Financing Micro-businesses: How to Fortify the House of Cards
In two recent papers, we consider the problems that arise in the financing of micro-businesses, apart from the limited, though important, finance provided by microfinance institutions. One, 'Financing Micro-businesses and the UNCITRAL Model Law on Secured Transactions' (forthcoming in the Uniform Law Review) shows the existence of a gap in the availability of financing for micro-businesses, considers the contribution that the adoption of the UNCITRAL Model Law on secured transactions can make to the reduction of that gap, analyses the issues arising from such adoption, and proposes possible solutions. The second, 'A global tug of war: a topography of micro-business financing' maps out the reasons for the lack of financing for micro-businesses, as well as particular problems caused by the unique characteristics of micro-businesses, and suggests some legal and institutional responses.
Micro-businesses (those with no or fewer than 4 employees) are the lifeblood of any functioning economy: they are more numerous and, collectively, have a higher turnover than any other form of business in the majority of countries around the globe. Start-ups, in particular, are the entry point for entrepreneurialism, the channel to innovation, and the entry gate to the market for those who would otherwise have difficulty accessing the labour market (for example, the young, women, or minorities). Moreover, micro-businesses offer second chances to more experienced entrepreneurs and provide alternative opportunities for and those who have lost their jobs.
In all parts of the world, developed and undeveloped, however, micro-businesses are starved of finance, and such finance that is available is often on unsuitable and unsatisfactory terms. The reasons for this are all connected with the tiny size and the inherent structure of micro-businesses. They have few assets which are attractive to lenders as collateral, they are often informal, and so cannot offer reliable information on which credit decisions can be made and the cost of the steps that have to be taken by lenders to protect themselves (both on origination and enforcement) are out of proportion to the size of and return on the loans.
There are ways to increase the protection of such lenders, and to reduce its cost, so as to unlock finance for these businesses. For example, it can be made easier and cheaper to take security over the types of (usually circulating) assets which micro-businesses have (such as by legal reform on the lines of the UNCITRAL Model Law). Credit assessment can be made cheaper and easier and other measures can eliminate barriers, decrease costs, and increase lender certainty. However, by their nature, micro-businesses are vulnerable to abuse of bargaining power, and, since many of the risk-takers are individuals, lack of protection leads to social problems. Legal responses to these two issues (access to credit yet protection of the borrowers) are in direct tension with each other: a response designed to achieve the former usually cuts across the aim of the latter and vice versa. Without an appropriate balance being reached, changes designed to facilitate the financing of micro-businesses can either end up being so oppressive that the very people the changes are designed to assist fail to thrive economically or socially, or go too far towards protecting the borrowers and fail to increase access to credit. In designing legislative and other responses, the issues and the tensions must be identified and decisions must be taken as to the correct balance to be struck.
The two papers advance this process by identifying the problems, the responses, and the possible tensions. We identify issues that arise at the origination of credit, during the lifecycle of the credit, and on the verge and during default. Without such a map, the decisions resulting in the optimum balance cannot be taken. We argue that measures must be adopted both in the area of legal reform (secured transactions, contract, banking law, insolvency) and in the realm of each jurisdiction´s institutional setting. Those decisions are, of course, a matter of policy and will vary from state to state, depending on the context, the state of the market, and other factors. All that these papers seek to do is to suggest the approaches that could be taken to make those decisions. Applying the correct approach, however, is critical; it is as important as tackling the issues in the first place.
Louise Gullifer is Professor of Commercial Law at the University of Oxford, Fellow and Tutor in law at Harris Manchester College, Oxford, and Director of the Commercial Law Centre, Harris Manchester College.
Ignacio Tirado is Professor (Titular) of Corporate and Insolvency Law at the Universidad Autónoma of Madrid, senior consultant at The World Bank, and a member of the Academic Board of the European Banking Institute.