Given the nature of the financial market, which is underdeveloped and dominated by the commercial banks, commercial banks are naturally risk-averse, because they are deposit-taking institutions and hence they have a responsibility to protect depositors’ funds; which means they have to engage in prudent lending. Compounding the situation in which access to financing is apparently difficult for small and medium-sized enterprises especially is not necessarily the inherent nature of the commercial banks per se, but, rather, a series of limitations with respect to the businesses themselves, and by extension the management and owners of the said enterprises; hence it is twofold.
In the conduct of credit assessment, a borrower needs to fulfill certain qualifying criteria before the decision to approve a loan is made. One primary requirement in this process is collateral, and, in many instances, this is one of the main limitations – lack of adequate and tangible collateral. Instantly this may be a deterrent, much to the disadvantage of the prospective borrower.
It must be noted also that having healthy collateral is not always a decisive factor in the loan approval process. The more important decisive factors in this regard are premised upon the borrower’s ability to repay – debt servicing ability – and this other element, which might sound surprising, but in reality is the most crucial of them all: the borrower’s willingness to repay.
In respect to the technical limitations of businesses, most small and medium-sized firms lack crucial expertise in the industry within which they operate, sound financial management practices, and particularly cash flow management. These, therefore, inevitably disqualify such entities from accessing financing through the commercial banks.
The problem of access to financing is not so much an interest-rate problem or cost of capital. The broader problem about access to capital is not because of commercial banks; it is because of Guyana’s underdeveloped financial system. It is important to understand and acknowledge that commercial banks are inherently different structurally, and they are not designed for microfinancing. Commercial banks do, in fact, help and contribute to some extent, but microfinancing is usually risky for the banks.
With regard to microfinancing, the Institute of Private Enterprise Development (IPED), for example, was founded specifically for the purpose of microfinancing, and it is doing extremely well today. In this regard, it is worthwhile to examine the structure of IPED. Ironically, a few proponents are of the view that the commercial banks’ interest rates are “notoriously” high. However, IPED’s interest rates on microfinancing range from 20% to 30% in some cases. Of course, IPED’s interest rates are reflective of the high-risk nature of such businesses, and poor collateral.
Commercial banks’ interest rates are way below that, ranging from 10% to 18%. Now, in terms of IPED’s structure, the way this institution operates is to take a hands-on approach to help clients manage their businesses prudently in order to succeed, by doing extensive field work, and they even have training programmes for clients (small businesses). Commercial banks don’t do this, neither do they have the incentive to so do.
Another important factor with IPED’s structure is that they hold anything, from household effects to cars, or any asset as security, which the banks cannot do because of the regulations stipulated within the Financial Institutions Act. Therefore, in order to deal with the issue of microfinancing, that’s not for the commercial banks; what is needed is more microfinancing institutions like IPED, and this in effect speaks to capital market development. Moreover, IPED’s financing structure – that is, the source of its financing – is different from the commercial banks’. It is not a deposit-taking institution, its capital is actually shareholders’ funds, donor funds, and it reinvests its profits. This is unlike the commercial banks, which take savings from householders and lend to firms. So, the source of financing and the way microfinancing institutions versus commercial banks are designed are fundamentally different.
Within these pragmatic circumstances, how would the establishment of a Development Fund solve these problems? Development financing institutions are typically Government-sponsored financial institutions with the primary mandate to provide long-term capital to industry.
Given the inherent nature of development funds, they are largely not profit-driven, unlike the commercial banks. As such, the success of a development bank is not measured against the traditional set of performance indicators, but, instead, their contribution to economy-wide growth through the acquisition and dissemination of financial expertise in new industrial sectors.
In addition, the structure and manner in which development funds are designed to operate are different from those of the commercial banks, to the extent that they are required to have highly skilled and well qualified experts in various appropriate fields. The reason for this is because development funds or development banks provide long-term capital for repayment over longer periods, as long as 20 years, for example, while commercial banks generally could extend long term capital only for up to five years at maximum. Thus it is this distinguishing factor that sets them apart. However, development funds are not to be viewed as institutions competing with commercial banks; they are more complementary financial institutions wherein – one extends long-term capital in the creation of new industries, and the other sustains old or established industries.
The Fund can be institutionalised by way of legislation, and must be composed of a technically competent Board and a variety of professional expertise to manage and administer the Fund to execute its mandate.
With respect to the financing structure, this can come from a combination of sources, such as international financial institutions like the World Bank, Inter-American Development Bank, Caribbean Development Bank, and the Islamic Development Bank. These institutions can also serve on a technical committee to support the management of the Fund, to identify relevant development projects, and to assist in the conduct of feasibility studies as well for these projects.
Financing can also come from the Sovereign Wealth Fund. A percentage of that fund can go towards the development fund, as well as the local banking sector can invest into the fund. This, I am anticipating, would be helpful to provide project financing to the Private Sector as well for large investment projects at concessionary interest rates, and to support the development of small and medium-sized enterprises, in addition to large scale development projects.
About the Author: JC. Bhagwandin is a financial and economic analyst; and an Adjunct Professor at Texila American University, Business College. The views expressed are exclusively his own and do not necessarily represent those of this newspaper and the institutions he represents. For comments, send to [email protected]