The paper examines the impact of financial sector liberalization (FSL) policies on the financial management of small and medium-sized enterprises (SME) in Ghana; using six case studies. Its findings, which confirm and extend the conclusions of previous studies, are integrated into a framework that explains the impact of FSL and the factors at work. The main financial challenge facing SMEs is access to affordable credit over a reasonable period. This is determined by the financing needs of SMEs and the action of investors. SME financing needs reflect their operational requirements, while the action of investors depends on their risk perception and the attractiveness of alternative investment (which affects their willingness to invest). Government borrowing, the general economic climate, availability of collateral, quality of SME record keeping, and SME investor relations skills affect the way in which this challenge is managed. The impact of the activities and potential of enterprise development agencies are also discussed.
This paper presents a framework to explain the impact of financial sector liberalization (FSL) on small and medium enterprises (SMEs) in Ghana. SMEs are vital for economic growth and development because they encourage entrepreneurship, generate employment, and reduce poverty (Kayanula and Quartey 2000; Mead and Liedholm 1998; Fischer 1995). Previous studies (Dawson 1993; Steel and Webster 1992, 1991) focused on the impact of structural adjustment rather than FSL per se; thus, their conclusions on FSL are tentative. We confirm, extend, and integrate their findings in new ways. In the rest of the paper we briefly review the SME literature, describe our research methodology, discuss our findings, and present the framework.
Brief Review of the Literature
After a decade of economic decline, Ghana implemented economic reform and structural adjustment policies in the 1980s, with FSL as an integral component. FSL removed government controls on interest and foreign exchange rates and on credit allocation. Proponents claim that FSL increases credit allocation efficiency and, when properly implemented, reduces poverty. This should lead to reallocation of domestic credit toward SMEs and replace expensive forms of credit with cheaper ones (Cook and Nixson 2000). Critics point to its constraints and negative consequences, which include the urban bias of banks (ISSER 1999; Chandavarkar 1992), high transaction costs (Steel 1994), and market failure due to informational imperfections (Stiglitz 2002, 1994; Mosley 1999). These lead to an overreliance by banks on collateral for lending (Mambula 2002; Collier 1994).
Credit is provided in the context of information asymmetry on both sides (Fischer 1995) and can be resolved by demonstrating creditworthiness and project viability. However, because of poor accounting practices and record keeping, many SMEs are unable to do so (Cook and Nixson 2000; Binks, Ennew, and Reed 1992). This increases the risks and transaction costs (for monitoring and screening) of SME lending. Banks require collateral to manage this risk.
High transaction costs, risks related to small loans, and lack of collateral restrict SME access to formal credit (Steel 1994). Their owners raise funds from friends and relatives (Osei et al. 1993), leading to inadequate working capital and investment funds, which threaten survival and impede growth. These issues exacerbate other managerial problems of SMEs. For example, they determine not just the level but also the nature of technology investment (Cobham 1999). Even with sound management and strong product demand, the lack of credit constrains their capacity to respond to the market and expand production (Cook and Nixson 2000).
Research Objective and Methodology
The study aimed to identify and explain the impact of FSL on the financing of SMEs. We asked the following questions: (1) What financial constraints and opportunities did FSL create for SMEs? …