1. Overview of the credit gap
In microeconomics, continuous research addresses the credit gap faced by small and medium enterprises (SMEs), how this gap can be calculated and how solutions should be. At first glance, the challenge is that both formal and informal SMEs often lack the means to access bank loans and credit lines. Moreover, even if they do manage to borrow, they may be charged higher interest rates than larger corporations.
Developing world governments attempt to solve this perceived problem by establishing dedicated financing lines for SMEs. But is that really a solution? More importantly, is it truly the core problem?
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2. The Real issue and its underlying causes
In fact, the primary issue for SMEs is not their inability to borrow per se but rather the reasons that make them unqualified for credit in the first place. These underlying reasons (problems) must be addressed to genuinely invigorate this sector. After all, lending institutions sell money to those they expect can repay, and when they evaluate SMEs, they often see higher risks and a greater likelihood of default. Therefore, the solution is not to go against the logic of the market and lend to small businesses just to see them struggle and fail!
3. Limited professionalism and managerial know-how
More often than not, SMEs suffer from low levels of financial and administrative professionalism, inadequate cash flow management, and poor profit-and-loss tracking. They may also lack a clear organizational structure or a solid business model. In such cases, taking on a loan might lead to more trouble later than it solves in the short term.
Small and medium enterprises are the real drivers of economic growth, especially in developing economies, and they also contribute to social and political stability. Therefore, supporting them might be more effective through well-designed, subsidized educating and training programs for entrepreneurs and staff. This should later enable SMEs to make informed decisions about whether or not to borrow.
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4. Finally
Lending institutions will also be more confident extending credit to companies with clear plans and accurate assessments of profitability, losses and risks. Granting a loan to a business that cannot prepare a simple income statement or a future business plan or lacks the proficiency to calculate interest payments and debt amortization, will most likely lead to its downfall rather than helping it succeed.