How dose EBRD support for small and medium-sized business enterprise
Roby
Research Paper Supervisor: Dr. Sekou Conde
Minz Minzhu University of China 2006-2007 Academic Year
Ab
AbAbstract: Small and medium-sized enterprise is the most active section in business circle. But SMEs are harder to survival due to financing constraint. This paper simply explains how EBRD provided financing for SMEs, and by doing this, give some advises to Chinese SME’s financing.
KeKey Words : small and medium-sized business enterprise; finance support
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1. What is the EBRD
The European Bank for Reconstruction and Development was established in 1991 when communism was crumbling in central and eastern Europe and ex-soviet countries needed support to nurture a new private sector in a democratic environment. Today the EBRD uses the tools of investment to help build market economies and democracies in countries from central Europe to central Asia.
The EBRD is the largest single investor in the region and mobilizes significant foreign direct investment beyond its own financing. It is owned by 61 countries and two intergovernmental institutions. But despite its public sector shareholders, it invests mainly in private enterprises, usually together with commercial partners.
It provides project financing for banks, industries and businesses, both new ventures and investments in existing companies. It also works with publicly owned companies, to support privatization, restructuring state-owned firms and improvement of municipal services. The Bank uses its close relationship with governments in the region to promote policies that will bolster the business environment.
The mandate of the EBRD stipulates that it must only work in countries that are committed to democratic principles. Respect for the environment is part of the strong corporate governance attached to all EBRD investments.
2. EBRD’s principles
Every EBRD investment must
??span style="font: 7pt 'Times New Roman'"> Help move a country closer to a full market economy: the transition impact
??span style="font: 7pt 'Times New Roman'"> Take risk that supports private investors and does not crowd them out
??span style="font: 7pt 'Times New Roman'"> Apply sound banking principles
Through its investments, the EBRD promotes
??span style="font: 7pt 'Times New Roman'"> Structural and sectoral reforms
??span style="font: 7pt 'Times New Roman'"> Competition, privatization and entrepreneurship
??span style="font: 7pt 'Times New Roman'"> Stronger financial institutions and legal systems
??span style="font: 7pt 'Times New Roman'"> Infrastructure development needed to support the private sector
??span style="font: 7pt 'Times New Roman'"> Adoption of strong corporate governance, including environmental sensitivity
Functioning as a catalyst of change, the EBRD
??span style="font: 7pt 'Times New Roman'"> Promotes co-financing and foreign direct investment
??span style="font: 7pt 'Times New Roman'"> Mobilizes domestic capital
??span style="font: 7pt 'Times New Roman'"> Provides technical assistance
3. SMEs’s problems
According to the survey of the World Bank and the EBRD, lack of financing is the top three most important obstacles of SMEs in transition countries. This can be attributed mostly to the fact that transition economies are characterized by underdeveloped capital markets, in which access to credit is based on historically determined working practices and networks that closely link state banks with state and other large enterprises. So, gaining support form banks are difficulty to SMEs, particular in transition countries. Obstacles include limited access to working capital and long-term credit, legal and regulatory restrictions, inadequate infrastructure, high transaction costs, and limited managerial and technical expertise.
?‘ What does the EBRD can do for SMEs
1. EBRD’s special task
This is where the multilateral development banks (MDBs) can help the most. These financial institutions, however, are generally not well suited to providing direct support to the SME sector, partly because of their mandate and partly because of the financial instruments at their disposal. The World Bank (IBRD) lends to the public sector or under sovereign guarantee. The International Financial Corporation (IFC), on the other hand, lends to the private sector and has been active in a variety of domains (venture capital, bank credit lines, leasing). The European Investment Bank’s (EIB) principal activity has been to provide finance within the European Union and central Europe. Its financing of SMEs reflects the Union’s policy priorities in favour of that sector. The EIB offers a single, albeit flexible, instrument, the “global loan” (a form of wholesale approach) under sovereign guarantee.16 Size of sub-loans ranges from ECU 28,000 to ECU 23 million. The grant component in these loans is high and it subsidises inter alia the cost of capital.
At the time of its creation, one of the features that distinguished the EBRD from the World Bank and the EIB(European Investment Bank) was its mandate to support the private sector, which in the region consists mainly of SMEs. Its mandate allows it to focus on corporate governance and effective restructuring of the enterprises in which it invests. Moreover, small businesses are important to EBRD, not only because of the presumed high returns on the Bank's assets which they could bring, but also because the attention to SMEs meshed comfortably with the new bank’s special commitment to democracy. Support for SMEs is also a recurrent theme on the agenda of the Annual Meetings of the EBRD.
Direct investments generally range from €5 million to €230 million. Smaller projects are financed both directly by the EBRD and through financial intermediaries. By supporting local commercial banks, micro-business banks, equity funds and leasing facilities, the EBRD has helped finance over 1 million smaller projects. The EBRD provides loan and equity finance, guarantees, leasing facilities and trade finance. The Bank also finances professional development through support programs.
2. EBRD’s two ways of financing
There are two ways which EBRD finance for SMEs: direct financing and financing through intermediaries. The fundamental principles on which EBRD policy is based are: a preference for reaching SMEs via local financial intermediaries; a commercial approach to the provision of finance; and lastly a focus on development of the local financial system as a whole. Financing provided to intermediaries is not necessarily always intended, nor guaranteed, to reach SMEs. It is, however, guaranteed to create the appropriate financing channels which are necessary to ease the SMEs’ liquidity constraint.
Resources from EBRD official webpage
According to the table above, direct financing on SME is €199million compared with financing thought intermediary’s 55.7€million.It is demonstrated that nearly 3/4 investment on SME is direct financing. It should also be noted that over time the focus on financial intermediary operations has been maintained by delivering more and smaller projects,20 thereby balancing efficiency and productivity with smaller exposures in the higher risk and less advanced transition economies.
3. EBRD’s policies on SME financing
The EBRD policy on SME financing is characterized by the following elements: institution building, commercial approach and financial system orientation.21 According to the first principle,22 financial sector projects should not be directly oriented to the provision of financial services to the target group,23 but rather to the development of financial institutions that can ease the liquidity constraints for the SME target group. This approach does not reflect a neglect or doubt on the relative importance of the target group. It is in fact concerned with the creation of solid and stable financial institutions both able and geared to cater to any type of client, including SMEs, even after the program has run its course.
The “commercial approach” is based on the belief that, in the medium term, only an institution that can cover its costs can expect to survive. It can in fact be argued that if a small entrepreneur cannot count on his credit provider’s long-term survival, he will not make capital investments in assets that he will not be able to use because of lack of access to working capital. The essential elements of this approach are that the institution tries to keep its costs low and that it is able, willing and permitted to charge interest rates and fees commensurate to its total costs.
The financial systems orientation consists in focusing on the entire financial system of the
specific country for two reasons. First, the demand for financial services that SMEs may have should be satisfied by some element of the financial system, which does not need to be a specific one, tied to a specific project. Second, in order to provide financial services on a long-term basis, the provider of such services needs to be able to survive in the competitive environment represented by the respective country’s financial system.
It is worth examining the various solutions that the EBRD has investigated over the past several years. The Bank has gained substantial experience in this field by applying several instruments (as well as combinations of instruments) to address the gaps and needs previously identified. The bulk of its intervention in this field is geared to providing loan and equity finance to local SMEs and strengthening the local financial sector.
During the past five years the EBRD has developed a wide range of tools to provide capital to the private sector. Experience has shown that some tools are more successful than others, and that the choice of the right instrument is strongly related to the stage of transition and economic development of each country. The main forms of EBRD support for the private sector through financial intermediaries are:
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