Improving credit and financing for SMEs in the region: trends and innovative instruments
More innovative solutions to support financing are beginning to join the traditional instruments used in Latin America to try to meet the specific demands of SMEs according to the type of company. The last few years have seen an explosion of new types of initiatives, such as sector-specific programmes to support the financing of SMEs that are specifically designed for a certain sector, size of business or type of business; funds to finance innovations and exports; and non-financial support to improve management and the business culture. In some countries, but not all, initiatives are being rolled out to support businesses, taking into account their stage in the business cycle and potential growth. These initiatives foster the creation of innovative or technology-based firms through business incubators and programmes for the provision of seed and venture capital.22 Moreover, the expansion of the Internet has enabled the development of new online support mechanisms, which have often represented huge steps forward in streamlining and accelerating the processes.
The next section presents the main trends and developments in instruments to support the financing of SMEs in Latin America.
Innovative programmes for firms include SME financing support by sector, size and firm type, special funds for innovation and exporting firms, and non-financial assistance for improving managerial and corporate culture among SMEs.
Cutting down information problems
One of the main obstacles preventing SMEs in the region from accessing credit is information asymmetries and deficiencies. These problems are reflected in the excessive red tape required when applying for a loan, disproportionate requirements for putting together projects to be financed and even little knowledge of the products available among SMEs. To reduce these barriers, strengthening and improving business services has begun to be seen as an additional, effective way of improving access to credit for SMEs in many countries. Thus non-financial support for SMEs through alternative measures is growing. These measures include consultancy, training and services to support business management. Prominent examples of these non-financial services are SEBRAE in Brazil and the Financial Outreach Programme in Mexico.23
Public financial institutions and governments in the region could be essential in fostering a business-friendly environment. In recent years there has been growing interest in the study of public institutions and public policies aimed at fostering entrepreneurship among SMEs and developing a favourable business climate for them (Kantis et al., 2005). There is a consensus on the importance of governments’ role in creating the right institutional environment, especially in terms of the problem of asymmetrical information. Although several Latin American countries are taking measures in this direction, there is still plenty of scope in public policy to reduce the lack of knowledge among entrepreneurs in SMEs on finance instruments, budgeting tools and accounting. Transparency in accounting practices and the adoption of various corporate governance regulations are areas where entrepreneurs in Latin American SMEs can make progress (OECD, 2006).
Factoring and leasing
The instruments to support SMEs have multiplied in the region, prioritising the possibility of an integrated package of financial services. Commercial banks, development agencies and development banks are promoting the use of new financial instruments, including electronic payment systems, credit cards and leasing and factoring services.24 With factoring, SMEs receive immediate liquidity on credit sales, improving the firm’s cash flow and enabling the risk of default to be transferred.25 E-factoring enables firms to obtain immediate liquidity from a financial institution for outstanding invoices. It is fast becoming a better alternative to traditional factoring, in which the supply firm uses a third party (called a “factor”) to discount outstanding invoices received by the buying company.
The expansion of the available financial products with new instruments responds to the need to serve all SMEs in all business segments. The development of these instruments has also been facilitated by the expansion of online banking services, allowing businesses to use banking services even if they do not have any branches nearby.
One of the main forms of electronic factoring is NAFIN’s Production Chains Programme in Mexico, which lets companies in production chains have immediate liquidity for receivables through an electronic discount on their invoices before the due date. In practice, the finance is provided by NAFIN, which as a second-tier institution encourages the participation of other bank and non-bank financial institutions with attractive interest rates. The loans mature after 30 to 120 days and no fees are charged. The programme thus provides a supplier with more liquidity more quickly than traditional factoring and avoids the problems of costs and maturity dates that affect credit for SMEs (Leucona Valenzuela, 2009). The programme has been very successful in terms of the number of firms that have used it and the amount of finance it has provided.26 It also allows large firms to strengthen their relations with suppliers and SMEs to build up a credit history that will help them obtain longer loans.
Within the examples of factoring, NAFIN’s Production Chain Programme in Mexico stands out, letting companies have immediate liquidity for receivables through an electronic discount on their invoices before the due date.
Financing for firms in production chains
An example of a specific instrument for certain SMEs developed in the last decade is the funding programmes for production chains. In Mexico, NAFIN’s Production Chain Programme has been providing this kind of assistance to SMEs since 2002,27 and currently has 584 chains in operation. The programme takes into account the need for these agents to co-operate and network and seeks to promote the inclusion of SMEs in value chains. It has managed to successfully cut down the procedures SMEs must go through to access credit, with the help of new instruments such as e-factoring, and has helped reduce one of the most critical problems in Mexico’s production system: the disintegration of production chains since the 1990s.28
Start-up finance and creating new businesses
The lack of finance remains one of the main obstacles to creating new businesses in Latin America. Banks tend to consider start-ups as high-risk with no credit history. This limits their access to commercial loans and forces them to use self-financing or take on informal loans from acquaintances, relatives or suppliers in the early stages of their development. Public-sector intervention is therefore vitally important for new businesses to help them become part of the financial systems, since firms of this kind are usually highly dynamic and can transform economies and create positive externalities through innovation, productivity and employment. Since businesses’ financial needs change as they move through different stages of development, a financial support strategy must offer alternatives for these different stages, allocating resources to firms during their start-up phase and their first few years in business. Furthermore, in the four stages of a business’s development (seed, start-up, growth and maturity) there are four categories of financial-support instruments: technical support and incubators, seed capital, business angels and venture capital (Echecopar et al., 2006).
Latin America is beginning to promote comprehensive technical- and financial-support mechanisms for business start-up, especially for the firms with the greatest growth potential, such as innovative and technology-based firms. Although there is very little empirical evidence of their results, most countries are promoting business incubators. Various countries also have seed-capital programmes and incentives to boost the venture-capital industry, which is still in its infancy, as seen by the small number of capitalist angels. Despite some progress, the initiatives have seen mixed results, and there are too few impact-assessment mechanisms to show how effective they are.
Seed: initial technical support and business incubators. Most countries in the region have initiatives of this kind.29 During this initial phase, instruments to support business start-ups cover not only financial aspects but also technical-support programmes run by agencies that promote SMEs for business incubators and local support centres, as well as other business-development services. In Colombia, the National Learning Service (SENA) has led the development of the National Business Start-Up and Incubation System. The service was created through an alliance between public (governments and local councils), private (businesses, chambers of commerce and trade unions) and educational (technical schools and university) agents. The programme provides training services in business management and aims to improve training for entrepreneurs by focusing on business skills and interaction with customers and suppliers.30
Start-up: seed capital. In many countries, the most common form of intervention to support start-ups is through direct seed-capital subsidies. Successful examples of such projects can be found in various countries: the Brazilian Development Bank’s Criatec Fund and the Innovation Programme run by the Studies and Projects Funding Agency (FINEP) in Brazil; the Seed Capital programme run by CORFO and the Venture Capital programme run by the Technical Co-operation Service (SERCOTEC) in Chile (Box 3.4); and programmes in Argentina, Colombia, El Salvador and Mexico. In Colombia, the Entrepreneurs’ Fund was set up as part of the SENA to support innovative business projects by professionals who have recently graduated. In Brazil, the Criatec Fund was created in 2007 with Brazilian Development Bank funds and focuses on innovative firms in high-technology sectors such as information technology, biotechnology, new materials, nanotechnology and agribusiness.
The National Business Start-Up and Incubation System in Colombia, the Criatec fund in Brazil and CORFO in Chile are examples of technical and financial assistance to help in the creation of new firms.
Growth and maturity: business angels and venture capital. In the area of venture capital, in some countries agencies and/or development banks encourage the creation of investment funds and in some cases even make financial contributions. In Brazil, where the capital market is heavily regulated by independent bodies, FINEP and the Brazilian Development Bank play an important role in promoting venture capital and both are involved in investment funds, such as the Brazilian Development Bank’s Investment Funds Programme (BNDESPAR), with the aim of increasing the capitalisation of firms of various sizes. Launched in 2000, FINEP’s innovation programme promotes the creation of a venture-capital system for technology-based SMEs. Up to 2009 around USD 45 million had been leveraged with the aim of benefiting 100 firms over the following three years (de Matos and Arroio, 2011). In Chile, CORFO also provides long-term loans so that investment funds contribute to innovative firms (Box 3.4). In Mexico there is NAFIN’s Entrepreneurs Programme, while in Colombia BANCOLDEX offers incentives for creating private equity funds. Furthermore, business angel networks are still poorly developed in the region, and those that do exist, such as those set up by CORFO in Chile (Business Angels Network) and SEPYME in Argentina, have been underutilised.31 Because programmes to identify early-stage investors have not been successful, there must be space for improving such mechanisms. It seems that sufficient financial incentives are needed for these kinds of initiatives to develop in the future (OECD, 2006).
Despite these new instruments, start-ups still find it difficult to access credit. Commercial banks and private investors are still reluctant to lend to this segment of business, especially firms with no credit history and innovative firms. Instead, these firms must use their own equity or sources other than bank loans, such as vendor finance. Many problems still persist: credit programmes by second-tier institutions are biased towards larger firms, there are not enough long-term resources, and loans take too long to process.
Recuadro 3.4 La estrategia de apoyo de la CORFO en Chile
Recuadro 3.4 La estrategia de apoyo de la CORFO en Chile
As for non-bank financial instruments (e.g. venture capital), public institutions can play an important role in ushering in an investment-friendly climate and a suitable economic environment. Information problems in the venture-capital market are varied and the government can help reduce them through education and training for entrepreneurs, managers and investors, by supporting clusters and incubators, and by encouraging networking between investors and entrepreneurs (OECD, 2006).
Microfinance in Latin America
Given the importance of microenterprises in Latin America’s business fabric, microcredit plays a fundamental role in financing the production sector. Access to finance for microenterprises in Latin America is inseparable from the recent major growth of microfinance in the region. This growth has enabled the financing of work for people on low, unstable incomes who are refused credit by other institutions. Microcredit involves small, short-term loans (usually one year), with short repayment periods and high hidden interest rates.32
Traditionally, the main reasons for the lack of microcredit have been the high perceived risk of these loans and the lack of profit they generate. However, the region’s past experience shows that microcredit is profitable and the risk is moderate. In the last decade, microcredit grew to around 45% of total lending (EIU, 2011), and in 2011 Latin America had a total portfolio of USD 27.6 billion for 18 million customers. The vast experience gained by some countries in the region in managing microcredit in recent years has resulted in more services being offered and greater penetration in formal financial institutions. Despite this progress, the portfolio remains relatively small compared to total lending.
During the last decade microfinance in Latin America has grown at an annual rate of 45% (EIU, 2011), and in 2011 the regional portfolio reached USD 27.6 billion for 18 million customers.
However, there remain various challenges to the stability and growth of microfinance in Latin America, especially in the area of the regulatory and supervisory system. The regulatory aspects are essential to ensure the finance system is fair and affordable.33 The development of regulatory standards has not kept up with the pace of growth in the sector, and supervision remains weak, so stronger systems are needed to monitor lending institutions, while customer protection needs bolstering.34 Furthermore, the demand for credit from microenterprises has still not been clearly identified (whether it is for working capital, the purchase of assets or consumption).
Microcredit can be an intermediate platform towards more formal, more complex instruments and channels for access to credit. If microcredit were expanded in Latin America, the finance sector would become more formal as people and microenterprises build up a good credit history, giving them access to a wider range of services.