Although credit discouragement is a worldwide phenomenon, it is particularly acute in developing economies since their financial systems are often plagued by severe corruption and weak contract enforcement rights. As a result, many small business owners do not have confidence in their country’s financial system, and believe that the costs of undergoing a corrupted loan application process would outweigh the benefits of receiving one. Our paper offers some of the first cross-country evidence and general implications for business practices in a global setting.Duc Duy Nguyen, Senior Lecturer in Finance at King’s Business School, led the research
15 October 2020
SMEs in corrupt countries discouraged from applying for business loans, new research finds
Better governance would reduce barriers to credit for businesses lacking government connections
SMEs in countries scoring high on corruption indices are more likely to be discouraged from approaching banks for a loan if they do not have government connections than those that do have government connections, finds new research from King’s Business School.
Lack of access to external financing is one of the most significant barriers to entrepreneurship in many countries around the world. The research sheds light on the economic mechanisms through which government connections affect SMEs’ credit access. The findings suggest that SMEs with government connections have superior ‘inside knowledge’ that gives them more confidence they will successfully navigate the often complex loan application process.
These findings have important implications for policies targeted at reducing corruption, improving access to financing facilitating entrepreneurship, and attracting foreign investment. They also suggest that government connections act as substitutes for poorly functioning formal institutions.
The analysis further reveals that it is equally important to direct policy efforts to make access to financing easier for SMEs. Increased policy efforts to improve the quality of governance and accountability would give firms – especially foreign firms – more confidence in the financial systems of their host country. This would in turn improve access to financing, facilitate entrepreneurship, and attract foreign investments.
The researchers used a sample of SMEs across 30 developing countries in Eastern Europe and Central Asia. Countries in this region are considered to have a high degree of corruption, according to the Transparency International Corruption Perceptions Index, meaning that individuals and businesses are less likely to have their legal rights protected and have less confidence in the legal and financial systems.