Why Banks are reluctant to lend to SMEs in Developing Countries

• Banks can often earn high returns in their core markets, giving them little reason to take on additional risk in the SME market. Banks in countries with immature financial systems often face little competition and a low threat of entry  and can therefore earn handsome returns by lending to large public and private players.
• Banks incur higher administrative costs by lending to SMEs. The costs of lending to SMEs are relatively high, as loan sizes are small, and the transaction costs per loan are relatively constant.This reduces incentives for regular banks to lend to them. 
• Banks have difficulty providing long-term capital. Banks in developing countries are often reliant on short-term liabilities (such as deposits).
• Banks have limited information, skills and regulatory support to engage in SME lending.The countries often have weak accounting standards, and the SMEs have little to no accurate financial statements on their revenues, profits and  ability to pay . Furthermore, there is often little to no general market data available on the SME market and specific sub-sectors (e.g. default rates).This limits the potential for lending based on financial statements or small business credit scores.  Therefore, banks primarily engage in relationship-based or other forms of collateral-based lending, rather than cash-flow based lending. Banks tend not to provide financing for working capital to SMEs, which is cited by SMEs as one of the areas of greatest need. The lack of collateral for some borrowers and/or clear recourse legislation (e.g. ability to claim collateral) however, can complicate the possibilities to do collateral based lending (e.g. asset-based, real-estate or equipment lending). Finally, banks need specific skills to engage in the different forms of SME lending. A recent Dalberg survey showed that the difficulty in establishing credit-worthiness was a key barrier, with 80% of banks stating challenges in this area.Lack of these skills can lead banks to shun the SME market in its entirety,  and invest only in high-yielding sovereign government debt,  or  it can  translate into inadequate risk management, leading to lower repayment rates and returns. (Source:Dalberg)