Small Business Corporation: Sustainable Intervention to Address Gaps in SME Financing

The challenge to a developing economy such as the Philippines is to be able to implement credit supplementation programs that will effectively assist and develop Small and Medium Enterprises (SMEs) and be sustainable in the long term. The Small Business Guarantee and Finance Corporation (SBGFC) or Small Business Corporation for short is an organization that has attained these twin objectives of being developmental and sustainable at the same time. The key to the successful fusion of service and sustainability in a developing economy is being able to make SME financing a viable activity in which credit guarantees play a vital role.

Introduction to Small Business Corporation
With the vision of producing globally competitive enterprises, Small Business Corporation is fortunate to have a mandate that encompasses a wide range of possible financial interventions to develop SMEs. The SBGFC was established on January 24, 1991 by Republic Act 6977, and later amended by Republic Act 8289, otherwise known as the Magna Carta for Small and Medium Enterprises. This law was enacted to support the development of SMEs through the provision of various alternative modes of financing and credit delivery systems. It was on July 16, 1992 that Small Business Corporation started operations.

Under the law, the mandate of Small Business Corporation is to perform the following functions:
• Source and adopt development initiatives for globally competitive small and medium enterprises in terms of finance, production, management, and business linkages;
• Promote, develop and widen in both scope and reach various alternative modes of financing for SMEs including but not limited to the following:
1. direct and indirect project lending
2. venture capital
3. financial leasing
4. secondary mortgage
5. rediscounting
6. secondary/regional stock markets
• Guarantee loans obtained by qualified SMEs, private voluntary organizations and cooperatives;
• Provide second level guarantees (i.e. reinsurance) on the credit and investment guarantees made by credit guarantee institutions and other institutions in support of SMEs; and
• Provide instruments to the financial sector for alternative mandatory compliance as provided for in the R.A. 6977 as amended by R.A. 8289.

As a government agency, the Small Business Corporation is attached to the Department of Trade and Industry. It is under the policy, program and administrative supervision of the Small and Medium Enterprise Development (SMED) Council, the body responsible for the promotion and development of SMEs in the Philippines.

As provided in R.A. 6977, Small Business Corporation has an authorized capitalization of Five Billion Pesos (P5,000,000,000) of which One Billion Pesos (P1,000,000,000) have been subscribed and paid up. Of the initial capital of One Billion Pesos, five government financial institutions infused equity into Small Business Corporation in the form of common and preferred shares. These are the Land Bank of the Philippines (LBP), Development Bank of the Philippines (DBP), Government Service and Insurance System (GSIS), Social Security System (SSS), and the Philippine National Bank (PNB).

In November 16, 2001, the Small Business Corporation was merged with the Guarantee Fund for Small and Medium Enterprises (GFSME), one of several guarantee institutions in the country active in providing credit supplementation to SMEs. With the merger, Small Business Corporation’s capitalization as of March 31, 2001 stood at P 1.825 Billion and has emerged a stronger institution

Currently, Small Business Corporation has a total workforce of 98 personnel. Of this number, 84 staff are in the Head Office, six are in the Mindanao Area Office, six in the Visayas Area Office and one each in the La Union and Bicol Desk Offices.


The Credit Guarantee System

Small Business Corporation’s targeted clientele are the micro, small and medium enterprises. These enterprises are defined as any business activity engaged in industry, trading, agri-business, and/or services whether single proprietorship, cooperative, partnership or corporation whose total assets, inclusive of the proceeds from loans but exclusive of the value of the land on which the office, plant and equipment are situated have asset size values falling under the following categories:
• Micro : Up to P 3,000,000.00
• Small : P3,000,001.00 to P 15,000,000.00
• Medium : P 15,000,001.00 to P 100,000,000.00

Small Business Corporation’s guarantee serves as substitute or supplement to the collateral requirements of SME loans from banks and other financial institutions. The guarantee is a contingent liability of the Small Business Corporation to the lending bank and becomes only a real liability when the loan is defaulted and there is a call on the guarantee. Small Business Corporation then pays the lender the equivalent amount of the loan covered by guarantee.

Under the program, Small Business Corporation may guarantee loans used for the following purposes: 1.) acquisition of fixed assets; 2.) permanent working capital; 3.)temporary working capital by way of credit line facility with a term of one year; 4.) debt retirement/refinancing; 5.) financial lease/lease purchase of a single or variety of machineries, equipment and facilities.

Loans that can be guaranteed or lent to SMEs may range from P 100,000.00 to
P 20 million. The aggregate amount of loans to borrowers with related interest shall in no case exceed P 20 million.

The maximum guarantee cover is 85 percent of the loan amount depending on the type of guarantee being extended and the risk involve in the enterprise. There are two types of guarantee extended to SMEs: the clean loan guarantee, which is given to cover risk of loans without any collateral, and the credit risk guarantee, which is given to cover loans with real estate and/or chattel mortgage.


Financial Highlights of the System

Over the years, Small Business Corporation has guaranteed a cumulative amount of P 8,662,498,000.00 in loans for 4,675 accounts benefiting 209,688 SMEs. In 2003, it was able to generate guarantee approvals amounting to P 271,988.000.00 for 59 accounts. As shown in Table 2: Credit Guarantee Program (in Million Pesos), it will be noted that since the merger in 2001, and the economic downturn in 1997, guarantee originations have been gradually increasing indicating a gaining confidence in the system.

Paradigm Shift in SME Financing

The credit guarantee system is only one of several modes of financial intermediation used to develop SMEs in the Small Business Corporation. Aside from guarantees, the corporation is into wholesale and retail lending, and recently embarked on an equity financing program. Addressing the problems in financing SMEs, it has developed a new paradigm of SME financing.

The usual problem confronting SME financing is information asymmetry which is the imbalance in the exchange of information between the lender and the borrower. The lender does not trust the borrower because of inadequate information in the same way the borrower does not want to fully disclose his business plan because he fears the lender might pass the information to his competitors. In this kind of situation where reliable and timely information is critical, the first step to bridge the gap between lender and borrower is to invest in systems and that make for proper accounting and business transactions, and to encourage transparency.
In the new paradigm, it was observed that SMEs can be classified into several types based on their capability to provide credible information about their business which translates into how the banks and financial institutions perceive them. Based on the studies of these SMEs, Small Business Corporation classified SMEs as bankable , meaning those who are already assisted and preferred by banks; the nearly bankable, those that are capable, with a business track record, but lack the credit track record and collateral to secure a loan; and finally the non-bankable and yet viable, those that are limited in both business and credit track record, no collateral and has limited management systems, but has a viable business.
In the paradigm as illustrated in Fig 2: Small Business Corporation’s Credit Delivery Intervention, the credit guarantee system becomes the major intervention to assist SMEs that are near bankable. For the Non-Bankable SMEs, the intervention is direct lending because other financial institutions will not want to lend to them. For the Bankable SMEs, the intervention is to provide wholesale funding to financial institutions who in turn will re-lend to the Bankable SMEs.

The credit guarantee intervention addresses the security requirements of the loan, and enables the SME to enter the formal lending system paving the way for it to grow and establish its bankability. It also helps the banks open up to these SMEs and learn the way to finance SMEs while significantly reducing their credit risks.

Role of SBGFC in SME Development

As the leading player in SME development in the Philippines, Small Business Corporation’s role is largely to address the gaps in SME financing. As already illustrated in the paradigm of SME credit delivery, SMEs being assisted are those rejected by the banks or those the banks perceived to be lacking in their capacity to borrow and repay the loan. However, the corporation maintains a high level of professionalism and attention to credit evaluation processes that minimizes information asymmetry resulting to a high quality of loan, guarantee and investment portfolio that would sustain operations in the long term.
In this light, the programs of the Small Business Corporation give SMEs the break they need to enter mainstream business and to grow themselves into competitive enterprises. It does not compete with the formal banking sector but complements their efforts in helping SMEs.


Strategies to Expand the System

The strategy to expand the credit guarantee system is three pronged:
• Geographical Expansion – Financial services and access to credit is mostly found in the urban centers. These are the metropolitan areas and regional capitals which are also centers of business. The rural areas which compose majority of the country’s regions are largely unserved by Small Business Corporation. There is so much economic and business potential for SB Corporation to finance the requirements of SMEs in these areas to upgrade the quality of goods and services using indigenous raw materials and human resources. Part of the strategy for expansion is setting up area offices and Small Business Incubation Centers (SBIC) The strategy includes going into joint ventures in setting up the SBICs which will serve as Small Business Corporation’s extension offices marketing its services and financial products.
• Program Technology Expansion - Another opportunity for expansion is to fill the gaps in financing technology and information asymmetry in the SME sector. The strategy is to develop products and services that would meet the financing and technology needs of the SME sector. These are market niches that have not been served by banks and financial institutions.
• Asset base expansion – There is a need and an opportunity to expand Small Business Corporation’s asset base. This can be done by leveraging its existing funds through the credit guarantee system, and by securing additional funding from other sources. Asset base expansion answers the need to fully finance its mandate.

Future Prospects

A really strong and effective credit supplementation system is one that can direct investments and loans with a high level of confidence towards certain industries, enterprises or firms. An indication of this ability is when a lending institution accepts a credit guarantee with a high level of trust and confidence, and will readily lend or invest in the given enterprise.
Given this precondition to the development of a strong and credible guarantee system, Small Business Corporation is set to launch two programs, the Credit Guarantee Certificates (CGC) and the Automatic Guarantee Line (AGL) that will redefine the credit guarantee as a financial intermediation tool to encourage small and medium enterprise (SME) lending
The plan to introduce these new programs this year was made to increase loan originations and the use of credit guarantees. But more importantly, they were meant to change the way banks and financial institutions view the credit guarantee system.
Since the financial crisis of the late 90s, the banks have remained very cautious in lending to SMEs, and require hard collateral such as real estate as part of the loan security. The new programs will aim to make the banks take a second look at credit guarantees and gain renewed confidence in using them.
Oftentimes, banks view credit guarantees as having tedious documentation and being difficult to collect on guarantee calls because of possible revocation and non-payment due to technicalities. The CGC and the AGL will hopefully change these perceptions. Both will do away with the tedious evaluation and documentation that go with guarantee approval, and provide a more efficient system of guarantee call payments. In short, the CGC and AGL answer the need for a fast and reliable credit guarantee facility that will boost confidence of financial institutions in the system.

The system may, in the future, be performing the primary evaluation of the loan or investment application and the lending or investing financial institution performing the secondary credit evaluation. This is a vision that is not easily attainable, but can happen through a build up of a credible track record and excellent performing portfolio of SME credit guarantee accounts.

In line with this vision is the establishment of a new model for the system, which is a state agency type of guarantee model using the sovereign guarantee as major feature and the portfolio and mutual guarantee systems as subsidiary systems to effect industry and regional development.