The impact of the regulatory business environment on SMEs' funding choices in developing countries: Evidence from Africa

Abstract

AbstractWhile it is known that some elements of the business environment (BE), such as macroeconomic conditions, impact access to finance and the funding choices of SMEs, very little is known whether other elements of the BE—such as the institutional setting and the regulatory business environment (RBE)—influence access to (or supply of) finance and the funding choices of SMEs. Using a World Bank Enterprise Surveys panel sample (2003–2020) from 30 African countries and employing Propensity Score Matching (PSM) methods, it is noted that while an enabling institutional setting and RBE in Africa increases access to external finance for SMEs, SMEs still opt for retained earnings over funding from banking and non‐banking financial institutions for their working capital. This funding behaviour can be explained by that SMEs located in enabling RBEs have increased productivity and financial performance and so can employ larger amounts of retained earnings for their operations. Furthermore, even though more accessible in enabling RBEs, external finance remains unaffordable for most SMEs in Africa. These findings indicate the need to tailor interventions to make varied finance more accessible and affordable for SMEs in developing countries.