Séverine DEBOOS-DAVID opened the session by explaining that she would follow an unconventional format, starting with a short introduction to the issue of formalization of enterprises from the perspective of the International Labour Organisation (ILO). After that, a discussion in two small groups would address the two key points of the session: 1) access to finance as a driver for formalization, 2) the role of MFIs in driving formalization. Bernd BALKENHOL would deal with the first discussion point, whereas K. Paul THOMAS would cover the second one.
In her introduction, Deboos provided an overall picture of informal enterprises worldwide. She started by highlighting that there are 450 to 510 million micro, small and medium enterprises (MSMEs) globally, representing a large share of the total number of enterprises. Deboos further revealed that micro and small enterprises account for a much higher share of total enterprises in low-income countries. In addition, she mentioned that informal SMEs outnumber formal firms of the same size in these countries, but emphasized that informality is not defined under a single category. Deboos explained that the spectrum ranges widely from subsistence to official enterprises, depending upon factors such as the registration status, management method and employment situation. In terms of ownership profile, including financing needs, Deboos highlighted the specific relevance of microfinance for the group of subsistence enterprises.
Subsequently, Deboos demonstrated that formalization brings about a number of economic benefits, thus influencing performance, employee benefits, revenue levels and attitude toward the government. These factors reinforce each other, leading to a virtuous circle. At the same time, she mentioned that studies show that informal firms are making a rational choice on whether or not to formalize by comparing the expected benefits of becoming formal to the cost of doing so. She then linked the idea to the typical policy interventions aimed at enterprise formalization, which tend to focus on simplifying the process for registering informal firms and extending the benefits of formalization. Up to now, however, evidence indicates that it is very difficult to get businesses to formalize in terms of entry costs, and that information, waived costs, and enforcement on formalization of informal firms has positive effects, but requires comprehensive policies.
Following the introductory presentation, and linking the session back to microfinance, Deboos split the audience into two groups to discuss the questions below:
The first group to present the results of their discussion mentioned that none of them had ever experienced efforts from an MFI to formalize enterprises, and that it should be an aspect explored by the panel. Balkenhol recalled that formalization is usually considered as an issue for public policy, not a concern for MFIs. Several empirical studies have shown, however, that policies have not been very effective in encouraging or enforcing formalization. Balkenhol also reminded the audience that formalization is multi-faceted (accounting, taxation, social security contributions, registration, membership in professional organizations). Each of these dimensions has often its own dynamics. The benefits to different actors, namely the state, the enterprise and the financing agent (bank or MFI) also vary widely. For an MFI, a formalised client represents a client who is more transparent and hence less risky, which helps to reduce operating costs and to identify more quickly and precisely future earning opportunities. As an example of an MFI intervention, Balkenhol presented the case of ABA (Egypt), whose eligibility conditions related to enterprise formalization, are linked to a specific loan amount. He mentioned ABA works in a gradual approach encouraging clients to become more formal as the demand for ever larger and more complex loan products grows.
The second group then presented the outcomes of their discussion, revolving around the role of MFIs to promote formalization. The group mentioned that MFIs' outreach could be an interesting characteristic, since the typical MFI client is financially excluded and inherently informal. MFIs could also be involved in awareness-raising of clients concerning formalization and actually take clients through the process. In addition, the group mentioned that the role of MFIs could be important in developing new products targeting emerging client needs in light of formalization. Nonetheless, the second group raised the concern that, by promoting the formalization of clients, MFIs would be in fact create the risk of losing their clients.
Following this presentation, Thomas illustrated the role of MFIs in formalization by presenting the case of ESAF (India). In cooperation with ILO, ESAF engaged in an awareness-raising campaign and business development services for the formalization and strengthening of growth-oriented enterprises. Thomas mentioned that the starting point of this project took place in 2008, with a diagnostic study which identified the status quo of clients and resulted in the selection of 300 ‘ready-to-grow' clients. After the implementation of the project, several changes were observed in terms of registration of enterprises, application for government schemes and improvements in branding, marketing and other business areas. In addition, it was seen that awareness on formalization increased by 93%, but enterprise formalization itself had a 70% increase. Thomas explained that ESAF realized that continuous support was key in the formalization of enterprises, which led to follow-up actions after the project, such as the creation of a separate department for livelihoods activities (including formalization), improved loan support to enhance microbusinesses, adopting registration of the business as an indicator to track changes.
The floor was subsequently open to questions from the audience. The first question revolved around tax payment, which is an inevitable consequence of formalization. Thomas admitted that there is a hesitance of enterprises to formalize due to taxes, but clarified that this can be addressed through awareness-raising.
He explained that entrepreneurs end up realizing that paying taxes will increase their visibility, and will mitigate risks such as corruption. Balkenhol reminded the audience that informality does not mean that enterprises are not paying any taxes at all: bribes and protection money can be considered "taxes" in the informal economy. He also reiterated that this is part of the calculation of an entrepreneur related to cost and risk, including the ability of the state to provide the protection and security of law and order and fair tribunals. Deboos added that the state must have policies to promote formalization by creating a conducive environment through policy-level interventions such as simplifying regulation procedures.
Another discussion point revolved around the improved performance of enterprises due to formalization. Thomas mentioned that formalization is only the beginning, and can lead to follow-up actions such as business planning, branding and social security system, which can improve the performance of enterprises.
The audience also addressed the role of sector organisations, questioning whether associations rather than MFIs would not be a better channel to tackle training capacity and formalization processes. Deboos admitted that microfinance is a small part of formalization efforts, also recognizing the role of associations such as cooperatives as a powerful channel for formalization. She mentioned that ILO does have activities targeting associations specifically. Balkenhol added that joining is part of formalization, and that associativity creates the opportunity to introduce norms to deal with social ideas in a less corrosive way than the state. This, in turn, could softly move enterprises towards formalization. He emphasized, however, that these should be genuine grassroots initiatives.