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Why scarce small and medium enterprise financing hinders growth in Latin America: A role for public policies

Small and medium-sized enterprises provide the vast majority of employment in developing countries and are keystones in the productive structures of emerging economies. This column argues that the growth of such firms is being hindered by scarce financing. Looking at Latin America, it is clear that public financial institutions are increasingly important in meeting credit demands. If emerging economies want to see long-term growth, there needs to be a comprehensive approach to reducing the ‘traditional’ barriers to small and medium enterprise financing.

Small and medium enterprises represent a significant share of emerging economies’ business fabric. Nevertheless, they continue to face multiple challenges in meeting their financing needs. Public financial institutions have come to play an active role in addressing these financing gaps through new operational mechanisms and adapted instruments. While the strategies for procurement of small and medium enterprise credit diverge across regions (in terms of, say, the macroeconomic context or lending model), the rising role of public financial institutions has been growing across regions, in part as a countercyclical response to the crisis. To shed further light on this issue, we focus on the case of Latin American small and medium enterprises with an analysis based on survey information and interviews with development financial institutions.

Small and medium enterprises in Latin America account for nearly 99% of businesses and employ up to 67% of its employees. However, their low productivity means that they contribute relatively little to GDP. Large firms contribute up to 33 times more than micro-enterprises (vs. 2.4 times in OECD countries) and up to six times more than small firms (vs. 1.6 times in OECD countries) (OECD-ECLAC, 2012a).

The Latin American Economic Outlook 2013 addresses some gaps in the financial channels and sheds light on the following:

  • How do Latin American small and medium enterprises compare with the OECD’s in terms of financial access?
  • How can public financing institutions deliver co-ordinated and complementary financial support in an effective way?
  • How have financial instruments evolved in order to adapt to small and medium enterprises’ needs?

Access to finance for Latin American firms is extremely unequal and about one third of small businesses in Latin America identify it as a serious restriction. Small and medium enterprises in the region receive only 12% of the total credit, compared with 25% of total credit in the OECD zone (see Figure 1) Only 22% of long-term investment is financed through financial institutions, compared to 34% in OECD economies (IDB 2010). Moreover, although the cost of debt financing is also higher for small firms than for large firms in OECD countries, the gap in Latin America is considerably larger.

Figure 1. Credit to small and medium enterprises as a percentage of total credit, 2010

Source: CGAP (Consultative Group to Assist the Poor), Financial Access 2010.

Current credit models for small and medium enterprises in Latin America suffer from insufficiencies both on the demand and supply sides. In practice, these insufficiencies reveal themselves in the form of a lack of resources, frail competition, asymmetries of information and self-exclusion.

The region’s transition from relational banking to multi-service banking explains, in part, some recent developments. Financial innovation and prudential regulation have led to a risk-focused approach, incorporating a standardised screening process for firms. Other drawbacks of relationship lending, such as high mobility costs for companies and hold-up risk, were not overcome by multi-service banking, and in some cases increased these pivotal problems. The results are poor credit risk assessments, less flexible financing schemes, high collateral requirements and higher banking fees for small and medium enterprises. In addition, small and medium enterprises lack substantial information on financial instruments. This gap between the financial sector and small and medium enterprises has prevented small companies from applying for existing tools and often leads to self-exclusion from the market. This is paradoxical, as the level of approval for loans to small and medium enterprises is relatively high (80%) in countries such as Brazil and Argentina, and 77% of banks in Latin America expect to increase investments in this sector (IDB 2012).

The role of public financial institutions

Public financial institutions have become prominent actors in the region to mitigate the financial constraints of small and medium enterprises. Public financial institutions, which include development banks, public commercial banks and guarantee funds, among others, provide medium- and long-term resources for investment by devising financial instruments and complementing private banks. Public financial institutions in the region have had a sustained annual growth of 15%, tripling their loan portfolio to 600 billion dollars between 2000 and 2009. Even before the financial crisis, their growth was favoured by the lack of interest from private banks and their specialisation in sectors in which private actors lacked experience.

Figure 2. Public financial institutions’ participation in Latin American banking systems, 2007-09

Source: De Olloqui and Palma (2012) based on Latin American Association of Development Financing Insitutions (ALIDE) data.

Small and medium enterprise financing programmes in public financial institutions are normally run by promotion agencies in co-ordination with development banks, usually based on second-tier systems or mechanisms for channelling direct loans. However, public institutions are diversifying their support systems for Small and medium enterprises beyond credit, integrating and implementing environmental sustainability and new sectors for long-term industrialisation in areas such as technology, energy, and infrastructure (Scott 2007). BANCOLDEX, Colombia’s biggest public development bank, has strongly prioritised its small and medium enterprise financing and micro-lending business lines, focusing on medium- and long-term debt for fixed capital investments. This increased the average maturity of loans to small and medium enterprises from seven to 12 years between 2006 and 2010, with the bank allocating 40% of its total disbursement to this sector.

A major obstacle to small and medium enterprise financing, the lack of collateral, has also been the object of public financial institutions’ activities through credit schemes. In recent years, the coverage of national guarantee systems has rocketed. Today, there are 83 guarantee societies and guarantee funds in Latin America, providing guarantees amounting to $30 billion in 2011 for more than two million small and medium enterprises (ALIDE 2011). The composition of guarantee societies has gradually evolved to an increased risk-sharing between private and public sectors, as evidenced in mutual guarantee schemes. In Argentina, Garantizar SGR is the only guarantee society with public-sector contribution to its risk fund (involving 4,900 participating partners in 2010). Around 20% of the $180 million risk exposure included new products such as financial trusts for productive value chains, factoring and leasing services. Despite these good prospects, guarantee programmes face limitations related to insufficient resources to meet commitments, slow approval and payment processes for guarantees banks, and a general distrust for public guarantee funds.

New financing instruments

In recent years, new instruments have been introduced to facilitate small and medium enterprise financing in the region. Although these tools have a relatively low coverage, their importance derives from their involvement in strategic sectors, often related to innovation and technology. Despite their potential, high-growth firms have limited access to commercial channels, forcing them to use self-financing or take on informal loans. Recent experience in the region shows that instruments customised to different stages of development of a startup business can prove valuable. While business incubators and local support centres are effective in the very early stages of firm development, seed-capital subsidies and venture capital instruments have been introduced for later phases. The flexibility of these mechanisms is essential to respond to the needs of small firms.

In Chile, CORFO supports small and medium enterprises and, especially, innovative business startups. The Subsidio Semilla de Asignación Flexible seed grant program is aimed at incubators and startups with high growth potential. At the same time, SERCOTEC and InnovaChile are co-financing programmes which support the creation and growth of competitive, highly productive companies. CORFO encourages the rise of a venture-capital industry through programmes to provide long-term finance and credit, linking up investment funds and innovative firms.

Beyond new instruments, the persistent information gaps between firms and financiers requires that policies expand small and medium enterprises’ knowledge base, also providing non-financial support mechanisms. Such tools include consulting, training and support services to improve firm management. Public financial institutions and governments have an essential role in fostering these activities, improving small and medium enterprises’ entrepreneurs financing instruments, budgeting and accounting tools.

A comprehensive approach is required, in which policies to reduce the ‘traditional’ barriers to small and medium enterprise financing, such as lack of collateral or credit history, must go hand in hand with non-financial policies.


ALIDE (2011), “Crecimiento con sustentabilidad: Garantías cuesta arriba”, Revista ALIDE, July-September, 6-8.

IDB (2012), “Las Pymes de América Latina y el Caribe: un negocio estratégico para los bancos de la región, 5ta encuesta regional en América Latina y el Caribe”.

Kantis, H, P Angelelli, and V Moori (eds.) (2005), Developing Entrepreneurship: Experience in Latin America and Worldwide, Inter-American Development Bank and FUNDES Internacional, Washington, DC.

OECD (2006), The Small And Medium Enterprise Financing Gap: Theory and Evidence, Vol. 1, OECD, Paris.

OECD (forthcoming), Perspectives in Global Development 2013, OECD, Paris.

OECD-ECLAC (2012), Latin American Economic Outlook 2013: Small And Medium Enterprise policies for structural change, OECD, Paris.

Scott, D (2007), “Strengthening the Governance and Performance of State-Owned Financial Institutions’, Policy Research Working Paper Series 4321, World Bank, Washington, DC.

Levy-Yeyati, E, A Micco and U Panizza (2007), “A Reappraisal of State-Owned Banks”, Economía, LACEA - Latin American and Caribbean Economic Association.

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