Sustainable Financing Strategies for the SMEs: Two Alternative Models

Abstract

A sustainable financing strategy for SMEs should aim to enhance a low-cost collateral-free supply of loans to SMEs with good track records of repayments to banks. In this paper, we suggest two alternative financing models for SMEs that address certain borrowing constraints of SMEs. First, the model incorporates institutional mechanisms involving the government, banks, and SMEs. The strategy employs a two-pronged approach: (i) the government enhances the supply of loanable funds to banks, and (ii) identifies good SME borrowers through skills development programs and introduces them to banks. This model will reduce default risk and allow banks to offer lower-interest and collateral-free credit to SMEs, thereby improving their access to finance and performance. Second, the model could be extended to accommodate digital finance using a data-driven credit risk score of the borrowers to reduce banks’ default risks and transaction costs with or without government funds. The proposed model could resolve the moral hazard and selection bias problems. Our proposed models are based on a public-private partnership approach and therefore could solve certain borrowing constraints of SMEs. Our empirical results support the model outcomes and therefore are consistent with the predictions of our theoretical models.