Business Options
By Benel P. Lagua
Consultants for the SME Development Plan are developing indicators to review the situation on access to credit. They basically ask these questions. One, have SMEs been borrowing from formal sources? And, two, have financial institutions been lending to SMEs? They also want to gather indicators that will measure the total number of SMEs applying for a loan, the total funds lent to the SME sector, the ratio of loans to applications, and the ratio of loans to available funds.
At the onset, these numbers appear to be reasonable gauge of whether or not those who applied for loans are able to solicit funding. But probing deeper, are these indicators valid and substantive, even if available?
According to the Bank of England (2001), "Public sector initiatives to support the financing of small firms may be justified if market imperfections mean that the private sector does not provide capital to firms on competitive terms. In the absence of market failure, such initiatives may themselves cause distortions by subsidizing at considerable public costs, non-viable firms which are not attracting enough capital because they do not offer good investment opportunities, the information that is then conveyed to other potential investors may be misleading."
The key issues here revolve around the validation of what constitutes market failure. Some economists and bankers, in reaction to the indicators above, argue that the ratios are too simplistic. This school of thought believes that, in most cases, the inability of firms to acquire capital reflects a reasonable business decision by the potential financier. According to this theory, firms unable to access capital are inherently too risky and do not present proper fit with the supply of capital. These firms are simply unable to meet specific business standards in terms of the usual five C’s of credit — capital, character, condition, capacity to pay, and collateral.
In sum, the argument is that a valid credit gap exists only if it can be well demonstrated that firms unable to obtain financing actually merit financing. It must be shown that there is rationing of some form which has disadvantaged legitimate and well deserving small businesses. Accordingly, a denied SME loan application represents market failure if and only if the SME account represents a potentially viable exposure.
To my mind, this is the challenge in the Philippine business environment. Because it would appear that some, if not many, of those who are so noisy about the credit access problem may not be so "deserving" in the first place. For example, there are suggestions for the build up of a quick disbursing fund to assist distressed firms. Now, how did these firms become distressed in the first place? If the reasons are exogenous, then some support may be well deserved. But if the poor state of affairs is traceable to mis-management, should public funds be invoked?
Addressing the credit gap is indeed a big challenge. The Small Business Corporation (SB Corporation) assumes there is such a gap and aims to plug in the holes given its limited resources. One such area is in the micro finance sector. But since the Small Business Corporation is only a support player, it innovates in order to spread its outreach.
After a successful negotiation for a US $ 15.0 million Official Development Assistance (ODA) fund with the International Fund for Agricultural Development (IFAD), the SB Corporation redesigned its program with features crafted as a result of focus group discussions and consultative meetings with industry players as well as with other micro finance government financial institutions (GFIs) and with the Regional Operations Group of the Department of Trade and Industry.
Based on the said recommendations, the new products under the program shall be differentiated based on the type of conduit as follows: MICRO-LEAD- micro lending through LEAD MFIs or those whose lending portfolio and organizational structure are pre-dominantly micro-finance; MICRO-LOCAL- micro lending through Micro and Small and Medium Enterprise Rural Banks; and MICRO-LEAP- micro lending through small micro finance providers such as community cooperatives and local NGOs.
The redesigned program will allow larger and well-established micro-finance institutions (MFIs) higher loans ceilings than the smaller MFIs, but with stricter eligibility criteria. Moreover, to enable greater access to the program, the eligibility criteria will be relaxed, but the selection of the conduit shall be undertaken through a competitive process.
Loans under the program regardless of the type of conduit shall be for one year payable either monthly or quarterly only. The pass on rates to the conduit will depend on two factors: (1) their credit risk rating using the recently published micro finance standards, and (2) loan size or per Peso transaction cost. This means less risky and more efficient conduits will enjoy a lower pass on rate. Additional incentives such as rebates on the corporation’s fees will be adopted for conduits that are able to offer more competitive pricing to the microentrepreneurs.
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(Mr. Benel P. Lagua is the President / COO of the new Small Business Guarantee and Finance Corporation. He is likewise an active member of FINEX. Feedback and comments are welcome at benellagua@alumni.ksg.harvard.edu).
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