New study shows barriers to financing for MSMEs in developing and emerging countries | Finance Watch

New study shows barriers to financing for MSMEs in developing and emerging countries

Finance Watch and the Green Economy Coalition propose eight evidence-based recommendations to address key challenges and help MSMEs contribute to the sustainable transition.

  • This report is based on information collected by environmental organisations and think tanks on the ground in seven developing and emerging countries, namely India, South Africa, Peru, Trinidad and Tobago, Senegal, Uganda and Mongolia.
  • It finds that informality, while playing an important role in sheltering people from extreme poverty, must be taken into account by policymakers as it can limit the performance and growth of MSMEs and act as a significant barrier to financing in developing and emerging countries.
  • Another struggle facing MSMEs is the mismatch between collateral requirements of financial institutions and types of assets MSMEs are able to pledge. MSMEs´ main assets, such as machines and equipment, are generally not accepted as collateral by financial institutions, which effectively blocks MSMEs from accessing formal sources of funding. Reforming collateral laws could help ensure MSMEs can pledge these movable assets as collateral, unlocking funding.
  • Finance Watch and the Green Economy Coalition put forward eight key recommendations for policymakers in the countries analysed, as well as international finance providers, in this report to address the difficulties MSMEs have in accessing formal finance.

A new report by Finance Watch, the pan-European NGO dedicated to making finance serve society, and the Green Economy Coalition, the world’s largest alliance for green and fair economies, reveals that Micro, Small and Medium Enterprises (MSMEs) in developing and emerging countries struggle to access the formal financing they need to make their business more sustainable. To achieve our global climate and environmental goals, MSMEs in developing and emerging economies need to be included in the sustainable transition.

MSMEs are the backbone of developing and emerging countries. Existing data shows their share of GDP varies from 20% (Uganda) to 65% (Trinidad & Tobago), and that they account for between 23.5% (India) to 90% (Uganda) of employment. MSMEs in developing and emerging countries have great potential to conduct sustainable activities and contribute to global climate change mitigation and adaptation efforts, but often lack supportive legislation and face other barriers in funding access.

To better understand the challenges facing MSMEs, this report leverages evidence collected by Green Economy Coalition members across seven emerging and developing countries. Environmental organisations and think tanks on the ground in India, South Africa, Peru, Trinidad and Tobago, Senegal, Uganda and Mongolia gathered data, conducted interviews, carried out research, produced national reports and organised dialogues with local policymakers.

Finance Watch then consolidated and analysed this information, complementing it with existing literature, to develop recommendations for policymakers to address the challenges that can prevent MSMEs in these countries from becoming part of the sustainable transition. The country-specific context for each is accounted for, with policy recommendations tailored accordingly.

A key finding across the economies analysed for this study is that informality acts as a major barrier to financing for MSMEs. The informal economy refers to unrecorded activities with market value which do not enter the official GDP statistics and do not contribute to tax revenue. In India for example, out of a total of 55.8 million MSMEs, 47.6 million are unregistered according to existing research. Although an informal economy shelters a significant part of the population from extreme poverty and unemployment, for enterprises it often proves detrimental for accessing formal finance.

In developing and emerging countries, the informal economy is closely connected to the state of the environment. Those dependent on natural resources to support their informal businesses, like fishermen or farmers, are particularly vulnerable to the impact of climate change, pollution and worsening environmental conditions, which exacerbates the poverty cycle. To create more sustainable and resilient economies in the countries identified in this report, Finance Watch and the Green Economy Coalition urge national governments to include the informal sector when designing green economic strategies.

Linked with the challenge of informality is the high and inappropriate collateral requirements of financial institutions in the countries analysed in this study. A lack of appropriate collateral blocks MSMEs from accessing formal sources of funding. Movable assets, such as machinery or equipment, represent 78% of MSMEs’ capital stock according to past research. But financial institutions require immovable assets as collateral, for example land and buildings.

As a result, MSMEs often rely on informal sources of financing, including from family and friends, that require no collateral. This is limiting, as access to finance will depend on the depth of a person’s network, not the strength of their project. Others turn to informal moneylenders, which often use usurious interest rates and unregulated aggressive debt collection practices.

This report recommends creating conditions to allow MSMEs to pledge movable assets as collateral to increase their access to formal credit. Finance Watch encourages national policymakers to put in place a secure transaction framework that governs the creation, priority, and enforcement of pledges over all types of assets, including movable assets. Moreover, modern collateral registries that act as a centralised registration point for both fixed and movable assets with online public access, should also be set up where missing.

Other recommendations for national policymakers include ensuring green MSMEs have a clear legal status, and creating a robust, but simplified chain of ESG information, for example, by establishing green taxonomies to classify sustainable economic activities. Further, in countries where they are not in place, an MSME agency should be established to act as a “one stop shop”, increasing awareness of existing support, providing technical assistance and training, and making it easier for people to register their businesses. These proposals would help national policymakers to alleviate information asymmetry, another significant barrier to financing identified in this report.

While the eight recommendations are targeted at national policymakers, they are highly relevant for international donors, such as the EU and its Member States, who can support developing and emerging economies in overcoming barriers to financing for sustainable MSMEs.

Ludovic Suttor-Sorel, Research and Advocacy Officer at Finance Watch and lead author of the report said:

“If we hope to meet our global climate and environmental commitments, everyone has a part to play. Reaching our goal demands more than a “one-size fits all” solution, because a policy that supports a large business in Belgium on its sustainability journey is unlikely to be a feasible option to help a green microenterprise in Peru.

By analysing data from the ground across these seven countries, our aim was to create a set of policy proposals that work in the real world, and that will help green MSMEs in developing and emerging countries get access to the funds they need to grow, while also supporting MSMEs at the beginning of their sustainability journey to become part of the change.”

Ahead of the 27th United Nations Climate Change Conference (UNFCCC COP 27) and the 15th meeting of the Conference of the Parties to the Convention on Biological Diversity (CBD COP 15) later this year, Finance Watch and the Green Economy Coalition call on negotiators from the UNFCCC and the CBD to set up a joint green MSMEs financing facility capitalised by donor equity and supported by public guarantees. Such a facility would help development finance institutions take more risks by financing green MSMEs in developing countries. Making it easier for development finance institutions to take risks would unleash their potential to support MSMEs on their sustainability journey.

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Download the report: Financing Local Green Enterprises: Closing the funding gap for sustainable MSMEs in developing countries

Notes to Editors

Environmental organisations and think tanks involved in information gathering for this report included Foro Nacional Internacional and Libélula in Peru, Caribbean Natural Resources Institute in Trinidad and Tobago, Innovations Environnement Développement Afrique and the International Union for Conservation of Nature in Senegal, Advocates Coalition for Development and Environment in Uganda, Trade and Industrial Policy Strategies in South Africa, Economic Policy & Competitiveness Research Centre in Mongolia and Development Alternatives in India.

To arrange an interview with Ludovic Suttor-Sorel, Research and Advocacy Officer at Finance Watch, please contact Alison Burns at alison.burns@finance-watch.org or call on [+32471577233]

About GEC and Finance Watch

The Green Economy Coalition (GEC) is the world’s largest alliance for green and fair economies. We work with our partners around the world, united by the Principles of A Green Economy, to give citizens a voice, hold governments to account, and drive real economic change. GEC represents a range of sectors, NGOs, businesses, research institutes, UN organisations and trade unions. Although we are diverse, we are united by the same vision. We know that green economies are possible, necessary and desirable. www.greeneconomycoalition.org

Finance Watch is an independently funded public interest association dedicated to making finance work for the good of society. Its mission is to strengthen the voice of society in the reform of financial regulation by conducting advocacy and presenting public interest arguments to lawmakers and the public. Finance Watch’s members include consumer groups, housing associations, trade unions, NGOs, financial experts, academics and other civil society groups that collectively represent a large number of European citizens. Finance Watch’s founding principles state that finance is essential for society in bringing capital to productive use in a transparent and sustainable manner, but that the legitimate pursuit of private interests by the financial industry should not be conducted to the detriment of society.

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