Working Paper Series: Special Edition of 2016 to 2018 Interns

1 Introduction In perfect frictionless credit markets, there is an unlimited supply of funds available to firms with feasible investment strategies and interest rates are determined by the interaction of market forces. However, in reality, this does not exist as imperfections in credit markets arise due to asymmetric information and agency problems. These imperfections violate the assumption of perfect markets and affect the free flow of capital from lender to investors with profitable ventures. In the literature, it has often been argued that larger firms are less likely to be constrained when it comes to obtaining financing because of their ability to supply collateral, build relationships with lenders and establish credit ratings and records of accomplishment. Such factors seemingly mitigate the risks associated with information asymmetry. More so, empirical studies have found that smaller and younger firms which are more informationally opaque as a result of unavailable or poor financial information, are usually more constrained in accessing external finance (Berger & Udell, 2004), (Fazzari, et al., 1988), (Petersen & Rajan, 1994). This inability to access credit markets severely inhibits them from making profitable investments, which may impede their growth and development. These firms typically have to use internal revenues to fund their investment strategies, causing them to become cash constrained especially in times of economic uncertainty. In the ECCU, access to credit is consistently cited by the private sector (which consist mainly of small and medium enterprises), as one of the major hindrances to growth and expansion of their businesses. According to the Foreign Investment Advisory Service (2004), high cost and low access to finance were among the top four cited binding constraints to doing business in Grenada. This is also consistent with the findings of (Brewster) 2006) who surveyed 125 firms within the CARICOM region. While some financial institutions, such as development banks and credit unions have facilitated SMEs by channelling resources to them, the prospects of the aforementioned institutions in their present state, making any significant contribution to growth is minimized given their current financial position (Jack & Samuel, 2013), (Eastern Caribbean Central Bank, 2014).

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