Advocating more small business lending
When the Asian Banking and Finance editorial team invited this author to speak in its Retail Banking Forum early this month, it was an avenue to push a personal advocacy for banks to lend more to small businesses. Despite the growing awareness within the Philippine MSME community that there is no lack of supply of loanable funds, it seems not flowing towards the direction of the sector in need.
Based on the MSME law, banks need to allocates at least eight percent (8%) and two percent (2%) of their loan portfolio based on their balance sheet as of the end of the previous quarter for lending to micro and small entreprise (MSEs) and medium enterprise (MEs), respectively. Historical data reveals that the MSME loan portfolio of banks has been declining at an alarming trend. From a high of 29.2% in 2002, it consistently fell to 23.2% in 2005, 19.7% in 2007, 17.9% in 2009 and finally to the present compliance ratio of 9.8% in September, 2015. The total loan portfolio net of exclusion of the Philippine banking sector has reached 4.44 Trillion, while total funds set aside for MSME is only 435.5 Billion.
Many banks advertise their aim to grow the small business segment, but have not been honest nor bold enough to admit they are not really prepared to engage into this market. They have not walked the talk, as the cliché goes. While banks attempt to put the organization and structure to do small business lending, the strategy and practical tactics including the necessary manning, investment and process change have not been sufficient enough to make the desired impact. Also, servicing the small business segment needs to be viewed in the long-term as the effect of the conversion in accomplishments will not be immediate. Small business lending is not a stop-gap measure but must be backed up with firm commitment from all process participants.
SME lending represents a new frontier in terms of growth as estimates of the finance gap is huge, conservatively placed by the DTI at 180B. With intense competition in the banking sector as the BSP continues to encourage mergers and competition, and with the projected influx of foreign banks coming as a result of the ASEAN integra- tion, it will get crowded up there.
As the net lending margins narrow in a low interest rate regime, SMEs are still able to absorb a higher rate in consideration of the risk profile and size/scale constraints. Their own profit margins and basic earning power allow the same so it is still a win-win situation because the alternative is tapping into shadow banks which obviously charge unconscionable interest rates.
Finance has shown the immense benefits of diversification which means getting exposed to a wide variety of enterprises, industries and sectors, so that an unfortunate event that hits one will not induce collapse in the others. The technicians say diversification works well if the investments are not perfectly correlated, and this situation is precisely the case with a large number of small business clients. Lending to large firms can backfire when even a few of the large clients collapse.
The total business capture for financial institutions lending to small business must extend beyond loans provided. Building a profitable lending partnership is key and this means generating the appropriate deposits. Most small business lenders say they can generate more deposits than average consumer deposits from small businesses, and the nature of such deposits are stickier meaning they tend to stay in the bank last longer. Also, small business profitabilities means the bank should capture other services – deposits, credit cards, cash management, personal loans, investments, safety deposit box, remittances, trade finance, etc. The expanded target should be the business owners, their households as well as their employees.
Top management is key to building the small business segment as they have to allow the devotion of time and energy required for success. Unfortunately there are many cases of public relations talk about the segment, and not many in the top have complete buy-in. It is unquestionable that success in this space requires dedication and peristence, even some initial pain. But the bank that succeeds in the engagement will create revenue and income streams that pays off while keeping the bank relevant and appreciated by the stakeholders, especially in the communities they serve.
*** (Benel D. Lagua is Executive Vice President at the Development Bank of the Philippines. He is an active FINEX member and a long time advocate of risk-based lending for SMEs. The views expressed herein are his own and does not necessarily reflect the opinion of his office as well as FINEX.)