This article captures insights from a recent workshop we organized, exploring the role of development finance institutions in future-proofing small and midsize enterprises. The workshop was held in cooperation with the European University Institute’s School of Banking and Finance.
Having just come through the COVID-19 crisis, small and medium-sized enterprises (SMEs) found themselves face-to-face with a range of new challenges, including rising costs of production, a talent shortage, increased political risk, and an expected global economic slowdown in 2023.
Development finance institutions (DFIs) played an important countercyclical role in helping SMEs weather the storm and emerge stronger. In doing so, they not only tailored their support solutions but also increasingly sought to ensure their activities remained relevant to broader global macrotrends, particularly the effort to achieve a net-zero emissions world.
Navigating economic challenges and uncertainty for SMEs
The current macroeconomic environment poses major challenges for SMEs. A deterioration in consumer sentiment likely led to a reduction in consumption and, thus, business revenues, while a mix of exogenous shocks (including rising energy prices, supply chain constraints) increased production costs.
The weakening financial position of businesses compounds such difficulties. SMEs accumulated significant debt during the low-interest rate environment of the past decade. However, borrowing costs rose rapidly while corporate profits are declining, and banks tightened lending standards given a worsening macroeconomic environment. Consequently, access to finance declined for SMEs, restricting their ability to cover expenses and make capital investments.
At the same time, governments were less able to support SMEs. Fiscal policymakers needed to manage tightening national budgets and found it challenging to provide support measures such as the subsidy programs set up during the COVID-19 crisis. With inflation at multidecade highs, central banks were unlikely to offer relief and reverse their course of monetary tightening in the near term.
How DFIs provide support
DFIs had the capacity and capabilities to support SMEs where commercial lenders were hesitant and governments could not. They continued to have significant room to maneuver because of their strong financial position. Moreover, they had an agile toolkit at their disposal, comprised of a range of funding and financing products as well as advisory services.
Importantly, DFIs adopted a tailored approach to supporting SMEs. To be more effective in their work, institutions calibrated their product offering based on the underlying economic challenges of the specific geographic context. For example, the European Investment Bank (EIB) leveraged guarantee programs to address market failures in Europe and facilitate SME access to commercial loans. In Latin America, small enterprises required measures that enabled them to become part of the formal economy. There, the IDB Lab deployed a combination of grants and advisory services to support innovative ventures that helped address the informal sector, such as digital payment solutions.
Preparing for inclusive and sustainable growth with DFIs
To remain relevant as catalysts of change, DFIs also sought to align their activities with broader macrotrends, such as inclusive and sustainable growth. Those trends were critical to building the economy of the future, allowing us to unlock previously untapped business models and reach net-zero emissions in the coming decades.
DFIs adapted their mission to this new environment. Many institutions began revising their mandates to focus more on inclusion and diversity and expanded programs to support female and minority business owners and address regional disparities. For example, the British Business Bank launched several regional investment funds seeking to help boost productivity, innovation, and jobs in the United Kingdom.
Moreover, DFIs overhauled their metrics of success, increasingly emphasizing the broader economic, social, and ecological impact of their work. For instance, a core element of the 2022 strategic plan of the Brazilian development bank BNDES was to shift the organization’s focus from purely financial value creation to one of positive socio-environmental impact.
DFIs stepped up their climate finance activities. They increased the financing and funding of climate-positive projects and introduced bespoke, new products that aimed to accelerate efforts to achieve net zero. The EIB invested in dedicated private equity and venture-capital facilities to cover critical market gaps in long-term financing sources for climate tech. And several institutions introduced transition finance programs, which provided capital to companies seeking to reduce their emissions.
Additionally, DFIs leveraged their advisory services to support firms in adopting sustainable business models. They sought to build bridges between emerging climate technologies and industries that had been slow in introducing innovative solutions to reduce emissions; the Asian Infrastructure Investment Bank, for example, provided dedicated support for construction companies to transform their operations and cut emissions. In this context, through their vast capacity and credibility, DFIs helped set climate standards.
DFIs facilitating innovation and sustainable technologies
Going forward, DFIs will play a key role in facilitating innovation by crowding in investments for emerging sustainable technologies. In particular, the green hydrogen industry will require support to overcome financing gaps, and several DFIs, including the Chilean economic development agency CORFO, are already in the process of establishing dedicated hydrogen funds.
Unlocking the full potential of these breakthrough technological developments will pave the way for more sustainable and inclusive growth. DFIs are best equipped to accomplish this and propel economic transformation, even in times of hardship.