SMEs and financial dependence: how important are foreign banks?

Purpose - The importance of financial dependence of small and medium enterprises (SMEs) on their performance is a relatively unaddressed area of research. Relatedly, whether and to what extent foreign bank penetration exerts an impact in the presence of financial dependence also remains an open question. The purpose of the paper in this regard is to exploit unit-level data on Indian SMEs and assess the independent and interactive effects of financial dependence on SME behaviour, in the presence of foreign banks. Design/methodology/approach - This study uses fixed effects specification to address the issue. In subsequent analysis, this study also uses an instrumental variable approach for robustness. Findings - The results indicate that financial dependence improves investment and employment, although there is a decline in productivity. These findings differ across size classes of SMEs. Similar is the evidence in the presence of foreign banks. In particular, foreign bank penetration leads to a decline in investment for micro and medium SMEs, although for small SMEs, the impact is found to be the opposite. Originality/value - To the best of the author’s knowledge, this is one of the early within-country studies to examine the interface between SMEs and financial dependence and the role played by foreign banks in this regard.