Do Credit Guarantee Schemes encourage banks to lend to SMEs?

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Countries everywhere are focused on supporting Small and Medium Enterprises (SMEs).  From successive G20 presidencies (Turkey, China, Germany) to many of our emerging country clients, supporting SMEs has become a clarion call.  While this support appears to be largely driven by the global unemployment crisis (particularly among the youth) SMEs contribute much more than just jobs, including exports, production, innovation, diversification, geographic dispersion, and opportunities for women and youth entrepreneurs.
A lack of access to adequate finance is one of the biggest constraints SMEs face worldwide.  It is estimated that between 50% to 70% of SMEs in emerging markets are either not funded or under funded by the formal financial sector.
If SMEs are responsible for delivering so many economic benefits – why are banks so reluctant to lend to them?  Clearly there are problems of information asymmetries – weak accounting data provided by SMEs, a tendency to produce multiple books of accounts (where accounts even exist), poor information on their overall activities, badly designed business plans and loan applications and, possibly most importantly, a lack of the types of collateral generally demanded by banks (fixed assets – land and buildings).
To address these issues, the World Bank has focused on establishing a robust set of financial infrastructure: (a) credit information systems to provide more data on borrowers (b) secured transactions registries for movable property to provide a wider range of collateralizable assets (c) insolvency laws which are more efficient and effective in the case of loan default – supplemented by modernized court systems which can expedite the speedy resolution of disputes and (d) electronic payments platforms to speed and digitalize payment flows.
To this list, shouldn’t we also add a Credit Guarantee Scheme (CGS) architecture – to help de-risk SME lending even further – by providing partial guarantees in the case of default?  In this context, the World Bank and the FIRST Initiative have undertaken a considerable amount of work on the proper design of CGSs Principles for Public Credit Guarantee Schemes for SMEs.
A recent SME Finance Conference held in Harare, Zimbabwe – “Reigniting SME Development in Zimbabwe – Learning from Global Experiences” – brought in practitioners from Malaysia’s Credit Guarantee Corporation Malaysia Berhad (Mr. Keet Loong Wong), Korea’s Credit Guarantee Scheme/KODIT (Mr. Inkook Hwang), and the American Small Business Administration/SBA (Mr. Giuseppe Gramigna).  The Malaysian and Korean experts were provided by the support programs that the World Bank has with those two governments.
Malaysia.  In Malaysia, 645,136 SMEs represent 97.3% of the entire enterprise sector.  Their Credit Guarantee Corporation was designed in the early 1970s to help diversify the economy away from a very heavy reliance upon tin and rubber – as well as to move beyond the agricultural sector.  Since its establishment in 1972, it has provided 445,217 guarantees for a cumulative amount of $14.8 billion.  The Corporation is owned by the central bank (Bank Negara Malaysia) and various Malaysian financial institutions.  Over time, it has progressively diversified its product offerings with exciting new moves into support for start-up enterprises, women headed enterprises, and green tech financing.
Korea.  Emerging from a severe post conflict environment in the 1950s, Korea saw the importance of supporting its SME sector to help the economy recover and grow.  Currently, Korea’s 3.4 million SMEs account for 99.9% of all registered businesses; 87.5% of total employment; and 47.6% of production.  Their development has been supported since 1976 by KODIT which has been funded (mainly) by government but also by the banking sector and by large enterprises.  In 2017 it had outstanding guarantees of $41.1 billion – making it one of the largest credit guarantee agencies in the world.  KODIT research has demonstrated that its guarantees have resulted in lower interest rates for SMEs due to the de-risking flowing from the guarantee.  KODIT also actively uses the credit guarantee mechanism as a tool of counter cyclical policy in periods of economic down turn.
United States of America. The Small Business Administration (SBA) of the United States, established in 1953, has a range of tools to support American SMEs including the Small Business Investment Company (SBIC) to provide equity for innovative SMEs, defined as “Ideas Rich but Capital Poor” enterprises.  The SBA also provides a guarantee instrument for SMEs to encourage banks to lend to this sector.  In 2016 – 69,264 guarantees were issued with a guaranteed value of $29.4 billion.  Research undertaken over the period 1976 to 2009 indicates that 216, 203 guarantees had been issued – creating direct jobs at a cost of $31,932 per job.  However, when multiplier effects were also considered, the scheme only spent $6,942 per job created.  In contrast to KODIT, the SBA’s guarantee mechanism has not been used as a tool of counter cyclical policy – except during the 2008-11 Global Financial Crisis.
These three international experts pointed to the valuable contribution their credit guarantee schemes made in promoting SME development in their respective countries.
As the Reserve Bank of Zimbabwe progresses with the design of its own Credit Guarantee Scheme – taking these international lessons of scheme design into account will be critical in ensuring success – while recognizing that it will take time and training to ensure the necessary familiarity with the scheme, by both banks and customers.  The inclusion of representatives from South Africa at the conference will also, hopefully, assist them as they contemplate design changes to their own existing guarantee scheme.
Image Copyright: Nafise Motlaq/World Bank


Crispen Mawadza

Finance and Private Sector Development Specialist, World Bank

Simon Bell

Global Lead for SME Finance, Finance & Markets

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