Benel D. Lagua l February 8, 2024 l Manila Bulletin
Small and medium enterprises (SMEs) represent an important part of the Philippine economy. However, official records lump SMEs and bundle it with micro enterprises. The Philippine SME law is known as the Magna Carta for Micro, Small and Medium Enterprises. While this considers the numbers in the micro sector, there must be policy recognition of the significant difference between the micros and the mainstream SMEs. Some of the positive practices in micro enterprise support do not necessarily apply to the SMEs.
The true size of the micro and SME market is understated due to informality. The most recent National Statistics Office data reveals the following. There are 1,076,122 MSMEs, which constitute 99.6% of all establishments in the Philippines broken down as follows – 977,670 micros, 94,008 small, and 4,444 medium enterprises. However, the microfinance industry estimates it has 6 to 9 million beneficiary clients, way above the NSO count. Even after accounting for some double counting, clearly there is a market out there not captured in official statistics.
Lack of access to finance continues to be a concern. There are significant differences in perception as to the size of the finance gap. The banking sector has been under compliant in the law mandating that loans for micro and small enterprises must be at least eight percent of the total portfolio. The law has lapsed, but the number is still being tracked. Allocation to micro and small is down to a measly 1.80 percent as of September 2023. Most big banks have opted to simply pay the penalty provision of the law, clearly ineffective as a disincentive.
The obstacles in lending to SMEs are varied. Informality, non-available or hardly reliable financial statements, limited management skills, no collateral and family ownership structure characterize SMEs. Burdensome regulations have been cited as unfriendly especially in terms of costs of reserves, harsh provisioning, transaction costs and the previous regulatory requirements for audited statements. Inadequate legal protection for creditors increases the time and cost associated with obtaining loans.
Despite this, many lenders know that they must support this market. Strategic statements coming out of the major players in the banking industry have been encouraging. Given the intense competition in the upper medium and large enterprise category, SMEs are now seen as the new frontier in terms of growth, perceived profitability from high loan spreads, cross selling opportunities, and diversification benefits. While the sector is perceived as risky, the prospects are improving.
A well-developed business and risk management model for SME lending is key. Banks will need to adapt their practices, create dedicated and specialized SME relationship managers, and review their distribution channels. Banks that appreciate the attractiveness of this market may need to set up dedicated SME units. Many will attempt to develop standardized and mostly short-term loan products, just like those offered in consumer loan products. Credit institutions should, however, realize that on-site visits and interactions with SME owners are imperative. Small business lending cannot be a cookie cutter affair.
White credit scoring models will help, SME borrowers by their nature must be appreciated on a case-to case basis based on both quantitative and qualitative factors. Progressive institutions can use risk-based and cash flow lending techniques, to skirt around the typical unavailability of collateral by small businesses. With an increasing database, more sophisticated business models, scoring systems, processes and practices can be introduced, including measurement of loss-given-default parameters for SME loans.
Unlike big loans which produce instant portfolio build-up, growing the SME credit book will take time and patience. But once the business picks up and as the processes are fine-tuned, the portfolio can grow exponentially, with all the benefits of a bigger margin and a well-diversified exposure. The banks that start early in this game will enjoy a competitive advantage.
The policy environment must be made friendly, and it all begins with a positive macroeconomic environment. The financial infrastructure must foster innovative financial technologies.
The legal framework for secured lending must enhance the ability of SMEs to pledge both real estate as well as moveable property as collateral. The country needs credible registry systems. The framework for creditor rights and insolvency proceedings must strengthen enforcement procedures.
Government support programs must be responsive, and this includes a strengthened credit guarantee system, support for capacity building for SMEs and development of new SME financing instruments. Proportionality in banking regulation must consider the peculiarities of SME support. The credit information system must be truly functional. Data collection on SMEs must be improved to clearly understand their characteristics in terms of size, economic sector, countrywide distribution, employment contribution and value addition. Information asymmetry must be addressed.
*** Benel Dela Paz Lagua was previously EVP and Chief Development Officer at the Development Bank of the Philippines. He is an active FINEX member and an advocate of risk-based lending for SMEs. Today, he is independent director in progressive banks and in some NGOs. The views expressed herein are his own and does not necessarily reflect the opinion of his office as well as FINEX.