# **1 Introduction**

**Expanding SME access to finance has proved a challenge in many developing countries, especially in the Middle East and North Africa (MENA) region.** Research shows that SMEs contribute to a large share of employment and GDP in developing economies.<sup>2</sup> Despite their importance, SMEs are significantly more financially constrained than large firms, especially in developing countries. This problem seems severe in MENA countries, where about 33% of SMEs report difficulties in getting finance, compared to 25% on average in other emerging countries<sup>3</sup> . The lack of SME access to finance is to a large extent the consequence of weaknesses in the enabling environment for finance (e.g. weak credit reporting systems, collateral regimes) that result in informational asymmetries and high risks to creditors<sup>4</sup> .

**Deficiencies in the enabling environment have motivated government interventions designed to expand SME finance.** Government interventions may be justified when it takes time to build an effective enabling environment, or where some groups remain difficult to reach, even when efficient financial infrastructure and regulations are in place.  Traditionally, such policy interventions have included partial credit guarantee schemes, direct lending facilities, and lending by state-owned financial institutions.

**Partial Credit Guarantee Schemes (PCGs) are operated by a large number of countries and are considered one of the most market-friendly types of interventions** .  In developed countries such schemes have been operational for over four decades while their use in developing countries is more recent. PCGs facilitate access to finance by creditworthy firms when such access is constrained by insufficient credit information and collateral. As a risksharing mechanism, PCGs reduce the risks and potential losses of creditors, inducing lending to riskier types of borrowers. Arguably, PCGs generate fewer market distortions compared to other policy interventions, such as directed lending programs or state banks, because they usually entail less interference in credit allocation and use private banks as the main vehicles for loan origination.

**Many countries have also used PCGs as a countercyclical policy tool.** Korea is one of the most notable examples of a country that have used credit guarantees during crises to alleviate the adverse effects on SMEs<sup>5</sup> . As another example, in the current global crisis the European Union has allowed PCGs in member states to increase the coverage ratio to 90 percent for distressed SMEs until end-2010, and allowed the possibility for subsidized guarantee premiums. In addition, some guarantee schemes introduced simplified and faster approval processes (e.g. Portugal, Romania, Greece) or raised the maximum guaranteed loan amount (e.g. Germany).

**Many countries in the MENA region have established PCGs to facilitate SME access to finance** .  These schemes can play an important role, especially in a period where MENA governments are making efforts to improve the effectiveness of credit registries and bureaus

> 2 Ayyagari et al., (2003) .

> 3 See www.entreprisesurveys.org

> 4 Beck, Demirguc-Kunt and Peria (2009) show that differences in the quality of the legal framework explain the differences in SME lending between developed and developing countries.  Rocha, Farazi, Khouri, and Pearce (2010) provide similar evidence for MENA.  A review of SME finance is provided in World Bank (2008) and IFC (2010)

> 5 IFC (2010).

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