Most days, many of us walk into a small business and buy something. We take it for granted that the businesses will be there—with the goods and services we require. However, most of us don’t think that many micro, small and medium-sized enterprises (MSMEs) lack the finance they need to thrive.

MSMEs are the essence of Nepal’s economy. They contribute significantly to the country’s economic growth by creating thousands of jobs. A United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP) report estimates that the country’s MSMEs employ more than 2.7 million people.

Consider some statistics. In Nepal, it’s estimated there are more than 923,000 registered businesses. Approximately 90 percent of those are MSMEs, accounting for 45 percent of all jobs. And about 12 percent are small and medium businesses, accounting for 40 percent of employment. Yet despite their prominent contribution to the economy and jobs, 37 percent of the MSMEs report access to finance as a significant constraint to growth. For MSMEs in Nepal, the projected financing gap is estimated at $3.6 billion, with only around $731 million currently available.

Massive collateral

Considering the gap in financing and the funds they currently have access to, it’s clear that promoting MSME finance is critical for Nepal. This need is underscored by the fact that many commercial banks in Nepal do not differentiate much between large corporates and MSME clients. Seventeen percent of MSMEs use banks to finance investments, but the required collateral is massive, reaching up to a staggering 364 percent of the loan value. For smaller firms, access to finance is an even bigger struggle, which is why only 9 percent reportedly use bank loans.

In Nepal, real estate is the only widely accepted form of collateral, and the lack of real estate collateral is cited as one of the key barriers to accessing finance. Land as collateral effectively excludes MSMEs, women-owned businesses, businesses in rural areas and start-ups, which tend to have moveable assets—like machinery which people can take with them—instead of significant real estate.

Nepal Rastra Bank, the country’s central bank, has been working to improve access to finance for MSMEs. Financial inclusion has been a key strategic focus of Nepal Rastra Bank, and several enabling reforms are being undertaken to boost MSME finance and digital financial services.

There are some innovative solutions which can help accelerate the reform process. One such innovation began earlier this year when Nepal became the first South Asian country to pilot the Psychometric Scoring Solutions, jointly implemented by Nepal Rastra Bank and the International Finance Corporation (IFC). Psychometric tests are a standard and scientific method used to measure an individual’s mental capabilities and behavioural style. For financial institutions, the Psychometric Scoring Solutions helps them statistically analyse the personality and psychological traits of potential borrowers by generating a risk profile as a first step in building a formal credit history for someone to access formal financial services.

So far, the scoring tool has been used in Morocco, Ethiopia and Senegal. This innovation, designed to facilitate more accurate credit decisions, helps spur broader access to finance through an additional layer of information consumers provide to microfinance institutions (MFIs). Small business entrepreneurs generally lack credit files and primarily operate on a cash basis. Through the Psychometric Scoring Solutions, credit providers can determine a borrower’s willingness and capacity to repay loans, making informed decisions.

This innovative tool is part of a broader access to financial services project by Nepal Rastra Bank and IFC, with the support from the governments of Japan and the United Kingdom. This project aims to create the right environment for MSMEs to grow and also focuses on developing the financial and market infrastructure to strengthen MSMEs, including a robust payments system and innovative solutions to accelerate reforms.

Special attention

IFC is committed to helping close the MSME financing gap in Nepal and to supporting the country’s efforts to follow a sustainable and inclusive growth trajectory. IFC’s broader strategy to strengthen SME banking involves supporting regulatory reforms, technical assistance and providing up to $170 million in financings (loans and equity), specifically on SME lending, to several banks. By the end of June 2022, IFC is looking to invest upwards of $50 million, spread over three banks in Nepal. As part of the SME Ventures programme, IFC invested in Business Oxygen (BO2)—the country’s first private equity fund—between 2015 and 2017. BO2 has made equity investments in 17 SMEs in various sectors, creating hundreds of jobs. IFC has also invested $10 million in Dolma Impact Fund II, bringing its investment in the sector to $24.3 million to date.

As Nepal recovers from the impact of the pandemic, the MSME sector, which has been hit hard, clearly deserves special attention. The reform measures highlighted above will go a long way in supporting the lifeline of the Nepali economy.