Abstract

This study evaluates the Impact of Asymmetric Information on Bank Financing of Small and Medium Size Enterprises. Specifically, how Asymmetric Information affects Bank Financing in SMEs and How Moral Hazard and Adverse Selection will affect bank financing of SMEs. The research instrument employed in this study is a closed ended structured questionnaire administered to the staff members of the selected firm.

The data collected are analyzed using Pearson’s correlation statistical tool to test whether there is a significant linear relationship between Asymmetric Information and Bank Financing. The statistical package for social science (SPSS) was employed for the data analysis. The result generated from the study indicates that Information asymmetry has a significant effect on Bank Financing. The study concluded that Asymmetric Information has a positive and strong relationship on Bank Financing due to Non- Verifiable Actions and Ante- hidden information in FundAndImpact Inc Buea.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Enterprise is commonly defined as a set of combined factors, whose activity leads to the production of good and provision of service sold in a market. In the economic theory of the firm, little attention is paid to the environmental concern and information plays a vital role in delivering better services to customers but the problem arises due to the presence of ASSYMMETRY INFORMATION.

The theory of asymmetric information was developed in the 1970s and 1980s as a plausible explanation for market failures which analysis the tendencies that one party in a transaction has superior information compared to the other party. The theory proposes that an imbalance of information between buyers and sellers can lead to market failure. Market Failure in bank financing means that the price mechanism does not work effectively. Therefore, three economists were particularly influential in developing and writing about the theory of asymmetric information (George Akerlof, Michael Spence, and Joseph Stiglitz) the three shared the Nobel Prize in economics in 2001 for their contributions. They jointly argued that,

• Asymmetric information theory suggests that sellers may possess more information than buyers, skewing the price of goods sold.
• The theory argues that low-quality and high-quality products can command the same price, given a lack of information on the buyer’s side.
• Others argue that ignorance of the facts is not a given, as wary buyers have access to information on demand.

Furthermore, information asymmetry causes some major problem like Moral Hazard and Adverse selection nobody can ignore it. This is imperative in banking sector especially as “it is commonly accepted that bank lending to corporate borrowers establishes the relationship and produce information flow between the lender and the borrower which in turn facilitates further lending “(Boot 2000) thus causing asymmetric information as a problem for small credit (SME Financing) to the banks.

Like in the case of Bangladesh, collecting information about client is very costly and time consuming, so there is always a problem of information asymmetry. On the other hand, it may arise due to disclosure problems of the enterprise. for example, if the seller does not disclose the required terms and conditions of the product, the client may suffer losses both in the short and long run again without utmost good faith of a product it is difficult for a client to go in to real contract with the enterprise. More so, if the enterprise does not supply true information to its clients, it will create a room for Moral Hazard problem for the bank and Adverse Selection to the customer.

After the development of the information economy and economies of uncertainty since the early eighties (80s). Banks consider that the lack of information production and the weak financial structure of small and medium enterprises are key factors in the mistiness of their relationship, which explains why banks are hard to deal with this type of institution.  Thus, improving the access of small and medium-sized enterprises to funding sources is an interest shared by Government, Central Banks and Supervisory Ministries. This interest explains in an important aspect the problem of asymmetric information. The theory of microeconomics addresses the problem that is at the heart of the modernization of micro-finance theory.

The importance of small and medium enterprises for economic and social development has been dictated by the transformations and economic developments resulting from the phenomenon of globalization and economic blocs, which led investors and businessmen to reconsider their interventions, especially in the field of investment, where they favor the trend towards the small and medium enterprises Which are characterized by the ability to adapt quickly with economic changes, rather than the huge economic structures that have often  been disrupted by the economic crises in the world.

Small scale enterprises are generally vulnerable to unsuitable business conditions, as a result of significant few breaks through the hurdles to survive. opinion has it that, such distributing factors to small business operations include; bottle neck in accessing credit from financial intuitions, adverse economic conditions that steams from volatile government policies, ram-shackled state of infrastructure   aids, undercapitalization, non- transparency and expressing an offhand in supporting the SMEs sector in agreement with (wale A et 2000). Though several obstacles posted to the growth and success of SMEs both less developed and more developed economies, funding has the frontier factor in the line with (UNCTAD2001, 1995; SBA 2000). When SMEs can easily access finance, the chance for developing business and acquiring better technology for production increased thus aiding their competitive power.

Locally, the economic choices of the past have encouraged the achievement of big economic groups. Thus, small and medium enterprises in Algeria do not have a tradition of value, which requires giving it a chance in the process of restructuring the national economic structure, especially as it is better aligned with the demands of market economy.

1.2. Problem Statement

Information asymmetry arise in the credit market since borrowers know more about their investment project than the lender thus leading to Agency cost. Making credit facilities available to small scale businesses as a highlighted problem apart from being caused by financing insufficiency may also be as a result of incomplete preparation stemming from the entrepreneur of these SMEs in their request for credit assistances. Information gap between the principle and the agent could also be the case.

Not only are that, servicing of SMEs account are also strenuous to monitor considering it small nature. The general equilibrium theory assumes that all goods are homogeneous and that prices are determined according to supply and demand, but this analysis is not always the case.  If we drop the example Based on Adverse Selection on the reality of bank financing for small and medium enterprises, Institutions that are in a difficult position are more willing to accept loans no matter how high the interest rate is, while good institutions respond negatively to accept loans with increasing of interest rates, since some of the enterprises might not have enough expertise who enlighten them on current market situation. Which leads to the following result;

“Because of the problem of information asymmetry, the most insistent SMEs in obtaining loans are most likely to produce unsatisfactory results for lenders (because of high risk), while at the same time they are more likely to get loans.”

Unlike the adverse selection problem that can occur prior to a transaction, the problem of moral hazard appears only after the contract, so that the borrower uses the finance obtained in unproductive or high risk activities, which increases the likelihood of default, This is Usually associated to the problem of agency , especially in the financial markets through the inability of managers of companies as agents of shareholders to maximize the wealth of these individuals, and bondholders also may be exposed to this type of problems, which raises the problem of how to guide the behavior of these agents in the direction of achieving the objectives of Securities Campaign.

The problem of moral hazard can be summed up as a problem with the behavior of the borrower, which the lender cannot predict and it is more likely present in financing of small and medium-sized enterprises compared to financing big enterprises because of their lack of financial transparency, ownership structure and their owners’ concealment of the real purpose of the project. The distortion that led to this situation is what can be called the problem of asymmetric information, where one party has all the information about the transaction at the expense of the other party, without cost, leading to economic decisions are not sound. Thus, research will be carried out to identify the most important implications for the financing decisions of banks under asymmetric information.

Main Question

How does information asymmetry affect bank financing in small and medium-size enterprises?

Specific Questions

1. What relationship does moral hazard have in bank financing?
2. How does adverse selection affect bank financing of small and medium-sized enterprises?