Development situation of SMEs in Vietnam

‘Title page
FINANCING SMALL AND MEDIUM ENTERPRISES IN VIETNAM: AN
EXPLORATORY STUDY
by
Hoang Hai Yen
A research study submitted in partial fulfillment of the requirements for the degree
of Master of Business Administration
Examination Committee: Dr. Do Ba Khang (Chairman)
Prof. John C. S. Tang
Dr. Fredric W. Swierczek
Nationality : Vietnamese
Previous Degree: : Bachelor of Economics
University of Economics
Hanoi, Vietnam
Scholarship Donor : Government of Switzerland
Asian Institute of Technology
School of Management
Bangkok, Thailand
April 1999
Acknowledgments
I wish to express my deeply gratitude to Dr. Do Ba Khang, my advisor and chairperson of
research committee, for his valuable guidance, comments and encouragement throughout
the course of this research study.
I am also highly indebted to Prof. John C. S. Tang and Dr. Fredric W. Swierczek, who have
served as committee members, have provided me with constructive suggestions.
I would take this opportunity to extend sincere gratitude to the Government of Switzerland
for providing the scholarship for my study in MBA program.
I would like to thank to Dr. Nguyen Thac Hoat, a member of Board of Administration of
Vietnam Commercial and Industrial Banks.
I would like also thanks to my colleagues in National Economic University, my classmates,
my friend Ms Lien, Mr. Hung. Special thanks are due to Phan Trieu Anh, without his help,

this research would not have been possible.
Last but not least, I remain indebted to my beloved parents and family members for their
tremendous sacrifices, enduring encouragement and push which lead me to this stage of
life.
ii
Abstract
Vietnamese Small and Medium Enterprises have considerable development in the recent
years, however are facing the two most critical problems of funding and lack of product
market.
The study involves in the understanding of the current situation of financial sources for
Small and Medium Enterprises in Vietnam. The objective of this study is to identify
financial problems faced by Vietnamese SMEs by reviewing and analyzing some past
surveys on SMEs as well as SMEs financing cases to gain some experience in the
development of SMEs in the coming time.
The problems stem from not only capital supplying capabilities of financial institutions but
also the weaknesses of SMEs themselves. The analyses of several case studies of
selected SMEs successful in getting funds recently are the basis to derive possible lessons
for others.
The study concludes with some recommendations for both Financial Institutions and Small
and Medium Enterprises to overcome the problems identified.
iii
Table of contents
‘Title page..................................................................................................................................i
Acknowledgments.....................................................................................................................ii
Abstract....................................................................................................................................iii
Table of contents......................................................................................................................iv
List of abbreviation...................................................................................................................v
List of figure.............................................................................................................................vi
List of Table.............................................................................................................................vii
1 Chapter 1.................................................................................................................................1

2 Introduction.............................................................................................................................1
Chapter 2...................................................................................................................................6
Literature review......................................................................................................................6
Chapter 3.................................................................................................................................14
Development situation of SMEs in Vietnam........................................................................14
Chapter 4.................................................................................................................................20
Analysis of Funding sources of SMEs in Vietnam..............................................................20
Chapter 5.................................................................................................................................38
Case studies on SMEs financing............................................................................................38
Chapter 6.................................................................................................................................52
Recommendations and Conclusions ....................................................................................52
References................................................................................................................................56
iv
List of abbreviation
SMEs: Small and medium enterprises
LEs: Large Enterprises
SOEs: State Owned Enterprises
NSEs: Non State Enterprises
GDP: Gross Domestic Product
VND: Vietnam Dong
CGSs: Credit Guarantee Schemes
VCCI: Vietnam Chamber of Commerce and Industry
MPI: Ministry of Planning and Investment
CIEM: Central Institution of Economic Management
ILO: International Labor Organization
MOLISA: Ministry of Labor, Invalids and Social Affairs
OECF: Overseas Economic Cooperation Fund
SPA: State Planning Committee
UNIDO: United Nation Industrial Development Organization
BID: Vietnam Investment and Development Bank

ICB: Vietnam Commercial and Investment Bank
Vietcombank: Vietnam for Foreign and Trading bank
RIDA: Research Institute for Development Assistance
MPDF: Mekong Project and Development Facility
HCMC: Ho Chi Minh City
CESAIS: Center for Economic Studies and Application
v
List of figure
Figure 1.1 Research methodology 3
Figure 5.1 Organization chart of BEMES company. 41
vi
List of Table
Table 3.1 Trend in number of business enterprises 15
Table 3.2 Equipment and technology level of SMEs (1991-1995) 16
Table 3.3 Difficulties facing SMEs in general 18
Table 4.1 Funding source of financing NSEs in HCMC and Hanoi 22
Table 4.2 Credit sources 23
Table 4.3 The main purpose of borrowing from banks 24
Table 4.4 The short-term credit distribution of banks to NSEs 25
Table 4.5 Medium and long-term credit distribution of banks to economy by
sector
26
Table 4.6 The level of capital borrowing from banks 27
Table 4.7 The changing interest rate from 1986-1995 28
Table 4.8 Difficulties in borrowing from banks 29
Table 4.9 The difficulties in borrowing money from banks 31
Table 4.10 Problem SMEs faced when asking banks loans 31
Table 4.11 Classification of companies according to the size of business
capital
32

Table 4.12 Overdue debt in short-term credit banks classification of
economic sector
33
Table 4.13 Overdue debt in long-term credit banks classification of
economic sector
36
Table 4.14 Target when borrowing money from informal financial source of
SMEs
37
Table 4.15 The condition to borrow from informal financial sector. 37
Table 4.16 Evaluation of SMEs about advantages of financing in informal
finances
38
Table 4.17 The borrowing interest of informal source 39
Table 4.18 Summary the criteria and characteristics of each funding
source.
48
Table 5.1 Income statement of January-September 1998 49
Table 5.2 Balance sheet of January-November 1998 49
Table 5.3 Pro forma income statement for the new project 50
Table 5.4 The growth rate of labor and sales of 1994-1997 52
Table 5.5 Leasing package for Xuan Kien by International Leasing
Company.
54
vii
1 Chapter 1
2 Introduction
1.1 Rationale of the study
Small and medium sized enterprises (abbreviated as SMEs) play significant economic,
social roles in employment creation, resource utilization, and income generation, contribute

to exports and make the economy more dynamic. Governments in most countries, whether
they are highly industrialized, developing or among the least developed, have expressed
increased enthusiasm for SMEs because of their contribution to the people’s well being
and satisfying their basic needs.
SMEs also occupy a vital role in the distribution system of all nations. This sector works
closely with customers, which is essential to promote the industrial growth of industries.
SMEs can provide new and innovative ideas to industries, which require a huge
investment for developing and existing. So, it is important to facilitate SMEs.
However, SMEs in most of the developing countries face many difficulties such as
shortage of capital, or the lack of materials and management skills. The promotion of
SMEs may be an effective and important approach to economic development. According
to the preliminary findings of a survey of 17 economies conducted by Taiwan economists,
the problems faced by SMEs in Asian-Pacific region differ considerably. In developing
countries like Vietnam, the main difficulty in business of SMEs is the lack of financing.
SMEs are hungry of capital. Nhuan (1997) and an overview of Vietnam Fund (1997) by
Bear Stearn International Limited show that: Financial institutions can not exploit
completely their capital capability while SMEs face shortage of capital. The question is why
SMEs can not be qualified to borrow this available fund? Which factors cause borrowing
failure of SMEs?
Besides, Beesly and Rothwell (1987) observes that companies need to complete a good
financial plan before talking with potential lenders. The financial institutions looking at
some criteria (four “Cs” (Characteristic, Capability, Collateral and Capital) model that will
be mentioned in the literature review) in the lending decision. For borrowers, particularly
SMEs need to know the factors that influence the lending decision of financial institutions.
They also need to know which criteria they should focus and improve to get fund from
financial institutions. Some recent surveys on evaluating loan eligibility in New Zealand,
Canada which are mentioned in literature review show that lack of management skill, poor
performance, weak financial position, ability to repay debt and insufficient security of SMEs
are the key reasons for banks to reject lending to SMEs. The question is that whether
SMEs in Vietnam have the same difficulties or not?

1.2 Problem statement
In Vietnam SMEs has been formed and developed since the late nineteenth and early
twentieth centuries. Up to present, SMEs have remained dissatisfied with the funding
supply from all financial institutions. The gap between the funding needs of SMEs and the
supply from financial institutions stems from both the capabilities of SMEs themselves and
1
different requirements of the others. In getting loans from different sources, SMEs have to
satisfy different provisions, which sometimes turn out to be impossible for them. Many
SMEs have struggled to get fund from multiple sources at reasonable prices. Some have
succeeded but the others either have stayed lack of fund or have to agree with unbearable
interest.
1.3 Objectives of the study
1. Review financial sources for SMEs
• Identify the different financial sources available in Vietnam for SMEs.
• Determine contribution of each major financial institution to funding SMEs.
• Identify an analyze difficulties facing SMEs in getting loans from financial institutions.
2. Based on several case studies of selected SME’s successful in getting funds recently in
order to derive lessons for other SMEs.
1.4Research framework
The research framework has been designed in such a way that both SMEs and financial
institutions are attributed and treated in one topic. This whole research focuses upon the
SMEs financial problems in getting funds from formal financial institutions.
The research has been carried out in Vietnam, and can be divided into three stages:
• In the first stage, the review of commercial banks, SMEs and Government bodies that
have responsibility of supporting SMEs development were carried out. The relevant
data in financing was collected and reviewed during this stage.
• In the second stage, the data was analyzed to know the situation of SMEs in Vietnam
especially in financing area. The common obstacles SMEs have to face were
classified. Which ones are raised by Government’s policy, which ones are raised by
financial institutions and which ones are raised by SMEs themselves. The

responsibilities in those obstacles of the Government policies, financial institutions, or
SMEs are identified.
• Some companies that were successful in getting external funds are selected to analyze
for in-depth understanding the successful factors to have lesson for others.
• Finally, in the third stage, all the data has been composed into this report.
The framework for the study research is showed in the following figure.
2
Research Framework
F
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n
a
n
c
i
a
l

i
n
s
t
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t
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t
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Banks
Financial
leasing
Informal
sources
1. Contribution to funding
SMEs
2. Criteria in evaluating loans
to SMEs
3. Advantage and
disadvantages
1. SMEs’ capabilities
-Management
-Financing
-Technology
-Market
2. Financial
documentation
- Business planning
- Bookkeeping activities
Gap
Analysis of selected cases
SMEs
Lessons and recommendations
3
1.5Research methodology
Both primary and secondary data were collected for this research study.
Primary data:
♦ In-depth interviews with financial institution’s executives (bank officials, lessors,
SMEs creditors), the pattern of these interviews was a mix of structured and

unstructured type of interviews, following areas were discussed:
Financing policies for SMEs.
Financing distribution for SMEs.
Financial institutions’ opinions on SMEs
Difficulties these financial institutions facing in funding SMEs.
♦ In-depth interviews with SMEs managers, the following areas were discussed:
Financial situation of the companies
Past financing sources the companies call for
Where did the companies often get funds?
Difficulties in getting fund from each financial institution.
What were the companies’ efforts to get funds?
Secondary data:
♦ Annual reports and others publication of
Federal Bureau of Statistics on non-state sector and statistics Yearbook
State bank, World Bank and Commercial banks
Some Government bodies such as Vietnamese Chamber of Commerce and
Industry (VCCI), Industrial department of Ministry of Planning and Investment
(MPI), Central Institution of Economic Management (CIEM), Project on
Assistance to SMEs.
♦ Newspapers, magazines, journals and books
♦ Case studies, speech reports
1.6Scope of the research
♦ SMEs in Vietnam include both State-owned and non-State owned enterprises (SOEs
and NSEs). In this research only NSEs was selected to study.
♦ The research focuses only on financing problems and issues related to SMEs.
♦ There are many financial institutions supporting SMEs in Vietnam financially. They
are commercial banks, financial leasing and international funds based in Vietnam
4
such as Vietnam Templeton Fund, Vietnam Frontier Fund, or some funding
supporting organizations for SMEs that are aided by some international

organizations. However, just three main sources known as banks, financial leasing
and informal sector are chosen to study.
♦ Geographic area of Vietnam has been selected.
1.7Outline of the study
Chapter I introduces the rationale, problem statement, objective, methodology and
scope of the study.
Chapter II is a review of certain number of previous studies on SMEs, its contribution to
economy, its advantages and disadvantages. However, financing problem is the central
concern of the review. Besides, to solutions, models that have been applied in other
countries and arguments on them will be presented.
Chapter III provides an understanding of the situation of SMEs in Vietnam and their
contribution to the economy. General difficulties facing SMEs will be discussed.
Chapter IV introduces the available financial institutions in Vietnam, their contribution to
funding SMEs and their criteria in evaluating loans to SMEs. The difficulties facing SMEs
in getting funds from financial institutions is finding, in which the difficulties that due to
weaknesses of SMEs themselves are focused as certain concern.
In Chapter V three selected case studies will be presented background of the company,
development history and financial situation, their funding problems and ways overcome
the problems will be discussed to draw possible lessons
Chapter VI gives conclusions and some recommendations. Potential application of the
research, its limitation and some suggestion for to further studies are also give.
5
Chapter 2
Literature review
2.1The role of SMEs to the national economy
2.1.1 Employment creation
Small-scale businesses are likely to utilize labor-intensive technologies. They can
establish rapidly and put into operation to produce quick return. This has been found
also that it is cheaper to create jobs for employment for SMEs than in large industries
(Bosworth, 1986). For example, in Indonesia, the LEs capital intensive industries require

an investment of US $ 50,000 to employ an additional worker. One the other hand, the
small-scale industries require an investment of US$ 500 for an additional worker
employed (Tan Thiam Soon, 1984). United Kingdom for example, at one time
encouraged small enterprises to employ more manpower and the Government provided
subsidy to the employer for each additional worker employed. With the relative ease of
starting of small enterprises as compare that of starting a large enterprise, there is a
potential of job creation in the small business sector. For countries, it is a solution to
generate more jobs for employment.
2.1.2 Regional and Rural Development
Tan Thiam Soon (1984), small business requires relatively little amount of capital and a
low level of technology. They can be easily established in the less developed areas of a
country, and help in spreading economic activities from urban to rural areas. In this way,
small enterprises not only provide the country flakes with employment opportunities, but
also help to reduce the flow of migration from the rural to the already overpopulated
cities.
2.1.3 Provision of Services to Local community
Tan Thiam Soon (1984), small enterprises play a very important role in many countries
in providing daily services. Indeed SMEs are responsible for the supply of food,
transportation, and daily necessities. Services are all provided better by small business
than State-large enterprises. Small retailers make it possible for the customers to
purchase many different items in one shop. As a matter of fact, without the services of
SMEs, our life will be hampered and very inconvenient.
2.1.4 Supporting the Large Enterprises (LEs)
Tan Thiam Soon (1984), the advantage of economies of scale can be achieved only
through larger operations. Some business activities require larger amount of capital and
a high level of technology, which are beyond the capability of small businesses. Hence,
large enterprises are also important to the national economy in terms of providing
employment and training of skills. However, (Beesley and Rothwell, 1987) in many
countries like Japan, large enterprises cannot survive on their owned. They require the
supporting services of small enterprises in terms of supply of material, parts and

components, semi-finished goods and distribution of finished products. Some foreign
investment also looks at the sufficiency and efficiency of locally supporting services.
6
Some products or components and accessories do not require high precision work and
can be outsource to allow companies to concentrate upon more important areas such as
marketing, quality control, product design and research and development.
2.2Main barriers to growth of SMEs
Three sources of constraints or barriers for the growth of SMEs have been identified by
Barber (1987). The literature on the issue will be presented according to this
classification of finance, skilled labor, and technology.
2.2.1 Skilled labor barrier
Small firm is likely to face special difficulties in the attracting and retaining skilled labor.
The evidence found out by Beesley and Rothwell, R., (1987) shows a consistent picture
of wages and salaries per employee increasing with plant and firm size. Lower level of
training that in small firms tends to be more often of an informal rather than formal nature
also appears to be associated with smaller size.
Access to skilled labor is often crucial to the successful innovative performance of the
firm; any evidence of small firms being specially disadvantage in their capacity to train or
recruit skilled labor has particular significance. The point made by Bosworth (1986), is
that there are two distinctive types of skilled labor shortage. One is the actual shortage
that a firm may experience because of its current planned activities. The second is a
latent shortage because firms reconcile themselves to shortages by default. Against
though as with the case of finance, the available literature often fails to make important
analytical distinctions of this kind.
In Vietnam, a report on the survey of management training need of SMEs in Vietnam
(1997) that conducted by MPDF determines the need for management training and
related services. The difficulties faced by managers of SMEs are found in with financial
management, financial planning is two of the most difficulties. The survey was not only
demand statistics for management training of SMEs but also did the qualitative and
quantitative analysis in supply side. The finding from the survey about 92% of the

companies have a need for management training. The survey also finds that private
firms operate in a mostly hostile legal/ regulatory environment. In addition, few support
services are available to private businesses, virtually none tailored for SMEs in Vietnam.
2.2.2 Technology barrier
Perhaps the clearest answer on a particular factor imposes barriers to growth of small
firms comes from the paper by Rothwell and Beesley (1987) on access to external
technology. These is also supported by Giaoutzi (1988) that for SMEs to be able to play
an effective role on technology development. Access to higher education and
technological research institutions need to improve. Venture capital, other innovative
structure, improving infrastructure should be provided. Besides, the establishment of
Science Park, regional technology is not real barrier to innovation and technologies.
Because the use of external technology is seen as a employment to, and not a substitute
of, in house technological efforts by innovative firms- the employment of qualified
scientists of, in house technological efforts by innovative firms - the employment of
qualified scientists and engineers being quite central to the technological development of
the firm.
7
Growth will also depend on the willingness and ability of SMEs to exploit the availability
of such resources to take advantages of the opportunities in the markets for their
products. The explanation of the growth of SMEs lies in the interaction between the
inherent motivation and capabilities of the firms themselves and the external
environment in which they much endeavor to survive and prosper.
2.2.3 Policy effect
In the past, the structure of effective protection in developing countries seems to have
benefited large enterprises (LEs) more than SMEs. Hiemenz and Bruch study (1983)
suggested that LEs generally were concentrated in industries with relatively high
effective rates of production, while SMEs were concentrated in industries with low and
even negative effective rates of production. Furthermore, selective measures with regard
to individual industries tended to aggravate policy-induced discrimination against SMEs
vis-à-vis LEs. Such measures comprise foreign exchange and import control, selective

tariff protection on a case-by-case basis, exemption for import duties, tax incentives, and
subsidized export credit. Finally, the protective system and additional selective
measures have negative repercussions on the growth potential of SMEs. These impede
an upgrading of technology and improvement in product quality and output mix.
Domestic demand for SMEs products is negatively affected in two ways: import
protection creates a bias against the use of labor, which retards growth of demand of
LEs from local to import markets. With respect to industrial exports SMEs suffered from
an artificial disadvantage because incentives, which could compensate for the
discrimination of exports through import protection, were not available.
Little (1987) argued that the relative decline of small enterprises particularly in most
developing counties can be understood by industrial policies adopted in these countries.
It was argued that rapid decline of small firms in the highly export-oriented economies of
East Asia was mainly due to economies of scale in export marketing, good job
opportunities, and high deposit rates of interest. According to the traditional approach,
financial assistance, extension services, marketing assistance, and the provision of
infrastructure facilities must be considered as elements of a Government intervention
packages intending to diminish policy - induced disadvantage of SMEs. However, such
program has frequently created additional distortions and suffered from a number of
internal inconsistencies that reduced their effectiveness. There are also more
fundamental considerations leading to a conclusion that the results of specific assistance
to SMEs may remain unsatisfactory as long as the plant size bias in the policy
framework is not substantially reduced. Reform of trade policies and rationalization of
investment promotion measures are therefore important preconditions for a significantly
enhanced contribution of SMEs to employment, output, and income generation.
M.Gaedeke and Tootelian (1985) explain that financial deregulation and liberalization
alone unlikely to improve access to credits for SMEs in the short and medium term.
Interest rates have initially to rise to very high levels to make lending to SMEs profitable.
At such high interest rates, demand for loans is very low and default risks may be higher
than at lower rates. These might be also the tendency for individual banks to avoid the
initial costs involved in improving the capabilities of SMEs borrowers to deal with

financial institutions in the expectation that other such institutions would make such an
investment. There is also evidence that in countries that have deregulated domestic
interest rates, credit markets segmentation and oligopoly market structure persisted,
continuing to discriminate against small and medium of financial institutions.
8
2.3Financial difficulties facing SMEs
There are numerous sources available for funding a business, including the traditional
financial institutions. In addition to what the entrepreneur may already have accumulated
in preparation for the new venture, according to Kitchen (1986), some other informal
sources include ‘ family and friends, private investors such as business professionals,
advisors and business contacts, employees, potential customers and suppliers, past
employers”. However, without a solid overall plan for the business, it is virtually
impossible to obtain funding. Some of the more formal sources of fudging included “
venture capital firms, investment banking firms, insurance companies, large
corporations, small business investment companies and minority enterprise small
business investment companies, accountants, banks.”
2.3.1 Informal credit market and SMEs
• Richardron, and Singer (1982) shows that in a situation where barriers against to
formal credit on the part of SMEs are high, entrepreneurs are largely confined to their
own funds and informal sources of credit, such as family members, friends, relatives,
money lenders, and suppliers of materials. In financing SMEs activities informal
credit markets have some distinct advantages over formal markets, such as a higher
degree of flexibility and lower transaction costs. Transactions are based on the
confidence engendered by face-to-face relationships between creditor and debtor,
and there is usually no collateral involved. Security on loans is contingent upon the
borrower’s past saving and credit record and on social pressure.
• According to Story (1988), as the opportunities cost of SMEs are quite high
compared to LEs, therefore an enterprises employing 10 people out of which 4 gets
busy in fulfilling the collateral requirements of the financial institution is costly to
SMEs than LEs. Hence, many SMEs prefer informal loans to finance small

purchases of fixed assets and normal requirements of working capital. On the other
hand, Kichen (1986) explains that informal credit markets are subject to some
marked disadvantages from the point of view of the individual entrepreneur as well
as concerning social efficiency. Informal loans are usually confined to small amounts
and short repayment periods. The efficient allocation of funds tends to be impeded
by the local nature of informal markets; and their capacity for mobilizing savings,
refinancing, and term transformation is rather limited in general. Informal sources are
likely to be adequate for financing traditional activities, where investment in fixed
assets can be made in small steps and gestation periods are short.
2.3.2 Formal credit market and SMEs
• Most Governments, in the developed world have been involved in offering a variety
of capital and R&D subsidies to industrial firms for many years. In principle, these
subsidies have been available to firms of all sizes, but in practice the bulk of the
support in most countries has traditionally gone to large firms (Rothwell, 1985). In an
attempt to redress this large firm bias in R&D support, most European governments
began in the 1970s to provide special funds earmarked specifically for the support of
innovation activities in SMEs (Rothwell, 1987). Access to finance has frequently
been cited in the past as a key constraint on the growth of small firms in may
countries and more generally on innovation (Berber et al., 1987). In his survey of
capital market institutions, he deals with the long-standing issue of the alleged gap
between the needs of small and the willingness of holders of capital to meet this
9
need. Clearly finance is a major resource, the lack of which can cripple growth
prospects. Some of the findings identified that all the blame for capital market
deficiencies cannot be placed upon the lenders (Barber et al., 1987). The owners
and managers of small firms are often woefully lacking in their ability to present
convincing business plans (Vermeer, 1990). Clearly there are great dangers here in
treating finance as if it were a commodity divided into homogeneous bands of risk
each carrying its own rate of interest There are numerous sources available for
funding a business, including the traditional financial institutions. According to Barber

et al (1987), the size of business determines the amount of capital that will be
needed. As the business grows, the need for more funds increases. Some of the
reasons that business need funding are to start the business (rent or building cost,
raw materials, and so on), to obtain money for new equipment and for facilities, and
to obtain finance for growth. Compared to large scale companies, SMEs are less
liquid, exhibit more volatile profit and cash flow measures, and rely more heavily on
short-term funding. Given SMEs reliance on short-term funds, it has long been
recognized that the efficient management of working capital is crucial in respect of
the prospect of the prosperity, and indeed survival, of small firms (see e.g. Deakins
and Philpott, 1989) has also reported that the most important internal problems
identified by small firms related to inadequate capital, cash flow management and
inventory control. In the context of (Michael J. Poor or careless financial
management is a major cause of small business failure (Berryman, 1983). In
addition, a recent major survey by the Insolvency Practitioners Society (CIMA, 1994)
indicated that 20 percent of UK corporate failures (the vast majority of which are
small firms) were due to bad debts or poor credit management. Addition recent
research, commissioned by the National Westminster Bank and the Norfolk and
Waveney TEC (Shaw, 1994) revealed that no less than 80 % of small business
which failed in the area, did so largely in consequence of the poor management skills
of their owners. As a result, small business in the locality are being offered cheaper
(discounted) bank finance, if their owners undertake to attend financial management
training courses. Besides, Hansen, Derek (1981) focused the cost of lending and
explains that, when banks have little experience with lending to SMEs, transaction
costs are exceedingly high. Since in equilibrium the banks expected rate of return on
all loan contracts must be equal, interest rates for SME loans would have to exceed
interests rates for LEs loans by a huge percentage that is equal to the difference in
transaction costs. In such a situation the default risk is, however, likely to outweigh
the direct effect of high interest rates on the banks’ rate of return. Therefore, loans to
small and medium scale applicants may not be disbursed at all. Morvis, G.M., (1986)
also points that when there is a lack of familiarity of banks with SMEs as well as of

SMEs with banks, it is especially difficult and costly for a formal lender to identify the
risks of projects among SMEs when documentation is deficient. Loan application by
LEs establishments, on the other hand are often evaluated on the basis of indirect
statements. Often banks are also reluctant to lend to SMEs because they have little
knowledge of the condition under which such projects succeed. Objective differences
in the average risk of projects between small and large scale borrowers may result
from a number of factors, for example, management and entrepreneurship may be of
a lower quality in SMEs compared to larger establishments. External factors that may
account for a higher average default risk being connected with loans to SMEs are
their discrimination by the protective system and by investment promotion measures.
And, finally, deficiencies in the legal system may restrain actions to be taken against
delinquent small-scale borrowers.
10
2.4How some countries overcome financial barrier
2.4.1 Networking by external support agencies and financial institutions
Problems in risk assessment arise because of asymmetric information. For example,
funding providers face the twin problems of adverse selection and moral hazard (Stiglitz
and Weiss, 1961: Binks (1988). Banks and venture capitalists may have different criteria,
which are used to assess propositions may reflect these problems. It has been shown
that the quality of information and criteria used are critical to overcoming adverse
selection (Deakins and Hussain, 1994). Dealing with the problem of risk assessment,
networking by external support agencies and financial institutions plays a very important
role. Networking improves the information set in risk assessment. Effective working can
go some way to reducing risk assessment problems for financial institutions and SMEs.
In addition, networking between finance providers and agencies would affect the
awareness and take up of alternative funding schemes (Deakins, 1994). However,
networking should enable the profiling and take up of alternative schemes to be
increased, it should also enable the potential of informal sources of equity to be
exploited if they exist. Mason and Harrison (1992) have shown that, there is much
potential from the development of informal sources of venture capital exist in the form of

search costs and availability of information. The study with UK bank officers revealed
that risk assessment practices of UK banks suffered from a high degree of variability and
a market reluctance to use outside expertise to reduce problems that might arises from
asymmetric information (Deakins and Hussain, 1994). In West Midlands, the banks have
started to work more closely with support agencies such as Enterprise Agencies (EAs).
In some cases there are close links with the Chamber of Commerce or other business
associations. Bank officers regarded information on market research as essential. The
support infrastructure can be exploited by both financing providers and SMEs. In the UK,
networking provides most potential for improving both risk assessment practices and
SMEs financing support (Bennett, et al (1994).
In Germany, networking between banks and other agencies and educational institutions
is popular. If an entrepreneur does not possess this knowledge then he will be required
to obtain consult and advice from either local Industry-und-Handelskammern (IHK) or
Fachhochschule. All manufacturing SMEs belong to the IHK. Compulsory membership
ensures a strong body to represent the interests of SMEs, although it is admitted that the
extent of interaction with financial institutions will vary with the individual IHK (Deakins
and Hussain, 1994). In Germany there was a willingness to share information. Often
more than one bank would be involved in financing and assessing a proposition. If one
bank had a network of contacts or a specialist in the area then information could be
shared. Co-operation existed between different banks. So, formal and informal sources
of equity finance could be exploited by entrepreneurs in Germany (Stanworth and Gray,
1991; Storey, 1993).
2.4.2 Credit Guarantee Schemes (CGSs)
Collateral is one of the criteria of banks in evaluating potential customer. As mention by
the model 5Cs: character, capacity, capacity, capital, conditions and collateral (banking
Liaison Group). Collateral had been a very important requirement to get loans from
banks in some countries. Adams (1988) shows that banks may reject a SME loan for
many reasons. The most common are under capitalization, high debt compares with
equity and lack of collateral. The reasons generally provided by SMEs why purchases of
fixed assets are not financed by institutional sources are: the enterprises lack collateral,

11
informal loans are faster and more convenient. So, collateral is played a significant role
in borrowing application.
To deal with the collateral facing SMEs, in some developed as well as in developing
countries, Credit Guarantee Scheme were formed and developed. Credit guarantee
schemes (CGS) provide loan guarantees to banks. They compensate the lenders
(banks) for much of the cost of risk, if an SME does not pay back the loan. This means
that the credit guarantee provided by the CGS replaces some of the collateral required
by the bank. In addition to this, handling costs that are related to the amount of collateral
that is displaced by the credit guarantee helps in reducing the administrative cost in
current by the banks.
A global study of Levitsky, Jacob (1993), shows that credit guarantee schemes are
operating in several countries and there is renewed interest on the part of donors to
provide support for them. There are also arguments against CGS. One argument is the
“moral hazard” issue namely that CGS weaken the will and commitment of the borrower
to repay the loan. In addition, some argue that ” moral hazard” is likely on the part of the
lenders (banks) in that they will have less incentive to supervise the loan properly or
pursue actively the collection of repayments.
The result, as pointed out in Holden’s (1994) paper, is that Latin American credit to the
private sector in no country of the region exceeded 50 percent of gross domestic product
(GDP), even though there has been rapid growth in the amount of credit granted by the
banking system in recent years. By contrast, in the United States and Germany, Holden
points out, outstanding credit equals or exceeds GDP. Even in Singapore and Thailand,
the two Asian economies with fastest growth rates, the very rapid expansion of credit
mirrors the economic expansion. It is therefore not surprising that the Inter-American
Bank’s organization of a Round Table Meeting on Credit Guarantee Systems in June
1996 aroused considerable interest both among representatives of Latin countries and
among those that have been working on the operation of the financial sector in
developing countries. Although such CGSs have been in operation in different forms in
Europe and Japan for over 30 years in some cases there are still strong differences of

opinion whether credit guarantee schemes can in fact help resolve the real problems
caused by the underdevelopment of the financial system.
The papers both of Vogel and Adams (1995) and of Gudger (1996) support the view of
Holden that CGSs are not effective substitutes for financial reform. The Vogel/Adams
paper argues strongly that ‘‘asymmetry of information’’ (i.e., that SME borrowers will
always know more about their ability and willingness to repay the loan than will the
lender) and high transaction costs are the real problems, and that CGSs are likely to
increase rather than reduce these. Vogel and Adams, who clearly are opposed to any
form of subsidies for SMEs, believe that CGSs must involve some forms of subsidy.
They do, however, admit rather grudgingly that whatever the benefits and costs of loan
guarantees are, they do less damage than does providing lenders with cheap,
subsidized funds.
Gudger (1992) maintains that introducing a guarantee scheme might well save some of
the 2 percent loan risk but would probably also raise the 12 percent administration by an
equivalent amount.
Westley (1996), commenting on Vogel and Adams’ paper, supports their view that there
is little conceptual justification for publicly supported credit guarantee schemes, and
questions whether such a guarantee system could be part even of a second-best
solution for getting credit to the target group of small businesses. Westley argues that
12
the legal framework would better be examined so as to change banking regulations in a
way that could lower transaction costs and make SME lending more attractive to banks.
Castellanos follows by raising the issues of designing a credit guarantee organization
and of whether the operation of this financial instrument should be subject to the same
standards applying to other financial intermediaries. Castellanos argues that it is both
possible and desirable, to create a special regime for financial supervision of guarantee
schemes.
Meyer’s paper (1997) maintains that all evaluations of credit guarantees schemes until
now have proved inadequate to reach conclusions on the effectiveness of credit
guarantees in attaining sustainability or achieving in banks’ SME lending. He sees

guarantee schemes as a means to entice lenders to increase lending to SMEs and
believes that once lenders learn that this is not as risky as they thought, they will lend to
SMEs in the future without guarantees. Meyer also sees other possible long-term
benefits of guarantee schemes: improvements in loan conditions, longer term loans,
lower collateral requirements, and even, in some cases, lower interest rates.
According to Levitsky, Jacob (1993), Credit Guarantee Schemes should be launched
only when is recognized by all concerned-and specifically the guarantee organization
that it is entering into contracts on which payments will have to be paid necessary in the
proportion of risks, participation, premiums, etc.
In conclusion, financial shortage is seemed to be a problem of SMEs over the world.
Based on the macro environment and characteristics, each country has difference
method to improve this situation. However, a synergy between government bodies and
SMEs is needed to be successful.
13
Chapter 3
Development situation of SMEs in Vietnam
3.1Characteristics of SMEs in Vietnam
3.1.1 Establishment and development process of SMEs
Private sector was accepted by law on company in late 1990. Then, law on foreign
investment, private enterprises and companies (1991) had been enacted, marking an
important step towards reducing official distrust and harassment of the private sector.
According to a data provided by CIEM and the Enterprise Department of MPI (1997),
since 1990, numbers of private companies have increased consistently with 190 joint
stock companies 8,900 limited liability companies 21,000 private enterprises registered
in 1996. Private enterprises are mostly small scale, but a number of medium scale
operations are beginning to emerge. Most of the former industrial and services sector
co-operatives have been disbanded are reorganized as SMEs. The number of
household businesses is estimated to have increased from about 0.84 million in 1990 to
2.22 million by 1996. The data are presented in Table 3.1.
Table 3.1 Trends in number of business enterprises

Unit: company
Year 1990 1991 1992 1993 1994 1995 1996
State enterprises
Centrally managed
Locally managed
Domestic non-state
Joint-stock
Limited liability
Co-operatives
Private enterprises
Household enterprises
(million)
12,084
1,695
10,389
-
-
-
-
.84
9,832
2,331
7,501
3
43
n.a
76
n.a
9,300
n.a

n.a
65
1,170
3,231
3,126
1.50
5,704
1,1675
4,029
106
3,390
n.a
8,684
n.a
5,835
1,678
4,157
126
5,258
2,275
14,052
1.53
6,310
1,847
4,463
165
7,346
1,867
18,243
2.05

n.a
n.a
n.a
190
8,900
n.a
21,000
2.22
Source: CIEM-MPI (1997).
3.1.2 The structure of Vietnamese SMEs
As cited in “Non-State sector in open door time 1991-1995” issued by General Statistics
Publisher (1996), 46.2% of SMEs participating in trade and repairing services is large
relative to the total number of SMEs. Nearly 18% of the total number of SMEs in the
country are working in industry and construction. Among the industrial SMEs, 37.3 % are
operating in food processing industry: 11% are working in textile, garment and leather;
12.3 % are participating in mechanical engineering, producing equipment, machinery,
14
precision tools, and assembling motorcycles and transportation facilities.

Ten percent of
the total number of SMEs are operating in transportation and warehouse services. The
remaining small number of enterprises participates in various other activities.
So, SMEs prefer invest to sectors that achieve quick return on investment. Industrial and
infrastructure fields account for a small percentage of SMEs.
3.1.3 Technology and equipment of SMEs
In 1995, Vietnam Chamber of Commerce and Industry (VCCI) concluded a survey on
420 private companies belonging to the three biggest economic centers of Vietnam: Ho
Chi Minh City (HCMC), Hai Phong and Hanoi. 140 private enterprises were selected
equally in each province. It covered three sectors: manufacturing, service and trading.
The survey found that only 10% of enterprises surveyed were entirely equipped with

modern technology. In which only 6.7 NSEs surveyed were equipped with modern one.
Middle level technology was used by 38% SMEs while 27% NSEs using so. Over half
(52%) of SMEs survey faced with old level of technology. This technology level was also
used by 66.3% of NSEs. In general, NSEs surveyed used either old or middle level of
technology. The model one was used with only small percentage of NSEs (6.7%).
The table 3.2 presents the survey in more detail.
Table 3.2 Equipment and technology level of SMEs (1991-1994)
Unit: percent
Type of enterprises Modern Middle level Old level
SOEs
Non-SOEs
Joint stock companies
Private enterprises
Co-operative
Others
In general
11.4
6.7
19.4
30.0
16.7
3.6
10
53.1
27
54.8
30.3
33.3
22.8
38

35.5
66.3
25.8
50.0
50.0
73.6
52
Source: VCCI (1995)
3.1.4 The education level of employees and managers in SMEs
As cited in Statistics on private sector in open door time issued by General Statistics
Publisher (1996), the skill of labor in SMEs do not meet the required standards. It dues
to the majority of laborers, did not attend any additional training course while their
education level is too low. Only 5.3 % of laborers in the non-state sector have a college
degree. In which, 80% are concentrated in limited companies and joint-stock companies.
The majority of the owners of NSEs established in recent years did not attend any
training course. Among the owner of non-state enterprises, 31.2 % have a collage or
higher degree. However, the ratio of the owners of NSEs having the knowledge about
the market economies is very low.
Unlike large-scale enterprises, SMEs in Vietnam have simple organization hierarchy.
Manager has all authority as well as final decision. It puts in need high skilled
15
management. However, management skill of SMEs is not high enough to run business
well. The survey of VCCI shows that over 50% of members of management board are
required to be post-graduates, only 2.62% of companies meet this condition. If over 50%
council members must be college graduates, the condition is fulfilled by 35.23% of the
SMEs. In the views of specialists and managerial officials the standard of management
skill of boards members in general is far below the requirement of enterprises
management in the market mechanism.
3.2The role of SMEs in the socio-economic development of Vietnam
3.2.1 Contribution in production of goods, services and job creation

According to General Statistics Bureau (1995), value added that produced by non-state
sector is accounted for 65% of GDP. The contribution share of NSEs, including SMEs, in
GDP is approximately at 40.66%. SMEs in Vietnam generated 25% of gross national
industrial output, 54% of regional industrial value, 64 % of commodity circulation. In
some special fields, these business even manage hundred percent of certain products
on the market. Those specializing in industry, trading and services have employed over
3.5 million labors. High-tech industry alone cover half of the local work-force, at the
same time, the average expenditure on a job creation of VND 749,000 is only three per
cent of that in major businesses. SMEs have invested VND 4,150 billion in trading,
transportation, and construction. The total investment in these fields is VND 9,100 billion.
The share of SMEs in GDP is approximately at 40.16% in 1996 and 39.82% of GDP in
1997 (Economic time, 2 January, 1998).
Following the Statistics Yearbook 1997 issued by General Statistical Publisher, at the
end 1996, total number of laborer in all SMEs of Vietnam is about 7.8 million persons,
accounting for 22.5% of total labor force of the country. In other words, the share of
laborers in all SMEs is equal to 79.2% of non-agricultural labor force. Over 85% of labor
in SMEs are participating in processing industry, construction, trade and transportation
services.
3.2.2 Creativeness and more efficiency of the economy
According to a remark made by the Enterprises Management Committee under the
Central Management Institute (1997), Vietnam’s medium and small businesses are very
dynamic. These are also highly adaptable to numerous fields in the market, ready to
invest in new areas, and to adjust their technology to produce high quality product
attractive to investors. So, SMEs have helped make the economy more active, more
effective and competitive and in generally, improve profit making.
Recently, newly emerged services as industrial production, hotels, tourism, customer
goods production, and mini-super market etc., are generally dominated by smaller
businesses. Acting as distributors for bigger enterprises, those smaller units quickly
make all kinds of goods available for customers.
The important objective of the following part is to identify some of the barriers that may

be restricting the development of NSEs and to suggest measures to provide equal
opportunities in this sector.
16
3.3Problems facing SMEs
In 1994, the survey tiled “The small and medium business in Northern of Vietnam” that
conducted by International Labor Organization (ILO), under the support by SIDA and
Ministry of Labor Invalids and Social Affairs (MOLISA). The survey selected a sample on
200 NSEs in three northern provinces of Vietnam: Hanoi, Hai Phong and Quang Ninh.
There were 120 small and 80 medium enterprises selected. Manufacturing, trading and
services fields were selected for the study. The survey found that, 47.9% small and
62.5% medium enterprises surveyed faced with lacking of capital. It was a biggest
difficulty. There were 44.4 % small and 29.2 % medium enterprises surveyed faced with
lacking of product market. Lack of progressive machinery and equipment was the third
difficulty. It complained by 18.7% small and 27.1% medium enterprises surveyed.
Government policies also had some negative effects on the business of SMEs. There
were 15.2% small enterprises complained with Government policies and 16.7 medium
enterprises did so. Hence, SMEs in Vietnam are very small in terms of capital size.
Limited access to capital is also reflected by the low asset values, which in turn imply
low level of technology in SMEs. The second largest group of constraints is related to
lack of marketing and lack of transport facilities, coupled with constraints identified as
limited current demand for products and too much competition. This grouping together
with unstable Government’s policies, became three biggest difficulties of SMEs. The
detail result of the survey will be presented as Table 3.3.
Table 3.3 Difficulties facing SMEs in general.
Kinds of difficulties Small enterprises (%) Medium enterprises (%)
Lack of capital
Lack of market
Lack of progressive equipment
Lack of product items
Government policies

Lack of energy
Lack of materials
Lack of technical labor
Unclear local policies
47.9
44.4
18.7
15.2
13.6
13.1
7.5
5.1
3.0
62.5
29.2
27.1
27.1
18.8
14.6
6.3
16.7
2.0
Source: ILO (1994)
To help SMEs resolve the above difficulties, it is necessary to analyze, in a more
concrete way, the main difficulties encountered in the investment and operating process.
In addition, consequences of Government policies on development of SMEs are also
considered.
3.3.1 Lack of capital
There are more financial institutions investing in Vietnam such as financial leasing
companies (Vina Lease-1995), or international funds (Vietnam Fund Limited-1991).

Besides, some funds supporting SMEs aided by international organizations such as
SMEs Development Fund (SMEDF) with capital above USD 25 million or World Bank
(WB) though State Bank (SB) have lending programs to support SMEs. However, SMEs
17
are still facing of lack of capital. According to Riedel and Chuong (1997), the shortage of
capital is a weakness of SMEs in Vietnam. Most of the credit supplied to the SMEs is
short-term credit for one year or less. Companies need medium and long-term credit to
upgrade technology and expand their capacity. However, in their interviews with 50
SMEs in Hanoi and HCMC, 83% enterprises interviewed had at one time or another
obtained bank loans of three to six months maturity to finance working capital. There
was only a very few (6.7%) were able to obtain medium to long-term bank financing for
fixed investment. And 76% of companies interviewed had to rely entirely on cash
holding, retained earnings or by borrowing from informal credit markets to finance fixed
investment. The report also cited that, while SMEs have virtually no access to long-term
credit of the domestic formal financial system, they hardly have other access to foreign
sources of finance. Vietnamese law precludes from taking equity from Vietnamese
private companies, and interest rate ceiling and financial regulations make it relatively
unprofitable and risky for foreigner to lend directly to Vietnamese SMEs.
3.3.2 Lack of market
In general, SMEs usually have the ability to show flexibility in business activities, due to
the small size. Low technological standards, lacking of management skill make product
quality of SMEs rather low. SMEs encounter a number of difficulties in the competition
with LEs. According to the ILO survey (1997) (see Table 3.4) 44.4% of small enterprise
and 29.2% of medium enterprises facing problems with their product market.
In addition, the VCCI survey (1995) showed that in both domestic and foreign market,
about 30% of companies encounter difficulties in the sale of their products. The highest
figure being in Hai Phong (over 45%) and lowest in HCMC (15% only). To an acute
competition by imported goods, especially the smuggled ones, a very important cause of
difficulties lies in the bad quality of the products that do not fit with the tasks and the
needs of the consumer. The small size and weak production capability are also obstacle,

which push up the production or business cost and reduce the competitiveness of the
companies.
3.3.3 Government policies on the development and funding mobilization of
small and medium enterprises
• The policies on trade
The Government has implemented decree 97/CP that relaxes restriction on imports and
exports. The administrative management mechanism regulating imports and exports has
been replaced by market oriented policies. The NSEs have been allowed to export those
commodities produced by them to import the input factors necessary for their production.
They have to get the permission of the Prime Minister, if they want to participate in
export and import activities. Since the beginning of 1997 the regulations on the exported
commodities limited by licenses have been abandoned. However, export and import
activities of the majority of NSEs have been trusted to the large SOEs that have
obtained licenses for exporting and importing. Decree 90/CP and 91/CP, on
establishment of general corporations and the special preferential treatment to SOEs
through credit and export-import policies, are placing the private sector at a
disadvantage. So, the number of trade licenses given to enterprises in the private sector
accounts only for 15-20% of the total number of trade licenses. In 1996, only 19
enterprises are allowed to export rice and 25 enterprises are allowed to import and
18