Influence of commercial bank characteristics on lending approaches to small and medium enterprises in Kenya

Abstract

Banks use various approaches to lend to SMEs. Among others, two main lending approaches used to finance small - and medium - sized enterprises (SMEs) can be primarily distinguished by the type of information that a bank uses in granting and monitoring the loan. On the one hand, transaction - based lending approaches are primarily based on borrowers‘hard quantitative information, such as the strength of the financial statement or the value of their assets, which are relatively easy to document and transfer. On the other hand, relationship lending is extended primarily based on borrowers‘soft qualitative information, such as the entrepreneurs‘characteristics including skill and integrity, which are difficult to verify. It is not quite known how, and to what extent, bank characteristics influence the choice of lending approach used by banks to finance SMEs. Using data from a survey on banks serving primarily SMEs in Kenya, the study investigate d how bank size, organization structure and ownership structure influence s the choice of different lending approaches which are utilized in lending to SMEs. The targeted population was the 44 commercial banks in Kenya. Sample size was 18 commercial banks that served SMEs. Respondents were 4 employees involved in SME lending from each of the 18 commercial banks. Questionnaire method was used to collect data. Secondary sources of data were also used to get information on bank classifications in Kenya. The study utilized descriptive statistics and regression analysis to analyze the collected quantitative data. Study findings indicated that size of a bank is significant in predicting the choice of lending technology in a bank. Large banks relied more on hard information than small banks. The findings further reveal that organizational structure had significant effect on the lending approach applied by commercial banks when lending to SMEs. Banks that made their lending decisions in the head office were more inclined to rely on hard information. However, the study results indicated that ownership of a bank is not a significant predictor of choice of lending technology. The following recommendations are made. First, the government should support small banks through regulatory and tax incentives so that access to finance by opaque SMEs is enhanced. Secondly, should decentralize their lending decisions to ensure that they have a more responsive structure to respond to the credit needs of SMEs. Lastly, small banks should invest in infrastructure and human resources so that they are not disadvantaged in processing hard as well as the soft information for SME lending.