Until more is done to facilitate access to credit for Latin American SMEs, their role as drivers of the region’s burgeoning economy could be under threat. Eleanor Wragg reports.


Once a byword for economic turbulence, Latin America now experiences growth rates that are the envy of other, wealthier regions, mostly driven by its millions of small and medium enterprises (SMEs). But a combination of factors – from local banks’ lack of liquidity to a higher perceived risk of lending to the sector – has led to a sizeable financing gap for SMEs in the region, which could put the brakes on its continued development.

Across Latin America, as in other regions of the world, SMEs play an important role in creating jobs, fostering economic growth and social stability, and contributing to the development of a dynamic private sector.

In Chile, 99% of all enterprises are SMEs, employing 57% of the workforce; while out of Brazil’s over 5 million businesses, SMEs account for 98% of the total and produce 20% of GDP. In Mexico meanwhile, SMEs contribute a whopping 35% of GDP.

Unfortunately, progress has been slower on tackling the obstacles facing SMEs as they attempt to obtain credit.

“As a rule, transaction costs remain high across the region and are a deterrent for banks. Governments in some countries have tried to encourage banks to invest in SMEs by providing subsidies to mitigate transaction costs, or by providing guarantees for SMEs requesting credit from banks,” says Katie Micklethwaite, Americas analyst for Control Risks. In Chile, for example, the Economic Development Agency (CORFO) encourages entrepreneurs to apply for credit at a select number of banks, and acts as a guarantor to facilitate SMEs’ access to credit.

Another issue for SMEs is red tape. In Brazil, for example, it takes on average 120 days and 15 procedures to start a business, 411 days and 18 procedures to gain a construction permit, and 2,600 hours a year to file taxes – not attractive figures for any potential investor.

That said, a recent simplification of the tax system has incentivised more businesses to move from the grey market to the official fiscal system, resulting in stronger governance structures and better, more sustainable businesses. “SMEs have cited a number of obstacles to their efforts to export goods and expand their businesses globally, including reliability of overseas suppliers, customs delays, and taxes placed on imports and exports,” explains Micklethwaite.

Financing woes

Mostly commodity and agricultural producers, these businesses have a raft of opportunities for foreign trade, both within and outside of the region, given the stack of trade agreements with countries as far-flung as South Korea, the UK and Australia. According to the latest edition of the UPS Business Monitor Latin America, 60% of the region’s SMEs are currently engaged in international trade or have plans to do so. However, access to financing – or the lack thereof – is a serious issue.

“SMEs face a variety of barriers that prevent their growth, but most SMEs rate access to finance as the main obstacle,” said president of the Inter-American Development Bank (IADB) Luis Alberto Moreno, speaking during the inauguration of the 15th Inter-American forum on microenterprise
in early October.

Adding to this dilemma, some banks that used to focus more heavily on SMEs are now choosing to diversify in order to mitigate risk. “Our strategy in recent years has been a downsizing of the loan portfolio,” says Ronald Gutiérrez, general manager of Bolivia’s Banco Ganadero, although he highlights that SMEs still make up 31.5% of the bank’s loan portfolio.

“This diversification has been gradual and important in terms of profitability and reduction of credit risk. In the past, Banco Ganadero has been very dependent on corporate and short-term loans, and fierce competition in the latter has led to an important reduction of margins.”

“Some local Latin American banks have backed off borrowing for trade finance purposes,” says Antonio Alves, principal regional head of short-term finance at the IFC, adding that Latin American SME importers and exporters are experiencing increases in pricing when it comes to securing financing from cash-strapped lenders.

Nevertheless, according to a survey carried out last year by the IADB and the Latin American Banking Federation (FELABAN), nearly 90% of banks in the region had an active lending policy towards SMEs, and 73% expected their SME portfolio to increase.

Banks are keen, therefore, to find innovative solutions to overcome hurdles in financing this key market.

“Pricing has increased dramatically during the eurozone crisis and to work around this, local banks in some Latin American countries are swapping local currency into dollars at an overall lower cost than borrowing dollars from another financial institution. The final cost in most cases is more competitive. This is not something that is only happening in larger economies such as Brazil and Mexico, it can also be a compelling strategy in countries such as Colombia, Argentina, Honduras and Guatemala among others,” says Alves.

But not all banks have this luxury, and a higher cost of trade finance restricts capital to SMEs, slowing the pulse of the economy.

“ECAs, multilaterals and development banks are working to develop solutions to address this head-on,” says Alves. “It really has become a priority.”

New schemes

Through its short-term finance department in Latin America the IFC is currently putting together SME finance-focused products that aim to produce the greatest impact possible on the development of the region’s private sector.

“One product that we are introducing in the region is the indirect pre-export finance to suppliers of exporters. Through this new product, the IFC will risk-share and finance, together with local financier partners, SME suppliers of large exporters in the region,” says Alves.

“This new product will provide not only better access to finance to SMEs, but also will help the SME segment with more flexible finance conditions, and therefore improving the cashflow management for SME suppliers.”

In addition, initiatives like the US$3bn global trade finance programme (GTFP), which extends the capacity of banks to deliver trade financing by providing risk mitigation in new or challenging markets where trade lines may be constrained, have helped local banks to reach clients they may not have been able to access otherwise.

New ways to screen SMEs

According to consulting firm McKinsey & Company, over 35% of Latin American SMEs do not have access to credit, and the existing financing gap amounts to between US$125bn and US$155bn.

“In part, this is the result of banks’ reservations about extending credit to first-time entrepreneurs in the absence of the kind of metrics, such as credit scores and past borrowing history, usually used to measure reliability,” explains Katie Micklethwaite, Americas analyst for Control Risks.
However, this is beginning to change owing to banks’ increased willingness to embrace innovative methods of screening entrepreneurs.

“We have changed our credit policies in the bank a lot over the last few years,” says Luiz Masagao Ribeiro, CEO of Brazil’s Banco Indusval, a midsize wholesale bank focused primarily on structured lending to SMEs.

“When we started lending to SMEs, we focused on collateral and guarantees, but within time this proved not to be the best policy. Today, we have more technical criteria. We look more at the underlying business to be able to provide funds to companies that have a really long-term perspective.”

Ribeiro notes that as a result, the bank has been able to increase its SME portfolio by 40% this year, and is aiming for comparable growth in 2013.

Since SMEs often lack traditional credit-worthiness measures such as extensive business plans, collateral or borrowing history, the use of psychometric assessment through a method devised by Harvard University’s Entrepreneurial Finance Lab Research Initiative (EFL-RI) has been adopted by a number of financial institutions across the region.

The tool applies psychometric principles to credit scoring, examining such dimensions as intelligence, business acumen, honesty and psychological profile to predict risk and future earnings potential.

In pilot tests over the last four years in seven countries, the tool was able to predict default as well as or better than credit scoring models used in developed countries with corporate clients.

This method of assessing the creditworthiness of applicants is now being routinely used as part of the screening process by a number of banks and other financing institutions across the region.

“The Inter-American Development Bank is actively involved in promoting the use of psychometric testing as a credit-scoring tool in other countries in the region, notably in Haiti, where access to finance is an extremely pressing issue facing the small and informal businesses which dominate the economy,” adds Micklethwaite at Control Risks.

Mexico’s BBVA-Bancomer and Colombia’s Bancolombia were joined in September in using the tool by Costa Rica’s Bancrédito, which sees such opportunity in SME financing that it has decided to change its business strategy altogether to focus on the sector.