assessment process. Only one possibility is visible, which is the empowerment of the branch level loan officers. However, the literature provides some fundamental barriers in financing where the risk is assessed. The key risk is whether the return will come back according to the loan contracts. The risk is fundamental in the financing relation between lender and borrowers. Based on different studies, the entire risk is theorized in different concepts. They are principal-agent concept, information asymmetry, adverse selection and moral hazard. The risks act through the concepts in financing more likely small business than large. The gap was firstly outlined in the publication of Macmillan report as
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early as 1931 (Lean & Tucker, 2001) in UK, which is still a concern in this modern business age despite happening much improvement and changes in technology and business environment (Beck & Kunt, 2008; ADB, 2013).
3.7.1. Information Asymmetry problem
Information asymmetry is an information gap-oriented problem between lenders and SMEs where the owner-managers of firms have more information and realization than lenders about the prospects and/or potential risk of business (Binks & Ennew, 1996; Lean & Tucker, 2001 and Lambert, Leuz, & Verrecchia, 2012). Furthermore, this is such a problem where shareholders of a firm have less information than owner-managers and even in this lack of information gap; shareholders put a considerable size of fund in the firm (Jordan, Lowe, & Taylor, 1998). In general, in a perfect market setting, there is full availability of information for both the firms and financial institutions and there should be no uncertainty regarding present and future market condition. However, information in very reality of financial-trading condition is neither perfect nor entirely costless and perhaps for the reason both the small firms and finance market is characterised by risk and uncertainty regarding future conditions (lean & Tucker, 2001, p-45). Hence, a critical and important gap has been playing a great role in interrupting SMEs financing accessibility to banks.
This interruption causes in some ways. Firstly, it create poor attitude to SMEs. Due to having risk and uncertainty, the banks need monitoring each funded business firm or project by investing additional time and resources, which is uneconomic for banks. If banks want to monitor SMEs, then their cost will be high and they have to impose additional service charge, which eventually increase the interest rate. Secondly, in that case, banks also have to require additional and strict collateral to cover additional risk raised by asymmetric information. It is widely recognised that collateral is a great concern for SMEs because by nature they have lacking of sufficient collateral. Finally, due to avoid risk and uncertainty, banks reject the loan application if banks lack adequate information to critically and accurately gauge the degree of risk associated with lending to SMEs. However, this rejection happens not on the specifically identified issues that surely harm the business. Entirely, the result goes against the small business financing accessibility (Altman, 1968).This issue has been clearer in adverse selection and moral hazard concept. Ennew & Binks, (1996) argued that there is no difference between more
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successes or less success small business in the issue of bank finance, which means banks entirely have poor attitude to SMEs finance. This attitude could be significantly reflected in primary research if it is same for first accessing SMEs.
3.7.2. Adverse Selection concept
Adverse selection refers to a situation where the SME owner-managers with more risky business more actively prefer to equity financing rather than debt (Jordan et al., 1998; Stiglitz & Weiss, 1981). Stiglitz & Weiss (1981) have an explanation that in the case of adverse selection, banks have incomplete information about the underlying problem of the project and management quality i.e. firms’ internal quality concerned with the project implementation. Another scholar argued that due to information asymmetry between lenders and borrowers, adverse selection influences borrowing decision (Brealey, Leland, & Pyle, 1977). On the side of borrowers’ perspective, it could be argued that the adverse selection reflects a positive management capability of the project. This is because the borrowing firm has confidence to make a project successful and less likely prefer to pay dividend rather than additional interest to banks. In the borrowers’ adverse selection model this is argued that SMEs classify themselves by pledging different size of collateral to equity lenders (Besanko & Kanatas, 1993; Stiglitz & Weiss, 1981).
In this circumstance created by information asymmetry system, thus, banks have endeavoured to reduce the negative impact of information asymmetric condition; banks approve the loan application of small firms by imposing higher rate of interest than ideal risk-adjustment rate of interest (Lean & Tucker, 2001). The eventual result is that averagely the SMEs with poor or normal project management capacity experience a higher rate of interest, which could be argued as an obstacle to SMEs financing accessibility to formal financing market. In addition, as the information asymmetry causes are prior to the information provided by SMEs regarding their internal quality, it is argued that poor quality is itself responsible for this sort of financial constraint. Lean & and Tucker (2001) and Dabo (2006) agree with Stiglitz and Weiss (1981) that incomplete information about the underlying management capability of small firms rise problem of adverse selection. Furthermore, it is too costly for banks for monitoring and screening to small firms that raise the problem of moral hazard (Bester & Hellwig, 1989). One of the
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different approaches is that the banks judge the credibility of the loan application based on the firm’s financial information.
In the research, the information was all about bank statement; however, this study found that the kind of information is low. The degree of quality of information is positively related to the degree of firm assets. Hence, the quality of information is important in influencing PCBs’ financing decision. No research proposed any theory to reduce information asymmetric affect. Moro, Fink, & Maresch (2015) found that reducing information could be an important approach that if performed by enhancing the openness of information of Owner-managers to PCBs. How does the openness work if the quality of information itself is low?—the question is still unsolved.
3.7.3. Moral hazard concept
Moral Hazard concept is emerged from information hazard. Some owner-managers of small business have other sources of income having low potential risks due to the firm being well liquidated which encourages them to take higher risk for a project than they otherwise would (Carpenter, & Petersen, 2002). In the concept, owner-managers of firms provide banks some misleading information; the liabilities and assets have attitudes to take higher risk than usual (Debo, 2006). This situation put banks into information asymmetry problems and they have to be more suspicious in approving loan to SMEs. This is referred to as moral hazard problem.
Stiglitz & Weiss (1981) argued that this situation happens in the case of entrepreneurs those who are innovative to multiple investment opportunities where the increasing amount of interest differentially affects the rents from safe versus risky ventures. The preference of taking risk of borrowers increases with the interest rate. Hence, the increasing interest rate pushes the borrowers’ project choice in greater risk.
The theoretical concepts discussed in above are closely related to the attributes of financial institutions. It is perceived that the problem associated with information asymmetry is conducted by SMEs’ weakness about their capability to make a project/business success. These concepts will be further discussed later in the consideration of financial institutions characteristics. Since, to thus far, it has been outlined that the small business finance is apparently distinguished from larger business financing, and the banking sector is the most significant source of debt finance.
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The information asymmetric problem matters in the financial accessibility on the basis of collateral and other hard information. However, it is not defined in the literature either the information asymmetry plays in soft-information-based financing or the way it plays in assessing the soft information. This study intends to investigate the issue.