Compendium 2.3 Finance

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Financial institutions often claim that there is always money available to finance a good business idea. However experience teaches that many potentially viable businesses are refused finance – for all the wrong reasons. Studies show that ethnic minorities refer to difficulties in accessing finance as the most important barrier to setting up a business, while for women it is the second most important barrier, and for young people the third. Problems are to be found on both the supply and demand sides of the equation.

Supply-side problems

The EU defines micro lending as consisting of loans of less than €25,000, but in fact many businesses need even smaller amounts of capital. There are two main reasons why these relatively small sums are difficult to raise. The first is that the smaller the loan, the higher the transaction costs are as a proportion. The second issue, particularly for non-traditional entrepreneurs, is perceived risk. Banks use elaborate scoring methods based on credit histories to assess personal lending, but disadvantaged people often lack not only collateral but experience and a business track record.

Regulatory reform, particularly the Basel II Accord (as implemented by the EU Capital Requirements Directives), is making access to finance even more difficult. Moreover the gradual withdrawal of traditional banks from the local and mutual economy, partially owing to the pressure from the banking regulations, is predicted to make things worse. Socially orientated financial networks like FEBEA (European Federation of Ethical and Alternative Banks) [1] point to the 'general withdrawal of (mainstream) banks from the local economy' and the 'gradual loss of the traditional banks of the local and mutual economy (e.g. credit co-operatives) by de-mutualisation, merger or privatisation'.

Demand-side problems

However, there is evidence[1] that there are also problems related to the demand for microcredit. Not all business proposals and people are ‘investment ready’. The take-up of microcredit is heavily affected by the competing availability of grants and the tax and social security implications of setting up a business. In this highly complex scenario, it has become clear that it is not enough simply to increase investment in funds that offer small loans: in some places, the take-up of such funds has been slower than expected. Moreover, an indiscriminate increase in small loans may increase problems of over-indebtedness (resulting from credit card and consumer loan abuse) among certain sections of the population. The key problem, therefore, appears to be not just how much finance is offered to disadvantaged people, but what kind of finance.

For example, an existing micro-enterprise may want a loan of near the €25,000 ceiling to develop its business. But unemployed people who want take the first step to earning an independent income, are often looking for less than €5,000. The financial needs of people who want to move from the informal economy, or from a low-paid job, to self-employment, also tend to require small first steps – as in the case of many women with family responsibilities, migrants, ethnic minorities and people with disabilities. This is particularly the case in the new Member States. If microfinance is to have a real impact on inclusion as well as sowing the seeds of future competitiveness, then the funding mechanisms must take these social factors into account.

[1] See the OECD report Entrepreneurship and Local Economic Development: Programme and Policy Recommendations (2003) [2]

Measuring social return

There is another dimension to the question of assessing the profitability of an investment, or the returns that are likely to be gained from supporting given business. This concerns the nature of the returns that one measures. For a purely commercial investor, the only relevant criterion is financial return on capital invested. But for public and social investors, the question is much broader. There may be a whole range of impacts that they wish to achieve by investing in enterprises: not only a healthy profit but for instance new jobs, the inclusion of particular disadvantaged groups, local regeneration and economic development, or environmental benefits. In order that they can take sound allocation decisions and assess the success of their actions, they need tools to measure the returns they achieve. The tools need to measure along several dimensions – not only economic but also social and environmental – and need to be sensitive to distribution – which stakeholder groups reap what return. EQUAL has pioneered techniques such as social return on investment (SROI) analysis to address this issue.

EQUAL’s work on access to finance can be described under the following six headings: