Managing Business Risks: Warning Signals that Help Avert Business Failure

Man’s survival since the beginning of time has relied on his ability to see signs of threats before they happen. This enabled him to prepare for the perceived threat and thus mitigated the adverse effects of the event--- when it happens---to his habitat and to his fellow human beings.

The ability to identify early warning signals (EWS) and to effectively act on them has become essential to man’s survival and is now a vital component of many aspects of his life.

From the environment, to man-made structures and from military and political organizations to business enterprises, early warning systems are found and make our world a more stable and safer place to live in.

What is an Early Warning System?

A more fundamental understanding of early warning systems may be gleaned from the following definition: “It is the process of gathering, sharing, and analyzing information to identify a threat or hazard sufficiently in advance for preventive action to be initiated.”

An early warning signal management system (EWSMS) therefore is a network of actors, practices, resources and technologies that has their common goal of detecting and warning about an imminent threat so preventive measures can be taken to control the threat or mitigate its harmful effects. The underlying assumption is that threats develop over incubation periods during which warning signals may be discerned, tracked and assessed.

Because many threats can have far-reaching and devastating impact, early warning systems today tend to be distributed, multi-level, and collaborative, and may be implemented or supported by a coordinating body or central clearinghouse.

Examples of these EWSs are the tsunami warning system in place in the Indian Ocean, the J-Alert system, a satellite based nationwide warning system in Japan to inform the public of threats, the typhoon warning system of the PAG-ASA, and the most common Warning Signal of an oncoming train in railroad crossings.

Then there are more primitive and natural warning signals such as the use of birds (canary) in detecting toxic gases in mines. When the bird dies inside the mines then its air quality is unsafe. Then there are the instinctive warning signals in our bodies such as fear and pain. The former is man’s emotional response to danger; the latter is part of the body’s defense system to avoid a harmful situation in the future.

In finance, more specifically in credit and loans management, early warning systems have increasingly been used by banks and other lenders to manage their portfolio and lessen the risk of loan default and consequently of portfolio quality deterioration. And since recent episodes of financial crises, early warning systems have been part of risk management structures in financial institutions.

The same basic principles can be applied in the management of enterprises, and EWS is a useful tool in being able to anticipate the occurrence of threats and thereby mitigate the adverse effects of a disaster when it comes.

How and where do we generate EWSs?

Early warning signals can be found in the most unsuspected places and circumstances.

In fact it can be found in our day to day work of going about our business. But that would be passive action and reactive response to possible threats if we waited for warnings to pop up our noses, and we do not want that kind of situation in dealing with uncertainty. We want to be capable of generating EWSs and be able to deal with them proactively.

We are able to generate EWSs from the data and information gathered in the course of monitoring our enterprise’s financial performance and operations and that of our suppliers, buyers, and markets. In short, the mechanism to generate EWSs lie in the Monitoring System in place in the different aspects of our enterprise’s operations and activities and that of the environment in which it operates such as the social, political, and economic conditions prevailing in the areas of production, and marketing.

Following are some examples of sources of EWSs:

1. External Sources – these are sources that are not part of or external to the enterprise. These may be in the form of events, news reports, studies, plans, etc.
• Natural disasters and calamities
• Political change and upheavals
• Wars and insurgencies
• Economic Crisis
• Lifestyle changes
• Technology advancement
• Changing weather patterns
• New and changing markets

2. Internal Sources – these are sources that can be found within the borrower’s physical boundaries, structures, systems, and territorial influence.
• Management (changes in ownership)
• Movements (people, offices and functions)
• Financial Statements
• Employees (news or gossip)
• Management and Production reports
• C I reports
• Legal problems
• Compliance to government rules and regulations




Early warning signals exist in abundance throughout any organization. They are in pieces of conversation you had with an office mate over lunch, papers given by competitors at conferences, gossip from suppliers, a conclusion a colleague came to after reading a press release, or in the knowledge of someone down the hall who years ago worked on a project that is now becoming important.

For example, a rise in the level of an enterprise’s receivables is a warning signal that may mean any of the following: our collection system has become inefficient, our buyers are having collection problems themselves, the market for our products is shrinking and retail sales are lower that’s why orders are not being paid on time, or there is a big increase in orders consequently resulting to an increase in receivables.

In any case, the sharp change, whether an increase or decrease, should turn on the alarm bells and should immediately cause us to investigate, identify and prepare for the possible threat. We can either prevent the threat from happening, or we can mitigate its adverse effects.

The problem with capturing this data is that the value of it is not often recognized by the person who has it. The backbone of such an early warning process and culture must be a technology for the capture, collection, assembly and dissemination of early warning signals. Usually, this involves a management information system (computerization of business processes and database management) and the ability to generate information from a database.

It must be easy to use, and it must provide value for the person entering the information, or they won't do it. This information then has to be sorted and pushed to the person who can make sense of it, who can see the pattern.

The process must separate noise from the true early warnings signals; the technology and the culture of the company must mesh. While having the technology to help us manage risk is a pre-requisite for effective use of EWSs, it is of greater importance that the person tasked to use the technology believes (this is the “culture”) in the EWSMS and takes seriously the process of valuing the EWSs and mitigating the risks identified.

In using the EWSMS, we should be guided by the following procedures (refer to EWSMS framework diagram):

• EWS generation

Involves maximum use of the senses and the tools needed to generate data and information. This requires to a large extent the monitoring of the internal and external environments of the business.

• Risk Assessment

Risks or uncertainties that affect the project or the borrower are identified based on the EWSs generated and observed.

• Risk Analysis

The effects of the risks identified are quantified. It is usually done by identifying risks and quantifying each risk’s probability of occurrence and the potential severity of its impact. The impact may be expressed as a range of values, with a confidence level, or as a probability distribution.

• Risk Mitigation

Risk mitigation involves preparation of a risk management plan. This is a list of action steps to do the following:
a.) Eliminate or reduce the probability of a threat occurring
b.) Eliminate or reduce the impact of the threat if it does occur.
c.) Ensure or increase the probability of an opportunity occurring.
d.) Increase the impact of an opportunity if it does occur.


• Risk Control

Risk control is the implementation of the risk management plan. This step includes the triggers referred to in risk mitigation. A key element of the implementation process is the continual tracking and reporting of progress with special attention given to variances and deviations along the way.

SMEs are Fireflies in a Vibrant Economy

They glow in the dark; small and numerous. Nowadays, they are often a fleeting and a rare occurrence in nature.

A beautiful sight to behold in the deep of the night, many small dots of flickering lights moving everywhere but nowhere, and yet synchronized to display their mating call to attract their opposite sex. These are fireflies when they are out to propagate their species, and attract partners to grow and continue their mundane natural existence.

But beyond the mating call is the meaning of their presence in a place.

Fireflies are an indicator; an index of a safe environment free from the toxic waste man has inflicted on Earth. It is a good assumption and a reliable marker that where there are fireflies, there are no poisons in the earth.

Where you see them, the environment is safe --- where life is free to grow and blossom. Where the fireflies are, is an environment where nature can develop to its full potential.

MSMEs are like fireflies.

They are small, but the good and healthy MSMEs will issue forth a glow that makes them attractive.

Like fireflies, many of them come and go. They exist fleetingly. But for those who are able to attract like minded MSMEs, they partner to collaborate, to engage in symbiotic relationship, to merge, to be one giving birth to a bigger and better enterprise.

Like fireflies, they are a sign of a safe and clean environment, a vibrant and healthy economic environment in this instance. The number of MSMEs in an economy is often indicative of growth or stagnation of an economic system. A high number and progressive growth of MSMEs is a sign of a healthy and business-friendly economic environment. while declining numbers of MSMEs is often a sign that an economy is in the brink of stagnation.

The seemingly inconsequential and insignificant existence of fireflies in the natural scheme of things in the environment is shared by MSMEs. Often thought of as irrelevant in an environment where bigness is a highly valued attribute in business, MSMEs by their sheer number, despite being small, have proven their economic contribution as they impact on the greatest number of people and sectors in the country, providing the most number of jobs and helping people survive in bad times.

This year, we celebrate the improving economic environment as the “fireflies” of the economy (MSMEs) have continually shown resiliency in the face of difficulty and have become the bearers of light, albeit small and flickering, during difficult times.

We feature the “fireflies” of the Philippine economic environment as we have shared in their development and their impact on the greatest number of people and lives in this country. On the following pages we take a look, and not help being inspired by their stories on how they have grown and done their share in growing the economy.

Unlike the real fireflies, we have discovered that MSMEs have an ability fireflies do not have.

The real fireflies will remain so in the natural scheme of things; MSMEs will turn into something else. --- big enterprises and institutions that will spread their wings to help fly our country’s economy to a future of prosperity.

Why Capacity Building?

Borrowing from an age old adage, “Give a man a fish; you have fed him for today. Teach a man to fish; and you have fed him for a lifetime." This is exactly what Small Business Corporation intends to do as it embarks on its capacity building programs for its various stakeholders in mSME development.
Capacity building is part of SBC’s new set of mandates as a result of the passage of the new Magna Carta for mSMEs or R.A 9501. Already, it has embarked on a two-pronged strategy to capacity building. First, is directed towards mSMEs addressing its various needs to improve the way it conducts business and how it keeps and share information. Second is directed towards Financial Institutions with the end view of providing a new mindset in SME lending that will result to mSMEs having greater access to financing and for the FIs to have the ability to expand their SME portfolio with a higher level of confidence because they are able to manage the risks involve in SME lending.
There are many definitions of capacity building suggested by practitioners who work with both profit and non-profit organizations. Given their differences, most have several elements in common----- they emphasize strengthening the institution and achieving sustainability; enabling institutions to achieve their mission is usually mentioned, along with increasing organizational effectiveness. They also identify specific areas of organizational capacity that should be addressed. The following definition from the Create the Future website captures the strengths of many definitions:

"Capacity building" refers to intentional, coordinated and mission-driven efforts aimed at strengthening the management and governance of institutions to improve their performance and impact. This occurs through organization development activities, such as leadership development, strategic planning, program design and evaluation, board development, financial planning and management and others.
Given this definition of capacity building, it becomes easier to understand the rationale behind the inclusion of capacity building in SBC’s mandate. It is a component in the mandate that ensures the continuity and endurance of SBC’s contribution to the development of mSMEs.
Areas of capacity building that SBC sees itself to be actively doing are: SME and microfinance lending technologies (such as risk-based lending); anti-fraud and anti-corruption practices; good governance and internal controls; and environmental management systems. These, it will deliver through TA-consultancies, trainings, coaching and policy advocacies.
A greater appreciation of capacity building will come from an understanding of its conceptual framework (refer to fig.1) in which we see the overriding significance of leadership and governance to the institution’s delivery of its products and services. The framework shows how and where capacity building can take place and make a difference. First is in the strategic plan ---its vision, mission, and objectives, then in the various spheres of doing business to deliver its services and make an impact on its stakeholders. Capacity building can enhance strategic relationships, its development of resources both human and material, and its ability to manage these resources and operate in a sustainable way.
Sans capacity building, and after many years of development work and the amount of financing and resources that went to mSMEs, the success rate remains low and the age-old problems continue to persist. It is in this context that capacity building was included and meant to address the perennial problems of mSMEs.

With capacity building, the mSMEs, or the Financial Institutions, or the other stakeholders, acquire capabilities that will enable them to work skillfully, adjust to challenges with a fresh mindset, create structures and systems that will improve efficiency and integrity of business processes, and imbibe the values that will instill the perseverance, diligence, and the courage needed to rise from setbacks, or worse, from the ashes of failed projects to start again and fulfill their mission.
Capacity building imparts to the stakeholders the capabilities and values that will not be lost in instances of business reversals and crises. It becomes part of the human or institutional psyche that will always be there from which people and institutions can draw their strength and inspiration to continue on, despite all the difficulties and hardships, and see success on the horizon.
It is somewhat sentimental, or worse, mushy, writing about capacity building in this way. But come to think of it, when all is lost; the money and the material resources gone ---- what’s left is what’s inside the person’s being, or for that matter, the institution’s consciousness.
Capacity building provides something that cannot be bought or taken away and serves as the key to making people and institutions sustainable.

Changing the Mindset towards Risk-Based SME Lending

This is the challenge of providing SMEs greater access to financing --- we have to change the way people think.

In this particular instance, the mindsets of both the borrower and the lender must be changed. Without the change in mindset, SME lending will remain to be collateral oriented and will be biased towards those who have collateral to the detriment of profitable and promising enterprises.

We say this because we ourselves have come to a change in mindset since we started using risk-based lending technology in extending credit to SMEs.

First, let us discuss what risk- based lending is all about.

Risk-based lending is a system of lending to SMEs that is based on an accurate assessment of credit risk in which the loan package i.e. loan amount, interest, and term, is determined and influenced by the credit risk level of the enterprise, specifically the quality of the borrower and the debt repayment capacity of the enterprise. In this type of lending, collateral is not a determinant of loan approval, but impacts on the pricing of the loan. More importantly is the quality of the borrower and his capacity to repay the loan. Under this system of lending, the lender is able to assess, price, and manage the credit risks to ensure repayment.

Risk-based lending requires the use of a credit risk rating tool. In SBC, we have a Borrower Risk rating tool which we call CAMP analysis because in it we examine the Cash, referring to the financials of the enterprise, the Administration, referring to the quality of management, Market, referring to the buyers of the products, and Production, referring to the capacity and efficiency by which the enterprise produces and delivers its products and services.

Using the BRR helps the lender come up with a risk rating of the borrower and with this rating identify its competitive advantages and its weaknesses or areas of risk. Our BRR is a 10 grade rating system with 1 as the least risky and 10 is the most risky. On this basis, the lender knows beforehand the quality of the borrower and decides to lend or not on this assessment of credit risk.

With the use of the BRR, the lender will know how “real” the business is, or how honest the borrower is in his declarations about the enterprise. So borrowers beware about the truthfulness of your declarations and disclosures. Using the CAMP analysis, the AO will surely uncover irregularities including fraud if not fully disclosed by the borrower.

In addition, the lender has identified the sources of loan repayment, and knows whether or not the borrower can repay the loan.

In this system, no amount of collateral can influence the lender to lend to a bad borrower unless, the lender has decided to accept the risk of non-repayment and has provisioned the account for eventual losses. Or he has priced the risk of lending to a bad borrower. In this system, the higher the credit risk, the higher the interest rate (pricing it right) and the stricter the loan covenants (monitoring the business and mitigating the risk).

While in risk-based SME lending lenders are able to manage credit risks well and may lend to all types of borrowers, there are certain non-negotiables such as: 1.) if the risk is so high for both BRR and FRR that it cannot be priced, then the Bank should not grant the loan at all; 2.) If the credit risk cannot be mitigated, don’t finance; and 3.) Do not lend if borrower does not have debt servicing capacity.

The last condition is the most important of all because debt servicing capacity will decide whether the enterprise will be lent how much and for what purpose. The DSC is not based on forecast and projections but on the current state and historical performance of the enterprise. The lender will know whether the borrower, as it operates now, will be able to repay the loan given its present income.

It is a change in mindset because using the technology will destroy all our traditional thinking and practice in lending to SMEs. While many of us will think this is revolutionary--- it is not. Many of these changes are actually reflection of good banking practices on the part of the lender.

Here are some examples of this new mindset:

• Collateral should be from the assets that were the object of financing

It is not bad to require collateral or security for the loan, but it should not be beyond what the loan is financing. Requiring REM or hard collaterals has no direct relationship with low probability of default. Whatever it is that is the object of financing is good enough to secure the loan. If the loan is for working capital, then ARs or inventories would suffice to secure the loan. These assets should then be closely monitored to forewarn the Bank of any problems which may be encountered by the SME and which may hamper loan repayment.

• Equity, not loan, should finance expansion

In general, this principle means that if the SME does not have enough capital, then it cannot support an expansion program. Expanding the business may be ill-timed if it cannot support the expansion from its net income and from equity. Banks are ill-advised if they grant a loan for project financing without looking at how the SME will be able to repay the loan from its existing level of operations. In these instances, the Bank should evaluate the SME’s present equity and DSC levels and their projections and make sure that the repayment for the loan can be financed from its equity and DSC. Ideally, according to this principle, project expansion should not be financed by a loan, but rather by equity.
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• REM as collateral does not necessarily prevent the occurrence of default

Unknown to many of us, but shown by studies on Banks and their loan portfolio in developed countries, it is a fact that REM as collateral does not mitigate the occurrence of default, nor does collateral have any correlation to default. Default is a function of debt servicing capacity of the borrower not the loan value or quality of the collateral. It is by this fact alone that the absence or lack of collateral should not hinder the SME from accessing credit for its growth. In fact a culture of collateral oriented lending contributes to the failure of most SMEs.

• SMEs should not be overtrading

Always look at the sales trend or its movement over a series of time periods. Normally, sales should only increase at a rate of about 10 percent. A steep climb (if increase is more than 50%) will always mean possible overtrading on the part of the SME.


Overtrading means a situation in which a SME is growing its sales faster than it can finance them. This usually leads to enormous accounts payable or accounts receivable and a lack of working capital to finance operations. SMEs may service larger orders only if it has the equity to support these orders.

A common scenario is for the SME to take the orders and try to squeeze its suppliers because it does not have the financing or the equity to support sales expansion. When this happens, the suppliers may stop supplying the SME.

And the SME is in trouble because it not only cannot meet its orders, but could not pay its creditors as well.

It is an established fact that 60 percent of all bankruptcies in U.S. and Canada are due to overtrading.


• Don’t finance expenses; only assets

This principle simply means that before we finance an SME’s needs, be it working capital or fixed asset, we must first look at the whole enterprise and see if it has enough assets to generate the net income that would serve as source of repayment. Does it have enough inventories? Recievables? Is it an operating concern? These questions when answered in the affirmative assures the lender that it is financing a business and not just any want the borrower needs to satisfy. It is also important that the Bank will not finance on the basis of expenses because these are supposed to be paid from the revenues of the business, not from a loan. The Bank should only lend on the basis of assets used to generate income for the SME; never expenses.


• Finance the business, not the transactions; Restructure the business, not the loan

This principle is really about looking at the big picture of the business, or getting the “global” view of the SME when financing, restructuring, or rating the SME. When financing, do not focus on the transaction alone. We need to look at the other aspects of the business most especially, its assets whether they are the kind that can generate the net income needed to repay the loan. Or in restructuring, see if the business can still generate enough business to meet the restructuring requirements. Don’t just focus on the loan amount and how this can be restructured to the benefit of the borrower. The most important point is whether the business as a whole can continue to exist and see the restructuring to the end. If in both instances, when the answer is in the negative, then easily, we should decide against extending or working out the loan. The situation in this case should be to focus on recovery and collection.



While risk-based lending technology is new to SBC and has been used for about three years, we can say that it has a positive impact on our past due ratio. In short, using risk-based lending has significantly reduced our past due ratio. It has also enabled us to make our pricing and our product features more responsive to risks. This has made financing more accessible to SMEs because collateral is no longer a determinant of whether to approve a loan or not.

While lenders must have a change in mindset, borrowers will have to make the same adjustments in the way they think. They must understand that this technology will weed out the fraudulent borrowers from the true entrepreneurs. And this will require their utmost cooperation when the AO will insists on the submission of records and documents pertaining to their operations. Or when the AO will have to ask a lot of questions about the business and do frequent project visits. The borrower must realize that these things are part of the evaluation and risk rating and management process, and it is only this way that more of them (SMEs) will be able to gain access to credit.

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.