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British Journal of Economics, Management & Trade
14(2): 1-14, 2016, Article no.BJEMT.26746
ISSN: 2278-098X
SCIENCEDOMAIN international

The Role of Financial Institutions in Promoting
Innovation of SMEs in Rwanda: An Empirical Review
Philippe Ndikubwimana1*
1College of Business and Economics, University of Rwanda, Rwanda.
Author's contribution
The sole author designed, analyzed and interpreted and prepared the manuscript.
Article Information
DOI: 10.9734/BJEMT/2016/26746
Editor(s):
(1) Paulo Jorge Silveira Ferreira, Superior School of Agriculture of Elvas (Polytechnic Institute of Portalegre),
Portugal.
Reviewers:
(1) Fang Xiang, University of International Business and Economics, China.
(2) Regaieg Essafi Raida, Higher Institue of Management, Tunisia.
Complete Peer review History:
Received 30th April 2016
Accepted 3rd June 2016
Review Article Published 10th June 2016
ABSTRACT
The government of Rwanda has set up an empowering environment to support SMEs and has
attracted players with good local, regional, and international experience in using innovation and
technology to expand business activities and increase economic growth. The majority of SMEs
struggle to increase productivity, organizational effectiveness, sustained competitive advantage
and satisfactory rate of return on investment. It is not an easy task to achieve such kind of objective
in an economy where traditional and informal practices of business management are still applied. It
is evident from research that innovative technology strategies are key resource for gaining
competitive advantage, but it is challenging because some enterprises lack entrepreneurship and
innovative skills. Consequently, many small businesses fail and close few days after their start up.
One way in which SMEs should operate to remain economically viable and contribute to a
sustainable economic growth is though innovation. The financial institutions play a role of
intermediating people, business companies or enterprises in need of funds (borrowers) with
lenders. This paper reviews empirical evidence on the contribution of SMEs to innovation,
examining the role financial institutions and SMEs in promoting innovation, the role of SMEs in
economic growth and challenges facing SMES.
Keywords: SMEs; innovation; financial institutions.
_____________________________________________________________________________________________________
*Corresponding author: E-mail: ndiphil2000@yahoo.fr, ndiphil2000@;
Ndikubwimana; BJEMT, 14(2): 1-14, 2016; Article no.BJEMT.26746
1. INTRODUCTION the, investment, capital, total number of
In Rwanda, after the Genocide of 1994, the
employees, income, the organization behavior,
government has tried to boost the business
their location and their market share; but the
sector's performance by establishing different
most commonly used characteristic is the
organizations enabling small and medium
number of employees in the enterprise [5]. Small
business operations. It is clear that the
and medium-sized enterprises (SMEs) are non-
government alone cannot succeed in its efforts to
subsidiary, independent enterprises which hire
make this sector productive and successful.
and employ less than a given number of
Institutions and other concerned bodies for small
employees. According to [6,7], the number of
businesses underline the importance of public
employees differs across countries. In the
and private partnership to initiate various tasks
European Union, the upper set limit in SME is
including research and development (which is
250 employees; however, some countries fixed
rare in this sector) to support entrepreneurs and
the limit number at two hundred employees,
owner-managers in better business operations
while the United State of America considers
management. As Rwanda moves towards
SMEs to include firms with fewer than five
becoming a middle income country, small and
hundred employees [8]. According to [9], the
medium enterprises are engine to its economic
SMEs account for sixty to seventy percent of job
development. The importance of Small and
creation and for almost sixty percent of the total
Medium Enterprises (SMEs) for economic
gross added value in Europe. They are
competitiveness and growth, employment and
considered as the true strength of the European
poverty reduction is widely recognized [1].
economy because they are mostly responsible
for wealth creation and economic growth, next to
The Small and medium enterprises (SMEs) their key role in innovation, resource and
support in strengthening entrepreneurship and development. According to the World Bank
innovation [2,3]. They contribute to economy by definition, the Small enterprises are generally
employing a large number of people and play a those with fewer than 50 employees, while micro-
big role by increasing economic development. enterprises have at most ten, or in some cases
However, the inability of SMEs to access five, workers [10]. Different banks use financial
financing remains one of the key constraints to assets to define SMEs [11]. [5] stated that SMEs
growth. With industrial change and recent are characterized by individual initiatives & skills,
government policy shifts, increased integration of greater operational flexibility, low cost of
global markets and business, many enterprises production, high propensity to adapt technology,
are experiencing increasing pressure to remain high capacity to innovate & export, high
sustainable as their markets grow, and they employment orientation, utilization of locally
begin competing with a larger number of firms. In available human and material resources, and
this regard, SMEs in particular, are exposed to reduction of regional imbalances.
this pressure, as they tend to be disadvantaged
comparing to bigger firms that generally have The concept of SME in Rwanda is used to refer
better access to funding and other resources. to micro as well as small and medium
There are demand side barriers such as enterprises. The Rwandan SMEs consist of 98%
verifiable borrower information or practical of the total businesses and account for 41% of all
business plans, lack of collateral, absent or private sector employment [12]. SMEs in
inconsistent record keeping and a poor Rwanda face many macro-level challenges faced
repayment culture among business owners [1]. by large companies, including limited transport
[4] emphasized that SMEs are more innovative and energy, lack of entrepreneurship skills, low
compared to larger enterprises due to their levels of societal trust, limited access to financial
diverse character but are limited in innovative institutions, challenges with contrast enforcement
capacity due to their financial and human and a weak education system. Unlike large firms
resources. This study is an empirical review on that may have the time and resources to invest in
the role of SMEs and financial institutions in resources and human capacity building, SMEs
promoting innovation. often have limited abilities to develop the skills of
2. BRIEF DESCRIPTION OF SMEs
their staff or take advantage of local economies
of scale in terms of energy, transport or row
2.1 Characteristics of SMEs material. The Rwandan strategy plan is to
construct a dynamic and viable SMEs with the
Small and Medium Enterprises are defined on purpose of increasing the economic growth
the basis of their characteristics, namely, size of through enhanced business support service
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Ndikubwimana; BJEMT, 14(2): 1-14, 2016; Article no.BJEMT.26746
provision, capacity building and enabling access the country now belongs to different
to finance, markets, innovation and technologies organizations like the Commonwealth, the
[13]. The government of Rwanda is continuously Eastern African Community, etc. Of course, this
engaged in formulating and implementing participation is, to some extent, unavoidable and
policies to assist SMEs sector so that they can it is indeed already taking place. To do this, there
play its role in the economic development of this are some recognized factors that been confirmed
country. Through an immense attention given to to play a significant and strategic role to support
the SMEs and entrepreneurship by Rwandan a sustainable economic development process.
government particularly Ministries of commerce
(MINICOM), Labor and Youth sector and with the Different studies by international institutions
coordination by Rwandan Development Board confirmed the key input of innovation and the role
(RDB) there is no concern that policy and good of small and medium firms (SMEs) in boosting
will is lacking [14]. In 2008, Private Sector economic development [15-24]. Some of the
Federation in Rwanda conducted a study and put conclusions of these international financial
SMEs at 72000 SMEs and 25,000 SMEs are institutions are that SMEs account for more than
formal or registered. The study carried in 2011 by 90% of all enterprises in activity in the vast
Rwandese Private Sector indicated that the majority of countries and provide the majority of
number SMEs operating in the private sector was jobs. Additionally, because of their dynamism
119,158 or 96.5% of work force. The SMEs and flexibility, they are crucial for the creation of
employ 281,946 persons. Micro enterprises jobs and, in a lot of countries, they are practically
constitute 92.6% of all enterprises and employ the only source of new jobs and reduce the flow
51.3 per cent of the workforce. Small enterprises of people from rural area to urban area.
make up 6.9% and employ 2.4% of the [8,25,26]. The SMEs contribute greatly to
workforce. Medium enterprises are 0.4% and economic development by creating more
employ 8.7 per cent of the workforce. Large employment opportunities, generating higher
establishments are 0.1% and employ 16% of the production volumes, increasing export and
workforce [15]. Additionally, 99.9% of whole sale introducing innovation and entrepreneurship
and retail trade are from micro or small skills [27].
enterprises. [4] stated that SMEs provide income, savings
2.2 Role of SMEs in Economic and employment generation at low investment
Development
cost and also the development of entrepreneurial
capabilities and technology. This has been
confirmed by [27] that SMEs are engines for the
Rwandan's economy has gone through a development of entrepreneurial capabilities
process of changes and transformations for last and innovative technology which generate
twenty years after genocide of 1994 that has employment in the country. SMEs constitute the
destroy almost all the sectors of the economy. foundation for industry and natural economy
After this period, the country started to develop development and they contribute substantially to
different institutions by establishing progressive the GDP, export earning, and the growth
inclusive rules and regulations. However, the prospects of the countries [28]. According to [6],
economy still faces some challenges, for in advanced economies, Small and Medium
example the level of exports is low, while the enterprises in formal sector contribute up to forty
level of imports keeps on growing due to a higher five percent of employment and up to 33 percent
demand for imported products than for domestic of GDP. In high income countries, they contribute
ones. At the same time, Rwanda doesn't have almost 50% of GDP. In low income countries the
big firms to compete with regional and percentage is sixteen (16%). In the countries of
international, counterparts, Rwandan small firms Africa it is below ten percent (10%). In the
have limited regional presence and they are countries of Asia-Pacific 32-48% of total
utmost all, at the moment concentrated in the employment is in SMEs, and 60-80% of the GDP
agriculture sectors [12]. In that sense, there is no is provided by this sector. SMEs contribute to
main receipt to improve competitiveness of a employment growth at a higher rate than larger
national and regional economy. Despite its lower firms do, and in the long term, they offer an
natural resources and a rather small domestic important share of overall employment. They
market, it would be a mistake for Rwandese offer economies greater flexibility and innovative
policy makers to consider that they can avoid service delivery. They increase competitiveness
participating actively in the current process of and help to limit the large firms' monopoly and
globalization and competition; where for example offer complementary services and engage in the
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Ndikubwimana; BJEMT, 14(2): 1-14, 2016; Article no.BJEMT.26746
fluctuation of modern economy [5]. They products and ideas, and can increase the
encourage entrepreneurial skills and innovation likelihood of a business succeeding. The
and play important part in the provision of innovation is a process of translating an idea or a
services in communities [29]. The primordial role discovery into a good or service that makes
of SMEs is to produce products and services value and is applied to meet and satisfy the
mainly for domestic markets. They form an needs and expectations of the customers [34]. It
effective supply chains for enterprises and includes different processes by which an
increasing service industry that contribute to innovator generates and converts new ideas into
increase the economy of gross development useful products [35]. [36-38] stated that
product. Preceding research shows that the innovations are grouped into two types:
operations function in SMEs generally has a poor evolutionary innovations (dynamic and
relationship with other functions in the business. continuous evolutionary innovation) brought by
Furthermore, the individuals involved in many incremental advances in process or
operations management are poorly trained, they technology; and revolutionary innovations
lack specific skills and are by large (discontinuous innovations) which are often new
technologically illiterate [30]. Indeed the survival and disruptive. The innovations help to create
and progress of SMEs are threatened by new methods of joint venturing, increasing
problems that may exist in the operations purchasing parity power, flexible work hours and
functional area. One of these barriers is that alliance creation. Organizations that are
entrepreneurs with technical backgrounds would technology based take greatest risk because
probably be weak in managing functional areas they create new products, opportunities and
such as general management and processes markets [24]. According to Wood [35], innovation
[31]. is mainly concerned with the acceptance of a
Business failure is often attributed to the lack
new product, service and methods by enterprises
of entrepreneurial information and business
and approved by them. This has been confirmed
management skills [22-24]. Low levels of
by [39] that innovation is creation or acceptance ,
education and training, as well as poor business
adaptation and utilization of a value added
skills are contributing factors to the lack of
novelty in business and manufacturing domains,
capacity and poor business efficiencies among
renewal and expansion of a product , services
SMEs. Most entrepreneurs often start a new
and markets, making of new ways of product
enterprise while ignorant of many key
development and establishing new management
dimensions of running their enterprises, and
system. Additionally, [37,38,40] highlighted that
must obtain the necessary skills if they are to
innovation is the process of development of new
survive [31]. It is imperative that the entrepreneur
output by implementing new methods of working
be knowledgeable about all the functional areas
and product development. Moreover, this new
in business. The importance of entrepreneurial
method of working is concerned with the
skills, such as innovation and risk taking should
improvement and better outcome of an
not be overlooked as essential ingredients to
enterprise that result in production of a new
SME success. Skills development and education
product, service and process. Innovation is
in general form part of human capital and
reproductive renewal and competence of an
according to human capital theorists, these
enterprise to perform in correspondence to
assets can improve SME productivity significantly
environment [38,41]. Innovative entrepreneurship
[32]. Entrepreneurs who have built successful
is the intersection between innovative
companies have solid entrepreneurial and
businesses, young and high-growth businesses,
management skills. Competency in a variety of
and SMEs [24].
skills will contribute to the profitability and According to [42] entrepreneurs are the principal
sustainability of a business, and a focus on skills actors in innovation. They bring change in an
development in the operations function is key to economy by providing new combinations: new or
competitiveness and growth for SMEs [33]. improved goods and services, methods of
2.3 Acquisition of Innovation in the production, markets, sources of supply of inputs,
Growth of SMEs organization of an industry, or management
processes within a firm. They disrupt markets,
2.3.1 The concept of innovation leading to long-run evolutionary growth in the
economy. [43,44] emphasized the role of
The concept of innovation, generally refers to entrepreneurs as discoverers and early
changing or creating more effective processes, exploiters of previously unnoticed profit
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Ndikubwimana; BJEMT, 14(2): 1-14, 2016; Article no.BJEMT.26746
opportunities. [45] highlighted that entrepreneurs According to [55], local innovation system is a
take risks by offering new solutions in the market regional innovation system where SMEs interact
in the face of uncertainty because they are not with enterprises and non-enterprises players in
sure 100% whether their solutions will be the local area. The studies by [56-58] confirmed
profitable. They facilitate economic adjustment that in local innovation system, enterprises
by forecasting where new profit opportunities will network within their sector and with other
open up and providing products, processes and enterprises in regions need identical skills and
business models [24]. Diverse studies have technology. This system helps SMEs to interact
classified the innovation into different process. reciprocally and exchange knowledge. The
[46 and 47] stated that innovation is the process global value chain offers an innovation system
to develop and improve services, products, and refers to activities required to get a product
processes and markets, with the purpose to or service from beginning, through different
increase value of the firms. [48] stated that this stages of production and delivery to end users,
process of innovation comprises four steps: [59,60]. The presence of a global value chain
invention, diffusion (communication), through provides access to explicit and appropriate
social system, time and consequences. As for, knowledge, which empowers SMEs to innovate.
[49], they identified four types of innovation: The capacity of SMEs to innovate, however
incremental, radical, modular and architectural depend on a strategic plan to approach global
innovation. [50] summarized these types of buyers and the mode of governance of value
innovation as radical or incremental. On one chains [61]. In absorptive capacity, SMEs are the
side, the radical innovation involves systematic focus part of an innovation system and
and scientific scholars and entrepreneurs to absorptive capacity enhances enterprises'
develop and assess new skills founded on abilities to gain and sustain competitive
technology methods [29]. A study done by [51] advantage [54]. The absorptive capacity
referred to this process as techno-globalization comprises four steps: acquisition, assimilation,
which includes multinational development of new transformation and exploitation. According to
technologies created by different firms across the [62], the acquisition is the firm's ability and
world. Moreover, Small and Medium Enterprises capacity to identify and acquire externally
with high technology participate also in this created knowledge that is critical to its
radical form of innovation process [29]. [52,53] operations. SMEs should obtain adequate
affirmed that SMEs are involved in radical knowledge to benefit from innovation systems
innovation when there is a huge gap in [63]. Assimilation includes the procedures of an
technology. On another side, incremental enterprise that allow it to examine and analyze,
innovation requires that current knowledge is develop and process, interpret and understand
combined, adjusted and used in specific context knowledge obtained from outside and within an
and confined perspective [29]. According to [54], enterprise trough training and communication
innovation process is linked to tree concepts that [62,64,65]. The transformation stage helps
explain the role played by innovation in social- enterprises to transform their routines by
economic change, innovation process in the combining old and new knowledge, it involves
firms and interactive process which includes entrepreneurship ability to analyze information
innovation systems. The following figure and to solve problems [47,62]. This process
illustrates the relationship between absorptive requires a willingness to invest, access to
capacity to local innovation systems and finance, management capability and business
global value chains in explaining the level of plans [66]. SMEs should have ability and
innovation. capacity to exploit the acquired knowledge [67].
Local innovation
system Absorptive capacity Innovation
Global value chains
Fig. 1. Innovation process
Source: [29]
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Ndikubwimana; BJEMT, 14(2): 1-14, 2016; Article no.BJEMT.26746
2.3.2 Role of innovation in SMEs development in their environment or business. The Small firms
are playing a continually increasing role in
The rising of international competition around the innovation, driven by changes in technologies
world and markets globalization force small and and markets. SMEs and innovative
medium enterprises to search for new, entrepreneurship play a key role in economic
innovative, flexible and imaginative ways to development and they are involved in the
survive [68]. Innovation is key to technology development and commercialization innovations.
adoption and creation through knowledge SMEs adopt also innovations developed by other
management in order to explain the vast business firms, and they also provide ideas and
differences in productivity across and within inputs to ideas generation that are exploited by
countries. In order to survive in the globalized large firms, scientific research centres and higher
market, small and medium enterprises need learning institutions. The majority of SMEs
to innovate. Consequently, knowledge innovate incrementally when they copy existing
management and innovation are important technologies and apply them to their
factors of success of economic growth. The environment. These innovations help SMEs to
factors that influence the innovation are compete at relatively low cost and increase
opportunities, new business proposition, high economic development [52,56,59,82]. SMEs
cost of existing product, aim to have more market inform themselves with up-to-date technologies
share or to be the market leader or to provide and market demands in interaction with
affordable medicine to everybody [69]. researchers, buyers, business associations,
Innovations play an important role in the business development services, finance
development of small and medium enterprises institutes, firms, friends and family [29].
through new venture creation process [70]. [31]
reported that innovation is key in ensuring According to [35], the creativity of SMEs is to
enterprises and long term loyalty competitive establish valuable and useful new products,
advantage. [71] in his theory of economic services or ideas and the methods by which
development confirmed also the importance of individuals work together in a complicated social
innovation as a key factor of economic growth system. Studies done by [37,38,83,84] reveal
and development [72]. Empirical studies on that innovation is used by SMEs to define their
innovation elaborate the relationship between problems, respond to unforeseen events, create
innovation and enterprise growth [73]. An solutions and develop new ways and procedures
important challenge facing SMEs worldwide is to organize their work, through the use of
continuous improvement. In today's markets, the experience, skills, motivation and the knowledge
inputs of customers and their fast changing accumulated is converted into the production of
needs makes it imperative that enterprises an innovative product or service. Empirical
continuously improve the way business is research indicates that there is significant
conducted [74]. Entrepreneurship and innovation relationship between innovation and growth of
are recognized as key drivers of economic the enterprises if there is a constant supply of
growth, productivity and employment and as a finances [85]. In the presence of innovation, the
basic aspect of economic progress [16]. overall enterprise outcome would enhance
Innovation is a significant mechanism that brings [68,86-90]. This shows that innovation is critical
opportunities to new inventions and building of for the growth of the firms in terms of its sales,
new markets [34]. In addition, there is a market penetration, profitability and sustainability
significant increasing interest trade and industry of organizations especially for small and medium
growth based on innovation and creation of enterprises.
competitive advantage [75-79]. To remain 3. THE EFFECT OF FINANCIAL
competitive in today's modern business world, INSTITUTIONS IN PROMOTING SMEs
SMEs should pursue innovation tool [80].
However, a question remains on how and what SMEs play a significant role in economic
to innovate. In recent studies, [81] concentrated development, both in developed and emerging
on this question and used previous theory to markets. Now the question arise: how small and
identify four modes of innovation (open medium enterprises (SMEs) finance their
exploration, closed exploration, open operations? What is the role of financial
exploitation, and close exploitation). [73] institutions in the growth of SMEs? Financial
confirmed that SMEs benefit more from institutions are intermediaries between surplus
innovation than the advanced enterprises and deficits. They play a role of intermediating
generally due to their flexibility to accept change people, business companies or enterprises in
6

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