Financing Constraints of SMEs in Developing Countries: Evidence, Determinants and Solutions

Abstract: This paper surveys empirical research that shows that small and medium enterprises (SMEs) are more constrained by financing and other institutional obstacles than large enterprises, exacerbated by the weaknesses in the financial systems of many developing countries. We use the concept of the access possibilities frontier to explain how difficulties in managing risk and transaction costs involved in SME lending makes financial institutions and markets so reluctant to reach out to this group of enterprises, especially in developing countries. We discuss different policies and reforms that can entice financial institutions and markets to lend to SMEs and comment on the role of the government in institution building, providing the regulatory framework and undertake market-friendly activist policies. However, we also point to pitfalls in government's involvement in SME financing.