Small and Medium Enterprises (SMEs) are widely considered to be the key drivers of inclusive economic growth – particularly in developing countries. According to the World Bank, SMEs account for the majority of businesses worldwide and are important contributors to job creation plus global economic development. However, SMEs themselves face various challenges to their day-to-day operations and growth. Access to finance is often cited as one of the primary obstacles that affects SMEs disproportionately more than large firms.
This global scenario also holds true for Bangladesh where SMEs represent 80 percent of the total business entities and contribute over 35 percent of total local employment – but are constrained by a $2.8 billion financing gap. According to an English daily newspaper, about 27.5 percent of SMEs have access to credit compared to 44 percent of large firms. According to the World Bank, one of the key reasons behind this gap is SMEs' limited ability to provide collateral, which creates the perception of a higher default risk of SMEs compared to large firms. Moreover, the Covid-19 pandemic has made financial institutions even more cautious due to the rising levels of non-performing assets.
The advent of the Covid-19 pandemic, and associated economic shock, has further exacerbated the situation; whereby the financial institutions are experiencing a liquidity crunch accompanied by an overall spike in credit costs, non-performing assets and default risk. Further, the SMEs are experiencing a drastic decline in revenue and cash-flow which are making it difficult just to sustain operations.
The situation has left the SMEs needing even greater access to finance but made the banks even more cautious due to the increasing levels of default risk. This has spurred the government to declare a Tk20,000 crore stimulus package addressing the financing needs of SMEs. However, the stimulus package does not fully address the management of increased default risk due to the impact of the ongoing economic shock on SMEs in the absence of adequate collateral. Hence, the question remains as to how to provide financial institutions with an appropriate risk management option as an alternative to collateral – to enhance SMEs' access to financing.
A situation like this, in most cases, calls for government interventions and public credit guarantee schemes (CGSs) – which are common forms of such intervention that help unlock finance for SMEs in emerging economies. A CGS provides third-party credit risk mitigation to lenders by absorbing a portion of the lender's losses on the loans made to SMEs in case of default, typically in return for a fee. According to the World Bank, more than half of the countries around the world have a credit guarantee scheme in place and the number is growing.
The primary reason behind the popularity of CGSs is the fact that they integrate a subsidy element with market-based arrangements for credit allocation; thus, leave less room for credit market distortions than more direct forms of interventions such as by state-owned banks. Moreover, CGSs can be leveraged to provide countercyclical financing to SMEs during an economic slowdown, like that of the ongoing Covid-19 crisis, when heightened risk aversion among financial institutions results in a credit crunch. The following are a few examples of countries that have successfully implemented public credit guarantee schemes to enhance SMEs' access to finance.
The Credit Guarantee Fund Scheme for Micro and Small Enterprises was launched by the Government of India to make collateral-free credit available to micro, small and medium enterprises (MSMEs) in India. The scheme is jointly run by the Ministry of Micro Small and Medium Enterprises and the Small Industries Development Bank of India, with a funding contribution ratio of four to one, respectively. Ever since its inception in 2000-2001, the credit guarantee scheme has been growing in popularity. From 2010 to 2016 the cumulative loan amount sanctioned under the scheme grew by 1,600 percent to INR 113,500 crore with more than one lakh credit facilities approved.
Both new and existing MSMEs can avail credit under the scheme. In terms of lenders, eligible banks and financial institutions include scheduled commercial banks and some regional rural banks that have been classified by the National Bank for Agriculture and Rural Development as "Sustainable Viable."
Limits and fees
The credit limit under this scheme is INR 1 crore per borrowing unit. The guarantee cover limit is 75 percent of the loan amount up to INR 50 lakh – for loans up to INR 5 lakh the guarantee cover is 80 percent. Guarantee tenure is as per the agreed tenure of the term loan/composite credit; however, for working capital, the guarantee tenure is five years or above – in blocks of five years. In terms of fees, there is a one-time guarantee fee of 1.5 percent and an annual service fee of 0.75 percent for lenders. For loans up to INR 5 lakh, the one-time fee is one percent and the annual fee is 0.5 percent.
The State Bank of Pakistan, in collaboration with the country's federal government and the UK's Department for International Development, has launched a credit guarantee scheme for small, rural and micro enterprises. Since its inception in 2010, this scheme has been helping SMEs easily obtain collateral-free – unsecured – credit from banks and financial institutions.
Eligible borrowers under the scheme include micro and small enterprises plus farmers with economic landholdings. The borrower shall preferably be a new customer; however, an existing borrower can also be extended additional lending facilities under the scheme considering cash flow, regulatory conformance and Credit Information Bureau records.
In terms of lenders, eligible financial institutions include scheduled commercial banks, SME-specialised banks and some microfinance institutions. Currently, there are 21 financial institutions listed under the scheme and the number is increasing.
Limits and fees
The credit limit under the scheme is PKR 500,000 for micro enterprises and PKR 2 million for farmers – which cannot exceed 20 percent of the allocated guarantee limit for the financial institutions – as per the State Bank of Pakistan's prudential regulations for small enterprises. The maximum credit tenure under the scheme is five years; however, for agricultural input lending the tenure limit is three years. The scheme provided guarantee coverage up to 60 percent of the lending amount, without fees to the banks and financial institutions, while the SMEs are charged a market-based interest rate.
Indonesia has an advanced SME credit guarantee system with institutionalised mechanisms at both the national and regional level as depicted in the table below.
The national level institutions provide technical assistance to regional ones for operations of the credit guarantee schemes. There are various credit guarantee programs offered by these institutions including – credit guarantees for loan programs, guarantees for microcredits, Islamic financing guarantees, commercial credit guarantees, counter bank guarantees, etc. These guarantee products can be classified into two categories based on whether the operating procedure is Conditional Automatic Coverage (CAC) and Case by Case (CBC).
Both new and existing SMEs are eligible for lending under the schemes – provided that their loan proposal is approved either by a bank or financial institution (FI) that has a CAC agreement with the guarantee institutions, or by guarantee institutions themselves directly in case of a CBC arrangement. The proposal may be channeled via the financing bank or FI as well. In the case of lenders, the banks or FIs that engaged in SME financing can become eligible lenders by forming CAC agreements or CBC arrangements with individual proposals.
Limits and fees
The overall maximum guarantee limit is 10 percent of capital for group companies and five percent of capital for individual companies. For CAC agreements, the guarantee cover usually is provided for 50 to 80 percent of the total loan amount. In CBC arrangements, the guarantee amounts vary depending on the risk of borrowers' businesses.
Fees for such credit guarantee schemes range between 1.2 - 2.28 percent. However, the fees vary depending on the type of loan, loan tenure, risk analysis, and guarantee coverage.
Based on the discussion above, we understand that credit guarantee schemes can be an effective tool for Bangladesh's government to improve SMEs' access to credit and to help banks deal with the pressure of a worsening non-performing asset ratio – especially during the current crisis brought about by the Covid-19 pandemic. The country case studies provided above reiterate the benefits of CGS and shed light on some standard operating processes. These may be considered along with guidelines, like the World Bank's 2015 "Principles for Public Credit Guarantee Schemes," from development financial institutions when introducing CGS in the country.