Demand for formal credit by small and medium size enterprises in Nairobi

Abstract

This study examines demand for formal credit by Small and Medium size enterprises in Nairobi municipality, Kenya. The study was undertaken at a time when financial sector had undergone tremendous growth in the recent years resulting into reduction of the proportion of population excluded in the financial sector. However, there is a consensus in the literature that small firms face financing challenges. Proximate form of finance is debt finance, but terms and conditions of credit are too stringent making credit unattractive for small firms. Over reliance on retained earnings impedes growth of these firms that playa crucial role in Kenyan economy since this source of finance for investment is inadequate for substantial capital accumulation in a short time. Demand for credit in this study is measured by application of credit and amount of credit applied. The study uses cross sectional data collected from Nairobi area in August 2010 using structured questionnaire. Heckman sample selection model was employed to correct for non randomness in entrepreneurs decision to seek credit and amount of loan given. Tobit model was also used to investigate extent of satisfaction of demand for credit to take into account heavy tails in success rate. Analysis of variance was utilized on variables on nominal and interval scale. Besides quantitative techniques, qualitative methods like focused group discussion and key informant interviews, were used. Empirical evidence suggests that firms finance their projects using retained earnings prior to debt. Despite there being no gender discrimination in the financial sector, female entrepreneurs are less likely to use debt finance due to self discrimination in seeking credit. Finally, growth oriented firms are more likely to seek debt finance.