February 2020 Gabriel Davel
Employment & Wages SME plays critical role in economy, employment creation » Business growth » Innovation & incubator for new businesses GDP growth » economic growth, exports, tax Bank finance is a critical factor for SME Trade & Exports growth, both in terms of working capital finance TAX REVENUES and finance for expansion. AND: Credit contraction in adverse Access to finance economic conditions a major obstacles to for SMEs SME survival & growth 2
Challenges to finance Banks generally accept SMEs as SMEs important & profitable client base, with high potential for growth → collateral quantity & quality → financial statements → management changes However, significant challenges in → credit information financing the SME sector → swings in the business cycle → reg. capital and provisions (Basel II / III + IFRS 9) Internationally, guarantee funds a preferred policy instrument to support contract enforcement & SME finance collateral recovery 3
Thailand Partial Credit Guarantee Schemes: Portfolio $ 12 bn long history in OECD & developing countries # guarantees 330,617 Average $ 37,000 Japan (1937), USA (1953), Germany (1954), Taiwan Canada (1961), Italy (1960); France (1971) … Portfolio $ 24 bn Value : risk; collateral; contract enforcement; # guarantees 161,370 information exchange Average $152,651 Traditionally govt initiated , but increasing Malaysia commercial interest Portfolio $ 783 mil Guarantee size from US$10k to US$200k+ … some # guarantees 8,999 much larger Average $87,000 Different guarantee products, sector / Chile population targets, disaster relief, industrial development Portfolio $ 505 mil # guarantees 32,165 Average $15,700 4 Government Guarantee Funds : Austria, Belgium, Canada, Chile, Colombia, Czech Republic, Denmark, Estonia, Finland, France, Georgia, Greece, Hungary, Ireland, Israel, Italy, Japan, Korea, Malaysia, Mexico, the Netherlands, Norway, Portugal, Russian Federation, Serbia, Slovak Republic, Slovenia, Spain, Switzerland, Thailand, Turkey, United Kingdom, United States …
Government Loan Guarantees as % of GDP Share of SME loans requiring collateral SME NPL% OECD 2019 5 OECD 2019
6 WBG
Theory of Partial Credit Guarantees Pay-out @ agreed % of net loss, after (bank) enforcement When pay: end of legal process, or 90 day advance payment? INTENDED IMPACT: Bigger loan (on existing collateral) Higher SME approval rate 7
CHILE SMEs: Counter-cyclical impact, prevent credit crunch in economic Chile: Portfolio cover, risk based pricing, strong commercial foundation & risk management framework. downturn TAIWAN Plus: Reduce risk of bank failure & improve economic & financial sector stability Taiwan: Countercyclical effect after credit contraction, through improved 8 guarantee terms & qualifying criteria
More Credit Increased access Employment Economic impact (SME growth, profits, tax) “Social profitability” 9
Ownership, Control & Capitalisation Donor Funds Government, Banking Industry or Joint SME Associations Capital of 7% to 25%, mostly gov’t transfers (or bank Guarantee Banks contributions) Private Guarantee Companies Special law; Recognition for bank capital req’s ? Reinsurance Capital Target market & Approval Only new loans to excluded clients; or current clients? Sector targeting; gender targeting etc? Allocation by auction Portfolio or individual … & individual approval? Bank apply for guarantee? Borrower apply for guarantee? Coverage, premiums & claim payment 30% - 80% coverage … after recovery of collateral Standard or risk based pricing … advance payment or end payment Moral hazard & Adverse selection Independent (professional) management Reduced caution, increased risk Performance monitoring profile 10 Partly policy options … but huge impact on risk & viability
Capital: “Equity Multipliers” 4 to 15 (7% to 25% capital adequacy). Counter-guarantees, increased leverage. Sound rules and effective risk management net loss ratios below 3% - 4% Capitalisation o Canada and France = budget o Chile = government equity ($168 mil) Loss rates 0.1% to 5% (WBG, 2009) o Korea 0.3% tax on bank lending 11
PD x LGD = EL across business cycle Insurance “margin” f or required “combined ratio” Guarantee premium
Financial Impact Increase SME margin from 3% to +10%, after cost of credit insurance, Income Statement Credit losses Cost of capital Premium pass-through (partial) Margin on improved loan/collateral ratio Balance sheet Reduce capital requirements Reduce loan loss provisions & IFRS 9 impact Liquidity 13 Early & predictable payment
“Commercial approach” , with “The Future” independent entity functioning as implementation agency Risk Based Pricing , based historic loan portfolio performance (standard Basel assumptions ~ PD/LGD/EL, across cycle) … stakeholder participation & Risk transfer to international profit share … gov’t, banks, reinsurers , subject to regulatory insurers, others? requirements Gov’t control & gov’t Public & donor funding to capitalise prescription …. many risks! “risk mitigation fund”, facilitate commercial participation … catastrophe insurance Central Bank control / Interface with fintech … application, oversight : Internationally, info integration, risk assessment, merits, risks … c ompromise monitoring & administration
Insured Banks SME Retail Loan Portfolios Premium Claims “Fund Management” I m p l e m e n t a t i o n a g e n c y & r i s k m a n a g e r Primary international Insurer O r i g i n at i o n s u p p o r t C re d it p o l i c y & p o r t fo l i o r i s k a s s e s s m e n t Claims Premium C l a i m s m a n a ge m e nt R i s k m o n i t o ri n g & e a r l y wa r n i n g i n d i ca to rs International reinsurer(s) S p e c i a l i st s u p p o rt t o Traditional reinsurance role + product support a rating enhancement b a n ks & i n s u re rs Risk mitigation for reinsurers Extensive collaboration with insurance and SME risk experts, from SA, UK and Germany. Risk Mitigation Fund Commitment to collaborate in Development funding to mitigate insurance risk in implemenhtation phase implementation. 15
Detailed business plan & operational procedures already developed Institutional structure Different institutional options & Governance Complete, based on international best practice (particularly FOGAPE / Technical design & Chile). Tested against reinsurance requirements based on detailed operational procedures engagements. Critical, without reinsurance support the facility is not feasible . Preliminary Capital support confirmed, will be involved in final structuring after domestic (bank Reinsurance support / government) acceptance & based on hard stats. Requirements & approval process defined (legal advice & precedent). Legal & regulatory o Confirmation of capital relief (product design conform to international requirements requirements) o Approval for direct risk transfer to international reinsurers Donor funding available, if needed. Potentially applied for: Funding / donor (a) Risk Mitigation Fund; (b) Implementation cost; (c) Incentives for bank support participation (subsidies?). Response has been ambivalent. Somewhat more positive after political Support from banks changes. But SME clearly not a priority for any bank; and little competitive 16 pressure .
Gabriel Davel - gdavel@davelassociates.com Dr Anthony Valsamakis - valsamakisa@eikos.co.uk
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