2021. “No Net Zero without SMEs.” OECD SME and Teare, G. 2020. “Global VC Funding to Female Founders Entrepreneurship Papers 30, OECD Publishing, Paris. Dropped Dramatically This Year.” Crunchbase News, 64 BOOSTING SME FINANCE FOR GROWTH December 21, 2020. https://news.crunchbase.com/ World Bank. 2017. Report on the Treatment of MSME venture/global-vc-funding-to-female-founders/. Insolvency. Washington, DC: World Bank Group. Teima, G. O., I. Istuk, L. Maldonado Garcia Pertierra, M. World Bank. 2018. “An Operational Guide to Women’s A. Soriano, and J. M. Wilson. 2022. Fintech and SME Entrepreneurship Programs in the World Bank.” World Finance: Expanding Responsible Access. Washington, Bank Group, Washington, DC. DC: World Bank Group. World Bank. 2019a. Credit Reporting Knowledge Guide. Thompson, J., K. Boschmans, and L. Pissareva. 2018. Washington, DC: World Bank Group. “Alternative Financing Instruments for SMEs and World Bank. 2019b. Secured Transactions, Collateral Entrepreneurs: The Case of Capital Market Finance.” Registries and Movable Asset-Based Financing, OECD SME and Entrepreneurship Papers 10, OECD Knowledge Guide. Washington, DC: World Bank Group. Publishing, Paris. World Bank. 2019c. World Bank Group Support for UNEP. 2021. Adaptation Gap Report 2021: The Gathering Small and Medium Enterprises: A Synthesis of Evaluative Storm—Adapting to Climate Change in a Post- Finding. Washington, DC: World Bank. Pandemic World. Nairobi: United Nations Environment World Bank. 2019d. Profiting from Parity: Unlocking the Programme. Potential of Women Businesses in Africa. Washington, UNSGSA. 2023. Green Finance: A Policy and Advocacy DC: World Bank. Approach. Inclusive Green Finance Working Group, World Bank. 2022. “Guidelines for Integrating Climate United Nations Secretary-General’s Special Advocate Change Mitigation and Adaptation in Public Credit for Inclusive Finance for Development. Guarantee.” Washington, DC: World Bank Group. USAID. 2022. “Inclusive Lending Sparks Success for Yemen’s World Bank. 2024. Women, Business and the Law 2024. Small Businesses and Banks.” Press release, October 13, Washington, DC: World Bank. 2022. World Bank. Forthcoming. Guiding Climate Action in the Walthoff-Borm, X., T. Vanacker, and V. Collewaert. 2018. Private and Financial Sectors: A Framework for Policy- “Equity Crowdfunding, Shareholder Structures, and Firm Makers. Performance.” Corporate Governance: An International World Bank and FIRST Initiative. 2015. The Principles for Review 26 (5): 314–30. Public Credit Guarantee Schemes for SMEs. Washington, World Bank. 2011. General Principles for Credit Reporting. DC: World Bank Group. Washington, DC: World Bank Group. World Bank and ICCR. 2022. Responsible Use of Technology World Bank. 2012. Global Financial Development Report in Credit Reporting. White Paper. Washington, DC: 2013: Rethinking the Role of the State in Finance. World Bank Group. Washington, DC: World Bank Group. World Resources Institute. 2023. State of Climate Action World Bank. 2014a. The Big Business of Small Enterprises: 2023. Evaluation of the World Bank Group Experience Yan, A. 2006. “Leasing and Debt Financing: Substitutes or with Targeted Support to Small, and Medium-Size Complements?” Journal of Financial and Quantitative Enterprises, 2006–12. Washington, DC: World Bank. Analysis 41 (3): 709–31. World Bank. 2014b. “Debt Resolution and Business Exit: Insolvency Reform for Credit, Entrepreneurship, and Growth,” World Bank Viewpoint Note 343, World Bank, Washington, DC. REFERENCES 65 Notes 1 See Didier and Cusolito (2024). 13 See for example Agoraki, Delis, and Pasiourasc (2011), 2 See IFC (forthcoming). Agostino and Tivieri (2010), Beck et al. (2008), Cetorelli (2004), and Leon (2014, 2015). 3 See Didier and Cusolito (2024). 14 In this report, fintech refers to new financial technology. 4 See Didier and Cusolito (2024). The development of fintech has led to the emergence 5 See for example Ayyagari, Beck, and Demirgüç-Kunt of new business models and new players (sometimes (2007), Ayyagari, Demirgüç-Kunt, and Maksimovic also referred to as fintechs). Some of these new players (2014), ILO (2019), and the SME Finance Forum’s offer credit themselves (for example, digital banks and MSME Economic Indicators Database 2019. There some lending platforms), whereas others focus on the is no universal definition of SMEs. In general, many provision of fintech-based services to or in partnership countries use the number of employees, assets, and with incumbent financial institutions to enhance their revenues, either separately or concurrently, as defining businesses (for example, companies that provide criteria. Moreover, the specific threshold to define a credit scoring methodologies). In addition, incumbent SME tends to vary across countries. The most widely financial institutions themselves have adopted fintech used parameter defines microenterprises as businesses solutions. In practice, the boundaries of these different with fewer than 10 employees and SMEs as those with fintech adoption channels are blurred. Consequently, fewer than 250 employees. See for example Khanna et measuring the extent to which fintech adoption is al. (2017). taking place is challenging. The study team is not aware 6 See for example Antoniou, Guney, and Paudyal (2008), of any robust assessment that has been conducted to Ayyagari, Demirgüç-Kunt, and Maksimovic (2013, 2018), date. See Didier et al. (2022) and CCAF, World Bank Bancel and Mittoo (2002), Beck, Demirgüç-Kunt, and and World Economic Forum (2022). Maksimovic (2005, 2008), Booth et al. (2001), Caprio 15 In this report, “big data” refers to large data sets that and Demirgüç-Kunt (1998), Demirgüç-Kunt, Martinez may be analyzed computationally to reveal patterns, Peria, and Tressel (2020), Demirgic-Kunt and Maksimovic trends, and associations, especially relating to human (1998, 1999, 2002), Giannetti (2003), de Jong, Kabir, and behavior and interactions. Nguyen (2008), and Lerner and Schoar (2005). 16 Most SMEs self-fund their activities from internally 7 Although there is virtually no variation in leverage ratios generated revenues. Self-funding remains an important across firms of different sizes in HICs, smaller private source of financing, particularly among young SMEs, firms tend to have significantly lower debt-to-assets and also constitutes a common practice among many ratios than larger firms in MICs. The differential among family-owned businesses. similarly sized firms between MICs and HICs declines 17 World Bank calculations for this publication based on as firms grow, with virtually no differences observed for International Monetary Fund Financial Inclusion Data, larger private firms and publicly listed firms. ADB SME Monitor and Organisation for Economic Co- 8 Persistent issues of lack of available data, including operation and Development SMEs and entrepreneurs’ firm-level survey data, have limited the ability to data and the World Bank development indicators; data estimate the gap beyond 2019, as well as to provide are limited to HICs and MICs. a disaggregation of the supply and demand of formal 18 See for example Beck et al. (2008) and Beck, Demirgüç- finance by size, gender, and sectors. Such estimates Kunt, and Maksimovic (2005). would benefit from more and better standardized data 19 In this report, embedded finance refers to the collection from stakeholders. See IFC (forthcoming). integration of financial services like lending, payment 9 In addition to the finance gap in the formal sector, processing, or insurance into non-financial businesses’ there is estimated to be an additional US$2.1 trillion in infrastructures without the need to redirect to traditional potential demand for finance from informal enterprises financial institutions. Embedded finance models have in developing countries. This figure is sizeable and is increased, including the following: (a) e-commerce equivalent to 8 percent of the GDP in EMDEs. See IFC platforms providing or enabling working capital lines to (forthcoming). merchants selling on their websites (Amazon, Mercado Libre, Lazada, and Jumia); (b) logistics platforms offering 10 See Didier and Cusolito (2024). per-ride insurance, vehicle finance, or advances against 11 See for example de la Torre, Gozzi, and Schmukler receivables for trips in progress (Grab and Kobo360); (2017). and (c) wholesale order management and payment 12 See for example Frame, Srinivasan, and Woosley (2001), systems providing inventory finance or consignment Jappelli and Pagano (2002), Kallberg and Udell (2003), sales of consumer goods stocked by small and micro- Love and Martínez Pería (2015), and Love and Mylenko retailers (Amigo PAQ, AwanTunai, and N-Frnds). See (2003). Saal (2021). 66 BOOSTING SME FINANCE FOR GROWTH 20 See Moody’s Investors Service (2022). financing). 21 World Bank calculations for HICs and MICs, drawing from 38 See, for example, CCAF, World Bank, and World International Monetary Fund Financial Inclusion Data, Economic Forum (2022). ADB SME Monitor and Organisation for Economic Co- 39 See Klapper (2006). operation and Development SMEs and entrepreneurs’ 40 See International Factoring Association. data and the World Bank development indicators. 41 The statistics for factoring and leasing reflect total 22 See Moody’s Investors Service (2022). market volumes; no information is available on a cross- 23 See British Business Bank’s website, https://www.british- country basis on the share of financing to SMEs. business-bank.co.uk. 42 See Carvajal et al. (2020). 24 See Business Wire (2022). 43 See Politecnico MIlano, Osservatori Entrepreneurship 25 See Business Wire (2022). Finance & Innovation, 9° Report italiano sui Minibond, 26 See CCAF, World Bank, and World Economic Forum 2023. (2022). 44 In many countries, the bulk of this financing has taken 27 See CCAF, World Bank, and World Economic Forum place through purely private markets, but more recently (2022). some jurisdictions have developed organized markets 28 In this report, big tech firms are large technology for “minibonds” to make them more attractive to companies such as Amazon and Apple, as well as investors. e-commerce platforms such as Amazon. Big tech firms 45 For a summary of preconditions see Carvajal et al. can trigger changes in the financial services industry, (2020). given the amount of user data they hold coupled with 46 See for example Brown, Fazzari, and Petersen (2009), their size and customer reach. Brown and Petersen (2009), Brown, Martinsson, and 29 See Gambacorta, Khalil, and Parigi (2022). Petersen (2013, 2017), Carpenter and Petersen (2002), 30 See for example De Roure, Pelizzon, and Thakor (2022) and Chemmanur, Krishnan, and Nandy (2011). and Jagtiani and Lemieux (2017). 47 In this report, VC funds are used to refer to collective 31 See Lu (2018). investment schemes that are not offered to the public 32 See CCAF, World Bank, and World Economic Forum at large and that invest in young companies with growth (2022). potential. This definition covers investment in a wide range of companies. In practice, however, over the last 33 See Frost et al. (2019), Gambacorta et al. (2019), and 40 years, changes in the VC industry have narrowed this Goldstein, Jagtiani, and Klein (2019). investment focus and led to concentrated investments 34 In this report, asset-based financing refers to different in technology companies. See Lerner and Nanda types of financial contracts where financing is based (2020). Moreover, proprietary databases tend to classify on the value of collateral, from asset-based lending, to equity investments through private markets as either factoring and leasing, and other types of contracts such VC or PE, as defined in this report. VC funds invest in as merchant cash advances and warehouses receipt companies through a variety of instruments including financing. This note focuses on factoring and leasing, equity, preferred equity, convertible debt, mezzanine given their importance volume-wise in comparison to loans, and subordinated loans. other contracts. The term factoring is used to refer to 48 World Bank (2023) shows that, relative to HICs, VC in different types of financial contracts in which financing EMDEs is more underdeveloped than public equity is based on receivables (credits), thus encompassing markets are. both transactions in which such receivables are sold and transactions in which the receivables are used to 49 See Didier and Cusolito (2024). obtain a loan. Leasing is used to refer to a financing 50 For example, there has been a substantial increase in agreement in which an asset (for example, vehicles, financing available for more mature, late-stage start-ups machinery, equipment) is made available for usage more recently in the United States. For instance, late- against periodic payments. The term encompasses stage start-ups are raising larger amounts of capital in both financial and operational leases. A financial lease the private markets from a growing pool of traditional essentially functions like a secured loan whereby the and new investors. See Ewens and Farre-Mensa (2022). asset a company wants to buy serves as collateral. 51 See, for example, Da Rin, Hellmann, and Puri (2013) 35 See Chigurupati and Hegde (2010), Sharpe and Nguyen and the references therein, which are largely focused (1995), Slotty (2009), and Yan (2006). on developed countries. 36 See Kwaak et al. (2021). 52 For example, less than 1 percent of the VC invested 37 In this report, reverse factoring refers to buyer-led went to firms younger than three years, less than 12 financing whereby the business to which the SMEs percent went to firms younger than five years in MICs, provides the goods and services facilitates the financing and roughly half of the VC financing in lower-middle- arrangements. This usually entails large corporations income countries went to firms older than 10 years. See that arrange for their banks to provide financing to World Bank (2023). their suppliers, from their own credit lines (supply chain 53 See, for example, Lerner and Nanda (2020). REFERENCES 67 54 See Didier and Cusolito (2024). of credit in over 4 million firms in 29 EMDEs and find 55 For example, other instruments used are convertible that the resulting access to finance is associated with notes and simple agreement for future equity (SAFE). higher employment growth, especially among micro, The latter is an agreement between the company small, and medium enterprises. See also Berger and and the investors whereby the company promises to Udell (2006), Brown, Jappelli, and Pagano (2009), Love provide the investor an equity stake if certain trigger and Mylenko (2003), and Martinez Peria and Singh events occur. (2014). 56 See, for example, Walthoff-Borm, Vanacker, and 69 A review of selected experiences in public-private Collewaert (2018). partnerships for the development of private credit bureaus is included in chapter 5 of World Bank (2012) 57 See CCAF, World Bank, and World Economic Forum Global Financial Development Repor 2013t: Rethinking (2022). the Role of the State in Finance. See also World Bank 58 Exit conditions can also play an important role for equity (2019a) Credit Reporting Knowledge Guide. In addition financing in private markets. A popular perception is to their role in fostering credit bureaus, governments that initial public offerings (IPOs) constitute the main in many EMDEs have been directly involved in the exit route for equity investors in private markets. development of credit registries. Credit registries Although VC-backed firms may represent a large share collect and compile information from regulated of IPOs, IPOs account for a small fraction of VC exits, financial institutions to support the financial supervision even in countries with well-developed markets such function. Generally, information is collected on large as the United States. On average, IPOs represent credit exposures. Credit registries also provide credit about 12 percent of the exits from equity investments reports that show aggregate loan exposures to the in private markets in HICs and upper middle-income regulated financial institutions that submit data to the countries, typically the most innovative and promising credit registry. Thus, their objective and coverage are ventures. However, the understanding of non-IPO exits different from that of private bureaus. constitutes an important knowledge gap, especially in 70 See World Bank (2011), World Bank and ICCR (2022). EMDEs. See World Bank (2023). 71 There is no universally accepted definition of alternative 59 Lerner (2013) notes that in most of the entrepreneurial data. The International Committee on Credit Reporting hubs that have emerged over the past two decades, (ICCR) defines it as “ways to collect and analyze data on critical early investments were not made by domestic creditworthiness which are ‘alternative’ to conventional investors, but rather by sophisticated international methods, such as documented credit history.” It has investors. been broadly categorized into (a) structured data—for 60 See Didier and Cusolito (2024). example, utilities, mobile phone, rental information and 61 World Bank calculations based on Pitchbook data. taxes, and (b) unstructured data—for example, social media and internet usage, emails, text and messaging 62 In this report the term “traditional public equity markets” files, audio files, digital pictures and images. What is used to refer to the issuance of shares under the alternative data entails varies depending on the country, public offering requirements along with their listing in since it depends on the kind of information collected in the exchanges under the ordinary listing requirements. each jurisdiction. As a result, what is alternative in one 63 For example, in Korea, the VC industry has developed in market can be traditional in another. See ICCR (2018). tandem with the Korean Securities Dealers Automated 72 The use of alternative data gives rise to data protection Quotations (KOSDAQ) exchange. In Japan, IPOs in the issues relating to personal information about the Mothers exchange have provided an exit option to VC individuals involved. The G-20/OECD High Level investments. Principles on Financial Consumer Protection, adopted 64 The level of patents in a jurisdiction has also been in 2022 state in Principle 11 that “Consumers financial found to be a predictor of VC activity, highlighting the and personal information should be protected through role of venture capital in the financing of innovation. appropriate control and protection mechanisms. These For a review of the existing empirical research, see the mechanisms should define the purposes for which the online literature review (forthcoming). data may be collected, processed, held, used and 65 Existing empirical research points to institutional drivers, disclosed (especially to third parties). The mechanisms such as rule of law and investor protection, as well as should acknowledge the rights of consumers regarding financial deepening as some of the determinants of VC consenting to data-sharing, accessing their data, activity. See the online literature review (forthcoming). being informed about breaches impacting their data, and seeking redress such as the prompt correction 66 For a summary of relevant research, see Fouejieu et al. and/or deletion of inaccurate, or unlawfully collected (2020). or processed data. There should be co-operation 67 Therefore, the definition of alternative lenders covers a among oversight bodies responsible for consumer wide range of financial intermediaries, including asset- data protection and privacy”. See https://web-archive. based lenders, digital banks, lending platforms, and oecd.org/2022-12-12/648348-G20_OECD%20FCP%20 capital markets solutions. Principles.pdf. In addition, the use of alternative data 68 For example, Ayyagari et al. (2016) use the introduction and automated approaches for credit risk assessments of credit bureaus as an exogenous shock to the supply have the potential to introduce biases into lending 68 BOOSTING SME FINANCE FOR GROWTH decisions. For example, there is the potential for supervision of fintech in EMDEs, see Alonso Gispert et discrimination biases (for example, gender, race, and al. (2022). geographical location) that arguably have a larger 82 For Hong Kong SAR, China, see the revised Guideline impact on underserved segments. The opacity of on Authorization of Virtual Banks (Guideline) on the algorithms makes it particularly difficult for policy May 30, 2018; for Malaysia, see https://www.bnm. makers to address these biases, complicating the g o v. m y / d o c u m e n t s / 2 0 1 2 4 / 9 3 8 0 3 9 / 2 0 2 0 1 2 3 1 _ adoption of safeguards to mitigate them. These Licensing+Framework+for+Digital+Banks. challenges might indirectly affect small firms, especially pdf; for Singapore, see https://www.mas.gov. microenterprises given the close connection between sg/regulation/banking/digital-bank-licence; for the enterprises and their principals. Therefore, they Mexico, see https://www.dof.gob.mx/nota_detalle. highlight the importance of a robust data privacy and php?codigo=5610487&fecha=28/01/2021#gsc.tab=0. protection framework that protects individuals that use Policy makers should also review whether physical financial services, whether for personal purposes or for presence requirements apply to other types of regulated their businesses. financial lenders in their jurisdictions. 73 For examples of guidance, see World Bank and ICCR 83 In the European Union, as per the Crowdfunding Service (2022). Provider Regulation, the operation of a crowdfunding 74 See Pazarbasioglu et al. (2020). platform can be undertaken by specialized entities, 75 Collateral registries perform two main functions. First, with proportionate capital requirements as well as they provide transparency of the existence of a security by regulated financial intermediaries, such as credit institutions and investment firms. In the United States interest over a particular asset, thus eliminating the risk crowdfunding platforms can be operated by funding that a borrower pledges the same asset as collateral to portals, which are specialized intermediary subject secure other loans without the knowledge of the lender. to proportionate capital requirements, and brokers’ Second, they also make transparent the seniority dealers. of existing registered security interests and other unsecured creditors. So functioning collateral registries 84 For an overall analysis of the potential impact of are critical for the expansion of secured transactions. fintech in financial services and a discussion of policy The introduction of collateral registries for movable implications, see Feyen et al. (2022). assets in particular has been shown to improve firms’ 85 In a Market Participants Survey conducted in 2021 close access to bank finance as well as to lower interest rates to 90 percent of bank respondents expected digital and extensions in loan maturities. See, for example, transformation to help reduce the costs of MSME Calomiris et al. (2017), Campello and Larrain (2016), lending. However, 48 percent expected MSME lending and Love, Martinez Peria, and Singh (2014). to become more concentrated, while 31 percent 76 See World Bank (2019b). anticipated less concentration. The Market Participants Survey found that 60 percent of commercial banks 77 See World Bank (2014b). saw a risk of losing MSME lending customers and 63 78 For instance, rescue financing can be introduced via a percent saw a risk to the profitability of this business line tailored insolvency framework, which can help SMEs due to digital transformation of the market. See Teima avoid resorting to liquidation when they could be saved et al. (2022). by simply accessing insolvency solutions. 86 Direct competition by big tech companies is generally 79 A typical insolvency framework in EMDEs is characterized more prevalent in EMDEs where financial systems are by high costs, lengthy timelines, and heavy procedural at an earlier stage of development, and there is a lower formalities, all of which stand as obstacles to SMEs penetration of financial services. See Teima et al. (2022). and deter them from accessing insolvency regimes. In 87 Studies that use market concentration as a proxy for addition, there is some overlap between personal and competition found mixed results in relation to its effect corporate insolvency proceedings in the case of smaller in access to finance. Studies focused on direct measures firms, especially for sole proprietors. For instance, the of competition and contestability show that access to fact that the owners of sole proprietorships sometimes finance is easier in more competitive banking sectors. use their personal assets to guarantee business loans See chapter 3, “The Role of the State in Promoting introduces a complexity rarely addressed by existing Bank Competition,” in World Bank (2012). insolvency systems. This calls for insolvency regimes with an efficient discharge of the natural person 88 There is no single definition of open finance, although entrepreneur. For more details, see for example World there is broad agreement on the multilateral nature of consumer data exchange between banks and financial Bank (2017). institutions on the one hand and third parties on 80 The Basel Committee on Banking Supervision has the other, based on consumer choice. The Bank for acknowledged the need for a proportional regulatory International Settlements (BIS) defines open banking and supervisory framework for MFIs, including lower as sharing and leveraging customer-permissioned data capital requirements in exchange for a more limited by banks with third party developers and firms to build set of permitted activities. See Basel Committee on applications and services, including those that provide Banking Supervision (2010). real-time payments, greater financial transparency 81 For high-level guidance regarding the regulation and options for account holders, and marketing and cross- REFERENCES 69 selling opportunities. This term is defined differently FCP%20Principles.pdf depending on the jurisdiction, and the concept of open 97 This includes the requirement that platforms provide banking has evolved to open finance and ultimately information about how the credit risk assessment to open data, allowing for broader scope of data and is conducted in the case of lending- or debt-based participants to the framework. platforms and what type of due diligence on the 89 There are different ways in which countries define businesses applying for financing is conducted by the a space for private offering. In some countries this is platforms in the case of equity crowdfunding platforms. done directly (that is, by including a definition of private It also requires the provision of clear information about offering), while in others is done indirectly (that is, fees. a private offering is any offer that does not meet the 98 For a review of investor protection issues involved in conditions of a public offering). Either way, in practice capital markets solutions see Carvajal et al. (2020). in many countries there are limits to the amount that can be raised through a private offering and limits to 99 For more detailed on the enabling environment for the number of non-professional investors that can be DFS, see Pazarbasioglu et al. (2020). targeted through a private offering. These types of limits 100 See GPFI (2023). seek to precisely balance investor protection concerns 101 Digital identification fulfills the same critical role in with the interest of allowing companies easier channels connection with individuals. to access the capital markets, particularly SMEs. 102 There is no global database that identifies the type of 90 In some EMDEs, the investment regulations for pension targeted interventions that governments have pursued funds limit their ability to invest in securities that are not to address financing gaps for SMEs, whether for HICs publicly offered or listed, thus preventing them from or EMDEs. For EMDEs, this chapter is based on a investing in PE and VC funds. desk review conducted by World Bank staff based on 91 See Carvajal et al. (2020). public sources, including relevant publications such as 92 In some exchanges, SMEs are allowed to list without the by Gutierrez and Kliatskova (2021) and Carvajal et al. need for a public offering. In these cases, the markets (2020), and World Bank experience in the field assisting are not directly accessible to retail investors; rather EMDEs in improving SME access to finance. For HICs, only to professional investors, including high-net worth key resource materials include OECD publications: individuals, institutional investors, and a limited number Koreen, Laboul, and Smaini (2018), OECD (2015, 2020, of retail investors (based on the country definition of 2022a), and Thompson, Boschmans, and Pissareva private placements). Many SME markets in Europe are (2018). structured in this way. 103 The results of a World Bank survey on DFIs conducted 93 For example, in the context of embedded financing, a in 2017 indicated that many DFIs use direct lending for platform might steer financing to the financial providers SMEs, either as their solo approach or in addition to that pay higher commissions or might not disclose in a an on-lending approach, whereby DFIs act as wholesale clear manner all the fees that apply. banks providing LoCs to private sector banks. According to this survey, 10 percent of DFIs provide 94 Prohibitions against such practices are increasingly loans and other financial services only in second tier, viewed internationally as necessary for the good 40 percent only provide loans to final borrowers, and functioning of markets and thus often apply beyond the 50 percent use a combination of the two. See Gutierrez range of consumer protection requirements that tend to be more targeted. and Kliatskova (2021). 95 Financial consumer protection seeks to address 104 Although credit guarantee schemes could emerge asymmetries in the relationship between the providers and develop privately, in many cases governments and the users of financial services. In general, in participate in these schemes, often directly. A survey EMDEs this imbalance is as acute for microenterprises of credit guarantee schemes around the world shows as for individuals, as microenterprises tend to be that over 30 percent of these programs have some form closely associated with their owner or principal (and, of state ownership, with governments playing a bigger in practice, they are often one and the same—that is, role in funding and management than in risk assessment a sole trader or entrepreneur). In this context, from a and recovery (Beck, Klapper, and Mendoza 2010). See policy perspective, the sensible practice is to apply World Bank and FIRST Initiative (2015). consumer protection laws to individuals as users of 105 This is not strictly a problem of EMDEs. A recent report financial services, including use for both personal and on impact evaluation of SME support programs by the business purposes. OECD found that comprehensive evaluations are also 96 For example, the G-20/OECD High Level Principles on missing in OECD countries. See OECD (2023). Financial Consumer Protection adopted in 2022 state Multilateral development banks have conducted that “while the meaning of financial consumer is not evaluations of their SME support programs to EMDEs, defined so as not to restrict coverage, it is generally which are publicly available. Overall, many of these considered to include private individuals at a minimum evaluations point to problems with the design of but may also include micro and small enterprises some of the interventions that have affected their however defined by jurisdictions.” See https://web- effectiveness, in particular the sustainability of the archive.oecd.org/2022-12-12/648348-G20_OECD%20 targeted outcomes. In addition, empirical research has 70 BOOSTING SME FINANCE FOR GROWTH been conducted by different stakeholders (including 110 Blended finance is a structuring approach, not an academics and staff from multilateral development investment approach. There is no globally accepted institutions) to evaluate the financial additionality of a definition for blended finance. Overall, most definitions selected set of interventions related to, in particular, include the following four structures: (a) concessionary lending, including subsidized lending, public guarantee capital on below-market terms to reduce the cost of schemes, venture capital, and taxation. The overall capital or provide an additional layer of protection to conclusion of such research is included in the analysis private investors; (b) guarantee or insurance on below- of the respective interventions in the body of this market terms to reduce lending risks; (c) a grant-funded Note. For the evaluations of the programs of the technical assistance facility that can be used pre- or World Bank, see Campos et al. (2019) and World Bank post-investment to strengthen commercial viability and (2014a). For other multilateral development banks see development impact; and (d) grant-funded transaction for example: for the African Development Bank see design or preparation to set up new investment vehicles. Independent Development Evaluation (2020), for the For a review of challenges mobilizing blended financing Asian Development Bank see Independent Evaluation in EMDEs, see Bartz-Zuccala et al. (2022). (2018), for the European Investment Bank (EIB) see EIB 111 The Green Climate Fund (GCF) is a fund established (2022; 2023a, 2023b), and Amamou, Gereben, and within the framework of the United Nations Framework Wolski (2020), for the European Bank for Reconstruction Convention on Climate Change to assist developing and Development (EBRD), see EBRD (2018), and for countries in adaptation and mitigation practices to the Interamerican Development Bank, see Murcia et counter climate change and support the achievement al. (2016). See also the accompanying online literature of their nationally determined contributions goals review (forthcoming) for a summary of the existing toward low-emissions, climate-resilient pathways. empirical research that is publicly available. GCF is mandated to invest 50 percent of its resources 106 Thus, these recommendations are equally applicable to in mitigation and 50 percent in adaptation in grant DFIs, including development banks, in the deployment equivalent. At least half of its adaptation resources must of SME finance interventions. be invested in the most climate-vulnerable countries (small island developing states, least developed 107 In France, the SME Observatory was created in 2005 and countries, and African States). The GCF can structure is managed by Bpifrance, the French public investment its financial support through a combination of grants, bank, whose mission is to provide support to MSMEs. concessional debt, guarantees or equity instruments In Morocco the SME Observatory was created in 2013 to leverage blended finance and crowd in private as a result of a public-private partnership, spearheaded investment for climate action in developing countries. by Bank Al Maghrib. One of the key objectives of the Governments can access the GCF through multiple Observatory is to consolidate information on SMEs. accredited entities, including national DFIs, provided To achieve this objective, the Moroccan Observatory they fulfill the requirements of the fund. has concluded data exchange agreements with Bank Al Maghrib, the General Tax Directorate, the National 112 See for example the Agri3Fund and the Africa Social Security Fund, and the Moroccan Office of Agriculture and Trade Investment Fund. Industrial and Commercial Property. See, for example, 113 the Women Entrepreneurs 108 Measuring additionality in the context of private capital Opportunity Facility. mobilization is complex. To have additionality, an 114 While still limited, the existent empirical research intervention should lead to additional finance by the indicates that financial literacy influences financial private sector to SMEs or an investment that would not attitudes, financial behaviors, organizational capabilities, have otherwise taken place. That would be the case, and performance of SMEs. See Graña-Alvarez et al. for example, if a bank or microfinance institution would (2024). See Atkinson (2017) for a stock taking of financial not have provided financing to an SME in the absence education efforts for SMEs in 21 jurisdictions. of a line of credit provided by the government or if an 115 The OECD conducted a review of SME support investor would not have invested in a fund that invests evaluation programs across OECD countries. The report in SMEs in the absence of government investment. identified 50 reliable evaluations, but the main message This presupposes that the intervention is not crowding is the need for countries to improve their evaluation out the private sector—that is, that it is not leading frameworks. To this end, the report also provides a set financial intermediaries or investors to commit fewer of recommendations. See OECD (2023). resources because the government is committing its 116 Economic additionality refers to whether interventions own. Determining such additionality is a counter factual achieve higher objectives or development goals, such that is very difficult to establish. as the creation of jobs, or higher productivity in firms. 109 Governments have provided concessional funding in two It is important to note however, that many other factors ways: (a) via cheaper funding to financial intermediaries beyond access to finance affect a firms’ growth and to incentivize their engagement with the SME segment, productivity, such as the business environment, firms’ and not always translated to better conditions for SMEs capabilities and access to markets, and more generally, (for example, lower interest rates) or (b) via cheaper the macroeconomic environment. A recent OECD financing to SMEs themselves, with financial institutions report on the evaluation of the impact of SME programs, typically receiving some spread over market rates. recommends using three basic sets of indicators REFERENCES 71 across all SME programs to assess and compare their Bank (EIB)-supported loans in the contracts with effectiveness: sales, jobs and firms’ survival. Assessment financial intermediaries that benefit from their lending, of economic additionality usually involve the use of which is done either at favorable (lower interest rates) control groups. See OECD (2023). or longer maturities that what is available in the market. 117 In this report, DFIs are defined as financial institutions See EIB (2022). with policy objectives that are closely related to the 124 Unviable either because there is no third party willing economic development of a country or given sector or able to provide such enhancement due to costs and are typically focused on financing productive or because the resulting rate of return is no longer investment through the provision of medium- and long- attractive to institutional investors. See Carvajal et al. term funding. According to a global dataset of 521 (2020). DFIs, as of 2020 there were 136 DFIs with the specific 125 Most of the empirical research on VC has focused mandate of supporting SMEs, with US$1.8 trillion on its economic additionality (for example impact in assets. In addition, several large DFIs with generic on innovation and sales). Bai et al. (2021) found that mandates also support MSMEs. See Gutierrez and public entrepreneurial finance crowds in (as opposed to Kliatskova (2021). crowding out) private financing, especially in countries 118 An entity’s governance framework specifies the with appropriate rule of law and a previously developed allocation of rights and responsibilities between its private VC market. See the online literature review different stakeholders and articulates the rules and (forthcoming). procedures for decision -making (World Bank, 2014b). 126 In a study of the effectiveness of tax incentives in the 119 For governance arrangements in development banks VC industry in Europe, the European Commission found see Gutierrez and Kliatskova (2021), for PCGs, see that tax incentives were used to support venture capital World Bank and FIRST Initiative (2015), and for funds, and business angels across the European Union (EU) see Divakaran et al. (2022). 28 and selected OECD countries. The study found that 120 Overall, the existing empirical research points to a tax incentives had been implemented by 19 of the 36 positive correlation between PCGs and the levels of countries in the sample. In terms of the EU-28, the study SME financing. The empirical effect on the interest rate found a marked contrast between the EU-15 and other is more ambiguous, with a mix of positive, negative, and member states in the prevalence of tax incentives, which insignificant coefficients. Just a couple papers deal with the study attributed to the differences in the level of the ratio of long-term debt and the number of lending venture capital and business angel investment activity relationships (borrowing from new banks), uncovering and differences in preferences for the use of targeted tax a positive effect in both cases. There is little to no incentives. Instead of trying to assess their impact, the EU evidence produced on the effect of this instrument on study identified a set of best practices in structuring these improving access to finance to SMEs willing but unable incentives based on an analysis of the scope, qualifying to enter formal credit markets. There is no indication criteria, administration, generosity, and stability of the in the literature that these programs massively serve schemes. See European Commission (2018). first-time borrowers. Instead, they seem to assist pre- 127 See the online literature review (forthcoming) for a existing bank clients. For more information see the summary of the existing empirical research. online literature review (forthcoming). 128 As indicated by Carvajal et al. (2020), many exchanges 121 For best practices see Goffe, Hammersley, and Rustom have concerns that tax incentives would attract (2021). companies that are mainly interested in avoiding taxes 122 The existing empirical research points to a positive but are otherwise not ready or suitable for listing on correlation between LoCs and bank debt. In addition, an exchange. If the quality of companies coming to lending programs appear to lower the interest rate market is poor, the reputation of the exchange can charged on SME loans—but this conclusion is not be damaged. In addition, some tax authorities are unanimous. A positive effect on loan maturity is picked concerned about the loss of immediate tax revenues up by a couple of studies that investigated this issue. from these tax incentives, while others consider that the There is some scarce but positive evidence of a less increased transparency and the potential for growth of cyclical SME credit behavior as well as a positive listed firms will increase tax revenues in the medium externality effect on the access to credit by other banks to long term. Policy makers need to weigh in on these in the aftermath of the intervention. Subsidized lending tradeoffs. seems to exert a positive impact on access to credit 129 See World Bank Gender Data Portal. and different SME performance indicators. Little to no 130 See World Bank Gender Data Portal. evidence is produced on the effect of this instrument on improving access to finance to SMEs willing but 131 See World Bank (2022). unable to enter formal credit markets. There is no 132 See GSMA (2020). indication in the literature that these schemes massively 133 A summary of the global evidence on the causes of the serve first-time borrowers. Instead, they seem to assist credit gap can be found in Cirera and Qasim (2014). preexisting bank clients. See the online literature review For Africa, Campos et al. (2019) offer a more recent in- (forthcoming). depth analysis of key factors affecting WSME access to 123 That is, a condition imposed for European Investment finance. Finally, Pavlova and Gvetadze (2023) summarize 72 BOOSTING SME FINANCE FOR GROWTH the evidence for Europe. This latter publication provides cross-country estimates of emissions from SMEs in a theoretical framework to analyze the causes of the EMDEs. One challenge in accurately assessing the credit and VC gaps that can be applied globally. emissions share of SMEs is the limited availability 134 In the context of an analysis of factors holding back of data. Many SMEs in EMDEs operate informally or women’s business performance in Africa, the World have limited resources and capabilities to measure Bank identified nine of them, broken down into three and report their environmental impact, making it categories of constraints: (a) contextual factors: legal challenging to obtain comprehensive information on discrimination, social norms, and gender-based violence; their footprint. (b) endowments: education and skill gaps, confidence 150 The European Union’s (EU’s) carbon border adjustment and risk preferences, finance and assets, and access mechanism is a tariff that will be imposed on certain to networks and information; and (c) household-level types of carbon-intensive products that are imported constraints: household allocation of productive resources into the countries in the European Union. This carbon and time constraints and care. See for example Campos border tax will be initially applied to imports of carbon- et al. (2019), Boden and Nucci (2000). intensive goods, such as cement, iron and steel, aluminum, and fertilizers. 135 In 21 economies women do not have the same rights over immovable property, including land; in 41 151 See World Bank (forthcoming). economies daughters do not have the same right to 152 These externalities can also be negative, for instance inherent as their brothers; and in 43 economies a female with costs rather than benefits not being internalized. surviving spouse does not have the same inheritance For example, when environmental costs are not rights (World Bank 2024). internalized, there may be overinvestments in non- 136 See Morsy (2020), and Ongena and Popov (2015). environment-friendly sectors, such as those that cause environmental damages. 137 See Pavlova and Gvetatdze (2023), and Alibhai et al. (2019). 153 A growing body of research emphasizes that informational frictions are one of the most binding constraints for 138 See Teare (2000). scaling up sustainable and climate-resilient investments. 139 See Abouzahr (2018). These investments are often perceived as high risk not 140 See Plaitakis and Staschen (2020). only because of mismatches in the time horizon but also 141 See Campos et al. (2019). due to heightened uncertainty stemming from limited information related to (a) technologies (for example, 142 See Kelly and Mirpourian (2021). uncertainty about the technical feasibility of adopting 143 See Sawhney et al. (2022). a new, sometimes untested, technology; lack of track 144 Acknowledging the differences in WSMEs across records of new technologies leading to uncertainty segments highlights the need for different interventions about their profitability; uncertainty about whether to close their financing gap. Notably, it is even more newer, more advanced alternatives will emerge, relevant to consider the goal of the interventions when rendering these investments outdated); (b) markets designing specific support policies. For example, if the (for example, uncertainty about evolving demand and goal is to maximize outreach to WSMEs (say based on competitiveness in the marketplace); and (c) policies the number and volume of WSMEs reached), support and regulations (for example, lack of clarity, stability, policies should recognize that WSMEs are more predictability, or even inconsistency in government concentrated among smaller size businesses and in policies). See for example OECD and ASEAN (2021). specific sectors, such as services and retail. 154 As noted, there are measurement challenges regarding 145 A number of existing reports, some of them produced the quantification of outcomes for adaptation recently, have collected and summarized evidence on investments, with a lack of standardized metrics. Unlike which interventions demonstrably move the needle to mitigation, which can be measured in terms of emissions support women in starting and growing businesses. reductions or energy savings, the impacts of adaptation These reports also include a review of the most common efforts are often context-specific and hard to quantify in interventions on access to finance and summarize the monetary terms. evidence regarding the most promising interventions. 155 See for example UNSGSA (2023). . Some of these reports include Burga et al. (2021), 156 See Dalhuijsen et al. (2023). The bias toward mitigation Buvinic, Furst-Nichols, and Pryor (2013), Campos et al. investments is further evidenced in other studies, such (2019), and World Bank (2018), as the International Development Finance Club (IDFC), 146 See for example Cucagna et al. (2020). which suggests that US$146 billion of the US$185 billion green finance provided by IDFC members in 147 See for example Campos et al. (2018). 2020 is dedicated to climate mitigation. See IDFC 148 For a more in-depth discussion, see Carvajal and Didier (2021). Similarly, Naran et al. (2022) shows that around (2024). 89 percent of climate finance from DFIs is dedicated to 149 See OECD (2021, 2022b). In the latter, OECD argues climate mitigation. that SMEs account for at least 50 percent of GHG 157 Survey results indicate that the most widely used emissions and 30–60 percent of energy use of the instruments to provide green financing is lending. DFIs business sector in OECD countries. There are no provide first- and/or second-tier lending, with short- to REFERENCES 73 long-term loans and credit lines, some at concessional energy reduction and energy efficiency purposes and terms. See Dalhuijsen et al. (2023). for greater adoption of renewable energy. 158 Some EMDEs have started to explore PCGs to support 164 For more details on this recommendation, see World adaptation activities, especially post-disaster financial Bank (2022). support through disaster-triggered guarantee programs 165 Dalhuijsen et al. (2023) suggests that DFIs can play a role (for example, Morocco’s Central Guarantee Fund). to reduce regulatory and policy risks. For instance, DFIs However, such initiatives are still at an incipient stage could act as a bridge between local governments and of development. See World Bank (2022). See also the market to address key concerns and uncertainties Inclusive Green Finance Working Group and Alliance about the policy and regulatory environment for green for Financial Inclusion (2022) and OECD (2022b) for a investments and drive necessary reforms to improve the discussion of some PCGs in some EMDEs. enabling environment, in addition to offering de-risking 159 World Bank (2022) argues that the lack of taxonomies or instruments such as political risk guarantee, first loss disclosure frameworks should not preclude PCGSs from provisions, and loan loss reserves. supporting climate-related financing support. PCGSs 166 See for example Dalhuijsen et al. (2023) for a review of should leverage existing taxonomies available in other the lessons learned from greening DFIs. jurisdictions to prevent greenwashing risks, to allow for the certification of green assets and investment 167 See Miguel, Pedraza, and Ruiz-Ortega (2022). projects, and to facilitate risk analysis. Similarly, PCGSs 168 For this Note, the definition of agri-SMEs includes all should encourage partner financial institutions and players involved in agriculture value chains from farm to SMEs to disclose climate-related information in line fork. These include commercial individual and groups with frameworks in use in other jurisdictions if domestic of farmers and all SMEs involved in agriculture and food ones are not available. Such guidance is particularly pre- and postharvest systems (for example, production relevant for SMEs as disclosure frameworks tend to systems, agritech companies, storage and transportation be in a more advanced stage of implementation for systems, processing and market infrastructure systems, financial institutions and large corporates, they remain wholesaling and retail infrastructure, exports related largely underdeveloped for SMEs. systems). Developing a sustainable access to finance 160 Outcomes on risk reduction from climate adaptation for agri-SMEs requires involving all the different lenders investments are typically expressed in specific ways to across the chain as they have different targets and roles. the respective sector or context of these investments 169 This estimate does not include smallholder farmers with (for example, as agricultural yields, health benefits, or limited commercial activities. The financial need of this reduced water stress). This highlights that “adaptation segment is estimated at US$240 billion annually and has no common reference metrics in the same way over 70 percent remains unmet (ISF Advisors 2019). that tonnes of GHGs or radiative forcing values are for Global agrifood systems are responsible for 170 mitigation” (IPCC 2014). approximately 30 percent of global greenhouse gas 161 See Buchner et al. (2021). Even if extensive global emissions; however, agri-SMEs in EMDEs seem to mitigation efforts are implemented, there are large contribute very little to this total. The bulk of emissions needs for financial resources for adaptation (IPCC 2023). in the sector are generated by large-scale, intensive The Adaptation Gap Report by the United Nations commercial agriculture in Europe, the Americas, and Environment Programme (UNEP) estimates that annual China. For instance, sub-Saharan Africa and Southeast adaptation costs in developing economies will be in the Asia contribute respectively 10 percent and 12.5 percent range of US$155 billion to US$330 billion by 2030 (see of the global agrifood systems emissions. Nevertheless, UNEP 2021). SMEs would need to contribute to their mitigation 162 While financing adaptation requires specific-localized efforts to remain competitive and part of global chains. solutions, financing mitigation is more standardized. 171 Other financiers, such as development banks and The response mechanisms to improve energy efficiency impact investment funds, support agri-SMEs in some and adopt renewable sources of energy tend to be EMDEs but the volume of financing is far smaller than similar across a wide range of country context and the latent demand. SMEs can use a similar set of financial tools to manage 172 See for example ISF Advisors (2022). transition risks. 173 See for example Alderman and Haque (2007); Carter, 163 The existing data suggest that very limited debt Galarza, and Boucher (2007); Carter, Cheng, and Sarris financing is being granted at concessional rates. (2016), and Santos and Barrett (2011). According to estimates from the Climate Policy Initiative, only 12 percent of total climate finance to 174 See for example Berhane et al. (2014), Cai (2015), Cole firms in the form of debt financing was characterized and Xiong (2017), Elabed and Carter (2013), Hill et al. by either low-cost or concessional debt in 2020 (2019), Jensen and Barrett (2017), and Karlan et al. (Buchner et al. 2021). But there is no information on (2014). who are the main beneficiaries of these financial flows. 175 There is in fact no agreed upon definition of FCV, and Anecdotal evidence suggests that public institutions different actors categorize FCV in different ways. Many (DFIs) are providing concessional financing to SMEs, in fact refer to it as a continuum rather than a binary either directly or through LoCs, in many cases for concept. For example, Assaf et al. (2021) consider 74 BOOSTING SME FINANCE FOR GROWTH countries within the entire fragility spectrum using 193 See Fisera, Horváth, and Melecký (2019). a continuum that synthesizes social, economic, and 194 See European Banking Authority (2016), Mayordomo political outcomes produced annually by the Fund for and Rodriguez-Moreno (2017), and Dietsch, Henri Peace’s Fragile States Index. The index is a composite Fraisse, and Lecarpentier (2019). made up of cohesion (security apparatus, factionalized 195 World Bank staff assessment based on information on elites, group grievance); economic (economic decline, NAFIN’s Annual Report 2021. inequality, human flight/brain drain); political (state legitimacy, public services, human rights/rule of law); 196 World Bank staff assessment based on RBI TReDs and social (demographic pressure, refugees or internally monthly statistics, June 2022. displaced persons [IDPs], external interventions) 197 World Bank staff assessment based on Bancoldex indicators estimated for 178 countries. website. 176 See Assaf et al. (2021). 198 World bank staff assessment based on Schammo (2019), 177 While the past decade has seen a high degree of HM Treasury, Bank Referral Scheme: Official Statistics. technology-driven innovation catalyzed by rising 199 World Bank staff assessment based on British Business penetration rates of mobile internet services in low- Bank website. income countries, the World Bank Enterprise Surveys 200 See Politecnico MIlano, Osservatori Entrepreneurship still highlight a drastic digital divide for FCV countries— Finance & Innovation, 9° Report italiano sui Minibond, with relatively depressed internet penetration rates and 2023. use of digital communication by enterprises (email and 201 World Bank staff assessment based on A2censo and websites) in fragile situations. See Assaf et al. (2021). Bancoldex websites. 178 See Calice (2023). 202 World Bank staff assessments. 179 See OECD (2022c). 203 The choice of an offshore jurisdiction is driven by 180 For example, the World Bank has engaged with policy multiple considerations, such as the availability of makers in South Sudan and Somalia in the development a robust regulatory regime, the level of regulatory of a digital payment ecosystem and the needed oversight desired, confidence in the rule of law, enabling environment. In Mozambique, a World Bank tax efficiency and neutrality, and the availability of project focused on government-to-person transfers to appropriate investment instruments not existent in the vulnerable populations exposed to conflict, violence, host country. Reputable offshore domiciles typically also natural disasters (including flooding, tropical cyclones, have a deep and experienced pool of service providers. and droughts), and food insecurity. The project has Specialized investment funds trying to attract global facilitated digital payments to more than 130,000 investors also consider domiciles that provide tax treaty social assistance beneficiaries. A similar project is being networks ensuring that cross-border investors are not developed in Burkina Faso. double taxed. See Divakaran et al. (2022). 181 The degree in which a country is affected by fragility, 204 See World Bank (2019d). conflict, and violence may vary across different parts 205 See Cucagna et al. (2020). within the country, and the intensity of these three elements can vary accordingly. 206 World Bank staff assessment based on CGAP (2022) and Kinara Capital website. 182 See Proparco Group AFD (2023). 207 See for example Bloom and Van Reenen (2010). 183 See Assaf et al. (2021). 208 This type of support may be less relevant with initiatives 184 See USAID (2022). that are designed to inject liquidity into the market and 185 See for example Beck, Demirgüç-Kunt, and Martinez provide working capital (for example, COVID-19 and Peria (2011). natural disaster support) to SMEs. 186 This appendix is based on Didier and Cusolito (2024). 209 Japan has traditionally combined loan guarantees with 187 See OECD (2017). compulsory business advice in their SME schemes. 188 See Staschen and Meagher (2022), Jenik and Zetterli 210 See Beck, Klapper, and Mendoza (2010). (2021), Plaitakis and Staschen (2020), and Lyman et al. 211 See Calice (2016). (2019). 212 For surveys of partial credit guarantee schemes, see 189 World Bank staff assessments. Beck, Klapper, and Mendoza (2010) and Honohan 190 World Bank staff analysis based on Binh et al. (2020). (2010). 191 World Bank staff assessments. 213 See World Bank and FIRST Initiative (2015). 192 See Financial Stability Board (2019). REFERENCES 75 Access to finance is one of the most significant constraints on the ability of Small and Medium Enterprises (SMEs) to grow and create jobs in emerging market and developing economies (EMDEs). Despite the vast array of support programs rolled out by governments in EMDEs to bolster SME financing, often at a large budget cost, the debt and equity financing gaps remain wide. Moreover, global shifts, including the rapid rise of new financial technologies and the escalating challenges of climate change, are reshaping the SME financing landscape. This report “Boosting SME Finance for Growth: The Case for more Effective Support Policies” offers strategic and actionable guidance to policy makers in EMDEs in reviewing and strengthening their access to finance support programs. Drawing on insights from the experiences of both high-income countries and EMDEs, this report emphasizes the urgent need to improve the core enabling environment for SME debt and equity financing. It provides a roadmap to guide EMDE policy makers in achieving this. While such reforms are necessary, cross-country experiences show that they are usually insufficient on their own. Targeted financial programs to increase both debt and equity financing to SMEs remain essential to bridge financing gaps effectively. This report outlines a set of recommendations for optimizing these interventions to maximize their impact and the effective use of public funding. This report also underscores the importance of a differentiated approach to address the unique challenges faced by specific SME segments, particularly those of women-owned enterprises, SMEs in agriculture, SMEs in fragile and conflict-affected states, and those seeking financing for climate change adaptation and mitigation. 76 BOOSTING SME FINANCE FOR GROWTH