Small businesses tend to face higher risks globally, particularly in developing countries like Jamaica, due to their limited economies of scale, networks and capital base. Hence, many small businesses find it difficult to access appropriate financing at an affordable cost.
Studies have found that credit access in markets dominated by a few large banks tends to be lower for small businesses than in markets with a relatively larger share of small banks. It has also been found that, all else being equal, regions with a robust network of small local banks are home to significantly more small firms. Community banks tend to do much more small business lending than their big competitors. One reason for this is that big banks rely on formal models and procedures to determine whether to make a loan. Because the local market conditions and the circumstances surrounding each borrower and his or her enterprise are so incredibly varied, this standardized approach does not work very well when it comes to understanding the nuances of risk associated with a particular small business. Consequently, as large banks have consolidated the market, small businesses have had a harder time obtaining loans from these traditional sources. By drawing on qualitative information – getting to know the borrower, learning about the business, and understanding the market – small banks can better assess risk and successfully make loans to a wider group of small businesses.
The lack of adequate risk assessment methods has been found to be one of the main challenges to serving small businesses. Many traditional financial institutions do not have separate methodologies for micro and small enterprise risk assessment. Most of these institutions use their existing risk assessment tools for small business clients despite the fact that a different level of client analysis, including life cycle analysis, might be required.
Micro Finance Institutions
Many financial service providers have experienced stagnating loan portfolios with existing clientele and have recognized the growth potential of small business lending, which can yield higher returns over the short term. Consequently, financial service providers have established Micro Finance Institutions (MFI) as branches of their operations to better serve the needs of small enterprises. Additionally, new market entrants have established exclusively as MFIs. These MFIs usually focus on enterprises that are smaller than usual banking clients and which are often informal.
Unfortunately, most MFIs in Jamaica continue to offer standard loan arrangements for clientele, and have not given much consideration to alternative financing arrangements for small businesses, such as factoring. The main reason given for the lack of innovation in financing is the undeveloped secondary market for tradable instruments and assets, and the regulatory deficit.
The Jamaican Experience
Jamaica recognizes the economic significance of the Micro, Small and Medium Size Enterprises (MSMEs) as a major creator of employment and wealth. The Government has placed entrepreneurship and MSME development at the forefront of the country’s Growth Agenda. The goal is to provide the best business climate and support services for MSMEs in order to help them to achieve success, while positioning them to contribute in a big way to the growth of the Jamaican economy and strengthen Jamaica’s participation in global trade.
Jamaica’s labour force data indicate that the “Own Account” category (representing sole traders) accounted for 36.3 per cent of the average employed labour force in 2015. In addition, MSMEs make an important contribution to gender equity in the local economy, with women representing approximately 52 per cent of the labour force in Micro and Small Enterprises (MSEs). There is also a strong linkage between MSEs and the informal sector, as many MSEs operate informally. According to a study, if the contribution of the informal sector were taken into account, it would have increased the size of Jamaica’s registered GDP by a range of 40 to 44 per cent.
Almost half of all MSEs and informal enterprises are engaged in the wholesale and retail trade, with education, social work and other personal services accounting for 22 per cent. This has important implications for the local debate about targeting financing for small businesses engaged in “productive” activities in order to increase exports rather than distribution. With half of MSE’s involved in wholesale and retail, this is a sector that requires access to financing.
Some of the initiatives to improve financing for MSMEs include: addressing regulatory deficits so as to encourage innovation in financing; expansion of capacity development programmes; increased role of Credit Bureaus to provide risk ratings; improving competition in the financial services industry; and improving the tax framework for the financial services sector.
In order to encourage innovative businesses, the Government is putting in place the framework to encourage private sector investment in venture capital funds. A Venture Capital Programme was established with a mandate to develop the ecosystem for venture capital and private equity in Jamaica. This Programme seeks to increase the access of dynamic small and medium enterprises (SMEs), with high-growth potential, to early-stage and growth equity financing.
Micro, Small and Medium Enterprises comprise three different categories of businesses that require different staff capacities at lending institutions, management systems, and risk assessment tools. They also require different types of financing at different stages of their life cycle. Lenders need to understand the financing requirements of these three categories of businesses and the sectors in which they operate, in order to tailor lending instruments accordingly. Likewise, governments need to tailor the regulatory framework because one size does not fit all.
Omar Chedda is Director of the Investment Branch at the Jamaican Ministry of Economic Growth and Job Creation. He provides support and advice to the government in the formulation of policies, creation of implementation strategies, and programmes that maximize the benefits of existing investments and that foster the expansion of investment opportunities in Jamaica. One of the officials in Jamaica leading discussions on investment climate reforms.