The Importance of SMEs in Ghana’s Economy

Category: Bank, Credit, Money
Last Updated: 31 Mar 2023
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Table of contents

Chapter I



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Small and Medium-Scale enterprises (SMEs) play important role in the economy. Apart from

creating jobs for the unemployed Ghanaian youth they also serve as a source of innovation

and competition to the larger firms, providing a source of alternative supply of products.

They also contribute their quota to the development of the nation by paying taxes.

The SMEs have become such an economic and social significance that their development

cannot be left to chance. They constitute the backbone of most countries and contribute

substantially to Gross Domestic Product (GDP). They help a lot since time immemorial as

well as this Golden Age of Global Business.

For the purpose of this study, a small-scale enterprise is considered as a privately owned firm

with 1 – 9 employees while a medium-scale enterprise has a workforce between 10 and 99


However, SMEs are often characterized by uncertainty due to their small customer base and

their limited resources. The success or failure of new businesses depend on the innovation of

very new products, and as SMEs struggle to survive and develop, they sometimes experience

constant structural and market changes, hence the need for support by means of micro-credit

and the fulfilment of Vision 2020 goal. It is against this background that this study is carried


Micro-credit is the extension of very small loans (micro loans) to the unemployed, young

entrepreneurs’ and people living in poverty through the formal source. SME’s also assess

financial support from the informal sector like ‘Susu’ collectors, relatives, societies and

groups they belong to.


Notwithstanding the prominence of the SME sector on the economy ofGhana, there are

many who believe that the single most important factor constraining the growth of the sector

is the lack of finance, Mensah (2004). Many commentators have asserted that there exists a

“financing gap” for SMEs. The term, financing gap is basically used to mean that a sizeable

share of economically significant SMEs cannot obtain financing from banks, capital markets

or other suppliers of finance. Furthermore, it is often alleged that many SMEs that do not

currently have access to funds would have the capability to use those funds productively if

they were available. This gap has been said to be due to structural characteristics in the

formal financial system that do not permit the provision of funds to such entities, OECD

SMEs’ difficulty in obtaining financing will be compounded when the business environment

lacks transparency, when the legal system is weak, and when monopolies are present. As

well, loan originators avoid providing financing to certain types of SMEs, in particular, start

ups and very young firms that typically lack sufficient collateral, or firms whose activities

offer the possibilities of high returns, but at a substantial risk of loss.

InGhana, even rural banks that are close to these SMEs and are supposed to appreciate their

peculiar situation seem to be reluctant to their need. Banks are reluctant to give micro-credit

to the SMEs due to high risk of default or lack of collateral for such facilities.


This study seeks to:

i. Examine the rural bank’s ability to grant credit to SMEs.

ii. Assess how SME credit requests are appraised.

ii. Identify the relationship between the worth of collateral and type of SME, on one

side, and amount of credit granted, on the other side, to these SMEs by rural banks.

iv. Examine the effectiveness of the credit to the SMEs.


Which type of SMEs benefits the mostWhat kind of businesses are the clients normally

engaged inWho qualifies for the micro-creditHow fast are they granted the facility?

When do they fulfill their obligations?

In answering the above research questions, this study also wants to test some hypotheses;

Amount of credit facility granted to SMEs depends on the worth of collateral.
Amount of credit facility granted to SMEs depends on the type of SME.
Quantum of loans granted to SMEs will increase from 2006 through to 2009.
Loan default rate will decrease from 2006 to 2009.


This study will serve as a source of information to interested individuals and organizations in

understanding the problems of accessing micro-credit facility by SMEs. It can lead others to

replicate, test or research further into what determines granting of credit facilities to SMEs.


Even though the data used for the evaluation is accurate and of the right source, it will be

most appropriate if the above conclusions are considered with the following study


i. Accessing information on relevant literature related to this study, especially in the

Ghanaian context was greatly difficult. This is due to lack of academic works in the

area and also since traditionally, activities of financial aspects of banks inGhana, are

shrouded in secrecy.

ii. Historic data being used to assess the Bank’s present and future ability to grant credit

facilities to SMEs is not perfect since the past is different from the present.

iii. Quantitative data being used to make qualitative conclusions and judgements may not

reflect the true picture.

iv External business factors like inflation, interest rate among others are not considered

in the analysis and conclusions.

v Since only one rural bank was used for the study, one should be careful how the

results and conclusions of the study is generalised.


My personal interest in this chosen topic was generated by the importance of the SME sector to

the development of the economy ofGhana. SMEs have become such a dominant force in the

social and economic development growth inGhanathat its importance cannot be left to chance.

Not only do they contribute their quota in terms of the paying of taxes, they also contribute in

terms of providing employment opportunities for many Ghanaians and substantially toGhana’s

GDP as well.

In view of this massive contribution to economy, not enough research has been done to actually

examine how these SMEs are financed in terms of having access to micro credit, which is their

source of credit. It is in light of this, that my interest is to contribute to the existing literature by

contributing to the understanding of the role played by the rural banks in granting of micro credit

to SMEs enterprises.


The rest of the study is organized as follows: Chapter two gives a review of the extant

theoretical and empirical literature on the lending technologies and requirements for granting

loans to SMEs. Chapter three explains the methodology adopted for the study. The empirical

results are presented and discussed in chapter four. Finally, chapter five summarizes the

findings of the research and also concludes the discussion.

Chapter II



A very important fact of the national economic development strategy of the Government of

Ghana(GoG) is the promotion and development of SMEs through private sector initiatives

and investments.

There is no single agreed definition of an SME Chopra (2005). According to OECD (2004), a

variety of definitions are applied among countries, and employee numbers are not the sole

defining criterion. SMEs are generally considered to be non-subsidiary, independent firms

which employ less than a given number of employees. This number varies across countries.

The most frequent upper limit designating an SME is 250 employees, as in the European

Union However, some countries set the limit at 200, while theUnited Statesconsiders SMEs

to include firms with fewer than 500 employees. Small firms are mostly considered to be

firms with fewer than 50 employees while micro-enterprises have atmost ten, or in some

cases, five employees.

Financial assets are also used to define SMEs. In the European Union, a new definition came

into force on 1 January 2005 applying to all Community acts and funding programmes as

well as in the field of State aid where SMEs can be granted higher intensity of national and

regional aid than large companies. The new definition provides for an increase in the

financial ceilings: the turnover of medium-sized enterprises (50-249 employees) should not

exceed EUR 50 million; that of small enterprises (10-49 employees) should not exceed EU

10 million while that of micro firms (less than 10 employees) should not exceed EUR 2

million. Alternatively, balance sheets for medium, small and micro enterprises should not

exceed EUR 43 million. EUR 10 million and EUR 2 million, respectively. In addition to

satisfying the criteria for the number of staff and one of the two financial thresholds, an SME

must be independent: to this end, the new definition distinguishes between autonomous

enterprises, partner enterprises and linked enterprises. Finally, the new definition, introducing

precise financial thresholds for micro-enterprises, thus recognizes the essential role of the

latter in the economy. OECD (2004).

The World Bank defines SMEs as economic entities with fixed assets not exceeding US$

l.5 million, Acquah (2001).

InGhana, SME is defined by the National Board of Small Scale Industries (NBSSI) as an

enterprise that has 29 or less employee or one whose plant and equipment does not exceed

US$ 100,000 NBSSI (1998).

The Ministry of Trade and Industry (MOTI), in 1998 estimated that the Ghanaian private

sector consists of approximately 80,000 registered limited companies and 220,000 registered

partnerships. Generally, this target group inGhanais defined as:

i. Micro enterprises: Those employing up to 5 employees with fixed assets (excluding

realty) not exceeding the value of $10,000.

ii. Small enterprises: Employ between 6 and 29 employees with fixed assets of

iii. Medium enterprises: Employ between 30 and 99 employees with fixed assets of up to

$1 million Mensah (2004).

Data from the Social Security & National Insurance Trust (SSNIT) reflects that, by size

classifications, the Ghanaian private sector is highly skewed, with 90% of companies

employing less than 20 persons, and a small number of large-scale enterprises.

Mensah (2004) defines the typical profile of SMEs as follows;

They are, dominated by one person, with the owner/manager taking all major

decisions. The entrepreneur possesses limited formal education, access to and use of

new technologies, market information, and access to credit from the banking sector is

severely limited,

Management skills are weak, thus inhibiting the development of a strategic plan for

sustainable growth.

This target group experiences extreme working capital volatility.
The lack of technical know-how and inability to acquire skills and modern technology

impede growth opportunities.


SMEs and informal enterprises are the largest providers of output and jobs in the developing

world. Although reliable data on the size of the SME sector are lacking, not least because of

widespread informal activity, the World Bank estimates that SMEs and informal enterprises

account for over 60% of GDP and over 70% of total employment in low-income countries,

while they contribute over 95% of total employment and about 70% of GDP in middle-

income countries Ayyagari et al. (2003).

They constitute the dominant form of business organization worldwide, accounting for over

95% and up to 99% of the business population depending on the country. For instance, in

2003, 99.8% of enterprises in the EU were SMEs (less than 250 employees). At the higher

end of the scale, small firms constitute 99% of manufacturing enterprises inItaly, and close

to 80% at the lower end for the United States OECD (2O04).

According to Ou (2006). SMEs in theUnited States represent 99.7 percent of all employer

firms. SMEs are quite important in the economy ofChina. In the case of industrial concerns,

there were totally 7,929,900 enterprises in 1999, and 7,922,000 of them were SMEs, or

99.9% of the total. Defined in the broadest sense to include independent businesses with 500

or fewer hired employees,U.S.small businesses numbered 23 million in 2003, employed

about half of the private sector work force, and produced about half of the nation’s private

sector output USSBA (2003)3 Small firms are important to a competitive American economy

because they fill niches in both input and output markets, innovate, and contribute to the

dynamism in American industries and theU.S.economy.

SMEs play an important role in the economic development ofChina. Small enterprises (SEs)

contribute to the quick and constant development of the economy, while providing jobs and

deepening the overall economic reforms of the country. First, SMEs are quite important in

the economy ofChina. In the case of industrial concerns, there were totally 7,929,900

enterprises in 1999, and 7,922,000 of them were SMEs, or 99.9% of the total. The total

output value of industry was 12.6111 trillion Yuan, and 9.4529 trillion Yuan of it was

produced by SMEs, or 75.0% of the total. SMEs employed 117 million in 1998, or 83.9% of

the total employed in industry.

InJapan, SMEs were developed in 1948 and by 2001 was accounting for about 50% of

Japan’s export, Acquah (2001).Africa’s private sector consists of mostly informal micro

enterprises operating alongside large firms. Most companies are small because of policy-

induced obstacles and a poor business environment that discourages investment, entering the

formal economy and more broadly private sector activity. Between these large and small firms,

SMEs are very scarce and constitute a “missing middle”. Even inSouth Africa, with its robust

private sector, micro and very small enterprises provided more than 55% of all jobs and 22% of

GDP in 2003, while large firms accounted for 64% of GDP. InNigeria, SMEs (about 95% of

formal manufacturing activity) are key to the economy, but lack of security, corruption and poor

infrastructure prevent them from becoming motors of growth.

InGhana, available data from the Registrar General indicates that 90% of companies

registered are micro, small and medium enterprises. Because of the lack of a nationwide

business registration and deregistration system in the country, tracking the small business

population and its dynamic changes has been a challenging task. It has, however, been

identified as the catalyst for the economic growth of the country as they are a major source of

income and employment, Mensah (2004).


Notwithstanding the prominence of this sector on the economy of nations, there are many

who believe that the single most important factor constraining the growth of the SME sector

is the lack of finance, Mensah (2004). Many commentators have asserted that there exists a

“financing gap” for SMEs. There is no commonly agreed definition of this gap, but the term

is basically used to mean that a sizeable share of economically significant SMEs cannot

obtain financing from banks, capital markets or other suppliers of finance. Furthermore, it is

often alleged that:

Many entrepreneurs or SMFS that do not currently have access to funds would have

the capability to use those funds productively if they were available;

But due to structural characteristics, the formal financial system does not provide

finance to such entities, OECD (2006).

Ray and Hutchinson (1984) explain the finance gap would exist if the marginal return on the

investment available to small business is excess of the marginal cost of capital due mainly to

discontinuances in the provision of fresh capital such that funds were not available for

otherwise profitable investment.

This financing difficulty that SMEs experience can stem from several sources. The domestic

financial market may contain an incomplete range of financial products and services. The

lack of appropriate financing mechanisms could stem from a variety of reasons, such as

regulatory rigidities or gaps in the legal framework. Moreover, development economists

increasingly accept the proposition that, due to monitoring difficulties such as principal/agent

problems (e.g. related to the shareholder-manager relationship) and asymmetric information,

suppliers of finance may rationally choose to offer an array of financial services that leaves

significant numbers of potential borrowers without access to credit. Such credit rationing is

said to occur if:

Among loan applicants who appear to be identical, some receive credit while others

do not; or

ii.There are identifiable groups in the population that are unable to obtain credit at any

price, OECD (2006) and Mensah (2004).

Owing to their inherent monitoring problems, SMEs will be at a particularly severe

disadvantage relative to larger and more established firms. SMEs’ difficulty in obtaining

financing will be compounded when the business environment lacks transparency, when the

legal system is weak, and when monopolies are present. As well, loan originators may avoid

providing financing to certain types of SMEs, in particular, start ups and very young firms

that typically lack sufficient collateral, or firms whose activities offer the possibilities of high

returns, but at a substantial risk of loss, ADB (2004)1.

The problem of SME access to financing cannot be separated from considerations about the

environment in which these firms operate. The institutional characteristics of the financial

sector and the various factors affecting the volatility of the business environment

(information asymmetries, poorly defined property rights, lack of contract enforcement or

protection of creditors’ rights, high crime rates, etc.) impact on the ability of firms to access

credit directly and indirectly by raising the SMEs perceived risk ,OECD (2006).

Africa’s SMEs have little access to finance, which thus hampers their emergence and

eventual growth. Their main sources of capital are their retained earnings and informal

savings and loan associations, which are unpredictable, not very secure, and have little scope

for risk sharing because of their regional or sectoral focus. Access to formal finance is poor

because of the high risk of default among SMEs and due to inadequate financial facilities.

Small business inAfricacan rarely meet the conditions set by financial institutions, which

see SMEs as too risky because of lack of information about their ability to repay loans and

the limited guarantees they can offer. The financial system in most ofAfricais under-

developed and so provide few financial instruments. Capital markets are in their infancy,

shareholding is rare and long-term financing is available for SMEs. Non-bank financial

intermediaries, such as micro credit institutions, could be a big help in lending money to the

smallest SMEs but they do not have the resources to follow up their customers when they



The conceptual framework to which most of the current research literature adheres is quite

helpful in understanding the institutions and markets that provide funds to SMEs in

developed and developing nations. It has also provided insights into the effects of Policies

that affect access to funding by creditworthy SMEs. However, Berger and Udell (2004) argue

that the current framework is oversimplified, and neglects key elements of the financial

system that affect SME credit availability.

In their paper, Berger and Udell (2004) propose a more complete framework in which

lending technologies play a key role as the conduit through which government policies and

national financial structures affect SME credit availability. They emphasize a causal chain

from policy to financial structures, which affect the feasibility and profitability of different

lending technologies. These technologies, in turn, have important effects on SME credit


According to Berger and Udell (2004), an important oversimplification in the current

framework is the way that lending technologies are often categorized into two types;

iTransactions lending that is based primarily on “hard” quantitative data and

Relationship lending, which is based significantly on “soft” qualitative information.

Under this categorization, transactions lending is generally viewed as being focused on

informationally transparent borrowers, while relationship lending is seen as used for opaque

borrowers. This characterization is fundamentally flawed. Transactions lending is not a single

homogeneous lending technology. There are a number of distinct transactions technologies

used by financial institutions, including financial statement lending, small business credit

scoring, asset-based lending, factoring, fixed-asset lending, and leasing. While financial

statement lending is focused on transparent borrowers, these other transactions technologies

are all targeted to opaque borrowers. Recognition of this heterogeneity among transactions

technologies and its impact on credit availability to opaque borrowers is often missing from

the academic literature, Berger and Udell (2004).

Berger and Udell’s framework specifies a causal chain from government policies to a

nation’s financial institution structure and lending infrastructure. These financial structures,

in turn, significantly affect the availability of finds to SMEs by determining the feasibility

and profitability with which different lending technologies may be deployed. The extant

research literature often neglects key elements of this causal chain, which may yield

misleading research and policy conclusions.

2.4.1 Lending Technologies

Berger and Udell (2004) define a lending technology as a unique combination of primary

Information, source screening and underwriting policies (and/or procedures), loan contract

structure, and monitoring strategies and/or mechanisms). In other words, each technology is

distinguished by a unique combination of the primary source of information, screening and

underwriting policies/procedures, structure of the loan contracts, and monitoring strategies

and mechanisms. In some cases, the technologies basically differ from one another in just

one of these dimensions (e.g., fixed-asset lending and leasing primarily differ from each

other on the contracting dimension specifically, the ownership of the fixed assets). In other

cases, lending technologies differ in multiple dimensions (e.g., small business credit scoring

and asset-based lending differ in primary information sources and monitoring mechanisms).

In many cases, a secondary information source, screening/underwriting procedure, contract

feature, or monitoring mechanism is used, but we distinguish the technologies based on the

primary foundations of the lending decisions. Thus, a credit score may be used as secondary

information or collateral may be used as a secondary source of repayment, but the lending

technology would still be relationship lending if the lending decisions are primarily based on

soft information gathered over the course of a relationship.

Lending technologies are often categorized into transactions and relationship lending. Transactions Lending Technologies

Transactions lending is based primarily on “hard” quantitative data and includes financial

statement lending, small business credit scoring, asset-based lending, factoring, fixed-asset

lending and leasing. Transactions lending is generally viewed as being focused on

informationally transparent borrowers. Financial Statement Lending

Financial statement lending is a transactions technology based primarily on the strength of a

borrower’s financial statements. There are two requirements for this technology that depend

on hard information. First, the borrower must have informative financial statements, such as

audited statements prepared by reputable accounting firms according to widely accepted

accounting standards such as GAAP.

Second, the borrower must have a strong financial condition as reflected in the financial

ratios calculated from these statements. The loan contract that arises out of the analysis of

these financial statements may reflect a variety of different contracting elements such as

collateral and personal guarantees. However, under financial statement lending, the lender

views the expected future cash flow of the SME as the primary source of repayment.

Financial statement lending, unlike other lending technologies, is reserved for relatively

informationally transparent firms. Small Business Credit Scoring

Small business credit scoring is a transactions technology based primarily on hard

information about the SME’s owner as well as the firm. The owner information is primarily

personal consumer data obtained from consumer credit bureaus. This is combined with data

on the SME collected by the financial institution and often from commercial credit bureaus.

The data are entered into a loan performance prediction model, which yields a score, or

summary statistic for the loan. The models are usually designed for credits up to $250,000,

but many institutions use them only for credits up to $100,000. The technology is relatively

not widely used in theU.S.until the mid-l990s.

This technology may be applied to very opaque SMEs, given that much of the information is

based on the personal history of the owner, rather than the SME. Consistent with this opacity,

recent research finds that this technology is associated with credits under $100,000 that are

rated as relatively risky, have high interest rates, and are often located outside of the banks’

local markets Frame et al. (2004) and Berger et al. (2004). Asset-Based Lending

Asset-based lending is a transactions lending technology in which financial institutions

address the opacity problem by focusing on a subset of the firm’s assets, which are pledged

as collateral, as the primary source of repayment. This technology provides working capital

financing secured primarily by accounts receivable and inventory. The amount of credit

extended is linked on a formula basis using hard data to a dynamically-managed estimation

of the liquidation value of the assets used as collateral. The value of collateral is assessed

daily in the case of accounts receivable, and typically weekly or monthly for inventory, and

linked to the size of the credit available, so that the liquidation value of the collateral always

exceeds the credit exposure, Udell (2004).

The use of collateral itself, however, does not distinguish asset-based lending from the other

lending technologies. The pledging of accounts receivable and inventory is often associated

with financial statement lending, relationship lending, and credit scoring, where collateral is

used as secondary source of repayment. Under asset-based lending, in contrast, the extension of

credit is primarily based on the value of the collateral, rather than the overall creditworthiness of

the firm. Factoring

Factoring involves the purchase of accounts receivable by a “lender” known as a factor. As in

asset-based lending, factoring focuses on the value of an underlying asset, rather than the

overall value/risk of the firm. Factoring is similar to asset-based lending, but there are three

important distinctions. First, factoring only involves the financing of accounts receivable,

unlike asset-based lending which also involves financing inventory. Second, under factoring,

the underlying asset is sold to the “lender.” Third, factoring is essentially a bundle of three

financial services: a financing component, a credit component and a collections component.

Under most factoring arrangements, the borrower outsource its credit and collections

activities in addition to obtaining financing. Factoring is a transactions technology because

the underwriting process based on hard information about the value of a “borrower’s”

accounts receivable. Factoring addresses the opacity problem by focusing primarily on the

quality of the obligor, rather than the “borrower.”

The use of factoring varies widely across countries. For example, the ratio of the volume of

factoring to GDP in 2002 was 11.9% inItaly, but only 0.9% in Switzerland Bakker et al. (2004). Fixed-Asset Lending

Fixed-asset lending technologies involve lending against assets that are long-lived and are

not sold in the normal course of business (e.g., equipment, motor vehicles, or real estate).

Like asset-based lending – which is based on accounts receivable and inventory – the

underlying assets in fixed-asset lending are pledged to the lender as collateral. However,

unlike accounts receivable and inventory, the pledged assets are virtually always uniquely

identified by a serial number or a deed. The long life and unique identification of fixed assets

leads to very different underwriting processes, contract structures, and monitoring

mechanisms. At the underwriting stage, the focus is on assessing the market value of the

asset – for equipment and real estate; this is often in the form of a formal appraisal. The

contract structure typically specifies an initial loan-to-value ratio less than one. It also

typically involves setting a loan amortization schedule with a final maturity less than the

lifep of the asset. The schedule insures that the ratio of the outstanding loan balance to the

liquidation value of the asset is less than one over the life of the loan. This contract structure

also feeds back to the underwriting process, where the primary financial analysis focuses on

coverage ratios that measure a firm’s ability to meet the amortization schedule (i.e., debt

service). Unlike monitoring asset-based loans, the existence of collateral (i.e., ownership of

collateral by the borrower) is not problematic in fixed-asset lending.

The borrower can only fixed asset by transfer of title, which can only occur if the

lender agrees to release the lien: Monitoring the borrower’s ability to pay (i.e., its cash flow)

is tied to the observation of timely repayment as specified by the amortization schedule.

Failure to meet a required payment signals inadequate cash flow and triggers a default on the

loan. Leasing

Leasing involves the purchase of fixed assets by a “lender” known as a lessor. Leasing is a

very common method of financing equipment, motor vehicles, and real estate in many

countries by both banks and other institutions. The lessor purchases the fixed assets and then

simultaneously enters into a rental contract with the lessee (the “borrower”) that specifies the

payment schedule. The contract often contains an option whereby the lessee can purchase the

assets at the end of the lease at a pre-specified price.

Leasing is a transactions technology because underwriting is substantially based on hard

information about the value of the underlying asset, analogous to asset-based lending,

factoring, and fixed-asset lending.

Like these other technologies, leasing can be used to provide financing to opaque firms

because the underwriting decision is primarily based on the value of the asset being leased. it

has also been shown that leasing can mitigate an adverse selection problem, either in the used

equipment market by encouraging a higher quality of product sold “off-lease” (i.e., sold by

lessors when the purchase option is not exercised) or in the new product market, Chemmanur

and Yan (2000); Hendel and Lizzeri (2002); Gilligan (2004). Relationship Lending Technologies

Under relationship lending, the financial institution relies primarily on soft information

gathered through contact over time with the SME, its owner and the local community to

address the opacity problem. This information is acquired in large part by the loan officer

through direct contact with the borrower and through observing the SME’s performance on

all dimensions of its banking relationship. This soft information may also include an assessment

of the future prospects of the SME gathered from past communications with SME’s suppliers,

customers, or neighboring businesses, Petersen and Rajan (1994), Berger and Udell (1995),

Degryse and Van Cayseele (2000). As noted, this soft information may often remain proprietary

to the loan officer because it is not easily observed, verified, or transmitted to others.

Relationship lending is generally seen as used for opaque borrowers.

2.4.2 Financial Institution Structure

Financial institution structure refers to the market presence of and competition among

different types of financial institutions. Financial structures include the presence of different

financial institution types and the conditions under which they operate.

The research literature provides a considerable amount of evidence on the effects of financial

institution structure on SME lending, but the findings rarely go beyond the distinction

between transactions lending technologies versus relationship lending to parse among the

different transactions technologies. Review of the findings has been done with regard to the

comparative advantages of large versus small institutions, foreign- versus domestically

owned institutions, state- versus privately-owned institutions, and market competition. Large versus Small Institutions

For a number of reasons, large institutions may have a comparative advantage in transactions

lending and small institutions may have an advantage in relationship lending. Large

institutions may be able to take advantage of economies of scale in the processing of hard

information, but be relatively poor at processing soft information because it is difficult to

quantify and transmit through the communication channels of large organizations e.g., Stein

(2002). Under relationship lending, there may be agency problems created within the

financial institution because the loan officer that has direct contact over time with the SME is

the repository of soft information that cannot be easily communicated within the financial

institution. This may give a comparative advantage in relationship lending to small

institutions with fewer layers of management e.g., Berger and Udell (2002). Finally, large

institutions may be disadvantaged at relationship lending because of Williamson-type.

Williamson(1988) organizational diseconomies associated with also providing transactions

loans and other wholesale services.
The empirical literature generally does not identify the lending technologies, but in some

cases draws conclusions from the characteristics of the SME borrowers and their

relationships with financial institutions.

In most cases, the research is based on data fromU.S.banks and SMEs. Large institutions are

found to lend to larger, older SMEs with stronger financial ratios, and small institutions are

found to rely more on soft information and lend to SMEs with which they have stronger

relationships e.g., Berger et al. (2004). The strong financial ratios and SME size and age

findings are consistent with a comparative advantage for large institutions in using financial

statement lending based on financial ratios for relatively transparent SMEs (which tend to be

larger and older), given that financial statement lending is the only lending technology

generally used for transparent borrowers. The strong relationships and use of soft information

by small institutions is consistent with a comparative advantage for small institutions in

relationship lending. There is very little evidence on comparative advantages by financial

institution size in the other transactions lending technologies, although it is likely that large

institutions have comparative advantages of differing degrees in the other transactions

technologies due to economies of scale in processing hard information.
A limited amount of empirical evidence also addresses the issue of a general comparative

advantage of large versus small institutions in SME lending and the policy question of

whether a sizeable presence of small institutions is necessary to promote credit availability

for SMEs. One study finds that the likelihood that an SME has a line of credit from a large

bank versus a small bank is roughly proportional to the deposit market presence of large

versus small banks according to Berger and Udell (2004). This is not consistent with a

general comparative advantage by financial institutions size and suggests that a strong

presence of small institutions may not be needed for general SME credit availability. This

study also found few significant differences in the opacity or other characteristics of small

businesses that borrow from large versus small banks. These two findings are consistent with

the hypothesis that large institutions using various transactions technologies are just as able

to supply SME credit to opaque SMEs as small institutions using relationship lending.

Another study found that the local market shares of large and smallU.S. banks have

relatively little association with SME credit availability, but did not account for the size of

institutions making the loans, Jayaratne and Wolken (1999). This study is also consistent

with the hypothesis that large institutions are not disadvantaged in SME lending and that a

strong presence of small institutions may not be needed for general SME credit availability.

An alternative hypothesis to explain this finding is that large institutions may be generally

disadvantaged at SME lending, but that a sufficient market presence of small institutions

efficiently arises when needed to provide adequate SME credit. Supporting this second

hypothesis, several studies find that large institutions reduce their SME lending after mergers

and acquisitions, but that other banks in the same local markets appear to respond by

increasing their supply of SME credit substantially e.g., Berger et al. (1998); Berger et al.

(2001); Avery and Samolyk (2004). As well, new small banks are often created in these

markets that supply additional SME credit Berger et al. (2004). Foreign-owned versus Domestically-owned Institutions

Foreign-owned institutions may have a comparative advantage in transactions lending and a

disadvantage in relationship lending in part because these institutions are typically large. In

developing nations, foreign institutions headquartered in developed nations may have

an additional advantage in transactions lending because of access to better information

technologies for collecting and assessing hard information, Berger et al. (2004). Foreign

institutions may also face additional hurdles in relationship lending because of difficulties in

processing and transmitting soft information over greater distances, through more managerial

layers, and coping with multiple economic, cultural, language, and regulatory environments

e.g., Buch (2003).

There is little empirical evidence on SME lending by foreign-owned institutions in developed

nations. Some research finds that these institutions tend to have a wholesale orientation e.g.,

DeYoung and Nolle (1996), and in some cases tend to specialize in serving multinational

corporations headquartered in their home nation e.g., Goldberg and Saunders (1981).

Presumably, these institutions use transactions technologies applied to hard information.

There is more evidence on foreign-owned institutions and SME credit availability in

developing nations. In most of the studies, foreign banks are associated with greater SME

credit availability e.g., Berger et al. (2004). However, some find that foreign-owned banks

may have more difficulty in supplying credit to SMEs than to large firms e.g., Berger and

Klapper (2004). This relative preference for large firms over SMEs has also been found for

foreign lenders entering formerly socialist countries, Giannetti and Ongena (2005). Again,

the lending technologies are generally not identified. Although foreign institutions almost

surely use transactions technologies, it is usually not known which of these technologies are

employed or the opacity of the borrowers served. State-owned versus privately-owned institutions

State-owned institutions may be expected to have a comparative advantage in transactions

lending and a disadvantage in relationship lending because these institutions are typically

large. Other arguments regarding the ability of these institutions to supply funds to

creditworthy SMEs through any lending technology may also apply. State-owned institutions

generally operate with government subsidies and often have mandates to supply additional

credit to SMEs in general, or to those in specific industries, sectors, or regions. Although this

might improve funding to creditworthy SMEs in principle, it could have the opposite effect

in practice because these institutions may be inefficient due to a lack of market discipline. As

well, much of their SME funding may be to SMEs that are not creditworthy because the

lending mandates do not necessarily require that the funding be used to finance positive net

present value projects, or that loans be repaid at market rates. Some of the funds may also be

subsidized or directed for political purposes, rather than economic ends e.g., Cole (2004);

Sapienza (2004). State-owned institutions may also deploy relatively weak monitoring

strategies and/or refrain from aggressive collection procedures as part of their mandate to

subsidize targeted borrowers or because of the lack of market discipline. In nations with

substantial state-owned banking sectors, there may also be significant spillover effects that

discourage privately-owned or foreign-owned institutions from SME lending due to a

“crowding out” effect from subsidized loans from state-owned institutions.

The empirical findings are generally consistent with unfavorable effects of state ownership.

Studies of general performance typically find that individual state-owned banks are relatively

inefficient and that large shares of state bank ownership are typically associated with

unfavorable macroeconomic consequences and less developed financial and economic

systems e.g. Berger et al. (2004). Some evidence also suggests that less SME credit is

available in nations with large market shares for state-owned banks e.g., Berger et al. (2004).

As well, nonperforming loan ratios at state-owned banks tend to be very high, consistent with

lending based on negative net present value projects weak monitoring, and/or lack of

aggressive collection procedures e.g., Berger et al. (2004). Studies of the effects of bank

privatization in both developed nations and developing nations typically find improvements

in performance following the elimination of state ownership e.g., Clarke et al. (2005). Similar

to the case for foreign-owned institutions, state-owned institutions likely use transactions

technologies, but the technologies are generally not identified in the research. Market Competition

Under the traditional structure-conduct-performance (SCP) hypothesis, market power

reduces credit access through any lending technology. Institutions with more market power

may charge high rates or fees on loans; have tight credit standards; and/or be less aggressive

in finding or serving creditworthy SMEs so managers can take advantage of a “quiet life”.

An alternative hypothesis suggests that for one of the lending technologies relationship

lending, market power may be associated with greater access to credit for SMEs.

Market power may encourage institutions to invest in lending relationships because the

SMEs are less likely to find alternative sources of credit in the future. Market power helps

the institution enforce a long-term implicit contract in which the borrower receives a

subsidized interest rate in the short term, and then compensates the institution by paying a

higher-than-competitive rate in a later period, Sharpe (1990); Petersen and Rajan (1994).

However, under a different theoretical model of relationship lending, greater concentration

may be associated with less credit availability using this technology.

Thus, economic theory offers conflicting empirical predictions that arise out of different

theoretical models about one of the lending technologies, relationship lending. Without

separately identifying relationship lending from the other technologies, the empirical

predictions for access to credit for SMEs are not clear. For example, market power could

increase credit availability for some SMEs through a positive effect on relationship lending,

but may decrease availability for other SMEs that are more suited to one of the transactions

lending technologies. Thus, the effect of market power on overall SME credit availability

may go either way, depending on the strength of the different hypotheses and the extent to

which the different lending technologies are employed.

A number of studies have looked at measures of SME credit availability, activity, and general

economic performance and their association with indicators of market power such as

concentration and regulatory restrictions on entry and competition. The empirical results are

mixed, with some studies finding generally unfavorable effects from market power e.g., Elsas

(2005) and others finding favorable effects e.g., Petersen and Rajan (1995)

2.4.3 Lending Infrastructure

The lending infrastructure refers to the rules and conditions that affect the ability of these

institutions to lend and includes the information environment, the legal, judicial and

bankruptcy environments, the social environment, and the tax and regulatory environments.

All of these elements may affect SME credit availability by influencing the extent to which

the different lending technologies may be legally and profitably employed. The final element,

the regulatory environment, may also restrict SME credit availability by constraining the

financial institution structure. The Information Environment

An important aspect of the information environment is the accounting infrastructure. Strong

accounting standards and credible independent accounting firms are necessary conditions for

informative financial statements, which is key to the financial statement lending technology.

These are also important for many components of loan contracting associated with financial

statement lending and some of the other lending technologies to a lesser extent. For example,

covenants based on financial ratios are not feasible if the ratios calculated from the financial

statements are not reliable.

Another important aspect of the information environment is the sharing of information.

Commercial and consumer credit bureaus provide formal organizational mechanisms for the

exchange of payment performance data. Credit bureaus have also been found to reduce the

cost and time to process loans and the, level of defaults Miller (2003). Commercial credit

bureau data have also been shown to have power in predicting firm failure beyond financial

ratios and other descriptive information about the firm.

There is considerable variation across countries in terms of the existence of credit bureaus,

whether they are publicly- or privately-owned, and the coverage of available information

Miller (2003). Empirical evidence suggests a statistically important link between the

existence of third-party information exchanges and credit availability Love and Mylenko


Specifically, countries with stronger formal information sharing exhibit greater bank lending

relative to GNP and country-level credit risk is negatively correlated with measures of formal

information sharing Jappelli and Pagano (2002).

Credit bureau information, where available, is used in conjunction with all of the lending

technologies, but it is a driving component of one of the lending technologies, small business

credit scoring.

It is necessary to have a large database on SME loan performance and the variables used to

predict that performance in order to estimate a credible credit scoring model. The evidence

also indicates that access to historical credit information such as business credit bureaus is

positively related to the presence of factoring, Klapper (2005)3.Under certain circumstances

factoring can also work well even in weak domestic information environments if the

receivables are from obligors located in strong information environments. The Legal, Judicial and Bankruptcy Environments

A country’s legal, judicial, and bankruptcy environments significantly influence the context

in which loan contracting is conducted. The legal environment that affects business lending

consists of the commercial laws that specify the property rights associated with a commercial

transaction. The judicial and bankruptcy environments determine how well these laws are

enforced in commercial disputes and in bankruptcy resolutions. This enforceability, in turn,

determines the confidence of contracting parties in financial contracts. Collectively, these

features constitute the rule of law as it relates to the extension of credit.

Countries differ significantly on this dimension: for some, commercial laws are unambiguous

and conducive to commercial transactions and enforcement is predictable; for others

commercial law is ambiguous and incomplete, enforcement is problematic, and criminal and

racketeering behavior block the creation of new businesses, undermine existing ones, and

deter foreign investment, EBRD (2003).

Empirical studies have shown that firms in countries with greater financial development and

stronger property rights have increased levels of investment funded by external finance.

Firms in countries with weaker financial development and property rights, in contrast, are

more likely to rely on potentially less efficient financing from development banks, the

government, or informal sources, Berger et al. (2004). Smaller firms may be particularly

affected. One study found that the effect of financial, legal and corruption problems

consistently constrained the growth of smaller firms more than larger firms in a cross-country

analysis, Berger et al (2004).

Commercial laws and their enforcement of these laws also affect the ability of banks to

deploy specific contracting elements that can be used to address informational opacity

problems. Specifically, they can affect the deployment of contracting elements such as

covenants, maturity, collateral, and personal commitments that have been shown to mitigate

adverse selection and moral hazard problems e.g., Sharpe (1990).

The commercial law on security interests (collateral liens) in a nation, for example, is

important in determining the efficacy of collateral in a loan contract, the essential component

of the asset-based lending and fixed-asset lending technologies. Key issues include whether a

country’s commercial law clearly defines how a collateral lien can be perfected, how

collateral priority is determined, and how notification of a lien is made.

The efficiency of the judicial and bankruptcy systems is also critical to credit availability.

Recent theoretical and empirical research suggests that judicial inefficiency (i.e., high-cost

judicial procedures) is associated with decreased access to credit, Jappelli et al. (2005). It has

also been shown that countries with greater legal procedural formalism – typically associated

with civil law countries -take longer to enforce some types of financial contracts.

The length of time in bankruptcy is a particularly important dimension of efficiency. Also

important is the degree to which the application of bankruptcy procedures is associated with

adherence to absolute priority. The power of collateral ex ante ultimately depends on the

whether the priority rights of secured lenders are upheld in bankruptcy ex post. The Social Environment

The social environment may also affect SME credit availability. Evidence suggests that the

level of social capital and trust may be important in facilitating the writing and enforcement

of financial contracts. Social capital, as proxied by electoral participation, has been found to be

significant in explaining regional differences in some measures of entrepreneurial activity, such

as number of firms and new firm entry. Common language may also help develop mutual trust

and facilitate relationship building. It has also been found that cultural differences across

countries are associated with differences in the level of investor protection, Stulz and

Williamson (2003).

The greatest impact of the social environment is likely on relationship lending because social

norms, religion, and culture may have the most effect on the production of soft information

and the ability of banks to use this information to forge relationships. The social environment

could also affect the production and use of hard information used in the transactions

technologies, but likely to a lesser degree. The Tax and Regulatory Environments

The tax and regulatory environments may have significant effects on SME credit availability.

For example, stamp taxes on factored invoices and certain types of value-added taxes can

have negative impacts on factoring. Changes in capital regulations and tougher bank

supervision in theU.S.are also often cited as contributing to the reduction in supply of

business credit or “credit crunch” in the early 1990s e.g., Berger and Udell


The regulatory environment may also affect SME credit availability by constraining the

financial institution structure. Government policies often affect the entry of different types of

financial institutions, their market shares, their abilities to compete, and their corporate

governance structure. In many parts of the world, the removal of geographic and product

restrictions has resulted in significant consolidation within the banking industry and between

banks and other types of financial institutions. In the EU, the single banking license and other

parts of the Single Market Programme appeared to spur considerable financial institution

consolidation within nations and somewhat less activity across international borders within

the EU.

Government policies that restrict foreign entry may have large effects on SME credit

availability, given the findings that larger market shares for foreign-owned banks are often

associated with greater SME credit availability in developing nations. Other research has also

found that restrictions on foreign-bank entry may be more strongly linked to bank

performance than the market presence of foreign-owned banks, Levine (2003)2 which may

suggest these restrictions have particularly strong effects in limiting competition, with

potential consequences for SME customers. As well, restrictions on foreign institutions may

limit the efficient use of some of the transactions lending technologies in developing nations,

given the likely advantage of these institutions in collecting and processing hard information.

Finally, government policies with respect to state ownership of financial institutions clearly

have important effects on credit availability. State ownership is generally found to have

significant negative effects on SME credit availability, with some reversal of these effects

after privatization. State-owned institutions likely use transactions lending technologies, but

the evidence does not suggest which ones these institutions use or that they have advantages

in any of the technologies.


SMEs require financing to establish and operate activities effectively. Apart from using such

credits as “seed money”, expansion of business activities like acquisition of new equipment

is another area that needs major financing. Others even use the credits as working capitals.

Acquah (2001) states formal and informal sources as the two main sources of credits for the

SME sector.

In modern financial systems, surplus funds may pass from “savers” to borrowers through

intermediated channels (e.g. banking, securitisation) or may be allocated directly to

borrowers. At its core, the process of financial intermediation is about processing information

of one form or another. Indeed, in the traditional theory of financial intermediation, financial

intermediaries exist only because of market imperfections, in particular, the asymmetry of

information between savers (sources of finds) and borrowers (users of funds). The theory

concedes that banks and other intermediaries add some value via diversification (i.e.

expanding the investment choices available to savers and the sources of credit for borrowers,

as well as the traditionally important role of management and diversification of risk) and by

transforming financial contracts and securities of one form (e.g. maturity, etc.), into another,

but concludes that intermediaries capitalize mostly on their possession of superior

information, OECD (2006).

In examining the financial intermediation process it is important to note that, because the

supply of credit is not inexhaustible, there will always be some borrowers whose demand for

credit is not satisfied, at least not in full or on terms they consider appropriate. That outcome

results from the normal operation of the credit allocation process.

Assessing higher interest charges and fees for borrowers considered to be risky is the norm in

commercial lending, but while interest charges and other fees and motoring address some

risks, they do not completely eliminate them and loan originators in some circumstances may

be inclined to restrict lending to address risks above a certain level, either by cutting back on

the amount of credit extended or by denying credit altogether for certain categories of

borrowers. In the competition for credit, borrowers whose credit risk is relatively easy to

assess have the advantage, while entities such as SMEs are more likely to have their requests

for funds denied. In fact, even in banking markets that are fully competitive and have no

major structural distortions, SMEs may well be at a considerable disadvantage in obtaining

financing compared with more established companies. Obviously, the possibility that large

numbers of small firms will be excluded from the credit market becomes even higher as

market imperfections gain is significance.

In reducing this difficulty, SMEs normally rely on informal credit sources such as private

money lenders, “susu” operators, credit from friends and relatives, family fund, accumulated

savings, rotating savings, credit associations and Non Governmental Organizations (NGOs).

Even though these schemes are accessible, they are not adequate for the substantial growth

and development of the SME sector.

2.5.1 Formal Sources of Funding for SMEs

According to Acquah (2001), the formal sources of financing mainly come in four (4) ways;

Automatic financing which comes in the form of trade credits and outstanding


ii.Short term, which includes short term bank loans, commercial papers and factorizing


Intermediate term, which come from medium term micro-loan facilities.

iv. Long term financing which may come from venture funds, sales of shares, bond and

retained earnings. Financial Institutions and SME Credits

In most jurisdictions, commercial banks as a group are the main source of external finance

for SMEs. However, there are number of rigidities of a macroeconomic, institutional and

regulatory nature that may bias the entire banking system against lending to SMEs.

Macroeconomic policies may lead to excess demand for available domestic savings, while

government policy may favour industrialization and/or import substitution, which effectively

gives large domestic firms privileged access to finance. The legal system may not provide

adequate protection for the rights of creditors and may be relatively inefficient in resolving

cases of delinquent payments and bankruptcy.

Additionally, the tax and regulatory framework may encourage firms to operate opaquely.

Furthermore, the financial market may not contain the necessary range of products and

services to meet the needs of SMEs.

The characteristics of the banking system in emerging markets frequently inhibit SME

lending. In many cases, many banks are state-owned. Histories of substandard lending may

leave many banks with weak balance sheets. Significant shares of total credit are often

allocated on the basis of government guarantees or under special programmes to support

targeted sectors. Banks may also be subjected to interest rate ceilings that make it difficult to

price credit to SMEs in order to fully reflect the risk of lending to SMEs. In many countries,

the authorities have been reluctant to allow banks to fail and the banking system was

therefore supported by implicit or explicit government guarantees. Many banks may have

ownership and other ties to industrial interests and, thus, tend to favour affiliated companies:

If the banking system has possibilities to earn acceptable returns by lending to other

borrowers, it will not develop the skills needed to do SME lending. If the formal banking

system shows little inclination to lend to SMEs, there is little incentive for firms to produce

credible accounts and operate transparently.

On a global level, a model of market-based banking has gained acceptance under which

banks’ management and boards are accountable for achieving high returns to shareholders

and maintaining high prudential standards, OECD (2006). As this model is applied and as the

business environment becomes more competitive, banks have stronger incentives to find

means to overcome the difficulties in SME lending. However, many emerging markets have

been comparatively slow in implementing this model, which may be reflected in low

volumes in SME lending. Lending to the SME sector would still be, in any case, subject to

agency problems and the phenomenon of incomplete markets.

The fact that SMEs in many emerging markets do not have access to credit financing is

especially worrisome because SMEs typically employ a large share of the labour force and

account for a large part of national income.

By way of contrast, banks in the most advanced countries are adopting strategies to reduce

the risk of lending to SMEs. They are investing considerable resources in seeking to

overcome information asymmetry problems by using credit scoring models and other

sophisticated techniques to discriminate between high arid low-risk borrowers. These lending

mechanisms enable banks to identify businesses likely to survive and expand, and with which

it is worthwhile to develop a long-term relationship. Banks are also altering the nature of

their products. An increasing proportion of bank revenue now comes from fees for services,

which favours lending to entities such as SMEs. Venture Fund and Equity Financing of SMEs

Venture capital provides a link between the SME and institutional sources of capital.

By providing opportunities for certain investors to deploy their capital to innovative and high

growth sectors of the economy, venture capital can offer diversification to offset the risks in

other asset classes venture capital also holds the promise of higher absolute returns over

time in order to compensate for the lesser liquidity and transparency of venture capital


The venture capital firm, which is typically organized as a limited partnership, brings

together venture capitalists (the general partners), who are active specialists in the various

stages of the venture capital cycle, with the investors (the limited partners.) The partnership

has a definite life after which it terminates. The partnership will normally have a number of

investments at various points of the investment cycle. Revenues from exits will normally be

reinvested in new ventures.

The SME typically proceeds through several stages, from “seed” before production has

begun through “early stage” and through one or more “expansion” or “development” rounds.

The venture capitalist may participate at any stage of that process, although as noted above,

the trend is increasingly to invest later in the life cycle of the company. At the end of the

process, the venture capitalists aim to realize a return on the investment through “exit”. The

exit may take the form of a trade sale to a company that wishes to acquire the company as

part of a strategic business or through an IPO. The normal expectation is that the investment

will be liquidated within a defined time horizon.

InGhana, long term financing in terms of equity capital, needed by growth-oriented mainly

small and medium companies, is virtually non-existent for SMEs. Only two commercial

venture capital funds have been established inGhanaover the past 10 years, Mensah (2004).

In 1991, U.S. Agency for International Development (“USAID”) and the Commonwealth

Development Corporation (“CDC”) sponsored the formation of a venture capital fund in

Ghanain response to a perceived need for financial products and services designed to meet

the long-term financing requirements of growing businesses inGhanawithin the context of

Ghana’s financial sector reform program.

In the absence of a regulatory environment, the sponsors agreed to establish, a non-bank

finance institution to hold the funds – Ghana Venture Capital Fund (“GVCF”), and a

management company, Venture Fund Management Company (VFMC) to make investment


USAID provided a one million and ninety-four thousandUnited States’ dollars

(US$ 1,094,000) grant to underwrite the operational expenditures over a three year period

ending in 1994, while CDC’s two millionUnited States’ dollars (US$2,000,000)

commitment to GVCF was leveraged for an additional three million and eight hundred

thousandUnited States’ dollars (US$3,800,000) in invested capital from developmental

finance and local institutions. The combined investment capital thus became five million and

eight hundred thousand United States’ dollars (US$5,800,000). The GVCF became

operational in November 1992, and was fully invested with 13 investee companies. The

average investment was two hundred and fifty thousandUnited States’ dollars (US$250,000).

In addition to managing the GVFC, VFMC in 1995 was awarded the management of a four

millionUnited States’ dollars (US$4,000,000) Enterprise Fund, promoted by the European

Unionwhich is also fully invested with 18 direct investee companies and 12 indirect (through

leasing) investee companies. The average size of investment by the Enterprise Fund was one

hundred thousandUnited States’ dollars ($100,000).

Subsequent to the GVFC, a five millionUnited States’ dollars ($5,000,000) Fidelity Equity

Fund was established by a joint venture between Fidelity Discount House and FMO (The

Netherlands Development Finance Company). This fund is also fully invested with 10

investee companies, and managed by the Fidelity Investment Advisors. In the recent past,

there has also been a trend of foreign direct venture capital investment inGhanafrom pan-

African focused VCFs such as Modem Africa Growth Fund, the Commonwealth Africa

Investment Fund and the AfricanEnterpriseFund, Mensah (2004).

A number of institutional investors have also been active in providing directly without

formally setting up a venture capital fund. Notable among these are:

i. Social Security and National Insurance Trust (SSNIT)

ii. Development Finance Institutions notably the International Finance Corporation,

CDC Capital Partners

In general, all these efforts have so far been targeted at growth oriented large enterprises.

Although there appears to be a good number of potentially viable investments in the (upper)

small and medium sized segment, the risks and costs involved in managing shareholding in

SMEs have so far rendered those investments not interesting. Usually, lack of management

skills and inappropriate management systems cause much higher business failure risks for

SMEs than for large companies. To counterbalance these risks through increased

involvement into the day-to-day management of the firms results in high costs for the venture

fund that can hardly be recovered through the return of the comparatively small investments.

In addition to venture funds and private equity investments, the Ghana Stock Exchange is

potentially a viable option for SME equity financing. Established in 1990 with 9 listings, the

GSE now has 26 listed equities. The GSE has facilitated the participation of SME by

establishing three Official lists.

The criteria for admission to listing on the GSE are summarized in Table 1, and are such that

the largest and most profitable companies are on the First Official List, while medium sized

and small companies are on the Second and Third Official Lists, respectively.

Table 1: GSE Listing Requirements

First Official List Second Official List Third Official List

Stated Capital ?100 million ?50 million ?20 million

Minimum Public
?30 million ?15 million ?5 million
Share Offer

Public Share Float (%)25% of Total Issued Shares

Accounts 5 Years 3 Years1 Year (May be Waived)

Profitable on Profitable on Not necessary but company

Profitability aggregate during aggregate during must demonstrate potential

Previous 5 Years Previous 3 Years to be profitable

In 1999, Camelot Ghana Limited became the first and only company to utilize the Second

Official List to raise equity capital. The GSE has made a further effort to facilitate the entry

of SMEs to the exchange by creating the Provisional List, which allows companies to list

provisionally for six months during which they are guided by the GSE, with the support of

the Africa Project Development Facility and financial advisers to meet the requirements for

full listing.

Government support for equity financing for SMEs inGhanahas been limited. It has,

however, provided incentives for active participation of both issuers and investors on the

Ghana Stock Exchange in the following ways:

i. Capital gains on shares listed on the GSE are tax exempt till 2005

ii. Dividends are subject to a withholding and final tax of 10%

iii. Companies listed on the Ghana Stock Exchange enjoy a lower corporate tax rate.

Until 2003, this rate was 30% compared to the general corporate tax rate of 32.5%.

Effective 2004, companies listing on the GSE for the first time will enjoy a lower tax

rate of 25% (compared to a general 30% corporate tax rate) for the first three years of


There are indications that government will now actively participate in the provision of equity

financing of SMEs. In 2003, the Government announced its intention to support equity

financing for SMEs through the earmarking of 25% of the National Reconstruction Levy

over a three-year period for the establishment of a venture capital fund. We are informed that

the modalities for the operation of the venture capital fund will be announced in the course of

2004. Official SMEs Credit Schemes in Ghana

Official schemes are schemes introduced by government, either alone, or with the support of

donor agencies to increase the flow of financing to SMEs, Mensah (2004). Government has

in the past attempted to implement a number of such direct lending schemes to SMEs either

out of government funds or with funds contracted from donor agencies. These funds were

usually managed by the Aid and Debt Management Unit of the Ministry of Finance and

Economic Planning. Most of the on-lent facilities were obtained under specific programs

with bilateral organizations in support of the Government of Ghana’s Economic Recovery

Program and Structural Adjustment Program. Examples of such schemes are:

Austrian Import Support Program (AISP)(1990)
Japanese Non-Project Grants (1987-2000)
Canadian Structural Adjustment Fund and Support for Public Expenditure Reforms


In all cases, the funds were designed to assist importers. For example, under the Austrian

Import Support Program (AISP), the beneficiaries were to use the facility to procure

equipment, machinery, raw materials and related services fromAustria. The Export Finance

Company, a quasi-public institution was made the sole administrator of the facility. The

Japanese and Canadian facilities were similarly designed to support imports from the

respective countries. While these schemes were not specifically targeted to SMEs, there were

no restrictions with respect to minimum company size and many companies that would fit

the SME definition were beneficiaries. The results of the direct lending schemes operated by

government have been mixed. For example, under AISP, 20 companies of varying sizes

benefited from the scheme. Beneficiaries were given six years made up of a one-year

moratorium and a five-year repayment period.

Since the loans were disbursed in 1990, the borrowers should have completely liquidated

their loans by the end of 1996. However as at December 2001, only 1 out of 20 beneficiaries

had fully paid. The results for the Japanese and CIDA schemes were much more encouraging

from a recovery perspective because repayments were guaranteed by various financial

institutions, although the Government has had to hire 18 debt collectors to recover

outstanding indebtedness under both schemes.

In addition to donor-supported schemes for direct lending, government has attempted at

various times to operate lending schemes for SMEs. The schemes have included the


Business Assistance Fund: The Business Assistance Fund was operated in the 1990s

to provide direct government lending to the SME sector. The program was widely

seen to have been abused politically, with most of the loans going to perceives

government supporters.

GhanaInvestment Fund: In 2002, theGhanainvestment Fund Act (Act 616) was

passed to establish a fund to provide for the grant of credit facilities by designated

financial institutions to companies. However, the scheme was never implemented.
iii. Export Development and Investment Fund (EDIF): Under this scheme, companies

with export programs can borrow up to $500,000 over a five-year period at a

subsidized cedi interest rate of 15%. While the scheme is administered through banks,

the EDIF board maintains tight control, approving all the credit recommendations of

the participating banks. Guarantee Facilities

Section 13 of the Loans Act of 1970 (Act 335) empowers the Government of Ghana (G0G)

to provide government guarantee to any external financiers who wish to advance funds to any

Ghanaian organization and the terms of such facility require the provision of guarantee from

the Government. Guarantee facilities are contingent liabilities of the Government. The onus

for repaying the facility lies with the borrower and not the Government. The facility

crystallizes and becomes liability due from GoG if the borrower is unable to honour his/her

loan obligation and the Government is called upon to settle the facility as a guarantor. In that

case the borrower is required to subsequently reimburse the Government for the amount


Although GoG in exercise of the relevant provisions in the Loans Act, has provided

guarantees to a number of’ bilateral and multilateral organizations in the past on behalf of

selected Ghanaian organizations in both the private and public sectors of the economy, no

targeted SME guarantee facilities has been introduced. A Loan Guarantee Scheme was

announced by the Ministry of trade and Industries in 2001 but was not implemented.

Currently, the only government-supported loan guarantee scheme in operation is operated by

Eximguaranty Company, which is majority-owned by the Bank of Ghana. However, the

company’s operations are limited by the size of its guarantee fund. Although GH?10 billion was

voted in the 2004 budget to augment the guarantee fund, it is small relative to the needs of

the SME sector. Direct Interventions from Development Partners

Many donor activities concentrate on various credit schemes through both commercial banks

and micro-finance institutions, and also on strengthening of micro, small and medium-scale

enterprises through training and business support services. Table 2 presents a list of projects

by the various development partners.

Table 2. Donor activities in the area of supporting SMEs


CIDA Private Sector Development Support

DANIDA Private Sector Programme

DANIDA Business Sector Development

GTZ Promotion of Private Sector

GTZ Promotion of Small and MicroEnterprise

GTZ Rural Financial Services Project

IFAD/AFD RuralEnterpriseProject

IFC African Project Development Facility

UNDP African Management Services Company

UNDP EMPRETECGhanaFoundation

UNDPMicro StartGhanaProgramme

UNDP Promoting Private Sector Development

UNIDO Strengthening competitiveness of MSMEs

USAID MicroEnterpriseDevelopment Assistance

USAID Trade and Investment Programme

WB Non-Bank Financial Institutions Assistance

Perhaps, as a result of the unpleasant experience of direct lending by government in the

recent past, more recent donor interventions in SME finance have used exiting financial

institutions to channel funds to SMEs. Table 1 provides a summary of available credit

facilities for SMEs inGhana. A number of lending programs are undertaken as partnerships

between government and donors are listed such as:

Trade and Investment Program (TIP), operated by USAID and the Ministry of


Private Enterprise and Export Development Fund (PEED) managed by Bank of

Ghanabut administered through banks.

Increasingly, however, donors have implemented lending programs directly with financial

institutions. Examples of such schemes are:

i. Small Business Loan Portfolio Guarantee (USAID)

ii. European Investment Bank Facility

iii. Care-Technoserve Fund for Small Scale Enterprises


v. GTZ Fund for the Promot

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The Importance of SMEs in Ghana’s Economy. (2019, Mar 28). Retrieved from

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