Introduction During 2010, the World Bank undertook a survey of the supply-side and demand-side of SME finance Important contribution of SMEs to employment, income and growth in SA Access to finance cited as a major constraint for small business development Challenging macroeconomic conditions of 2007-2009 Linking the demand- and supply-sides of the market Supply-side survey was conducted with 8 institutions including the Big 4, niche banks, non-bank FIs and DFIs Demand-side survey of 234 SMEs originally interviewed as part of the 2008 Enterprise Survey 4
Key messages of study Access to finance for SMEs worsened as a result of the economic downturn Sharp worsening of perception of access to finance as obstacle for SMEs Tightening of credit standards and decrease in successful loan applications Private sector is committed to this space and large in scale relative to the public sector Engine for future growth and profitable business in own right Some innovations (e.g. around credit scoring and provision of BDS) BUT banks remain cautious about lending to the sector Income driven by deposits and transactions, not credit Perception that SMEs higher risk and more costly to serve Lack of information about potential borrowers and concern about skills of potential entrepreneurs Therefore there is an important role for public policy Harness private sector expertise rather than competing directly with it Support the broader credit environment to overcome obstacles to lending 5
Demand-side: firms perception of finance as obstacle for business Is finance an obstacle for business? Percentage SME Large 9
Demand-side: worsening perception is supported by quantitative data Decrease in proportion of investment projects financed through commercial banks Decrease from 27% to 21% for small firms Decline in proportion of working capital financed through customers / suppliers (halved)... at same time, increase in share of working capital financed through commercial banks (doubled) Percentage of applications rejected in 2010 increased slightly from 18 percent to 22 percent Main reason: lack of appropriate collateral However decrease in percentage of loans requiring collateral from 68% to 45%, and lower average collateral requirement 10
Large banks constitute significant players in the market for SME lending Large banks: ~95% of all exposures to SMEs in 2009 Institutions with development mandate: ~2.5% Niche banks, non-bank FIs and public FIs also named as important participants Average ratio of loans to deposits of 58% for SMEs and 49% for SEs 1 Contribution to profits of SEs large (5.7%) compared to size as measured by loans ( 1.7 %) Over the economic downturn Decline in loan applications (by 23%) and loan approval rates (from 61% to 45%) Pricing for risk: difference between best interest rate for large and small enterprises increased from 2.5% to 3.8% Credit quality: NPLs for SEs remained flat at 4%, while NPLs for MEs tripled to 5% 11 Supply-side: some quantitative insights 1. For the Big 4 aggregated (all business areas) the ratio is 100% (source annual reports).
Supply-side: Drivers and Obstacles to Banks Engagement with SMEs DriversObstacles A feeder for future business Important to develop healthy pipeline of MEs Evidence of reorganisation to support this migration A profitable and resilient business in its own right… … but mostly transaction and deposit-led model, not credit Public programmes matter only to a very limited degree FSC: limited impact on lending volumes Khula guarantee scheme: volumes low Macroeconomic factors Most significant constraint cited Reflective of character of boom & nature of SME market Bank-specific factors Capacity to assess credit risk of SEs SME-specific factors Significant information gaps (e.g. financial statements) & lack of SME credit bureau Lack of basic business and financial skills Regulatory & policy constraints Concern of judicial processes required to recover a debt & R7,000 limit on small claims court Companies Act: concern over business rescue provisions 12
Credit represents a small proportion of total revenues Proportion of credit revenues, Big 4, 2009 Source: Based on authors analysis of survey results Innovation in new credit technologies may increase share
Impact of public policy 15 Percentage of institutions Impact of Government programmes on willingness to lend Percentage of commercial banks Could Government increase appeal through the following?
Policy themes identified IssueRecommendation Banks large in scale relative to DFIs but take cautious approach to SME lending Improve effectiveness of partial credit guarantee scheme 16 Performance of direct public lending schemes is mixed Review cost effectiveness and objectives of schemes Entrepreneurs lack business and financial skills but how to supply effective BDS? Support development of BDS market through public research Lack of credit information on SMEsSupport development of market credit information for SMEs (e.g. sharing of information & support for credit bureaus) Lending to SMEs is costly and risky, and information is lacking Subsidize R&D on lending technologies to overcome information gap (e.g. challenge fund) Some regulatory & judicial issues identified (e.g. collateral enforcement & impact of business rescue in Companies Act) Review impact of these issues
Khula experienced declining volumes over downturn Khula Credit Indemnity: volumes declining Banks raised concerns Complicated to administer Dual credit assessment Long recovery times Concerns being addressed by Khula & implementing portfolio indemnity scheme Will new structure reverse the trend in volumes? 17 Value (Rm)Volume New credit indemnities (Khula)
Appropriately designed PCGs can increase access to finance All SMEs All credit- worthy SMEs SMEs with access to credit Banks do engage with SMEs but mostly for transactional revenues and deposits They take a more risk averse approach to credit where risk parameters unknown Get to know you periods 80% perceive SMEs to be more risky and less profitable SME information gaps cited as major constraint Credit guarantees can be used to expand set of SMEs with access, but Be prepared for some loss Allow banks to asses the risk Ensure banks face sufficient risk Streamline administrative processes Payout quickly 18
Some features of PCG scheme design FeatureConsiderationsInternational comparison (Beck et al): 46 countries Loan-level versus portfolio guarantee (Typically loan-level involve guarantor in reviewing eligibility and risk profile) Staff of scheme any advantage in assessing risk? Administration costs 72% loan-level 23% portfolio or combined Government involvement in credit decisions related to higher losses Coverage ratio Incentives of institutions to assess risk and recover Economic attraction of scheme Many schemes offer 50% Median coverage ratio of 80% Fees Sustainability versus uptake Administration costs 63% per-loan fee vs 30% annual fee 25% adopt fee based on risk of borrower Payout timelines Incentive for intermediaries to collect Economic attraction of scheme 34% after borrower defaults 42% when bank initiates recovery 14% when bank writes off loan Targeting Additionality Verifications costs and limit uptake 95% have target restrictions Specific sectors, new businesses, geographic region, economic policies 19
It is also important to review the performance of direct credit schemes Performance of DFIs involved in direct credit provision varies greatly but all face challenges Unclear mandates Not pushing the risk envelope (e.g. holding large deposits) Profits derived from non-core activities (e.g. money market investments) Poor portfolio quality Achieving well performing and sustainable direct credit schemes is not straightforward and it dependent on: Capacity to assess credit Operational efficiency Scale of private sector involvement (>95% of SME lending) suggests that best option for government would be to harness private sector expertise, not compete with it 20
Other potential areas for Government support (1/2) 21 Policy areaComments Support development of BDS market through public research BDS can help to address some of intrinsic weaknesses in SMEs Banks remain vexed how to provide BDS efficiently and how to ensure it is appropriate and of a high enough standard Government may have a role both as a provider of BDS and in promoting good practice and standards across the sector Support development of market credit information for SMEs Challenges for credit bureau to capture all credit information relating to SMEs (e.g. from trade suppliers) Two potential areas for government support: 1) refinements to legal & regulatory framework to improve incentives to share information among lenders, and 2) education campaign promoting value of credit bureaus to SMEs and vice versa
Other potential areas for Government support (2/2) 22 Policy areaComments Subsidize R&D regarding lending technologies to overcome the information gap (e.g. challenge fund) Technologies have potential to reduce the issues of high transaction costs and risk profiles of potential borrowers (e.g. from microfinance sector) Evidence of innovations occurring in SA (e.g. relating to credit risk assessment) However the sector is still experimenting and room for innovation Establishment of new window of credit guarantees specifically to stimulate the use of automated scoring techniques? Address any regulatory, judicial and legal obstacles In general, not highlighted as significant constraints in SA However, still areas identified: e.g. issues registering and enforcing collateral, and concerns over the business recovery provisions in the new Companies Act
Definitions In principle, the term SME encompasses a very wide range of businesses: from a one-person business to firms with hundreds of employees No consistent national definition National Small Business Act: based on 3 measures of size (employees, turnover, asset value) but differs by sub-sector Financial Sector Charter: annual turnover range R500,000 to R20m Used in this study Demand-side: small (5-19 employees), medium (20-99), large (100+ employees) Supply-side: institution definitions of small and medium enterprises (typically based on turnover ranges R0.5 – 100 m) 24
Demand-side methodology Size distribution of sampled firms World Banks South Africa Enterprise Survey of 2008 complemented by second round in 2010 Written questionnaire conducted through face-to face interviews with firm managers Information on four broad areas: managers ratings of business environment; objective indicators of business environment; business information; business characteristics 2008: 1,057 establishments sampled from four locations: Johannesburg, Cape Town Port Elizabeth and Durban 2010: 234 of the original establishments resurveyed Sample compositions very similar 25
Supply-side methodology Specially designed questionnaire, administered to selected banks via on-site discussions Institutions chosen both to represent the major players actively involved in SME finance Institutions included both the Big 4 private-sector commercial banks, Sasfin, Business Partners, Khula 1, IDC and NEF 9 institutions surveyed, representing 89% of banking sector assets 72 questions focussed on: i.Extent of banks involvement with SMEs ii.Determinants of SME bank financing iii.Banks SME business model (including products and credit risk management) iv.Effect of the economic downturn and international financial crisis 26 1. Discussions were also held with Khula, although as a wholesale funder, this institution was not asked to complete the full written survey.