SMEs in corrupt countries discouraged from applying for business loans

A new paper from King’s Business School has found that SMEs without government connections in corrupt and developing countries are more likely to be discouraged from approaching banks for a loan. This is in comparison to SMEs with government connections and the ‘insider-knowledge’ necessary to confidently navigate the often complex loan application process. 

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 around the world and has found that superior know-how and familiarity with the systems give SMEs with connections to the government more confidence in seeking external bank financing. 

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 are substitutes for poorly functioning formal institutions.

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Duc Duy Nguyen is an Associate Professor of Finance at King’s Business School and who led the research said: “It is a common perception that SMEs face financial constraints because they got rejected when applying for loans. In fact, the majority of SMEs become financially constrained because they are discouraged from seeking external financing in the first instance.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”. 

The analyses further reveal 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 characterised by a high degree of corruption, meaning that individuals and businesses are less likely to have their legal rights protected and have less confidence in the legal and financial systems.