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SME credit guarantees

In the recent Asian SME Finance Monitor published by the Asian Development Bank, it was underscored that poor access to finance limits the ability of SMEs to survive and progress.  Growing SME access to bank credit is necessary to reduce the supply-demand gap in SME lending. The same report noted that in many Asian countries, public credit guarantees are contributing to enhancing SME bankability.  Finally, SME loans made up 25% of total bank lending in Asia and the Pacific in 2013, down from 27% in 2011.

The Philippines has a law called the Magna Carta for SMEs that mandates banks to allocate 10% of their portfolio for SMEs, 8% to small and 2% to medium.  But statistics reveal that overall, our banking system is under complied in small business loans and just a little over in medium-scale loans.  Overall, we are lucky if we hit the 12% mark in overall bank lending to SMEs.  We have a lot of catching up to do with our Asian neighbor.

As the ADB report implies, our Asian neighbors are plus 10% points ahead of us, on the average, and the active presence of their guarantee programs could have accounted for the difference.  We definitely need a big push for SME credit, and a well-funded public guarantee fund for SMEs might be the answer.

Credit guarantees are provided to lenders so that they will be encouraged to make SMEs grow.  It’s a risk reducing incentive for the creditor. These are not arbitrary dole-outs but loans, which passed careful scrutiny of the lending bank and validated by the guarantee agency.  The multi-level approval system discourages behest leans.  By their nature, credit guarantees will help SMEs become competitive businesses not only in the domestic economy, but in the global marketplace as well.

The credit guarantee system also helps the economy by staving off bankruptcies in critical times. During the financial crisis, its usefulness was tested when it helped SMEs avoid closure, by making possible a loan restructuring program to get them on the road to recovery. Our Asian neighbors have a lot to teach us in this regard.  Its impact is not negligible, but significant.

The guarantee system is a catalyst.  It spurs business activity and growth by encouraging development of SMEs.  It causes the flow of funds to SMEs.  It helps in establishing new businesses, and grows existing ones. Enterprises that are not able to borrow without the guarantee system are made bankable.  There is additionality in the system.

Handled properly, credit guarantee for SMEs is not an outright subsidy.  It comes with a price, and is given only to enterprises that meet the eligibility criteria on project viability.  Moreover, the guarantee is conditional and is paid only in the event of loan defaults and business reversals.

The guarantee system is sustainable.  It has been proven by experience that a guarantee program may be sustainable provided it manages it leverage ratios well. And mitigating covenants can be introduced to manage unbridled risks.

Finally, while insurance may encourage moral hazard behavior, the credit guarantee system may incorporate corrective measures to dissuade such behavior.  These mitigating measures will motivate lending institutions to upgrade the quality of credit evaluation and accounts management functions, thus promoting lending only to viable and economically beneficial enterprises.

In the country today, there are small agencies involve in credit guarantees for SMEs.  These are the Small Business Guarantee and Finance Corporation and the Trade Industry Development Corporation.  However, the sizes of these agencies are small.  As it is, the impact of the credit guarantee system is negligible not because it failed but because support is lacking.  In short, more can be derived from the SMEs if adequate attention is given the agencies’ programs.

It is about time the government fully supports its public guarantee programs.  Banks and small entrepreneurs are sorely missing this service.  And the agencies with mandates to help SMEs through guarantees are eagerly waiting in the wings.  Strengthen the guarantee programs for SMEs now, before it is too late.

(Mr. Benel D. Lagua is EVP and Head of the Development Banking Sector at DBP.  He is an active Finex member and a prime advocate of risk based lending for SMEs. Feedback and comments are welcome at benellagua@alumni.ksg.harvard.edu)