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New Approaches to SME and Entrepreneurship Financing

Broadening the Range of Instruments

Bank lending is the most common source of external finance for many SMEs and entrepreneurs, which are often heavily reliant on traditional debt to fulfill their start-up, cash flow, and investment needs. While it is commonly used by small businesses, however, traditional bank finance poses challenges to SMEs, in particular to newer, innovative, and fast-growing companies, with a higher risk-return profile.

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Capital gaps also exist for companies undertaking important transitions in their activities, such as ownership and control changes, as well as for SMEs seeking to deleverage and improve their capital structures. The long-standing need to strengthen capital structures and decrease dependence on borrowing has become more urgent, as many firms were obliged to increase leverage in order to survive the recent economic and financial crisis.

Indeed, the problem of SME over-leveraging may have been exacerbated by policy responses to the crisis, which tended to focus on mechanisms that enabled firms to increase their debt (e.g. direct lending, loan guarantees). At the same time, banks in many OECD countries have been contracting their balance sheets in order to meet more rigorous prudential rules.

While bank financing will continue to be crucial for the SME sector, there is a broad concern that credit constraints will simply become “the new normal” for SMEs and entrepreneurs. It is, therefore, necessary to broaden the range of financing instruments available to SMEs and entrepreneurs, in order to enable them to continue to play their role in investment, growth, innovation, and employment.