Brazil has a stable, dynamic and sophisticated banking system, but it has not managed to supply an adequate amount of credit to small and medium enterprises (SMEs). It is a deep-rooted problem that must be solved for its welfare and growth implications.
There is a strong correlation between the credit/GDP ratio and GDP per capita. The richer show proportionally more credit. A developed credit system channels funds throughout the economic system making it easier to grow. This is a fact for countries, enterprises and people. Richer countries have succeeded in fostering SME growth through specific taxing, regulation, programs etc. Access to credit promotes economic inclusion and equality, and more inclusion supports economic growth.
In Brazil, SMEs are responsible for 56.1 percent of employment in the formal sector, reinforcing their welfare importance. According to IADB (2005) “Libertar o credito” financing is the most important barrier to SME development; it ranks first before taxation, regulation, inflation, criminality, corruption, exchange rate and infrastructure.
Brazilian banking shows an asymmetric performance. On one side, its numbers of branches per habitant, information technology, charges for services, financial instruments sophistication and efficiency in operations are similar to any developed country; on the other its credit supply is low and concentrated on larger enterprises.
Financial systems operate from top down; big clients receive financing services first and the bottom of the pyramid ones last. This is because of fixed costs that can be better diluted with bigger clients. This explains the need for specific attention to the credit needs of smaller companies, for its scale diseconomies.
Giving credit its due
From a banking industry perspective, in a competitive environment, the expansion of credit depends on a wider supply at a lower cost. Other things equal – the lower the cost, the lower the price charged for credit and the supply is more abundant. The existence of financing at a low cost depends upon the banking system operating in more appropriate conditions.
Credit charges are the result of summing all costs plus a bank’s profits, and costs include labor, infrastructure, rents, security, technology, the compensation of risks – operational, default and market, and the cost of funds. The point is that, in a competitive environment, higher intermediation costs mean higher rates and less loanable funds. It is crucial to diminish the causes of high costs to lower lending rates and increase the credit supply for the country as whole.
Credit charges in Brazil are high and reflect a structure of high costs; the consolidated numbers of the banking system for 2003 show total income of R$ 220,382 million and expenses of R$ 203,821 million. For each R$100.00 of income, only R$7.51 become profits and the remaining R$92.49 are costs – interests rates, labor, taxes, etc.
Credit is expensive in Brasil, and the burden is higher for SMEs due to the scale factor.
Size matters in banking costs and charges; they are higher for smaller firms than for the larger ones. It is a worldwide effect; credit supply is regressive.
Financial systems – like other sectors – have fixed costs (contracting, monitoring, collecting, compliance etc.) to be diluted. Financial institutions have economies of scale when assessing and monitoring borrowers, and the smaller companies have higher costs for diversifying its generation of resources, thus reducing competition in suppliers.
Large companies have direct access to capital markets and international financing. Besides they can diversify their banking relations, while the smaller entrepreneurs are not able to do it due to their reduced scale. It explains the regressive feature of banking financing, where smaller firms pay higher interests.
Call for action
There is also an adverse selection problem for SME financing, due to the level of informality in Brazil. It is estimated that 39.8 percent of economic activity in Brazil is informal. High compliance costs, taxation and the bureaucracy induce part of the business community to the informal sector. Small entrepreneurs have proportionally more difficulties and costs than the larger ones to initiate and maintain a company, leading to a greater informality. There are too many requirements and bureaucracy on SMEs without a convincing economical justification.
The consequence of informality, the existence of extra official accounting generates a problem of adverse selection, because of the accuracy of credit information supplied to banks. It occurs every time there is uncertainty regarding the quality of information of a borrower. As the banking sector knows the average quality and distribution of information regarding the borrowers, they tend to attribute a higher credit risk once there is not way to assess the risks of each company in deep.
There is a call for action to correct the concentration predisposition. Even though there are some special programs to SMEs, a wide-ranging program to counterweigh the scale effect is needed. The issue of the financial gap for SMEs from a banking perspective is clear: To overcome the scale effect a special treatment to SMEs is demanded, and it is necessary for a consistent macroeconomic policy, an efficient taxation and a legal-institutional framework that fosters banking efficiency and stability protecting borrowers’ rights. These are necessary conditions for a better Brazil.
Roberto Luis Troster has a Ph.D. in economics and is an economist at Integral Trust in Sao Paulo, Brazil