VoxEU Column Financial Markets Productivity and Innovation

Foreign banks and small and medium enterprises: Are they really estranged?

Small and medium enterprises are engines of economic growth. But what kind of market structure is more conducive to financing these enterprises? This column argues that different types of bank, applying different types of lending technology and organisational structures can all play a vital role in financing them.

The financing of small and medium enterprises (SMEs) has been a subject of great interest both to policymakers and researchers because of the significance of SMEs in private sectors around the world and evidence that these firms are financially constrained. According to Ayyagari et al. (2007) and Beck and Demirguc-Kunt (2006), SMEs account for close to 60% of manufacturing employment on average across 76 developed and developing countries.

While SMEs rely mostly on bank financing (Beck and Demirguc-Kung 2008), a debate has been ongoing on what kind of market structure is more conducive to SME financing. Theory shows that foreign bank entry can be bad for opaque and small borrowers if foreign banks have a disadvantage in soft information acquisition compared to domestic banks and have centralised and hierarchical organisational structures (see for example Mian 2006, Gormley 2007, and Sengupta 2007). On the other hand, empirical work on the effect of foreign bank penetration has yielded ambiguous results. There are also differences across different regions of the world (see De Haas 2009 for a discussion on Central and Eastern Europe).

Our research (Beck et al. 2008) draws on survey data from 91 large banks of different ownership types across 45 countries to assess the extent and conditions at which banks in different countries and of different ownership types lend to SMEs and the different lending techniques and organisational structures they use.

The debate

The conventional wisdom regarding SME finance is that small and domestic banks are more likely to finance SMEs because they are better suited to engage in “relationship lending”, a type of financing based primarily on “soft” information gathered by the loan officer through continuous, personalised, direct contacts with SMEs, their owners and managers, and the local community in which they operate (see Berger and Udell 1996).

Recently the more nuanced view has been put forward that large and foreign banks, relative to other institutions, can have a comparative advantage at financing SMEs through arms-length lending technologies (e.g., asset-based lending, factoring, leasing, fixed-asset lending, credit scoring, etc.) and centralized organizational structures instead of relationship lending (see Berger and Udell, 2006 and de la Torre et al. 2008). This would imply that foreign banks can lend to SMEs to the same extent as domestic banks, but using different techniques and structures.

While there is a growing literature looking at the relationship between bank ownership and SME finance, mostly using firm-level data, cross-country supply analyses are far and between (see Clarke et al. 2006). Only recently has the attention turned to survey banks themselves on their exposure to SMEs and the lending techniques and organisational structures they use. This column reports on the first systematic cross-country effort to quantitatively gauge:

  • the extent, type and pricing of the SME lending, and
  • the lending techniques and organisational structures to lend to SMEs, and to relate them to country and ownership types.
Our survey

We sent our survey to the largest five banks in 80 countries, with 56 questions on three areas:

  • Documenting banks’ perceptions regarding the SME segment
  • Understanding banks’ business models (in particular, lending technologies and organisational structures) used to serve SME
  • Quantifying the extent, type, and pricing of bank financing to SMEs.

In total, we obtained responses from 91 banks in 45 countries. Rather than giving banks a predetermined size classification of firms, the survey asked banks to provide their own definition of small and medium-sized firms. In particular, banks were asked to provide a range in terms of sales, assets, or employees. Most banks (85%) define SMEs in terms of annual sales. On average, banks define small firms as those with annual sales between $200,000 and $4 million and medium-sized firms as those with sales between $2 million and $16 million. The definition of an SME is not very different across banks.

Our findings

There are significant differences across ownership types in lending technologies and organisational structures. Foreign banks are more likely to use hard information relative to private domestic banks. The share of secured SME loans is higher among foreign banks than domestic banks. Compared to domestic banks, foreign banks tend to be least likely to decentralise loan decision making and risk management. Consistent with theory and empirical country-level studies (Mian 2006), these results thus confirm that foreign banks do indeed use different lending techniques and organisational structures to reach out to SMEs.

  • Controlling for ownership and country type, there are few significant associations between lending techniques and organisational structure, on the one hand, and the extent, type, and pricing of SME loans, on the other hand. This suggests that different lending techniques and organisational structures are associated with similar outcomes in terms of SME lending.
  • There are few significant differences in the extent, type, and pricing of SME lending across bank ownership types. Most notably, we find no evidence that foreign banks tend to lend less to SMEs than other banks. This is consistent with the first two sets of results. Foreign banks lend to SMEs as much, but using different lending techniques and organisational structures.
  • There are significant differences between developed and developing countries. The share of SME lending for investment purposes is significantly lower in developing countries, while fees and interest rates are higher. These differences in SME financing between banks in developed and developing countries seem to be explained by differences in the economic, legal, and institutional environment banks operate in. These differences are stronger than any differences across banks of different ownership.

Our findings are consistent with studies that propose a new paradigm for SME lending, where different bank types, applying different lending technologies and organisational structures can play an important role in financing SMEs. Our findings are not consistent with theories that posit a comparative advantage of banks of a specific ownership type.

While a large literature has used firm-level data to analyse differences in access to finance by firm size, the effort described in this column is a first step in better understanding SME financing from the supply side using cross-country data. Going forward, it would be interesting to expand the number of banks and countries surveyed in order to see if we can corroborate our findings in a larger sample, especially one that includes small as well as large banks.

Disclaimer: This columns’ findings, interpretations, and conclusions are entirely those of the authors and do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent.


Ayyagari, Meghana, Thorsten Beck, and Asl Demirgüç-Kunt (2007), “Small and Medium Enterprises across the Globe”, Small Business Economics 29:415-434.

Beck, Thorsten and Asl Demirgüç-Kunt (2006), “Small and Medium-Size Enterprises: Access to Finance as a Growth Constraint”, Journal of Banking and Finance 30, 2931-2943.

Beck, Thorsten, Asl Demirgüç-Kunt, and Vojislav Maksimovic (2008), “Financing Patterns around the World: Are Small Firms Different?”, Journal of Financial Economics 89, 467-87.

Berger, Allen N and Gregory F Udell (1996), “Universal Banking and the Future of Small Business Lending” in Anthony Saunders and Ingo Walter (eds), Financial System Design: The Case for Universal Banking. Irwin (Richard D), Burr Ridge, IL, 559-627.

Berger, Allen N and Gregory F Udell (2006), “A More Complete Conceptual Framework for SME Finance”, Journal of Banking and Finance, 30, 2945-2966.

Clarke, George, Robert Cull, and Maria Soledad Martinez Peria (2006), “Foreign Bank Participation and Access to Credit Across Firms in Developing Countries”, Journal of Comparative Economics, 34, 774-795.

De Haas, Ralph (2009), “In defence of foreign banks”, VoxEU.org, 28 May

De la Torre, Augusto, Maria Soledad Martinez Peria, and Sergio Schmukler (2010), “Bank Involvement with SMEs: Beyond Relationship Lending”, Journal of Banking and Finance, forthcoming.

Gormley, Todd A (2007), “Banking Competition in Developing Countries: Does Foreign Bank Entry Improve Credit Access?"

Mian, Atif (2006), “Distance Constraints: The Limits of Foreign Lending in Poor Economies”, Journal of Finance 61(3):1465-1505.

Sengupta, Rajdeep (2007), “Foreign Entry and Bank Competition”, Journal of Financial Economics, 84(2):502-528.

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