Micro, small, and medium-sized enterprises (MSMEs) are pivotal to global economic growth, contributing approximately 90% of businesses and over 50% of employment worldwide. In emerging economies, formal SMEs account for up to 40% of national income (GDP), a figure that rises significantly when including informal SMEs. Despite their substantial impact, MSMEs often encounter significant barriers to expansion, with limited access to finance being a primary challenge. The World Bank identifies this as the second most cited obstacle for SMEs seeking growth in emerging markets and developing countries.

The Financial Inclusion Imperative

Estimates from the International Finance Corporation (IFC) suggest that 65 million firms—equivalent to 40% of formal MSMEs in developing countries—face an unmet financing need of $5.2 trillion annually, equating to 1.4 times the current levels of global MSME lending. This finance gap varies across regions, with East Asia and the Pacific holding the largest share (46%) of the total global finance gap, followed by Latin America and the Caribbean (23%), and Europe and Central Asia (15%). Addressing this gap is crucial, as financial inclusion is recognized by the World Bank as a key driver for reducing extreme poverty and boosting shared prosperity.

Challenges in Risk Assessment

A significant barrier to MSMEs accessing finance is the difficulty financial institutions face in assessing credit risk, primarily due to information asymmetry. The IFC's 2019 report, "Banking on SMEs: Trends and Challenges," highlights that a lack of verifiable information hampers proper assessment of an SME's financial situation, complicating risk evaluations. This challenge is exacerbated when businesses lack a trusted identity that can be linked to key information, preventing them from participating fully in global trade and financial systems.

Successful trading and financing require confidence that transactional partners are known and their identities can be verified. Financial institutions are reluctant to lend to unverified businesses, similar to how individuals are hesitant to loan significant sums to strangers due to the high risk of non-repayment. In many developing countries, over 50% of economic activity is conducted by unregistered businesses lacking official identities, which restricts their access to essential services such as payments and supply chains. This lack of transparency not only limits business growth but also increases vulnerability to corruption and bribery, leading to a higher dependency on development aid.

Establishing Trusted Identities

For MSME owners, establishing the legitimacy and credibility of their enterprises is the first step toward financial inclusion. While national business registries serve this purpose, a universally recognized and transparent identity offers significant additional benefits. The Legal Entity Identifier (LEI) serves as a solution in this context. An LEI is a 20-character, alpha-numeric code based on the ISO 17442 standard, connecting to key reference information that enables clear and unique identification of legal entities. Each LEI contains information about an entity’s ownership structure, addressing the questions of 'who is who' and 'who owns whom'. This system provides a universally recognized identifier paired with essential entity data, rigorous verification processes, and high data quality.

Although the use of LEIs has been driven by regulation in capital markets, their application offers economic benefits across all sectors, including enhanced risk management for financial partners and improved fraud prevention. MSMEs can proactively acquire an LEI to facilitate access to finance. Government and regulatory adoption programs can further support these businesses in securing verified identities, thereby promoting economic development.

Global Initiatives and Adoption

Encouragingly, initiatives such as the Bank of England's proposal to develop an open platform for competitive financing aim to address funding gaps for SMEs. The Bank suggested that SMEs could create a 'portable credit file' to share with lenders through a national financing platform, with the LEI system potentially adapted for British SMEs to facilitate this process. Such innovations demonstrate how embedding the LEI can promote transparency and trust, supporting the future prosperity of economies by opening up access to finance.

Obtaining an LEI

Registering for an LEI is a straightforward process supported by accredited LEI issuers. Through self-registration, a legal entity must supply accurate reference data, including business card information (e.g., official name and registered address) and relationship information identifying direct and ultimate parents, if applicable. Once the LEI issuer verifies the reference data with the local registration authority, such as a national business register, an LEI can be issued. Each LEI is published within the Global LEI Index, the only global online source providing open, standardized, and high-quality legal entity reference data.

By obtaining an LEI, MSMEs gain a trusted universal identity that can open up financing opportunities within a global, increasingly digital marketplace. LEIs simplify business transactions and enable trade and finance partners to make smarter, less costly, and more reliable decisions about whom to do business with.

Conclusion

In conclusion, establishing a trusted identity is a critical first step toward financial inclusion for MSMEs. The LEI offers a globally recognized solution that enhances transparency, reduces information asymmetry, and facilitates access to finance. By adopting the LEI system, MSMEs can overcome barriers to growth, contributing more effectively to economic development and shared prosperity.