For banks, lending to small businesses is a tricky thing. They are not going to make a lot of money and there is a chance that the business could go under, leaving the bank on the hook for the loan amount.
To them, it is largely a formula of low reward and high risk.
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 (CGS) as it reduces the risk to the bank even further.
It has been done before. India’s Credit Guarantee Fund Scheme for small and medium-sized enterprises (SMEs) issued on average 2 000 guarantees a day in 2016 to 2017, for a total amount of Rs199.49 billion (valued at R42 billion in August 2017).
Another country that has done well at capitalising on CGSs is Chile. Its loan guarantee fund Fogape issued 48 772 guarantees to a value of $876 million (R12 billion) in 2014. A similar scheme in Malaysia backed RM10 billion (R26 billion) in loans between 2000 and 2010.
South Africa’s state-backed scheme only supported 163 SMEs in the year to end-March 2019.
Saul Levin, executive director of Trade and Industrial Policy Strategies (Tips), an independent, non-profit, economic research institution, says although the prevalence of CGSs in South Africa is among the lowest in comparison to other developing countries, there is a way to make them achieve a higher level of impact.
Levin suggests that if government and the private sector were to work together in increasing access to these schemes, there would be an increase in job creation and a thriving manufacturing sector.
The purpose of these schemes is to share risk with commercial lending institutions that provide funding to SMEs, especially those with limited or no collateral.
South Africa’s Small Enterprise Finance Agency (Sefa) currently provides credit guarantees through its subsidiary, Khula Credit Guarantee (KCG), which acts as a short-term insurer to help address the financing gap faced by SMEs.
It was one of the several initiatives driven by government after it determined the impact that a well-designed partial credit guarantee (PCG) scheme could have in reducing risks for lenders, thus encouraging them to serve the SME segment.
The objective is to issue partial credit guarantees to lenders in cases where SME borrowers have difficulty accessing finance because they have no (or insufficient or unacceptable) collateral, as usually required by lenders.
It has been set up as a risk-sharing facility with partner financial institutions to facilitate access to finance by SMEs for the acquisition, establishment or expansion of a business.
Khula Credit Guarantee offers its partner financial institutions:
- Supplier credit guarantees,
- Individual bank guarantees, and
- Portfolio guarantees.
Khula Credit Guarantee has, for example, granted guarantee facilities to Absa to the tune of R60 million for its agribusiness arm and R150 million for funding through its Mercantile Bank.
So why is it important?
Between 2016 and 2017 the fund issued R120 million in guarantees. In contrast, other countries’ credit guarantees are in the billions of rands and more of their SMEs are covered.
“We are not quite scratching the surface,” says Levin. “We need to look at strengthening what we have in South Africa in order to support the growth of small businesses.”
Levin says an increase in CGS support is important for a developing economy such as South Africa’s in order to support and strengthen SMEs and the manufacturing industry, which is one of the largest employing sectors.
Levin proposes that banks issue a loan to the specific SME and that the government entity or private reinsurer be liable for the loan if there is a default in payment.
He adds: “This does not have to be a government reinsurer. It could be a private entity as well that provides the credit guarantee.”
In South Africa, many SMEs are unaware of the concept of a credit guarantee.
“We do not have a huge CGS in South Africa so businesses wouldn’t generally be aware of it, but in other countries depending on what the operations are, the businesses may or not be aware that their loan portfolio is guaranteed,” Levin says.
Target areas for support
He says a bank might come in and say to a credit guarantee institution: ‘Would you guarantee our portfolio of small businesses as it is a target area for support?’ – then, if it agrees, the credit guarantee entity would act as an insurer.
“It could be done in partnership between private banks and public institutions, or between any public or private institutions,” Levin says.
Banks would also need to undertake internal marketing of the product to build familiarity and promote usage. Lessons from other countries can be used effectively in terms of the technology they use to improve information flow, turnaround times and simple application and payment processes.
A government-funded credit guarantee scheme that operates at enough scale would support growth in manufacturing and job creation and should form part of a package of support to stimulate the manufacturing sector.
What of the risk to lenders?
Levin says the GCS would step in and protect the assets of the SME should they default on the loan instead of it forfeiting its assets.
“But the CGS would at least try to chase the companies that have defaulted for some of the money outstanding otherwise we would have a situation where every small business would just default on their payments because they are guaranteed,” he adds.
Banking Association SA’s Soneni Bhango (administration support: strategy and communication) agrees that the current CGS is not achieving the desired level of impact or performance. She says this is due to some administrative as well as technical problems.
“The industry and government have worked on a review of the scheme and developed a business plan for a reimagined scheme that would be more effective and address the challenges of the old scheme but that is yet to be implemented by Sefa.”
Bhango says funding is not the issue.
“In our view, there is enough funding in the system to support SMEs. The issue is improving access and increasing the variety of available instruments, not setting up more funds and this requires improvements both from the funders and the SME themselves.”