The document summarizes constraints on financing for small and medium enterprises (SMEs) in rural and underserved markets in Armenia and provides recommendations. It finds that 50% of SMEs do not use formal financing due to factors like high costs, unsuitable products, and weak enforcement of contracts. Recommendations target improvements to the legal system, regulations, availability of alternative sources, supporting services, and SME financial/technical capacity to strengthen access to affordable and suitable financing for SME growth and development. Priority next steps include setting an integrated action plan with public-private cooperation to implement recommendations.

1. FINANCING THE GROWTH OF SMES IN RURAL
AND UNDER-SERVED MARKETS IN ARMENIA
Constraints and Recommendations
January 2015
Anthony Sinclair
Director, Economic Growth
Cardno Emerging Markets
FED Technical Advisor

2. The Situation
• 50%+ of SME’s do not use formal finance: 60%-70% in rural areas
• 4 out of 5 SMEs report difficulty or have no wish to access formal
sources - lack of interest is uncommonly high
• Key sectors under-served: Production, agriculture, construction = 30%
of total finance;
• Amounts small: Average loan AMD 4mn; ag < AMD 3mn.
• SMEs rely on personal sources more than any other source (64% of
SME’s in ag said they seek personal sources first)
• 30% or less of finance directed for investment
• Banks primary source, but UCOs play important role with market shares
30%-60% in most areas except Yerevan.
• Reliance on donor and state support significant (20%)

3. Approach: “Access” Defined
Proximity between lenders and SMEs, operating hours,
ease of making and keeping in contact, etc.
Supply of funds, willingness of lenders to lend, etc.
Cost of finance, level of borrower risk, management
burdens
Suitability of products and services to SME needs
Healthy SMEs have access to formal lenders who are able and
willing to offer affordable and suitable financing.
Physical Access
Availability
Affordability
Suitability

4. Approach: Sources
Roundtables with SME’s and Lenders
Survey of 200+ hundreds businesses
Interviews with market participants
Separate technical studies: legal, supporting
services, agriculture
Various documents and studies
Roundtables
Surveys
Interviews
Diagnostics
Other
Opportunities to improve information collection

5. Approach: Scope of Assessment
Supply-Side Evaluation Enterprise-Side Evaluation
•Legal infrastructure
•Financial regulations
•Products and services
•Financial sector depth
•Supporting services
•State support
Risk
Cost
Knowledge
gaps
Market
failures
•Financial capacity of SME’s
•Technical/administrative
capacity to get credit
•Attitudes and expectations
•SME market structure

6. Supply-Side Constraints Enterprise-Side Constraints
• Inefficient credit
enforcement
• High costs of financing
• Poor product suitability
• Regulatory issues and lack
of incentives
• Few alternative sources of
finance
• Weak supporting services
• Limited effectiveness of
state and donor funds
FINANCE
GAP
•Weakened financial capacity
•Borrower attitudes and risk
aversion
•Weak capacity to present
business
•Weak SME market leverage
Access Constraints: The Big Picture

7. Weak
Enforcement
Impact of
Financial
Regulation
Poor
Product
Suitability
Lack of
Alternative
Sources
Underdeveloped
Supporting
Services
High
Costs
Supply-side Constraints
Loan loss
provision
rules
Collateral
bias
Regulation
of non-
banks
Uncertain
Impact of
Capital Rules
Weak
Enabling
Environment
Barriers to
leasing
Weak inter-
firm
financing
Under-
developed
Cap Mkt

8. Borrower
Attitudes &
Risk Aversion
Information
Asymmetry &
Legitimacy
Poor
SME Market
Leverage
Weakened
Financial
Capacity
Liquidity
issues
Inadequate
collateral
Low risk
tolerance
Expectations
of state
support
Negative
sentiment
Weak credit
culture
Weak
capacity
Informal
economy
Co-mingling
of finances
Weak
national
advocacy
Weak
negotiating
position
Demand-side Constraints

9.  Unclear reach to SMEs and priority sectors
 Bias to larger SMEs and existing bank clients
 Significant direct lending – under-leveraged
 Some weakness in transparency and SME feedback
Financing Support

10. Recommendations: Supply-side
During proceedings…
•Amend the law to make it easier to deliver notifications
•Amend the law to eliminate use of erroneous counter-claims to
create delays; enable concurrent proceedings
•Improve the legal definition and rules for setting priority of claims;
harmonize civil code and enforcement law
•Strengthen the technical capacity of courts to handle credit cases
•Improve consistency and uniformity of enforcement proceedings
among different courts; platforms for sharing info on cases
Enforcement of judgments…
•Amend the law to reduce erroneous appeals to delay actions
(more)
Weak
Enforcement
Legal
loopholes/
delays
Inefficiency
in claim
recovery
Out of court
process
limitations
Collateral
regime

11. Recommendations: Supply-side
Enforcement of judgments…
• Eliminate inconsistency between law on public bids and law on
enforcement
• Strengthen enforcement of law concerning creditor notifications
• Develop standards/protocols for enforcement officers in selling
assets; consider use of private creditor enforcement officers
• Upgrade electronic auction system to improve transparency and
ease of use
• Re-set commission structure to be more incentive compatible
• Eliminate the administrative barrier to re-registering foreclosed
property after auction
• Stronger legal deterrents against misappropriation of collateral
Weak
Enforcement
Legal
loopholes/
delays
Inefficiency
in claim
recovery
Out of court
process
limitations
Collateral
regime

12. Recommendations: Supply-side
Collateral infrastructure….
• Finalize development of centralized movable property register
• Establish legal basis for the use of enterprise-wide or floating
charges as collateral
• Evaluate the feasibility of setting up alternative collateralization
mechanisms, such as the use of bonded-warehouses, trusts, etc.
Extrajudicial enforcement…
• Amend the law to eliminate inconsistencies in reserve price-
setting requirements for in-court and our-of-court proceedings
• Continue to improve and promote the use of the arbitration court
Bankruptcy proceedings…
• Various improvements noted in our report
Weak
Enforcement
Legal
loopholes/
delays
Inefficiency
in claim
recovery
Out of court
process
limitations
Collateral
regime

13. Recommendations: Supply-side
High
Costs
Poor
economies
of scale
Externalities
Cost of
regulatory
compliance
 Calibrate regulatory requirements to the risks of SME lending
(e.g. banks vs. leasing, SMEs vs. Large Corporates)
 Apply RIA to financial regulations; consider use “SME test”
 Increased investment in shared platforms or services that help
to reduce the transaction costs of lending – more to follow…

14.  Gradually reduce reliance on minimum loan loss provisions
based on payment status
 Streamline prudential requirements for UCOs proportionate to
the risks they pose
 Harmonize regulatory charges between banks and UCOs (VAT
on guarantees branch taxes, ombudsman fees, etc.)
 Streamline regulations for leasing to be more in line with EU
practices; develop separate guidelines for banks involved in
leasing
 Apply RIA to existing regulations as well as new ones
 Improve info collection on SME lending
 Consider SME impact when setting Basle III requirements
Recommendations: Supply-side
Impact of
Financial
Regulation
Loan loss
provision
rules
Collateral
bias
Regulation
of non-
banks
Uncertain
Impact of
capital

15. Recommendations: Supply-side
On lending suitability and funding…
Incentives for investment in SME lending and expansion to
under-banked markets
Accelerate development efforts to develop national platforms for
mobile and e-banking (Separate FED report)
Consider government support/sponsorship for the development
of a new share-technology platform for credit scoring/screening
Comprehensive strategy for improving dinar-based funding
On improved risk intermediation…
Government-financial sector-donor collaboration on expansion/
development of risk management tools
State aid in the form of foreign exchange or interest rate risk
offset programs may have use in lieu of direct lending
Poor
Product
Suitability
Unsuitable
lending
models
Unsuitable
funding
Poor risk
inter-
mediation
Weak SME
knowledge

16. Recommendations: Supply-side
On improving knowledge of SME markets…
Poor
Product
Suitability
Unsuitable
lending
models
Unsuitable
funding
Poor risk
inter-
mediation
Weak SME
knowledge
 Improved information and data collection on the SME sector
 More collaboration by business associations (including bankers
association) in doing research on the SME sector

17. Recommendations: Supply-side
 Streamline regulations for UCOs
 Reform regulations on leasing and related tax and
accounting rules to make leasing cost competitive
 Promote financial intermediation between banks and
UCOs – e.g. in whole sale lending and loan
participations
 Promote increased use of Dram-based funding by
UCOs; more access to donor funds, assistance in
hedging FX risk
 Support for value-chain based credit arrangements –
next section
 Opportunities with diaspora
Lack of
Alternative
Sources
Weak
Enabling
Environment
Barriers to
leasing
Weak inter-
firm
financing
Under-
developed
Cap Mkt

18. Recommendations: Supply-side
On appraisal services…
Consider changing licensing from firms to individuals
Revise conduct standards, set continuing education
requirements, and strengthen sanctions
Strengthen capacity of the register to monitor and
sanction appraisers
Create a centralized database of all information
collected on real estate and make it available to
appraisal profession
Map the service area appraisers and monitor national
coverage
Underdeveloped
Supporting
Services
Quality of
appraisal
services
Quality of
Accounting/
auditing
Gaps in info
services

19. Recommendations: Supply-side
On accounting/auditing services…
Minimize use of staffing thresholds in audit firm
licensing – 5 staff may be too high in small markets
Strengthen the capacity of MoF for oversight or
transfer full oversight/sanctioning to private association
Promote widespread implementation of the new IFRS
standards for SMEs for lending
Update professional certification requirements in line
with international standards
Move to implement the measures in the latest ROSC
assessment and set out by the FIRST Initiative
Underdeveloped
Supporting
Services
Quality of
appraisal
services
Quality of
Accounting/
auditing
Gaps in info
services

20. Recommendations: Supply-side
On information services…
Support ACRAs expansion and promote the develop of
new reporting templates for rural and ag markets
Reduce delays in lending by quickly fixing errors and
omissions in the property registries – create a program to
“fast track” easily verifiable corrections
Improve the search functions of the business registry to
support lending
Explore opportunities for public-private partnerships to
improve the quality and type of information services that
support financing.
Underdeveloped
Supporting
Services
Quality of
appraisal
services
Quality of
Accounting/
auditing
Gaps in info
services

21. Recommendations: Financing Support
 Strengthen coordination and tactical use of state aid
 Enhance design and structure of products and programs; less
direct lending more collaboration with the UCO sector; use these
support mechanisms to catalyze innovation
 Strengthen communications with the SME sector; focus groups
 Strengthen information collection and distribution on SME
financing

22. Recommendations: Demand-side
 Various measures to improve liquidity conditions:
• VAT tax payments based on cash not invoice
• Reduction of payment delays through public sector
supply chain, etc.
• Quicker enforcement of inter-firm credit claims
 Better education for SMEs on collateral management
 Fast-track permitting for qualified real estate collateral
Weakened
Financial
Capacity
Liquidity
issues
Inadequate
collateral

23.  More communication and collaboration needed
between lenders and SME’s (+professional services
community)
 Improvements in credit enforcement will help to
reduce the personal exposures of borrowing
 Public-private collaboration in improving public
awareness and helping to promote positive credit
culture
 Support for entrepreneurship and belief in SMEs
needs to be explicit and promoted by government
Recommendations: Demand-side
Borrower
Attitudes &
Risk Aversion
Low risk
tolerance
Expectations
of state
support
Negative
sentiment
Weak credit
culture

24.  Training and support to business organizations to
build capacity of members
 Training and outreach by lenders and more
engagement by the professional services community
 Targeted incentives to get businesses out of informal
economy
Recommendations: Demand-side
Information
Asymmetry &
Legitimacy
Weak
capacity
Informal
economy
Co-mingling
of finances

25.  Business associations to take a more active role in
advocating for specific reforms to improving access to
members
 Business associations to take on intermediary functions
in working with banks and members to facilitate credit
flows
 More education for SME about to organize and make
joint approaches to lenders
 Public-private initiatives to promote value chain-based
financing
 Large corporations should help with solutions
Recommendations: Demand-side
Poor
SME Market
Leverage
Weak
national
advocacy
Weak
negotiating
position

26. Next Steps
Many
recommendations
are achievable in
the short and
intermediate term
… at minimal cost
Set priorities
Integrated plan with
responsibilities
Platform for public-private
cooperation/feedback
Financial and private sector
undertakings
Government-wide commitment
Tell businesses about progress

27. A Final Observation
SME’s have played a catalyzing and socially-
stabilizing role in the development of almost
every major industrialized economy we know in
the world.

28. www.armeniafed.com