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The benefits of credit guarantee schemes

‘There are lots of innovative ways of ensuring that small businesses are supported through access to credit’ – Saul Levin of Trade and Industrial Policy Strategies.

MELITTA NGALONKULU: Many say that for banks, lending to small businesses is a tricky thing, they are not going to make a lot of money and there’s a chance that the business could go under, leaving the bank on the hook for the loan amount. It could also be easily said that for them it’s largely a formula of lower reward and high risk. But there is a way of getting around this, they can reduce their risk by having the business take out insurance in the form of a credit guarantee on the amount loaned. This way if the business goes under, the lender can get their money back. This formula works even better when a state institution backs a credit guarantee scheme, as it reduces the risk to the bank even further.

Joining us today to elaborate on the benefits of credit guarantee schemes in developing countries is Saul Levin, the executive director of Trade and Industrial Policy Strategies. TIPS is an independent non-profit economic research institution. Hello Saul, great to have you joining us today.

SAUL LEVIN: Good day.

MELITTA NGALONKULU: Saul, in 2018 you had written a proposal on how developing countries have benefitted from credit guarantee schemes but I am not sure that many of us are even aware of what they are, could you please explain what is the purpose of a credit guarantee scheme?

SAUL LEVIN: The aim is to try and direct finance better from other areas of lending to small business in particular or to, say, for example, to industrial lending. So what it means is that an institution would stand as the guarantor to a bank, to say that if the loan is defaulted or part of the loan is defaulted, then the guarantor would contribute back to the bank to cover their losses. So what [the] net impact is, is that you then see more lending taking place to the small business sector because it reduces the risk for the bank to lend into that space.

MELITTA NGALONKULU: Would you say that previous attempts by the government, as well as the banking sector, have been underutilised?

SAUL LEVIN: Yes, definitely. We have seen some attempts in the past at credit guarantees in South Africa, there’s the Khula Credit Guarantee, which is now being run by Sefa [Small Enterprise Finance Agency], which is a state small business lending institution. It’s doing good work but it’s only very small amounts of lending, so in the last few years they are over R100 million now. But even then, when we look at other developing countries, we are talking in the order of billions of dollars.

If we look at the total amount of lending going into the small business sector, that kind of level of lending activity would be significantly improved with the intervention of an at scale credit guarantee scheme.

Many developed countries running credit guarantee schemes

MELITTA NGALONKULU: What do you propose could be done better?

SAUL LEVIN: So what we suggest is we take an example out of other developing countries and also many developed countries, particularly in the EU, are running credit guarantee schemes. So an example might be what we could do is bring in an at scale resource or we could even draw on international financial markets. So we have looked at a project where one of the global reinsurance companies could provide a credit guarantee or the state could put in resources through various mechanisms that would see billions of rands going into a type of credit guarantee that would then partner with the banks and then allow more resources or lending to go into the small business sector. So if we look at the EU, for example, there are 42 countries that are members of the EU association, which includes Turkey, but they lend an amount of about €125 billion, they guarantee that amount of loans and it’s over three million businesses, and that’s in a developing country context. You can also look at developing countries that have got similar large-scale credit guarantee schemes.

MELITTA NGALONKULU: How are the economies performing and is there a significant growth in the small and medium businesses?

SAUL LEVIN: That is very much part of the challenge because if we want to strengthen the small business sector, we need to see how we can provide a whole range of support measures. So finance is only one part of that puzzle, there are a whole lot of other things that need to happen to strengthen the support framework and ecosystem to enable the growing small business sector. But what we see, for example, in the downturn in 2008 and the global recession was that many countries ramped up their credit guarantee schemes, so that they put more money back into the economy and allow small businesses to stay afloat or to even fly because they were able to keep going. In South Africa we saw a million jobs being lost and many of them were in small business and the informal sector. So the big challenge is how do we use these financial mechanisms for good, so that we enable the economy to be strengthened and to grow?

MELITTA NGALONKULU: I suppose that access could also be an issue, would you say that it’s easily accessible?

SAUL LEVIN: Depending on how it’s structured, there are many different ways of doing it. In India, for example, they have a scheme where each individual loan is approved but it only takes a day. So they’ve got the technology and they’ve got the systems that allow very rapid turnaround and they’ve also been able to get very large numbers of lending, more credit guarantees. In other countries they do a portfolio approach, where an entire portfolio of small business loans are then guaranteed. It is obviously for the insurance company or reinsurance company if they take a portfolio approach and Sefa has been trying some of those experiments, tests or pilots with their credit guarantee but, again, it’s very small numbers that we’re looking at there. So there are many different options, we would obviously see more benefits through a portfolio approach, where you take a basket of small business loans and do a guarantee of that.

Khula Credit Guarantee Scheme

MELITTA NGALONKULU: What about the risk that financial institutions, as well as the government will have to take on, how do you mitigate that risk?

SAUL LEVIN: The key part is that the financial institution still has an obligation to chase after the loan if the business defaults. So even though the loan is guaranteed, usually and globally we see this as a practice that they can’t just say, okay, the business didn’t pay, we must now claim back from the guarantor. So what would happen is an obligation on the financial institution to then try and recoup some of the money that should have been paid. When those options no longer work, then they go to the guarantee ATC to claim back the losses.

Read: How loan insurance can boost the economy

MELITTA NGALONKULU: Saul, you mentioned that Sefa does have a programme, which is called the Khula Credit Guarantee Scheme, so which banks are actually part of this programme?

SAUL LEVIN: Sefa has been working with the banking sector but in the past they used the major banks. I’m not sure that all of the banks are still part of it because there were a few issues a few years ago around utilisation of the scheme. But also what Sefa has been doing is working with some of the trade finance companies. So when businesses, for example, might need raw materials, they can then get some trade finance and that is guaranteed by Sefa. So there are lots of innovative ways of ensuring that small businesses are supported through access to credit.

MELITTA NGALONKULU: In which industries would you say that these credit guarantee schemes are needed the most, in order to boost the economy?

SAUL LEVIN: My argument is that we would really need to look at small businesses across the board. It’s difficult to say let’s target one specific industry for small businesses because you’ve got small businesses that are largely in construction or retail. There are lots of small businesses in manufacturing. But we could also look at other types of credit guarantees, just for the industrial sector because it is a priority sector for the government. So we could say there’s a small business credit guarantee, as well as slightly bigger firms, medium-size firms, could also then apply for a guarantee if they’re in the manufacturing sector.

MELITTA NGALONKULU: That was Saul Levin, the executive director of Trade and Industrial Policy Strategies.

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