ASSESSING THE IMPACT OF INTEREST RATES ON SME CAPITALIZATION

By

FRANKLIN OTU

1
 CHAPTER ONE

INTRODUCTION

1.1 Background to the study

The private sector has often been touted as the engine of growth for many economies

(Agyapong, 2010). In the Ghanaian economy, things are not much different. Available data from

the Registrar General Department indicates that 90% of companies registered are micro, small

and medium enterprises (SMEs) (Mensah, 2004). The small and medium scale enterprises

contribute significantly to national development efforts in terms of revenues (taxes and bills) to

the state and provision of service to individuals and organizations. The small and medium scale

enterprises also contribute immensely to job creation, poverty reduction, generate income and

serve as a conduit for economic growth.

Nations and their citizens need small and medium scale enterprises to grow and flourish so that

they (SMEs) can continue to play the critical role they (SMEs) play in both human and national

development (Jensen & Uhl, 2008). To make progress and achieve success, SMEs need to be

constantly experiencing growth by expanding productivity and market size. The achievement of

these objectives however is, to a large extent, only possible via the injection of capital, which at

most times can only be accessed from mainstream financing institutions. The challenge however

is that SME access to finance is significantly limited as to banks, granting credit to SMEs

represents significant risk of investments. According to Lopez-Gracia and Sogorb-Mira (2008),

SMEs are also challenged as to their ability to present credible documentation on their business

activities and financial data to meet the paper requirements of most financial institutions. In

2
situations where SMEs are able to have access to credit facilities, the cost of the credit, as

represented by the level of interest can be devastating. to avoid the challenges that come with

inability to service loans, most SMEs decline commercial loans with high interest rates in favour

of going it small.

The natural question to ask in a situation like this is, is there a relationship between the level of

interest rates and SME demand for credit. In their treatise on the introduction to the risk

management approach in financial markets and institutions, Saunders and Cornett (2007) sought

to outline the negative correlation that exist between the level of interest charged on commercial

loans and SME appetite for taking loans under such regimes. Bawuah, Yakubu and Salakpi

(2014) in their treatise on the assessment of existing financial opportunities and their influence

on capital structure suggested that there are both direct and indirect relationships between the

level of interest charged on credit and the ability of most SMEs to afford the credit.

Despite these studies that seem to prove likely significant relationship between interest rate and

SME access to credit, other studies debunk any assertions of a possible relationship. There is also

a lack of consensus on the impact of the level of interest rate on SME ability to service a loan as

well as the impact of interest rates on the ability of small and medium scale companies to finance

capital project. To unravel the doubt and controversies that surround these questions, the study

sought to assess the impact of interest rates on SME capitalization

3
1.2 Statement of the Problem

The significance of the contributions of small and medium scale enterprises to individuals,

households and the national economy cannot be underestimated. for individuals and households,

the small and medium scale enterprises provide employment opportunities and assurance of

incomes whilst to government, the consistent contribution to revenue in terms of taxes and bills

cannot be overemphasized. The small and medium scale enterprises sector should therefore be

supported to continue to benefit both individual citizens and the government in general. yet, the

small and medium scale enterprises sector is saddled with enormous challenges stemming mainly

expensive credit facilities that SMEs cannot afford. As Bawuah et al (2014) asserted, the cost of

capital in Ghana especially for the informal sector is too high to enable any SME which borrows

at such steep interest rates to pay back comfortably. the challenge with high interest rates is that

it inhibits SME ability to capitalize thereby restricting SME capacity for growth and expansion.

Besides the real challenge of inability to pay back, do interest rate levels influence SME capacity

for capitalization? In the developed world, optimal levels of interest rates have positive influence

on SME demand for credit and positively influences SME capitalization (Leippold, Vanini &

Ebnoether, 2006). In Ghana, literature on the matter is not plentiful nor explicit. the relationship

between interest rate levels and demand for credit has not been put to much empirical test.

neither is there much data on the impact of interest rates on SME capitalization. the low

availability of data on the subject necessitates empirical studies such as this one.

4
1.3 Objectives of the Study.

The objectives of the study will focus on both the general and specific objectives.

1.3 General Objectives

The general objective of the study was to assess the impact of interest rates on SME capitalization.

1.3.1 Specific Objectives

The specific objectives of the study are as follows:

1. Examine the relationship between interest rates and SME demand for credit.

2. Examine the impact of the level of interest rate on SME ability to service a loan.

3. Assess the impact of interest rates on SME ability to finance capital project.

1.4 Research Questions

The study will seek to achieve the research objectives by answering the following research

questions.

1. What is the relationship between interest rates and SME demand for credit?

2. What is the impact of the level of interest rate on SME ability to service a loan?

3. What is the impact of interest rates on SME ability to finance capital project?

1.5 Research Hypothesis

Ho: There will be a significant impact of interest rate on SME capitalization

H1: There will be NO significant impact of interest rate on SME capitalization

5
1.6 Research Methodology

The study seeks to use a descriptive research design with a quantitative research approach. The

justification for using the descriptive design is that it provides a meaningful picture of events and

seeks to explain peoples perception and behaviour on the basis of data gathered at a point in

time (Yin, 2005). Quantitative analysis would enable the study to collect, group and categorize

data to allow for statistical analysis. The study seeks to combine the quantitative approach with a

descriptive research design to enable precise depiction of respondents characteristics and

findings of the analysis (Amin, 2005). Questionnaires would be used in collecting primary data

for the study.

The population for the study would comprise all SMEs operating in the Kumasi Metropolis of

the Ashanti region of Ghana. The study will adopt both random and purposive sampling

techniques. random sampling would be used to select the SMEs whilst purposive sampling

would be used to select the individual respondents from the selected SMEs. random sampling

would ensure that all SMEs have an equal chance of representation whilst purposive sampling

would enable the study target respondents it deemed to have the necessary experience and

knowledge levels in the field of study. Collected data would be coded into Statistical Package for

Social Science (SPSS) and Microsoft Excel softwares. Data would be analyzed using factor

analysis (frequency tables, mean and statistical standard deviation analysis) and inferential

analysis like correlation and regression analysis. Findings would be presented using tables,

smartart and charts.

1.7 Significance of the Study

6
This study is significant to various stakeholders of the SME sector. Firstly, the study would serve

to throw more light on the challenges to SME face in accessible credit and the effects of high

interest rates on SME ability to capitalize for expansion and growth. To managements of SMEs,

the study would serve as useful information on the relationship between interest rates and SME

ability to contract credit and pay back effectively. This would aid management decision making

in relation to accessing capital. the increased availability of literature on the topic and subsequent

improved knowledge levels amongst managements of SMEs would aid better decision making in

relation to other business areas that border on working capital management.

To employees of the SME sector, improved decision making as a result of increased access to

information would aid business sustainability and growth thereby providing assurance of jobs for

employees. the improved SME business environment would also serve to enhance job creation

and further employment of previously unemployed individuals. thereby the general public would

also benefit immensely. To government, improved SME business environment and the increasing

productivity that comes with it assures government of increasing revenues for national

development. To customers, better SME finances would serve to decrease profit percentages on

goods and services, thereby bringing down the cost of products to customers. To academia, the

study would add to extant literature on the topic and serve as a reference material to future

researchers. The findings of the study would also give directions to future researchers as to

which areas of the topic need further research.

7
1.8 Scope of the Study

The scope of the study is limited to assessing the impact of interest rates on SME capitalization.

Geographically, the study is limited to SMEs operating in the Ashanti region of Ghana.

Conceptually, the study focuses on examining the relationship between interest rates and SME

demand for credit, examining the impact of the level of interest rate on SME ability to service a

loan and assessing the impact of interest rates on SME ability to finance capital project.

1.9 Limitations of the Study

The major limitation the study anticipates is time. Since the study is an academic one set within

start and finish dates which the study perceives to be short and therefore limits the ability of the

study to select a larger sample size from a larger and geographically more diverse population. To

effectively combat this limitation, the study limited the geographical span for respondent

sampling and data collection and employed purposive sampling with the view of ensuring

representativeness and generalizability. The study will also execute the various chapters of the

work concurrently in order to meet the time limitations. Time is also a limitation on the side of

the study respondents some of who are expected to face difficulties having enough free time to

respond to the data collection instrument. This therefore would require the researcher to

constantly call to remind some respondents and in some situations, prevailing upon them through

persuasions and appeals before acquiring a fully filled questionnaire.

1.10 Organization of the Study

8
The study is organized into 5 chapter. Chapter one gives a description of the background of the

study in order to usher readers into the concept of the research topic. The chapter also discusses

the statement of the problem, the research objectives and questions, the significance of

conducting the study, a brief methodology on how the researcher intends to conduct the study,

the scope and limitations of the study and the organization of the study.

Chapter two presents extant literature and previous studies related to the research topic as well

the main concepts in the objectives of the study. this presentation of literature is focused on

theoretical as well as conceptual frameworks of the study. Chapter three presents the

methodology adopted to execute the study as well as the organizational profiles. The main areas

of discussion included the research design and approach, the population, sample and sampling

techniques used in selecting respondents, the data collection sources and data analysis

procedures and the profile of the study area.

Chapter four gave a presentation of analyzed data and the analysis that goes with the data as well

as a discussion of the data. The chapter first presents and discusses analysis on the demographic

characteristics of respondents and proceeds to discuss the analysis of data relating to the research

objectives. Chapter five gave a summary of the study findings, presented a conclusion to the

study as well as issued recommendations for stakeholders and for future researchers.

References

9
Agyapong D. ( 2010). Micro, Small and Medium Enterprises Activities, Income Level and Poverty

Reduction in Ghana- A Synthesis of Related Literature, International Journal of Business and

Management, Vol. 5, No. 12, pp.xx-xx.

Amin, M.E. (2005). Social science research conception, methodology and analysis. Kampala,

Makerere University Printery.

Bawuah, B., Yakubu A. S., and Salakpi A. (2014).Assessing the existing of financial opportunities and its

influence on capital structure of SMEs.A case study in the central region of Ghana, International Journal

of Development Research, Vol. 4, issue 5, pp. 1162-1173.

Jensen N. S and Uhl F. T. (2008).Capital Structure in European SMEs. An analysis of final and country

specific variables in determining leverage, Aarhus School of Business, Aarhus

Leippold, M., Vanini, B. and Ebnoether, S. (2006). Optimal credit limits management under different

information regimes,Journal of Banking and Finance,pp. 463-487.

Lopez-Gracia, J. and Sogorb-Mira, F. (2008).Testing trade-off and pecking order theories financing

SMEs,Small Business Economics,vol. 31(2), pp. 117-136.

Mensah S. (2004). A Review of SME Financing Schemes in Ghana, Presented at the UNIDO

Regional Workshop of Financing Small and Medium Scale Enterprises, Accra, Ghana, 15-16.

Saunders, A and Cornett M. M. (2007).Financial Markets and Institutions: An Introduction to the Risk

Management Approach, 3rd edition, McGraw Hil

10
Yin, R.K. (2005). Case Study Research: Design and Methods. Newbury Park, CA: Sage.

11