Can credit unions bridge the gap in lending to SMEs?

Abstract

Small firms continue to experience difficulty accessing adequate finance from formal external sources, notwithstanding many and varied institutional and policy initiatives introduced to address this seemingly perennial problem. Underpinning research indicates that information asymmetry is the principal reason for the finance gap, particularly for young firms. The aim of legislation introduced in the UK in 2012 is to utilise the credit union sector to increase the amount of new lending to SMEs. The rationale for this legislative change arises because credit unions typically operate within a defined geographic region wherefrom they can compile detailed local knowledge of small businesses and be therefore uniquely placed to minimise information asymmetries thereby reducing the funding gap for small firms. Despite this perceived advantage, credit unions have been reluctant to take advantage of this legislative, and therefore lending by credit unions to SMEs has been negligent to date. We investigate the reasons for this lack of engagement in SME lending by interviewing the chief executives of five credit unions in Scotland. Our findings reveal that the CEOs of the credit unions are reluctant to lend to SMEs at present as they are uncomfortable with the level of risk associated with lending to a sector of which they have little experience or expertise. Furthermore, credit unions will need to offer attractive interest rates to compete with high street banks and an increasing number of microcredit providers. Policy makers need to better understand the structure and function of credit unions before assigning a greater role in SME lending. It is too early to say whether credit unions can play a significant role in SME lending, and our evidence suggests that structural issues must first be resolved before they become an established presence in the SME lending ecosystem.