February 3, 2023

A new study confirms previous findings that small and medium enterprises (SMEs) that are unlikely to be able to obtain loans from formal sources often have more success from the informal financing sector, a situation that continues to hold back SME development.

A policy brief released this month by the Asian Institute of Management (AIM) found that among a sample of 480 SMEs in Metro Manila and Calabarzon, about 40 percent were credit-constrained – or unable to get a loan from formal sources – while 47 percent were quasi-constrained, that is, unable to secure formal loans but likely able to get informal loans.

Moreover, a larger proportion (42 percent) of small enterprises were found to be credit-constrained compared to medium enterprises (33 percent), according to the policy brief entitled “Firm characteristics and credit constraints across SMEs in the Philippines.”

The study said informal lending sources include the business owner or one of the owners, family or relative of the business owner/one of the owners, money lenders (five-six loan sharks), other sources apart from banks or financial institutions such as cooperatives, savings, and loan associations and lending companies.

“Despite their importance, SMEs face a host of challenges in attaining competitiveness, including lack of access to finance. The lack of access to financing hinders an SME from innovating and acquiring assets to expand its operations. In the Philippines, the lack of access to financing has been identified as one of the most critical obstacles that affect SME performance, competitiveness, and growth,” the study said.

Among the key findings of the policy brief is that the characteristics of a firm that are significant in accessing financing from formal channels seem not to be as highly rated by informal sources.

Characteristics significant to formal sources include the firm’s size, previous purchase of fixed assets, and increased use of digital technologies for accounting and financial management.

However, except for digital technology use, these characteristics appear not to be barriers to an average SME’s attempt to borrow from informal sources.

The report said this result was consistent with a previous study done by Dr. Rafaelita Aldaba in 2012 that found that smaller SMEs in the Philippines had a more difficult experience accessing external financing, largely due to having limited records and acceptable collateral, and inadequate financial statements.

Additionally, the study showed that having purchased fixed assets, which can be used as collateral and is also a positive signal of creditworthiness to creditors, likewise is not as significant a factor when borrowing informally.

But an SME’s increased adoption of digital technologies for accounting and financial management (AFM) does matter, for it could increase the chances of acquiring a loan, noted the study.

Using digital software for accounting and financial management may make it easier to oversee and generate reports on a firm’s finances.

Increased use of digital processes also improves a firm’s ability to organize its records such as financial statements. Thus, having a higher level of digital AFM use could make the firm more attractive to external creditors, especially if the creditor requires the financial statements of the firm, as do most banks and other lending institutions in the formal sector.

The report noted: “Lack of access to financing is one of the major problems that SMEs in the Philippines face. Since a large share of SMEs are unable to obtain loans from formal sources such as banks, it is not uncommon for some SMEs to explore alternative sources of financing from the informal sector.”

“We found that the firm characteristics that are significant in accessing finance solely through formal channels may not be significant when considering informal sources. In addition, we also found that the increased adoption of digital technologies has an inverse association with the predicted probability of being credit-constrained and quasi-constrained for the average SME in our sample.”

The report concluded: “Credit constraints hamper the expansion, innovation, and growth of SMEs, which serve as the backbone of our economy, in addition to being an engine of growth. Thus, enabling SMEs access to finance is essential to maximize returns from the SME sector, which plays a significant role in the economic development of our country.” – Press release