Credit for SMEs
The View from Taft
October 19, 2000
Despite the widespread popularity abroad of credit guarantees as an SME development tool, support for the local SME credit guarantee system is wanting. The combined resources of the country's credit guarantee agencies are only about two percent of total loans to the sector. These institutions include Guarantee Fund for Small and Medium Enterprises (GFSME), Small Business Guarantee Finance Corporation (SBGFC) and Trade and Investment Development Corporation (TIDCORP). Quedan and Rural Credit Guarantee Corporation, which also provides credit guarantees, is more focused on producer farmer groups.
In contrast, the governments of more advanced economies are using credit guarantees for SMEs as a significant economic strategy. This was specially highlighted during the recent Asian financial crisis. In Japan, it was reported that in 1999 one to of every three Japanese SMEs were covered by credit guarantees. In Malaysia, guaranteed loans to SMEs increased more than three times between 1998 and 1999. In South Korea, capital infusion from the national government to its credit guarantee institutions more than doubled in 1998 relative to the 1997 budget.
Here in the Philippines, sad to say, debates on the merits of credit guarantees continue between program managers and so-called scholars whose stance appears to be consistent with IMF-sponsored studies. These debates center on three issues: additionality, sustainability of a credit guarantee program, and leveraging impact.
Critics allege that instead of creating additionality in terms of new loans generated, credit guarantees add unnecessary costs to borrowings. Supporters, on the other hand, cite the voluntary support of the market as a counter argument, noting that a market as conservative and competitive as the local private banking system would not be paying guarantee fees had it not been necessary.
In the case of GFSME, for example, a recent independent study has shown that the bulk of the agency's guaranteed loans are from private banks and more than half of these loans did not have sufficient collateral. The same study also shows that "financial institutions differed significantly in their collateral requirements and inherent risk management policy" and that "private banks are more risk averse than government banks and NGOs."
While these are indications of the private banking system's conservative stance in lending to SMEs and therefore, further proofs for the need for guarantees, critics cite the same facts in arguing that credit guarantees are superfluous - because not all GFSME guaranteed loans are collateral deficient. Some critics have even forced new meaning into additionality, i.e., that the borrower must be first-time availers of the formal lending institutions, for it to be valid. The calculus is thus tipped towards forced rejection of the additionality benefits, In other words, supporters of the local credit guarantee system say that the glass is half-full and critics say that it's half-empty, an attitude that's academic among our Asian counterparts.
An often overlooked aspect of credit guarantees is the additionality created by its social marketing function. By softening the risks in lending to the sector, credit guarantees provide banks a benign learning experience for developing appropriate credit technologies for lending to SMEs and pioneering industries. A case in point is GFSME's recent experience with the asparagus industry.
Payments by withholding support from a project that has transformed what used to be marginally profitable farm land into dollar earners for the country? More significantly, probably learning from this project, many private landowners are now going into asparagus raising, presumably with financing support from the private banking system.
The second issue raised by critics on the sustainability of credit guarantee programs in the absence of continuing subsidies is something that each credit guarantee agency has to face. Ideally, the credit guarantee business, like the insurance business, need not be subsidized provided a mature market is in place. Subsidies for guarantee operations, if any, should be minimal and should be largely offset by the benefits to the SME enterprises it assisted.
In Japan, Korea and Malaysia, credit guarantee institutions are subsidized by their national governments. In Taiwan and Thailand, allocation is on an irregular basis. In Indonesia, Sri Lanka and Nepal, there is hardly a budget allocation as in the case of the Philippines. In the case of GFSME, there has been no annual infusion since the establishment of its seed fund in 1983. On the contrary, the agency has remitted back to the government over the years in cash an amount more than its original seed fund.
The third issue of leveraging and impact as it applies to the Philippine credit guarantee system, thus is like blaming the ant for failing to carry the mountain. Critics view the system as ineffectual because only a very small proportion of less than two percent of total lending to SMEs is guaranteed. But with the resources available to local credit guarantee programs, the metaphor is appropriate.
Admittedly, the Philippine credit guarantee system is still a work in progress. For a better appriciation of what it could accomplish, GFSME's experience is instructive.
GFSME's PhP300 million seed fund has guaranteed more than PhP6 billion in loans to SMEs as of yearend 1999. Without additional fund infusions, the Fund has grown more than three times, into a little more than a billion pesos despite earlier mentioned remittances to the national government, and after paying almost a quarter of a billion pesos in guarantee calls, about 4% of total guarantee approvals.
In short, GFSME has leveraged its funds at least twenty times. It grew without subsidies at a rate that enabled it to easily absorbed cash payouts of about twice its original size. More tellingly, it remains on solid financial footing despite the recent crisis that brought down to their knees some local small and medium sized banks with more resources than it has. It is sustainable and it has the support of the market.
Of course, the need of new funds in the future cannot be ruled out, especially in response to catastrophic situations, as did many Asian economies in the aftermath of the 1997 crisis. But that only means some form of credit-reinsurance must be set in place.
Whether GFSME's experience in particular defines success may be debatable but it certainly indicates that something good was accomplished. At the very least, it provides ample proof that the conflicting views about credit guarantees can be finely balanced to create a "sweet spot" where the beneficial effects of the concept outweigh its risk and costs.
And certainly, those who have successfully used credit guarantees in their economic strategies must have confronted the same issues that now challenge the local credit guarantee system. But they must have decided that you could do a lot with a half-full glass, and that credit guarantees are as good as any business as long as you treat it with the seriousness it deserves.