Is small the new big? Islamic banking for SMEs in Turkey

- Islamic banks are more inclined towards financing small businesses.
- Islamic banks' SME financing portfolio quality is comparable to that of conventional banks.
- Larger banks are less inclined to engage with SME customers.
- Islamic banks attach greater importance to soft information in financing decisions.

While SMEs constitute the backbone of many economies, many SMEs have limited access to finance. Yet, banks in some countries are actively financing SMEs. This paper examines whether this is true in the case of Turkey, a G20 economy that has a significant SME sector. We study the determinants of banks' willingness to finance SMEs and banks' processing ability of SME financing portfolio in Turkey based on a unique quarterly small business panel data set of 40 commercial banks from 2006 to 2014. Employing pooled OLS and fixed-effects estimators, we find that Islamic banks (known as Participation banks in Turkey) are more inclined toward financing SMEs than conventional banks. We also find that the quality of Islamic banks' SME loan portfolio is comparable to that of conventional banks. The results are fairly robust to different bank ownership forms (state owned, private, and Islamic banks) and alternative model specifications. Our findings provide further support to the notion of “small is the new big” in that banking for SMEs can be a viable venture.