Commercial banks mainly have provided loans to Small and Medium Enterprises (SMEs). Most of these loans are given to enterprises that have a relatively solid bottom line and sufficient financial data.
On top to this, collateral (being most important) is required for these loans in principal. Therefore, this type of loan is only available to some of the higher-performing SMEs. Consequently, many are disillusioned by the name and definition when looking for help with a small business loan through SME.
There is another financial system, Microfinance. Microfinance is generally defined as micro loans for realizing poverty reduction. It targets low-income groups. Microfinance has such features as non-collateral loans and mutual guarantee.
Here you can see there is a financial gap that is not covered by the two financial systems. The enterprises, which belong to this gap, have a potential to grow their businesses and create employment and grow in size.
The economic and social importance of the Small and Medium Enterprise sector is well recognized in academic literature. It is also recognized that these actors in the economy are underserved, largely in terms of finance.
This has led to significant debate on methods to serve people and/or groups. Although there have been numerous schemes and programs in different economic environments, SME finance can be summarized by two main approaches here.
Collateral based lending is offered by traditional bank and finance companies, make up a combination of: asset-based finance, contribution based finance and factoring based finance using reliable debtor or contracts.
Also, information based lending: financial statement lending, credit scoring, relationship lending and viability based finance is offered by venture capital.
A substantial portion of the SME sector doesn't have sufficient collateral required for collateral based lending and does not have high enough returns to justify the risks taken by venture capitalists.
In addition to these regulatory issues, there is ample evidence that SMEs are significantly under financed. A study of other countries SME programs, report that only 3 to 18 percent could obtain financing from banks.
Finally, SMEs are considered to be at a greater risk of failure, partially because company directors may have less collective management experience of business expertise than larger companies.
Also, many investors often shy away from investing in emerging economy SMEs because of unfavorable investment climates and the uncertainty of sufficient returns. The result is that often they secure financing only by agreeing to a high amount of collateral and shorter payback periods while the rest must rely on their personal networks.
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