Sustaining Small and Medium Enterprises through Financial Service Utilization: Does Financial Literacy Matter?

Promoting a dynamic operating environment for Small Medium scale enterprises (SMEs) is seen as a priority amongst economic development goals, in both developed and emerging economies. SMEs are a primary driver for job creation and GDP growth. They greatly contribute to economic diversification and social stability and they play an important role for private sector development. It must be emphasized, that the utilization of these financial products does not only promote the growth of the SMEs themselves but also their active participation in the financial services market leads to financial development which is widely recognized as an important determinant of economic growth and also recognized as important for enhancing the social and economic impact of the financial sector. In the past, SMEs, particularly, in developing countries, lacked access to financial products and services. The SME market was perceived by banks as risky, costly, and difficult to serve. However, with the advances in information and communications technology, the cost differential of serving poor customers has fallen and banks now perceive significant opportunities in the SME sector. Survey data from multiple studies show that banks have begun to target SMEs as a profitable segment. For example, a recent survey of 91 banks in 45developed and developing countries – Bank Financing for SMEs around the World – found that these banks overwhelmingly perceived the SME sector as a large market with good prospects. There exists an array of financial products - microcredit, savings, and loans, insurance, mutual funds, etc. – in both the formal and informal sectors in Ghana. Opportunities to utilize these financial services are now plentiful than about a decade ago. However, available studies have shown that about 44% of Ghanaians are financially excluded and have/use no financial products. This paper uses a direct measure of financial knowledge to empirically investigate the linkage between financial literacy and utilization of financial services by SMEs. However, since people’s level of knowledge can improve through utilization of financial service, we establish a bi-causality problem. In the analysis, two equations were estimated: (1) financial literacy level, and (2) utilization of financial service which includes financial literacy as an endogenous variable. The equation determining the level of financial literacy was estimated using the OLS while the equation for the utilisation of financial service was estimated using logistic regression. The IV method was used to correct for the problem of endogeneity. Overall, the results show that there was modest level of financial literacy among small and medium entrepreneurs in Ghana. Moreover, it was discovered that the better and more financially literate entrepreneurs were more likely to utilize financial service. The most commonly utilized financial service was operating a bank account. This has important policy implication. Finally, the instrument for financial literacy, recipient of financial education, also had positive relationship with utilization of financial service.