How loan insurance can boost the economy

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.

In South Africa, however, while CGSs for small businesses exist, few in the financial sector know about them – and even fewer use them.

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.

According to Saul Levin, executive director of Trade and Industrial Policy Strategies (Tips), the prevalence of CGSs in South Africa is among the lowest in comparison to other developing countries.

Shared risk

The purpose of these schemes is to share risk with commercial lending institutions that provide funding to small and medium-sized enterprises (SMEs), especially those with limited or no collateral.

Levin says that based on research by Tips, guarantees ranged from R10 000 to R3 million in 1996, but this has since decreased. 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.

Levin says India’s Credit Guarantee Fund Scheme for 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). Chile’s Fogape issued 48 772 guarantees to a value of $876 million (R12 billion) in 2014. Malaysia’s scheme backed RM10 billion (R26 billion) in loans between 2000 and 2010 alone.

SA’s state-backed scheme only supported 163 SMEs in the year to end-March 2019.

“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.”

So why is it important?

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 explains that is why the bank might come in and say to a credit guarantee institution, ‘may you guarantee our portfolio of small businesses, that is a target area for support’ then they would act as an insurer.

“It could be done in partnership between private banks and public institutions that the government may have oversight, over or it could be done in partnership between the public and private institutes,” 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.

According to the Tips proposal: “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.”

Risk mitigation

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.

Current challenges

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 [the Small Enterprise Finance Agency].”

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,” Bhango says.

Sefa did not respond to questions sent by Moneyweb.