Shanghai National Accounting Institute

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SME Financing in the Asia-Pacific Region Crisis
and Countermeasures

• Shanghai National Accounting Institute
• June 8-12, 2009
• Mr. Ying Qian
• East Asia Regional Department

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Introduction

• Background
• Impact of Crises on SMEs
• Access to Financing
• Government Support
• Lessons Learned
• Support Needed
• Credit Guarantee
• APEC Initiative
• ADB Recommendations

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Background

• Asian Crisis (1997-98)
• (i) sharp decline in domestic demand, combined
  with a credit crunch
• (ii) strong rise in input costs, mainly derived
  from the currency depreciation
• (iii) surge in interest rates
• Global Financial Crisis (2008-09)
• same credit crunch and demand slump but from
  rapid and persistent fall in international demand
  
• currency appreciation
• lower interest rates

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Impact of Crises on SMEs

• Most vulnerable sector in the global economic
  crisis particularly labor-intensive and
  export-oriented companies
• Shrinking orders, loss of business or suspension
  of operations as demand of foreign buyers
  continue to decline
• Production chain shortened, broken
• Increasingly tight squeeze on credit, as banks
  become more risk averse

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Impact of Crises on SMEs
1997-98 Asian Crisis 2008-09 Global Financial Crisis
Slump in domestic and international demand but international demand quickly recovered (currency depreciation made products from crisis-affected countries quite cheap) Insufficient international market demand Cancellation of contractual export orders High inventories (for export-oriented SMEs - with dire demurrage implications)
Drying up of formal credit (bank loans) and venture capital Credit crunch liquidity crisis Lower interest rates but more stringent requirements by risk-averse banks
Delayed payments - account receivables increasing
Reduced output, employment, investment Business suspension or bankruptcies
Most affected sectors import-dependent enterprises, Most affected sectors export, tourism and trade logistics services
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Access to Financing

• High cost of capital (high interest rates, short
  repayment periods, advisory fees)
• Lack of access to financing (insistence on
  collateral requirements, burdensome bank
  procedures absence of venture capital)
• General aversion of banks in dealing with a large
  number of small accounts
• Organizational structure of banks and processes
  create a specific bias against small loan
  portfolios
• No proper credit information on SMEs
• Banks are reluctant to lend to SMEs because of
• Lack of transparency of financial condition of
  SMEs
• Lack of managerial/marketing skills of SMEs
• Loans to SMEs in the past have compounded banks
  non-performing assets problems

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Government Support (1997-1998)

• After the Asian crisis, almost all governments
  issued laws, decrees, and government regulations
  to improve SME access to financing
• Legal and regulatory reforms (creation of several
  agencies with mandates to exclusively support
  SMEs issuance of laws, regulations decrees to
  strengthen SMEs
• Direct financial support (creation of special
  credit funds for SMEs, credit guarantee funds)
• Indirect financial support (tax incentives, lower
  interest rates, relaxation of requirements)

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Government Support (1997-1998)

• However, the reforms and interventions were
  poorly implemented, not well monitored
• PRC government lowered benchmark interest rate
  for bank but some banks still increased interest
  rates for SMES by 20-60, charged advisory fees
  and required cash-strapped enterprises to pay
  loans in advance
• India - despite repeated and clear admonitions
  from Reserve Bank of India not to insist on
  providing collateral from SMEs, collateral is
  still required

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Government Support (2008-2009)

• Most common government response has been to
  increase loan guarantee programs for SMEs
• However, banks are slow to participate because
• More time needed to implement the program through
  wide network of local branches
• Commercial banks have difficulty in finding
  bankable SMEs
• Government SME banks face huge amounts of NPLs

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Government Interventions
Region/Country 1997-98 Asian Crisis 1997-98 Asian Crisis 1997-98 Asian Crisis 2008-09 Global Financial Crisis 2008-09 Global Financial Crisis 2008-09 Global Financial Crisis
Region/Country Specialized agencies/ banks laws, regulations decrees Special funds SME loans Loan guarantees Tax incentives
South Asia South Asia South Asia South Asia South Asia South Asia South Asia
India Small Industries Development Bank of India Micro, SME Development Act 2006 Credit facility Risk sharing facility (guarantee reserves) Credit Guarantees Fund Trust for Micro and Small Enterprises
Pakistan Small and Medium Industries Devt Authority SME Bank Microfinance Banks No separate law for SMEs Enterprise Competitiveness Support Fund Subsidized Interest rates Credit Guarantee Agency Credit Information Center
Southeast Asia Southeast Asia Southeast Asia Southeast Asia Southeast Asia Southeast Asia Southeast Asia
Indonesia Small rural development banks, Cooperatives of small scale industries, Export Support Board Partnership Law and Law No. 9/1995 on Small Business Small scale credit Credit for village units Subsidized credit for farmers and village cooperatives Direct Peoples Business Credit Scheme (KUR)
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Government Interventions
Region/ Country 1997-98 Asian Crisis 1997-98 Asian Crisis 1997-98 Asian Crisis 2008-09 Global Financial Crisis 2008-09 Global Financial Crisis 2008-09 Global Financial Crisis
Region/ Country Specialized agencies/ banks Laws, regulations decrees Special funds SME loans Loan guarantees Tax incentives
Southeast Asia Southeast Asia Southeast Asia Southeast Asia Southeast Asia Southeast Asia Southeast Asia
Malaysia Natl SME Dev. Council, Credit Guarantee Corp. Small and Medium Industries Devt Corp. Malaysia External Trade Development Corp. SME Growth Acceleration Fund Credit Enhancer Scheme SME grants SME Credit Bureau
Philippines SME Development Council, Small Business Corp Magna Carta for Small Enterprises Small Enterprise Financing Facility, Rediscounting, Guarantee funds Exempt from income tax, import duty, for 6 years
Thailand SME Promotion Office Institute of SME Development SME Development Bank Peoples Naml SME Promotion Act 2000 Village funds (THA) (INO) Portfolio Guarantee Scheme for SMEs
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Government Interventions
Region/ Country Region/ Country 1997-98 Asian Crisis 1997-98 Asian Crisis 1997-98 Asian Crisis 1997-98 Asian Crisis 2008-09 Global Financial Crisis 2008-09 Global Financial Crisis 2008-09 Global Financial Crisis
Region/ Country Region/ Country Specialized agencies/ banks Laws, regulations decrees Laws, regulations decrees Special funds SME loans Loan guarantees Tax incentives
Others Others Others Others Others Others Others Others Others
China SME Dept in State Economic and Trade Commission SME Dept in State Economic and Trade Commission SME Dept in State Economic and Trade Commission Partnership Enterprise Law Sole Proprietorship Enterprise Law Law on Promotion of SMEs SME Credit Guarantee System 5 state banks to open special service credit outlets for SMEs in 5 yrs Additional RMB 1B for SMEs Tax rebates for exports
Korea SM Business Administration, Small Business Corp. SM Business Administration, Small Business Corp. SM Business Administration, Small Business Corp. SME Basic Law Law for Assistance of SME Startup Korea Credit Guarantee Fund Increase loans to SME from 21.4 B to 31.4 B Increase credit guarantee for SME 35.7B won
Japan Japan Finance Corporation for Small Business, National Life Finance Corporation and Shoko Chukin Bank Japan Finance Corporation for Small Business, National Life Finance Corporation and Shoko Chukin Bank Japan Finance Corporation for Small Business, National Life Finance Corporation and Shoko Chukin Bank New SME Basic Law Credit insurance system Credit guarantee system Safety Net Loan Emergency guarantee scheme of additional Y21T Reduction of corporate tax for SMEs to 18 w/ Y8million or less annual turnover
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Lessons Learned from 1997-1998

• Crisis had positive effects on SMEs
• Increased local demand for cheaper substitutes
• Sharp increase in number of SMEs partly due to
  more people losing jobs going into small business
• SMEs weathered the crisis better than large
  enterprises as they had more flexibility to turn
  to export due to favourable exchange rate
• The crisis renewed focus on crucial role of SMEs
  in their countries development that generally
  resulted in higher budget allocations and
  external aid for SMEs

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Lessons Learned from 1997-1998

• Forcing state banks to provide cheap and easy
  credit to SMEs without careful review is more
  likely to result in resource misallocation
• SME Bank of Thailand reported that NPLs of SMEs
  amounted to 22 of total credit outstanding
  compared to avg. of 16-17 for financial sector
  as a whole
• Mere provision of capital or credit does not
  ensure that SMEs will be successful but with
  technology and skills it is easier for SMEs to
  find capital
• Focus of assistance should be on long-term
  sustainable solutions i.e. not in helping SMEs
  survive crises but support capacity for long-term
  survival

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Support Needed for SMEs

• Most of the countries that provided government
  support to SMEs during and after the 1997-98
  Asian crisis through various programs including
  credit and guarantee schemes have not evaluated
  the impact of such interventions. It will be
  opportune to assess effectiveness of various
  interventions to determine future policies and
  action in closing the SME financing gap
• Experience from the past crisis indicated that
  capital injections into banks were not sufficient
  to increase lending to SMEs and government
  guarantees were also needed. However, banks are
  still reluctant to take up loan guarantees.
  Additional measures such as credit mediators
  monitoring of SME lending by banks and code of
  conduct for SME lending may be further explored

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Support Needed for SMEs

• An SMEs creditworthiness is usually evaluated by
  intuition rather than by statistical analyses due
  to lack of data on the SME. Establishment of an
  SME database or credit bureau can reduce
  information asymmetry between SMEs and banks
• Alternatives to bank loans should be further
  studied and explored and their availability
  widely disseminated to SMEs
• Equity finance - individual investors (business
  angels) and private equity houses invest in
  businesses in return for equity these investors
  prefer innovative and high-growth businesses
  which will provide reasonably high return on
  investment

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Support Needed for SMEs

• Asset finance - asset finance companies will
  purchase equipment specified by the SMEs and
  lease it to the enterprise some companies will
  buy the SMEs existing assets and lease them back
  to the SME
• Invoice finance - invoice finance companies will
  provide loans in proportion to the value of
  invoices in return for a percentage, daily
  interest or a management fee invoice financing
  is appropriate for SMEs whose clients
  traditionally pays within 30, 60 or 90 days on
  invoice
• Trade finance - can include letters of credit,
  export credit insurance, export factoring,
  forfeiting and others. In many countries, trade
  finance is often supported by quasi-government
  entities known as export credit agencies that
  work with commercial banks and other financial
  institutions

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Credit Guarantees

• Credit guarantee schemes reduce losses incurred
  by banks from defaulting SMEs by assuming a share
  of these losses normally in return for a
  guarantee fee
• Banks have traditionally avoided SME lending due
  to high administrative costs involved, asymmetric
  information about potential SME clients capacity
  and willingness to repay, high risk perceptions,
  and lack of acceptable collateral.
• By diminishing banks risks thru risk-sharing and
  motivating banks to explore the SME market
  segment, credit guarantee schemes can make bank
  finance more accessible for SMEs, and improve
  opportunities for economic and employment growth.

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Credit Guarantees

• Credit guarantee schemes have been criticized for
  
• not being effective
• not really achieving additionality
• being administratively costly
• being subsidy-dependent
• increasing the danger of moral hazard
• contributing to a weakening of credit morality
• Second level moral hazard on the part of the
  lending bank
• not motivated to supervise the loan properly
• will not pursue vigorously repayments when most
  of the loans are covered by a guarantee
• There has been no sufficient reason for
  government intervention by means of
  publicly-funded schemes

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Credit Guarantees

• Credit market failures and distortions can be
  better addressed through
• further capital market, banking and regulatory
  reforms
• risk management training of bank staff
• establishing credit bureaus and enterprise
  databanks,
• initiating legal reforms in order to overcome
  asymmetric information and SMEs difficulties in
  pledging their property as collateral
• The failure of many credit guarantee schemes in
  the 1980s and 1990s, mainly in developing
  countries, and the fiscal burden of European and
  the Japanese credit guarantee schemes, also led
  to controversy about the schemes justification
  and effectiveness

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Credit Guarantees

• The third generation of schemes and governing
  regulatory reforms in Europe, Japan and Korea
  have largely removed or avoided most problems
  through
• careful and prudent operational modalities
• encouraging private sector involvement
• prudent multipliers and provisioning for reserves
  and
• more discriminating eligibility criteria
• Reformed schemes have proven more effective,
  resulted in lower default rates, and have been
  able to serve increasingly larger numbers of SMEs
  
• Many credit guarantee schemes operate on a
  cost-recovery or self-sufficiency basis, and some
  even make a profit, but most larger schemes and
  all re-guarantee schemes are not sustainable
  without government subsidies

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APEC Initiative

• SMEs should continue to receive support from the
  government in accessing the financial markets
• Authorities should explore more ways to assist
  SMEs to tap the term debt market, for example
  sponsoring mezzanine funds to provide term
  capital for SMEs for investment such as land,
  buildings and equipment
• Authorities should consider creating a
  centralized credit bureau for banks to access
  credit information on SMEs to
• help reduce transactions cost,
• create more supply,
• improve transparency, and
• provide a centralized way of getting credit
  information

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ADB Recommendation 2004

• An independent, functional and powerful
  government agency is needed to support the needs
  of SMEs in China to
• effectively advocate for SMEs within the
  government, and formulate and implement policies
  to address the need of SMEs in China
• play a more important role in supporting SME in
  China as provided in the Law on Promoting SMEs
• build the capacity of SMEs to formulate and
  implement SME support policies and regulations
  regarding financing, innovation and services

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ADB Recommendation 2004

• Prioritize the enhancement and development of SME
  lending from policy and commercial banks
• catalyze the birth of an SME Policy Bank in China
  and adopt a commercial orientation in its lending
  policies to SMEs with a long-term goal of
  becoming a private, specialized SME finance
  institution
• provide incentives to banks and non-bank
  financial institutions for SME finance provide
  access to any technical assistance needed in
  order to lend to the SME sector
• pilot program for local SME-focused banks and
  facilitate investment and assistance into these
  institutions as much as possible
• improve SME credit guarantee operations and
  optimize risk and capital allocations through
  re-guarantee and co-guarantee schemes, supported
  by prudent institutional arrangement and
  operational procedures

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ADB Recommendation 2004

• Prioritize the enhancement and development of SME
  equity investment funds and programs
• develop an effective legal and regulatory
  environment for equity investment
• build up the skills of existing venture capital
  firms through policy support and access to
  technical assistance to existing venture capital
  funds investing in SMEs in China
• develop the pilot program for small business
  investment companies. Establish a new SBIC
  program, and create new funds through leveraging
  private investment with government investment
• promote capital market development by encouraging
  the development of the Shenzhen market and, where
  possible, helping SMEs and venture capital funds
  to use the market for exits and IPOs

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ADB Recommendation 2004

• Take steps to develop a country-wide support
  system for SMEs and SME-related intermediaries
• develop a one-stop access point for delivery of
  government related services to SMEs. The SBA
  could begin providing basic information and
  promoting existing services by government
• promote intermediaries to engage in SME-related
  services. The SBA should support relevant
  intermediaries through assistance and networking,
  and encourage them to work with SMEs

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Thank you

• Ying Qian
• Principal Economist (Financial Sector)
• Financial Sector, Public Management and Regional
  Cooperation Division
• Tel [phone]
• Fax [phone]
• Email yqian_at_adb.org