Subsidies for SMEs, again?
Credit to Author: The Manila Times| Date: Fri, 18 Jan 2019 16:20:46 +0000
Imagine you are an owner of a small enterprise servicing other businesses. You have been running your company for 12 years now with a lean team of 20. The business is experiencing a spike in demand, your team is willing and able, but your resources have been held up in earlier projects so you cannot accept new ones. You realize you need capital. If the expected profit from a new project is greater than the interest rate your bank charges for a loan, it makes sense to take out a loan from the bank to service the order.
But now imagine the banks, for one reason or another, can’t give you the cash you need – perhaps your credit line has been maxed out, or you don’t meet their rigid criteria for a higher limit. Or even if you do, they can’t lend in time. Pressed for capital, the financial system has kept you from better serving your customers.
This is the story of many entrepreneurs in the Philippines and it happens more often than you may think. According to a 2015 World Bank Enterprise Survey, only 5.1 percent of working capital and 10.1 percent of investments were financed by banks, which are the lowest figures among the Asean 5. The same survey found that 10.4 percent of enterprises in the Philippines cited access to finance as their biggest obstacle, third to informal sector practices (20 percent) and corruption (11.5 percent).
As small and medium enterprises (SMEs) are seen as riskier than larger companies, they bear the brunt of this problem through lower credit limits and higher interest rates. The Magna Carta for SMEs mandates banks to allocate 10 percent of their loan book to MSMEs. However, as of 2017, this figure only stood at 8.4 percent. This implies that banks are still not set up to lend profitably to SMEs, and this cannot be solved by merely ordering them to lend more.
In other words, for SMEs, financing supply is the problem, not demand. This is referred to as financial exclusivity, where financing remains practically restricted to larger enterprises.
The lost business opportunities due to the lack of financing has enormous economic cost to society, and the private sector offers no evident market solution. Especially as SMEs comprise 99.5 percent of businesses and provide employment to 61.6 percent of the labor force, actions coursed through SMEs are likely to see multiplier effects down the funnel if designed and administered properly. Hence, government action may be warranted, but in what form?
Maybe subsidies, but not in the way that perhaps first comes to mind (cash given to SME owners, which may be considered direct subsidies). Rather, I allude to indirect subsidies structured as some form of guaranty to SMEs. A guaranty that commits the government to fulfill a portion of a SME’s debt obligation in case it defaults, lowering the risk associated with loans extended to SMEs.
Therefore, guaranty schemes narrow the gap between the risk profile of SMEs and the risk appetite of funders, which sits at the core of this financing dry spell (arguably even more than liquidity). Similar guaranties currently exist at smaller scales, but the national government has the resources to provide broader access to SMEs through a more centralized program.
The issuance of guaranties, as a policy tool, is not new by any means, not least in the Philippines. The national government has always utilized guaranties to encourage and support private and public transactions in line with its policy objectives. For instance, home ownership is supported by guarantying individual housing loans and developers’ construction loans through the Home Guaranty Corporation.
SME credit guaranties have also been employed by governments in Ireland, the Netherlands, and Hong Kong to help nurture SMEs.
Guaranties seem like a reasonable match to the financing supply problem as diagnosed, but certainly not without faults. One caveat, much the same as in any public action, is that it can be gamed and defrauded to the disadvantage of the state and taxpayers.
Due to the inherent moral hazard (i.e. financial institutions issuing loans beyond what is prudent, or SMEs borrowing beyond their capacity), such a program can’t possibly cover all SMEs and all their loans. Standards and risk-based fees must be set, and SMEs and financial institutions must be prequalified to participate in a guaranty program like this.
The above discussion does not intend to discount current government efforts towards improving SME access to financing. Other government efforts include the Bangko Sentral ng Pilipinas’ advocacy for digital financial inclusion, and Small Business Corporation’s wholesale lending and credit guaranty to qualified institutions. These are clearly a shot in the right direction. However, the earlier World Bank figures indicate that we have still missed the mark.
As with any policy problem, financial inclusion has many facets. Capital specifically earmarked for SME lending is made more available through cheap wholesale lending by the government. Better access is being provided by new financial technology companies. SME financial literacy is addressed through trainings conducted by the DTI. Finally, helping to complete the picture of financial inclusion, underwriting concerns and risk mismatches may be addressed through guaranties.
The author is currently a Project Coordinator at First Circle, having previously served in government for three years at the Department of Finance. She is also a part-time lecturer for Public Finance at De La Salle University. She holds a Master’s degree in Finance and Development from SOAS University of London, and Bachelor’s degrees in Economics and Finance from De La Salle University.
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