DOES LOAN FINANCE HELP TO IMPROVE THE PERFORMANCE OF SME’S: EVIDENCE FROM BANGLADESH AND INDIA

Authors: Holscher, J. and Djalilov, K.

Start date: 24 June 2015

This study considers the effects of finance, in the form of loans, on firm performance for a sample of firms in both India and Bangladesh. An extensive theoretical literature exists on the contribution of finance to economic development. This has been supported by a body of empirical evidence, mainly at a macro-economic level. To date very few firm level studies have been produced but evidence of whether or not loans do improve firm performance could provide an important and fundamental test of the role of finance. To examine the role of finance at the firm level we use cross-sectional data from the World Bank enterprise surveys for Bangladesh (2013) and India (2014). OLS regression analysis shows that loans had a statistically significant and positive effect on the performance of manufacturing firms in both countries. However, OLS suffers from two key limitations. Firstly, the relationship between loans and firm performance may reflect a two-way causality because the willingness of banks to lend may be affected by firm performance. To address this we use an instrumental variables approach. This reaches similar conclusions – that firm performance is enhanced by loans. The second limitation of OLS is that it cannot account for firm heterogeneity. To address this we adopt a propensity score matching approach. The results of this analysis again further support the view that loans do matter for firm performance. The paper concludes with an analysis, using a Heckman selection model, of those variables most likely to complement or obstruct the impact of a loan on firm performance.

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