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Financing of SMEs in South Africa Results of a Survey of SMEs and Financial Institutions World Bank, Africa Region, October 2011 2 Contents • Introduction • Insights from existing studies and data sources • Survey results • Policy considerations • Discussion points 3 4 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 5 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 6 7 What does existing data say about banks’ lending to SMEs? Exposure to SMEs Credit impairments (all) Source: SARB returns (BA120, DI200, BA200) 8 Demand-side Supply-side 9 Demand-side: firms’ perception of finance as obstacle for business Is finance an obstacle for business? SME Large Percentage 10 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 11 Supply-side: some quantitative insights • 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 SEs1 • 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% 1. For the Big 4 aggregated (all business areas) the ratio is 100% (source annual reports). 12 Supply-side: Drivers and Obstacles to Banks’ Engagement with SMEs Drivers Obstacles • A feeder for future business • Macroeconomic factors ▫ Important to develop healthy pipeline of ▫ Most significant constraint cited ▫ Reflective of character of boom & nature MEs of SME market ▫ Evidence of reorganisation to support this migration • Bank-specific factors ▫ Capacity to assess credit risk of SEs • A profitable and resilient business in its own right… • SME-specific factors ▫ Significant information gaps (e.g. financial statements) & lack of SME credit bureau • … but mostly transaction and deposit-led ▫ Lack of basic business and financial skills model, not credit • Regulatory & policy constraints • Public programmes matter only to a very ▫ Concern of judicial processes required to recover a debt & R7,000 limit on small limited degree claims court ▫ FSC: limited impact on lending volumes ▫ Companies Act: concern over ‘business ▫ Khula guarantee scheme: volumes low rescue provisions’ Credit represents a small proportion of total revenues Proportion of credit revenues, Big 4, 2009 Innovation in new credit technologies may increase share Source: Based on authors’ analysis of survey results 14 15 Impact of public policy Impact of Government programmes Could Government increase appeal on willingness to lend through the following? Percentage of commercial banks Percentage of institutions 16 Policy themes identified Issue Recommendation • Banks large in scale relative to DFIs but take • Improve effectiveness of partial credit cautious approach to SME lending guarantee scheme • Performance of direct public lending • Review cost effectiveness and objectives of schemes is mixed schemes • Entrepreneurs lack business and financial • Support development of BDS market skills but how to supply effective BDS? through public research • Lack of credit information on SMEs • Support development of market credit information for SMEs (e.g. sharing of information & support for credit bureaus) • Lending to SMEs is costly and risky, and • Subsidize R&D on lending technologies to information is lacking overcome information gap (e.g. challenge fund) • Some regulatory & judicial issues identified • Review impact of these issues (e.g. collateral enforcement & impact of business rescue in Companies Act) 17 Khula experienced declining volumes over downturn New credit indemnities (Khula) • Khula Credit Indemnity: volumes declining • Banks raised concerns ▫ Complicated to administer Value (Rm) Volume ▫ Dual credit assessment ▫ Long recovery times • Concerns being addressed by Khula & implementing portfolio indemnity scheme • Will new structure reverse the trend in volumes? 18 Appropriately designed PCGs can increase access to finance • 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 19 Some features of PCG scheme design Feature Considerations International comparison (Beck et al): 46 countries Loan-level versus portfolio • Staff of scheme any advantage in • 72% loan-level guarantee assessing risk? • 23% portfolio or combined (Typically loan-level involve • Administration costs • Government involvement in credit guarantor in reviewing eligibility decisions related to higher losses and risk profile) Coverage ratio • Incentives of institutions to • Many schemes offer 50% assess risk and recover • Median coverage ratio of 80% • Economic attraction of scheme Fees • Sustainability versus uptake • 63% per-loan fee vs 30% annual fee • Administration costs • 25% adopt fee based on risk of borrower Payout timelines • Incentive for intermediaries to • 34% after borrower defaults collect • 42% when bank initiates recovery • Economic attraction of scheme • 14% when bank writes off loan Targeting • Additionality • 95% have target restrictions • Verifications costs and limit • Specific sectors, new businesses, uptake geographic region, economic policies 20 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 21 Other potential areas for Government support (1/2) Policy area Comments Support development of BDS market through • BDS can help to address some of intrinsic public research 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 • Challenges for credit bureau to capture all information for SMEs 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 22 Other potential areas for Government support (2/2) Policy area Comments Subsidize R&D regarding lending technologies • Technologies have potential to reduce the to overcome the information gap (e.g. issues of high transaction costs and risk challenge fund) 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 • In general, not highlighted as significant obstacles 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 23 24 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) 25 Demand-side methodology • World Bank’s South Africa Enterprise Survey of 2008 complemented by Size distribution of second round in 2010 sampled firms • 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 26 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, Khula1, IDC and NEF • 9 institutions surveyed, representing 89% of banking sector assets • 72 questions focussed on: i. Extent of bank’s involvement with SMEs ii. Determinants of SME bank financing iii. Bank’s SME business model (including products and credit risk management) iv. Effect of the economic downturn and international financial crisis 1. Discussions were also held with Khula, although as a wholesale funder, this institution was not asked to complete the full written survey.
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