Enhancing SME Growth: Effective Financing Strategies for Emerging Economies

The World Bank's report highlights the persistent challenges SMEs face in accessing finance, particularly in EMDEs, and provides recommendations for more effective public policies, including the promotion of fintech and alternative financing solutions. It emphasizes the need for targeted, evidence-based interventions to support innovation, resilience, and private capital mobilization.

The World Bank's recent report authored by Ana Fiorella Carvajal and Tatiana Didier, explores the persistent challenges faced by small and medium enterprises (SMEs) in accessing both debt and equity financing, particularly in emerging markets and developing economies (EMDEs). This report, drawing on both high-income countries and EMDE experiences, offers practical policy guidance for improving SME finance. SMEs are vital to global employment, making up around half of the world’s jobs, yet they struggle with significant barriers when it comes to obtaining financial support. These constraints are particularly acute in low and middle-income countries, where SMEs often cite access to finance as a major obstacle to their growth and productivity. Public programs in these regions have historically sought to improve access to financing, but despite these efforts, the SME financing gap remains vast, particularly in the least developed countries, and public budgets are stretched.

The Importance of SME Financing for Growth and Resilience

The report emphasizes that SME access to finance is essential for economic growth, productivity, and resilience. Financial constraints not only limit SMEs' capacity to grow and innovate but also restrict their ability to cope with external shocks. The COVID-19 pandemic underscored the importance of financial resilience, as firms with access to external financing were more likely to maintain employment levels and avoid defaulting on obligations. In contrast, smaller firms without adequate financial support were more likely to face significant hardships. Even though governments have tried to bridge this gap through various programs such as bank loans, public credit guarantees, and fintech lending platforms—these efforts have been insufficient in meeting the financial needs of SMEs. This is partly because traditional lending institutions often view SMEs as high-risk due to their opacity, lack of suitable collateral, and higher transaction costs compared to large corporations. In EMDEs, these issues are compounded by additional supply-side constraints, such as insufficient competition in the banking sector and underdeveloped capital markets.

Challenges in Expanding SME Financing in EMDEs

Although banks in EMDEs are the primary providers of financing for SMEs, the size of their SME loan portfolios remains much smaller than those in high-income countries. For instance, in 2020, SME loans accounted for 12% of GDP in high-income countries compared to 7% in middle-income countries and only 3% in low-income countries. Meanwhile, private markets for equity financing, critical for spurring innovation, are significantly underdeveloped in most EMDEs. Venture capital (VC) investments, which are vital for financing innovation, remain small, with many EMDEs seeing VC investments of less than 0.01% of GDP. While fintech has made inroads in expanding access to finance for some SMEs, especially those in underserved segments, the overall impact remains limited. Digital banks, alternative lending platforms, and asset-based financiers like factoring and leasing companies have helped provide short-term and working capital financing, but these markets are still relatively small and concentrated in larger, more developed economies.

The Role of Fintech and Asset-Based Financing Solutions

The report stresses that creating an enabling environment for SME finance is critical. This involves enhancing credit reporting systems, developing legal frameworks for asset-based financing, improving insolvency regimes, and supporting alternative lenders like microfinance institutions and fintech companies. By improving the infrastructure for both debt and equity financing, governments can reduce the costs and risks associated with SME lending. The development of secure transactions laws, movable collateral registries, and modernized insolvency programs is particularly important. These measures, when combined with robust financial technology systems, can help reduce the information asymmetries and high transaction costs that have traditionally limited SME access to finance. Additionally, governments need to promote equity financing for SMEs, particularly for firms engaged in innovative activities that often struggle to obtain traditional debt financing. Equity crowdfunding platforms and venture capital funds can provide essential resources for these businesses, but they require supportive regulatory frameworks and incentives to thrive.

Public Support for SME Financing: Evidence-Based Approaches

Public support for SME financing remains necessary, but governments must adopt more evidence-based approaches to ensure that their interventions are effective. The report calls for programs that crowd in private capital rather than displace it, particularly through initiatives like public credit guarantee schemes and investment in equity funds. It is essential that these programs are designed to address the most critical financial constraints faced by SMEs, while also being tailored to the specific conditions in individual countries. This requires robust diagnostics and data-driven approaches to ensure that support reaches the SMEs most in need. Targeted interventions should also focus on fostering innovation and entrepreneurship while promoting market competition and protecting consumers and investors.

Specialized Support for Key SME Segments

Special attention is given to four areas where SMEs face unique challenges: climate change adaptation and mitigation investments, agriculture sector financing, women-owned businesses, and SMEs in fragile and conflict-affected countries. These segments require tailored public policy approaches that go beyond standard financial interventions. For instance, financing adaptation to climate change often necessitates concessional financing, as the risks are higher than conventional investments. Similarly, women-led SMEs may need specialized financial products and delivery channels to address the gender gap in SME financing. The report concludes by emphasizing the need for continuous evaluation and adjustment of public support programs to ensure that they are achieving their intended outcomes.