and competition also play a role in spurring SME financial inclusion, though their effects remain ambiguous and largely dependent on country circumstances (see, for example, World Bank <u>2012).</u> Turning to institutional factors, it is well understood that institutions, i.e., the rules of the game in a society, influence the development of entrepreneurship (North 1990). Institutions can either be formal or informal, and while in FCS countries the latter tend to be subordinate to the former (Thornton et al 2011), primarily due to low levels of trust (Hoffmann and Lange 2016), ultimately solid formal institutions are needed to enhance SME financial inclusion, given their important role for the information environment and contract enforcement (see, for example, Beck et al <u>2005, and Djankov et al 2007) and for supporting equal treatment of firms in access to financial</u> services (Faccio 2006).

Our analysis shows that both economic fundamentals and institutional features are key drivers of SME financial inclusion in all countries, with the relative importance of key variables higher for FCS countries compared to non-FCS countries. Therefore, our findings suggest that constraints affecting SME financial inclusion are similar across FCS countries and non-FCS countries, with differences _in degree_ rather than _in kind_ . The results show that macroeconomic and institutional stability along with reduced informality, banking sector soundness, and improved credit information environment are associated with higher SME financial inclusion. The results also show that strengthening the rule of law, government effectiveness and control of corruption while increasing financial depth and reducing public sector borrowing and banking market concentration could help close the SME financial inclusion gap between FCS countries and the best performing countries. These effects are stronger for middle income FCS countries than for low income FCS countries. Overall, the results suggest the need to implement comprehensive macrofinancial and institutional strategies to improve SME financial inclusion in FCS countries.

The rest of the paper is organized as follows. Section 2 presents stylized facts on SME finance in FCS countries, including the SME financial inclusion index, a composite indicator that captures both access and usage of financial services of SMEs. Section 3 presents the methodology and data used in the analysis as well as the main results, highlighting the relative importance of variables for FCS countries compared to non-FCS countries. Section 4 offers some concluding remarks.

# **2. Stylized facts**

# **2.1. SME finance in FCS countries**

To characterize SME finance in FCS countries, this paper relies on WBES data. WBES is a firmlevel survey of a representative sample of an economy’s private sector. The surveys cover a broad range of business environment topics including access to finance, corruption, infrastructure, competition, and various business performance measures. WBES are available for both large firms and SMEs and the survey is done typically about every four years per country though some gaps remain in the overall coverage. We focus in particular on WBES data related 3