This study investigates the apparentcontradiction between the high propensity of small- andmedium-sized enterprises (SMEs) to identify finance as theirprimary constraint and the view of banks that SME lendingremains low in part for lack of bankable demand. Surveyswere conducted of relatively successful microenterprises andSMEs to assess demand and sources of finance, and formal andinformal financial institutions were interviewed to analyzeconstraints on the supply side. The survey results show thatcredit for start-up is rare and that the smaller theenterprise, the greater the equity finance share of theinitial investment. Many SMEs achieve substantial growththrough reinvestment of profits, making it difficult toconclude that entry and growth of SMEs depends crucially onloans. Other forms of finance, such as customers'advances and supplier's credit are at least asimportant as bank credit. Nevertheless, the evidencesuggests that exploitation of highly profitableopportunities by SMEs could be accelerated if they hadgreater access to external financing. Tight money,banks' efforts to improve portfolio performance,centralization of decision-making, and lack of competitionexplain why banks have shown little interest in developingSMEs as a market niche. The study suggests techniques thatbanks could adopt to overcome the problems of hightransaction costs and risks in SME lending, drawing on themethods of informal financial agents.
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