Small and Medium Scale Enterprises Financing In Ghana

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The Ghanaian Situation

There have been various definitions given for small-scale enterprises in Ghana but the most commonly used criterion is the number of employees of the enterprise (Kayanula and Quartey, 2000). In applying this definition, confusion often arises in respect of the arbitrariness and cut off points used by the various official sources. In its Industrial Statistics, the Ghana Statistical Service (GSS) considers firms with fewer than 10 employees as small-scale enterprises and their counterparts with more than 10 employees as medium and large-sized enterprises. Ironically, the GSS in its national accounts considered companies with up to 9 employees as SMEs (Kayanula and Quartey, 2000).
The value of fixed assets in the firm has also been used as an alternative criterion for defining SMEs. However, the National Board for Small Scale Industries (NBSSI) in Ghana applies both the International Research Journal of Finance and Economics – Issue 39 (2010) 221 “fixed asset and number of employees” criteria. It defines a small-scale enterprise as a firm with not more than 9 workers, and has plant and machinery (excluding land, buildings and vehicles) not exceeding 10 million Ghanaian cedis. The Ghana Enterprise Development Commission (GEDC), on the other hand, uses a 10 million Ghanaian cedis upper limit definition for plant and machinery. It is important to caution that the process of valuing fixed assets poses a problem. Secondly, the continuous depreciation of the local currency as against major trading currencies often makes such definitions outdated (Kayanula and Quartey, 2000).
In defining small-scale enterprises in Ghana, Steel and Webster (1991), and Osei et al (1993) used an employment cut-off point of 30 employees. Osei et al (1993), however, classified small-scale enterprises into three categories. These are: (i)Micro – employing less than 6 people; (ii) Very small – employing 6-9 people; (iii)Small – between 10 and 29 employees.
A more recent definition is the one given by the Regional Project on Enterprise Development Ghana manufacturing survey paper. The survey report classified firms into:
x Micro enterprise, less than 5 employees.
x Small enterprise, 5 – 29 employees.
x Medium enterprise, 30 – 99 employees.
x Large enterprise, 100 and more employees (see Teal, 2002).
In this study, SMEs were defined in terms of the number of employees instead in terms of both asset base and the number of employees. This was done because it was not possible to obtain information about the asset base of the SMEs before sampling decision could be made. As a result, in this study, SMEs were defined as firms with less 99 employees. This definition is consistent with the definitions provided by Ghana’s National Board for Small Scale Industries, UNIDO, and EC.

Small and Medium Scale Enterprises Financing In Ghana

The SMEs often complain that their growth and competitiveness are constrained by a lack of access to financing and the high cost of credit. Recent events in Latin America and East Asia lend credence to the argument that SMEs are more likely than larger firms to be denied new loans during a financial crisis (World Bank, 2000). In Ghana, because competition in the banking sector is limited, banks have not been under pressure to improve their lending to smaller clients. In addition, SMEs access to the formal financial sector is constrained by the high risks and transactions costs, real or perceived, associated with commercial lending to that segment of the market. Lenders are faced with a lack of reliable information on borrowers, difficulties in enforcing contracts (the result of inadequate legal frameworks and inefficient court systems), and the lack of appropriate instruments for managing risk (Hallberg, 1999). Often, the problem is compounded by supervisory and capital adequacy requirements that penalize banks for lending to enterprises that lack traditional collateral.
In the traditional approach to SMEs development, governments have provided credit to SMEs through first-tier development banks, second-tier credit facilities channeled through banks and other financial institutions, and portfolio requirements on banks, often supplemented by credit guarantee schemes. Subsidized interest rates and guarantees were common in the past and continue to be used. In part, this reflects a presumption that the high cost of credit is the main constraint facing SMEs, even though there is evidence that SMEs care more about access to credit than its cost (Sakai and Takada, 2000). The traditional approach of subsidized credit also may have been a reflection of the importance of state owned banks in Ghanaian financial markets.
Direct and subsidized credit programs have done little to achieve what should be their fundamental objective, which is, increasing the access of small enterprises to financial services. Instead, they inhibit the development of sustainable financial institutions and often foster a « non-repayment culture » among enterprises. Low rates of loan recovery push ex-post subsidies even higher than those intended in credit programs. Credit subsidies also create distortions in financial markets, since they discourage firms from using non-credit forms of financing. The traditional approach has failed to deal with the fundamental problems that raise the cost of credit and make banks reluctant to serve SMEs; the high risks and transaction costs (real or perceived) associated with commercial lending to the small scale segment of the market (Sacerdoti, 2005).
A market-oriented strategy for improving SMEs access to financing focuses on reducing the risks and transactions costs associated with this segment of the markets, strengthening the capacity of financial institutions to serve smaller clients, and increasing competitive pressure in financial markets. The aim is to increase the number of financial institutions that find lending to SMEs to be profitable, and therefore sustainable. Elements of this strategy would include:
x Reducing barriers to entry, for example, by reconsidering capital adequacy requirements and prudential regulations that may be inappropriate for financial institutions serving smaller clients.
x Reducing the risks associated with lending to small businesses, focusing on laws governing the enforcement of contract, forfeiture and collection of collateral, and the use of movable assets as collateral.
x Developing the policy, legal, and regulatory frameworks that are essential to the development of innovative financial institutions and instruments, including venture capital, small equity investments, and leasing.
x Promoting innovation in specialized lending technologies that reduce the administrative costs associated with credit application, monitoring, and payment.
x Strengthening the capacity of financial institutions to evaluate SME creditworthiness in a cost-effective manner, for example, through the use of credit scoring techniques.
x Providing information on the credit worthiness of potential borrowers, through the establishment of credit bureaus, and ways to help SMEs prepare business plans and financial projections.
Okraku and Croffie (1997) argued that in Ghana SMEs rely primarily on personal savings of owners, business profits, family members or friends for their financial needs. They have little or no access to external credit. The effect of this is inadequate fixed capital as well as working capital. The consequences of these are very slow growth rate and frequent failures among small businesses. At the regulation level, the problems identified are high interest rates charged by banks thus making bank borrowing very expensive. The lending rates at Ghana are as high as 40 percent. At the institutional level, banks were not motivated enough to lend to small business enterprises. The size of loanable funds available for lending to the sector is also small. Banks insist on tangible collateral as security as well as owner’s equity for loans. At the enterprise level, SMEs are unable to mobilize owner’s equity to satisfy banks requirement for loan, inability to provide acceptable collateral security to support loan and the lack of banking culture and practices.
Evaluating the impact of intervention on SME performance can benefit from the use of a logical framework that clearly defines the program’s objective and links activities and inputs to outcomes and impact. However, many of the often repeated justifications for the scale-based enterprise support have little empirical evidence. But whether their actions are based on myth or reality, government in both developing and industrialized countries do intervene to promote SMEs. Their SMEs assistance strategies often try to achieve a combination of equity objectives (alleviating poverty, and addressing social, ethnic, and gender inequalities); and efficiency objectives (raising the productivity and profitability of the business or firms). The confusion created by multiple objectives often leads government to over subsidize services that could be provided by the market (Hallberg, 1999). Added that direct provision of credit and non-financial assistance to SMEs tend to substitute for markets rather than dealing with the underlying causes of market underdevelopment. Consequently, the supports for SMEs through the development of markets for financial and non-financial services are only successful if their market-development effects outweigh their market-distortion effects. In turn, this depends upon whether the support resolves the underlying problems that constrain market development. This underscores the need to begin with a good understanding of the structure and performance of existing markets and to build upon institutions and inter-firm or business networks that are already in place.

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According to the Ghana’s 2000 Population and Housing Census, 80% of the working population is found in the private informal sector. This group is characterized by lack of access to credit, which constrains the development and growth of that sector of the economy. Clearly, access to financial services is imperative for the development of the informal sector and also helps to mop up excess liquidity through savings that can be made available as investment capital for national development.
The former UN Secretary General Kofi Annan during the launch of the International Year of Micro Credit (2005) said, “…Sustainable access to microfinance helps alleviate poverty by generating income, creating jobs, allowing children to go to school, enabling families to obtain health care, and empowering people to make the choices that best serve their needs.” (Kofi Annan, December 2003).
Micro credit is thus one of the critical dimensions of the broad range of financial tools for the poor, and its increasing role in development has emanated from a number of key factors that include; The fact that the poor need access to productive resources, with financial services being a key resource, if they are to be able to improve their conditions of life; The realization that the poor have the capacity to use loans effectively for income-generation, to save and re-pay loans.
According to Simanowitz and Brody (2004, p.1), micro-credit is a key strategy in reaching the MDGs and in building global financial systems that meet the needs of the most poor people.” Littlefield, Murduch and Hashemi (2003) state, “…micro-credit is a critical contextual factor with strong impact on the achievements of the MDGs. Micro-credit is unique among development interventions: it can deliver social benefits on an ongoing, permanent basis and on a large scale”. However, some schools of thought remain skeptical about the role of micro-credit in development. For example, while acknowledging the role micro-credit can play in helping to reduce poverty, Hulme and Mosley (1996) concluded from their research on micro-credit that “…most contemporary schemes are less effective than they might be” (1996, p.134). The authors contended that micro-credit is not a panacea for poverty-alleviation and that in some cases the poorest people have been made worse-off.
This notwithstanding, microfinance has emerged globally as a leading and effective strategy for poverty reduction with the potential for far-reaching impact in transforming the lives of poor people. It is argued that microfinance can facilitate the achievement of the Millennium Development Goals (MDGs) as well as National Policies that target poverty reduction, empowering women, assisting vulnerable groups, and improving standards of living as could be infer from Kofi Annan’s speech above.
Access to finance remained a dominant constraint to small scale enterprises in Ghana. Credit constraints pertaining to working capital and raw materials were cited by respondents in a survey conducted by Parker (Parker et al, 1995). Aryeetey et al. (1994) reported that 38% of the SMEs surveyed mentioned credit as a constraint. This stems from the fact that SMEs have limited access to capital markets, locally and internationally, in part because of the perception of higher risk, informational barriers, and the higher costs of intermediation for smaller firms. As a result, SMEs often cannot obtain long-term finance in the form of debt and equity.

Needs of SMES in Ghana

A number of studies have been carried out to identify the needs of SMEs in Ghana. Notable among is the one by Tweneboa-Boateng (2008). According to Tweneboa-Boateng (2008), the major needs of SMEs include lack of enabling environment (political instability, micro-economic instability, and poor physical infrastructure), lack of entrepreneurial skills, and lack of access to finance.
Similarly, Mensah (2004), in exploring the SMEs financing schemes in Ghana, has suggested that various schemes exist for financing SMEs operations. According to him, there are many who believe that the single most important factor constraining the growth of the SMEs sector is the lack of finance. There are many factors that can be adduced for this lack of finance:
x A relatively undeveloped financial sector with low levels of intermediation.
x Lack of institutional and legal structures that facilitate the management of SME lending risk.
x High cost of borrowing and rigidities interest rates.
Because of the persistent financing gap, many interventions have been launched by governments and development partners to stimulate the flow of financing to SMEs over and above what is available from exiting private sector financial institutions. Existing SMEs financing interventions can be classified under:
x Official Schemes.
x Financing provided by financial institutions.
Official schemes are schemes introduced by government, either alone, or with the support of donor agencies to increase the flow of financing to SMEs (Mensah, 2004). Government has in the past attempted to implement a number of such direct lending schemes to SMEs either out of government funds or with funds contracted from donor agencies. These funds were usually managed by the Aid and Debt Management Unit of the Ministry of Finance and Economic Planning. Most of the on-lent facilities were obtained under specific programs with bilateral organizations in support of the Government of Ghana’s Economic Recovery Program and Structural Adjustment Program. Examples of such schemes are:
x Austrian Import Program (1990).
x Japanese Non-Project Grants (1987-2000).
x Canadian Structural Adjustment Fund and Support for Public Expenditure Reforms (SPER).

Table of contents :

1.1 A General Overview of the SMES Sector in Ghana
1.2 Research Questions
1.3 Research Objective
1.4 Research Methods
1.5 Delimitations of the Study
1.6 Significance of Study
1.7 Structure of the Project Work
2.1 The Ghanaian Situation
2.2 Small and Medium Scale Enterprises Financing In Ghana
2.3 Microcredit
2.4 Needs of SMES in Ghana
2.5 Financial System in Ghana
2.5.1 Ghana’s Financial System: Pre- Reform Era
2.5.2 Ghana’s Financial System: Reform Era
2.6 Interest Rates
2.7 Demands for Credit
2.8 Loan Repayment
2.9 Access to Finance SMES
3.1 Design of the Study
3.2 Population
3.3 Sampling
3.4 Data Collection
3.5 Procedure for the Analysis
4.1 Company Profile
4.2 Situation of the Firm
4.3 Financing of SMEs
4.4 Future Growth and Obstacles to Growth
4.5 Interview with a Credit Officer
5.1 Summary
5.2 Conclusions
5.2.1 Alternative sources of raising capital for SME’s in Ghana
5.2.2 Accessibility to alternative financial gaps
5.3 Recommendations


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