FEATURE STORY September 20, 2018

Unlocking the Potential of SMEs with an Innovative, Risk-Sharing Financing Solution

Image

Sonia Arias opened a small clothing business in Medellín, Colombia. To get started, she had to take out an informal loan at very high rates since she lacked real property to use as collateral for a bank loan. 

“When I was paying off the loan,” she said, “it was as if I was being strangled to death.” 

Small and medium enterprises (SMEs) promote economic and social development, especially in developing countries—they boost GDP, exports, and job creation. 

But in many countries, SMEs – like Sonia’s clothing business -- don’t have sufficient access to credit because they lack land or buildings that could serve as collateral for a loan. Women are particularly disadvantaged because they own less property than men.

Several countries have tried to address this problem by modernizing their secured transactions and collateral registries framework, and by creating a legal and institutional environment to incentivize the use of movable assets as collateral. 

Sonia benefited from Colombia’s recent reforms in the secured transactions framework, which allowed small business owners, like herself, to leverage movable assets – like sewing machines –  as  collateral for a loan.


"When I was paying off the loan, it was as if I was being strangled to death."
Sonia Arias
Small clothing business owner

Under the new system, Sonia obtained a loan of US$15,000 and grew her company from three to eight employees. 

Yet, few banks in emerging markets accept movable assets as collateral, impeding entrepreneurs to prosper and expand their business. Without proper reforms, they are understandably concerned that it wouldn’t be possible to repossess the collateral after default, or that its liquidation value after repossession would be lower than the liquidation value estimated at the time of loan origination. 

At the same time, many countries offer public partial credit guarantees to encourage banks to lend to SMEs.  These guarantees give banks a greater incentive to lend to SMEs with these schemes rather than to rely on movable collateral, which requires evaluating, monitoring and assessing the value of the collateral, without a proven track record on the risk for doing so.  

Also, prudential regulation often doesn’t recognize movable assets as mitigating risk since banks’ supervisors are unsure about recovery values.  

The result is that banks are penalized to use movable collateral, as compared with real estate or public-sector guarantees, which offer more favorable regulatory treatment.  

Is there a solution to this problem?  

The solution is to continue moving forward with secured transactions reforms and provide banks with a standby guarantee that will allow them to test, in order to determine the effectiveness of enforcement remedies and values of movable assets.

This additional guarantee would protect banks in case of default, paying any difference between the assessment and liquidation value of collateral (or fraction thereof), up to the outstanding loan amount.

The Second Loss Partial Credit Guarantee (SLPCG), a new financial product designed by the World Bank Group to work alongside secured transactions reforms would cover the risk that movable collateral cannot be repossessed and liquidated by the bank, or that the liquidation value falls below assessment value. 

Operationally, the SLPCG kicks in only after the lender has exhausted all enforcement remedies under the secured transactions system, hence its “second loss” or “standby” nature. 

The “first loss” is covered by enforcing the security interest and liquidating the movable collateral in question—a quick and efficient process in countries with adequate STCR frameworks.  Benefits of the SLPCG include:

• Provides a way for banks to test loans secured with movable assets.

• Reduces the financial sector’s over-reliance on public sector guarantees by creating a viable private sector product. 

• Provides a regulatory structure using the same prudential treatment as a standard public-sector guarantee, with the added advantage of assets to cover a potential loss.

• Increases the reach of publicly funded guarantee system to greater numbers of SMEs.

• Frees up public sector guarantees to use with start-up SMEs that have limited credit history.

The World Bank Group is looking to partner with credit guarantee institutions to pilot the SLPCG in countries where the secured transaction system has been reformed. World Bank support can potentially include:

• Advisory Services provided to partial credit guarantee institutions to develop, tailor and fund the SLPCG within the country’s specific context.

• Economic support under the context of ongoing or new World Bank Group projects.



Api
Api