A framework for financing small and medium enterprises in the service sector : a case for Ghana

Abstract

The small and medium enterprises (SMEs) in the services sector form the majority of businesses in Ghana and contribute significantly to the growth of the country’s economy in terms of employment and Gross Domestic Product (GDP). SMEs across all sectors face diverse challenges, and access to finance has been identified as a primary challenge. Financial inclusion is easy access to and use of formal financial services, including credit sources for personal and business borrowings. However, Ghana lags in achieving full financial inclusion of businesses, and the majority of businesses experience voluntary and involuntary exclusion from financial services. Despite diverse approaches, such as government interventions and frameworks to promote financial inclusion to bridge the financial gap of SMEs, this challenge persists. The literature on SMEs in Ghana has not explored a sector-specific approach involving key stakeholders to improve the financial inclusion for SMEs in the form of access to financial services and credit. Therefore, this study focused on service sector SMEs’ financial inclusion by investigating the challenges of access to finance and using the outcomes to develop a framework for the financial inclusion of this group of businesses. The study used an exploratory sequential mixed-method design where seven financial institutions were first interviewed on their SME lending decisions. Subsequently, the study surveyed 663 SMEs in the services sector to understand what influences their access to finance. The study revealed that, in assessing SMEs for financing, financial institutions are guided by their credit policies inclined towards larger businesses, therefore placing a disadvantage on the SME loan applicant. The financial institutions, in the process of making lending decisions, assess the character of the SME owner or manager and review the financial records and collateral availability. The findings further revealed that although financial institutions are challenged in the lending process, they find SMEs valuable to their business. Therefore, they use alternative approaches such as tie lending to receivables, using lending schemes, use of grants where available, using loan insurance cover to protect the lending, bringing mobile banking to the doorstep of the SME client, and forming startup clubs to groom SMEs before lending to them. In addition, to overcome the lending challenges financial institutions face, they deepen their relationships with SME clients, reducing the information asymmetry challenges and making it easier to lend to them. Banks further develop basic financial information for the SMEs who need financial information and improve due diligence and monitoring of loans granted to SMEs to ensure repayment. The quantitative results indicated that, although most SMEs own bank accounts which is a requirement in the loan application process and an indication of financial inclusion, only a third apply for loans. Surprisingly, most of those who apply for loans get access to credit. However, the financing gap persists because less than a third of the SMEs were included in the credit dimension of financial inclusion. Using binary logistic regression analysis, the study found a firm’s balance sheet, cash flow projections and income statement were statistically significant in determining the access to finance or the usage dimension of SMEs' financial inclusion. The influence of SME owner/manager characteristics and collateral was insignificant in determining their access to finance, although the qualitative finding revealed otherwise. The SMEs would prefer to use angel investors and venture capital as alternative means of financing for their businesses, which will further improve their financial inclusion. The main contribution of this study to the literature on SME financing is the development of a financial inclusion framework for service sector SMEs in Ghana based on the outcome of the mixed methods study. The framework proposes solutions for the three key stakeholders, namely, banks, SMEs and government policymakers, to implement for SMEs' financial inclusion. For financial inclusion in both the dimension of access and usage, SMEs should formalize their business, improve their competence level, avoid the diversion of funds, maintain consistency, ensure a succession plan, and maintain financial information. Government in the financial inclusion strategy, should reduce SME taxes, ban import of inferior goods, institute policies to formalize all businesses, ease land registration process, access to credit policies, and provide stable economy for SMEs to thrive. Further studies on other sectors of the economy should be done to compare with the services sector.