In Thailand, political culture strongly supports the financial needs of the poor and small and medium-sized enterprises (SMEs). Consequently, there have been extensive government support schemes to provide financial services to these people through government specialized financial institutions (SFIs) and the Village and Urban Revolving Funds (VRFs). Compared to other microfinance schemes worldwide, the VRFs lend more money to more people than any other schemes, making it the most ambitious microfinance program initiative in the world. Against this background, a large number of small enterprises and households still rely on loan sharks (or moneylenders) which charge cut-throat interest rates. SMEs, for their part, are also gradually losing their positions in the competition to larger enterprises and the constraints to SME financing remain the main topic of policy discussion today. This paper explores institutional barriers to SME financing in Thailand and finds that the real issue may not be about the lack of financing per se but about the lack of proper incentives for private sector involvement in the SME sector. Given the institutional settings of tight regulations, restricted business security law, high cost of bankruptcy procedures, interest rate caps on microfinance lending and tough competition from government-subsidized credit, commercial banks have no incentives to downscale into small-client segment. The lack of private sector participation in the SME sector has limited the efficiency and quality of financial services, making Thailand’s microfinance industry log behind its peers in the region. The paper proposes that, as a bank-based economy, Thailand should benefit a great deal from designing incentive-compatible institutions and making use of commercial banks’ competitive advantage as well as existing microfinance providers, creating win-win situation among SMEs, microfinance institutions, commercial banks and the government. This will also ensure that lending to small-business clients is market-driven and self-sustaining in the long run.