group, and 73.8 percent for OECD countries. In response, banks in Mongolia have been forced to rely entirely on collateralized lending and to charge high risk premiums on their loans to small businesses and individuals.<sup>26</sup> Cheap financing is only made available to a few prime customers—typically big companies. For instance, whereas large firms can obtain financing for as little as 9.6 percent per year, the annual nominal cost of micro finance can be as high as 72 percent on short term loans to individuals or small firms (Table 7).

**Table 7:  Banks’ Lending Interest Rates** (annual percentage rate on loans extended by banks in Mongolia)

||**200**<br>|**3-III**<br>|**200**<br>|**4-III**<br>|**200**<br>|**5-III**<br>|
|---|---|---|---|---|---|---|
||**Average**|**Low,**<br>**high**|**Average**|**Low,**<br>**high**|**Average**|**Low,**<br>**high**|
|Up to 1 year|41.5|11.0-72.0|39.0|6.0-72.0|42.0|12.0-72.0|
|1 to 5 years|37.8|9.6-66.0|37.8|9.6-60.0|57.6|9.6-48.0|
|5 and more years|33.3|7.8-58.8|17.8|12.0-23.5|17.8|12.0-23.5|
|Industrial use|39.9|7.8-72.0|36.0|18.0-54.0|29.5|11.0-48.0|
|Non-industrial use|40.8|9.6-72.0|24.0|6.0-42.0|27.0|6.0-48.0|

_Source: Bank of Mongolia_ Access to capital in Mongolia has been limited for the majority of firms. Capital markets are underdeveloped and banks offer a limited range of products to firms<sup>27</sup> so bank loans are the primary instrument for raising capital from domestic sources.<sup>28</sup> Unlike firms in most of its neighboring countries, most Mongolian firms have relied largely on finance from informal sources for their investment and working capital needs. In 2004, only 6 percent of new investment was financed by commercial bank loans, compared to the average for East Asia (17 percent). In the same year, less than a third of the firms in Mongolia had a commercial bank loan, and of those only 3 percent had loans with maturities of more than 5 years (Figure 6). Without such long-term credit, potential productivity-enhancing investments in plants, machinery, technology upgrading of processes are difficult to undertake on a sustained basis, thereby inhibiting a firm’s capabilities to scale up existing operations or improve product quality.

The high collateral requirements have also resulted in limited access to credit. Collateralto-loan values are higher in Mongolia than in any other country in East and Central Asia. The ratio of collateral required to loan value is 224 percent in Mongolia compared to the average for East Asia (78 percent), and Europe and Central Asia (154 percent). Moreover, many people, especially in rural areas, do not have access to the collateral required by banks in the form of immovable assets (land or buildings) since the pastureland is not privately-owned (World Bank 2003). Land ownership in urban and

> 26 According to the Doing Business database, the degree to which collateral and bankruptcy laws in Mongolia facilitate lending are comparable to those in East Asia and Central Asia. Mongolia scores higher than East Asia and Central Asia in terms of rules affecting the scope, access and quality of credit information and the public credit registry coverage.

> 27 Financing through leasing arrangements is practically non-existent in Mongolia.

> 28 Mongolia’s financial system is dominated by commercial banks. The stock market is small and illiquid, insurance companies and pension funds are small, and a commercial bond market has yet to be developed (World Bank 1997).

15