FOCUSED AND QUICK (FAQ) Issue 16
Financial access of SMEs:the road to inclusive growth
เทียนทิพ สุพานิช
Providing financial services to SMEs means a country can reap the benefit of diversifying into new areas of unrevealed comparative advantage. However, for a long time SMEs in Thailand have had limited financial access. To tackle this, SME financing should be designed to reduce asymmetric information and transaction cost problems. Given the nature of the Thai economy, greater financial access of SMEs will help the country overcome a major obstacle to achieving inclusive economic growth.
Access to finance is necessary not only to firms' growth but also to growth of the overall economy. Research indicates that access to credit may affect economic growth by facilitating the entry of new firms (Kunt and Maksimovic, 1998, and Figure 1). Start-ups or smaller firms are usually the most dynamic and innovative. Therefore, providing financial services to these firms means a country can reap the benefit of diversifying into new areas of unrevealed comparative advantage. The lack of access to finance for these firms should also be taken as a priority because it suggests that some parts of the economy are left to struggle for financing on their own. Inevitably, this reinforces the vicious circle of poverty and inequality.
However, so far attention in financial development has focused on expanding the depth and efficiency of the financial sector, instead of on building an inclusive financial system - an important ingredient for sustainable and more inclusive growth. In this FAQ issue, we ask how serious is the problem in Thailand and what needs to be done to overcome it.
The SME sector is an important driver of the Thai economy, both in terms of economic growth and employment. SMEs make up a large proportion of all business registrations in the country, accounting for 99.8% of all enterprises (OSMEP 2010). The sector also plays an important role in providing job opportunities, creating as many as 9.7 million jobs or about 78.2% of total employment in Thailand. This is significantly higher than in other countries, where SME contribution to employment is around 30-60% (Ayyagari, Beck and Kunt, 2003).
SME contribution to GDP is also significant at 37.8% of GDP in 2009. Since 2002, however, the share of SME contribution to the economy has been declining (Figure 2). This is associated with the decline in bank lending to small firms from the peak of 35% of total bank loans in 2006 to 25% in 2010 (Figure 3). This may be an issue of concern as it may reflect the fact that SMEs are gradually losing their edge in the economy and access to finance.
Using database of all entrepreneurs registered with the Ministry of Commerce,it is found that SMEs in Thailand, particularly small and start-up firms, still face constraints with regard to external financing and, as a result, rely mainly on their own or their family funds to start and operate the businesses (Figure 4).
Surveys also indicate that there are still considerable gaps between funds provided by financial institutions and SMEs' funding needs. According to the latest survey by the Bank of Thailand, only 40% of Thai domestic companies (consisting mainly of small firms) gain access to credit, compared with 58% and 86% of Thai export and multinational companies, respectively. While the level of access to bank credit is lower for small firms, these firms regard bank credit as being much more important to them than large firms do, because of the lack of alternative sources of funding. Past study on Thailand confirms that higher financing constraints reduce the likelihood of starting a business, especially in poorer regions (Paulson and Townsend, 2004). This makes it difficult for SMEs to realise their maximum potential and contribute fully to economic development.
There are good reasons why the availability and costs of credit may be more adverse for smaller firms. First , the costs associated with loan appraisal, monitoring, and collection are not trivial. Information asymmetry and high transaction costs thus imply that it is better for banks to provide larger amounts of credit to a few larger enterprises than small amounts of credit to many smaller firms. Second , financial institutions often consider SMEs as high risk borrowers due to lack of transparency in their accounting practices and inadequate loan document, making it difficult to assess their potential (Sinswat and Subhanij, 2010). With such perceived high risk, commercial banks require high value of collateral and charge high interest rates, worsening the borrowing situation of SMEs (Bank of Thailand, 2009).Third , smaller firms are usually less able to provide collateral when applying for loans, so the costs associated with possible bankruptcy increase, further reducing incentives for banks to lend to smaller firms.
Despite the existence of SME Bank, retail banks and the Small Business Credit Guarantee Corporation, a large proportion of SMEs in Thailand still have credit access problems and are gradually losing edge in terms of contribution to the economy and financial access. Since SME loan provided by Special Financial Institutions (SFIs) accounts for only 7% of total loans to SMEs, relying solely on SFIs' loan is not enough to provide SMEs with sustainable financing.
It is thus necessary for the public sector (government and central bank) and the private sector to work together to provide greater financial opportunities to SMEs. In particular, the effort should aim at reducing information asymmetry and lowering transaction costs associated with credit appraisal, monitoring and collection. One suggestion is to find a business model that would lower transaction costs for commercial banks while making use of existing micro financial institutions (MFIs) such as cooperatives, credit unions and village funds. In parallel with that, access to SME credit history should be enhanced , for example, by expanding the coverage of credit bureau. These issues are discussed in more details below:
Two types of business models that work through existing MFIs are worth considering, as they could benefit from the local knowledge of many MFIs in Thailand.The first model is simple to apply as it is similar to typical commercial banks' lending procedure. The second model is more complex but relatively more useful as it takes advantage of commercial banks' infrastructure and credit review capability.
This is the most common model in other countries since it is closest to standard commercial bank lending. Under this model, commercial banks lend to MFIs who then use the funds to finance their clients. While commercial banks treat MFIs as their own clients, there is an agreement that commercial banks have the right to periodic financial statements and inspections. Several indications may be used to assess whether an MFI is ready for funding from commercial banks, including readily available financial information, high quality loan portfolio with appropriate provisioning and write-off practices, accurate and timely information system, as well as good growth prospect. However, there are currently some limitations to this model, e.g. lack of standardized lending practices to MFIs, lack of legal status of some MFIs, and lack of centralised information on MFIs. To overcome these limitations, MFIs should be strengthened, their legal status established, and centralised information on MFIs should be created, including their credit ratings.
Under this alternative model, commercial banks establish partnership with selected MFIs and outsource retail operations to the MFIs. In return for fees from its partner commercial bank and/or interest rate differential, an MFI would do the following: (i) originate and disburse micro credit loans, which will be registered on the bank's book; (ii) conduct credit review which could either be a joint decision or decided solely by the bank, depending on past records of the MFI; and (iii) manage the micro credit portfolio, including loan monitoring and collection. This arrangement benefits from commercial banks' infrastructure and funding, while takes advantage of MFIs' in-depth client knowledge (soft qualitative data) and operational knowhow in the local microfinance market. Moreover, it has the advantage of providing a way to strengthen many MFIs that already exist in Thailand, especially in rural areas, as well as to indirectly bring the semi-formal and informal sectors into the formal sector. Credit data in the system may also be improved as commercial banks' credit records will also cover clients using financial services from MFIs. However, there are also some difficulties in implementing the model, such as more complexity added to the structure and operation of MFIs, difficulties in drawing up effective and fair agreements between commercial banks and MFIs, and current restrictions regarding outsourcing operations. ICICI Bank and AIG in India provide examples of this model in practice.
In Thailand, substantial progress has been achieved with the development of credit bureau. However, there remains much work to be done to improve the quality of information available in the system and to establish the legal framework with regard to how the information can be accessed and used. Moreover, credit information should be expanded to include the semi-formal and informal sectors as well as data on guarantors. By including credit history from the semi-formal and informal sectors, financial institutions will be able to evaluate their small clients more effectively.
Besides the infrastructure mentioned above, other useful measures to help SMEs include market-friendly credit guarantee scheme and better incentives for venture capital investment . So far, a lot of progress has been made in terms of providing credit guarantee via the Small Business Credit Guarantee Corporation, but progress in terms of providing incentives for venture capital remains limited. This is largely due to strict restrictions in gaining tax incentives for venture capital investment in Thailand.
Acknowledgement: I would like to thank Roong Mallikamas and my colleagues at Economic Research Department for useful comments and suggestions.
Ayyagari, M., A. Demirguc-Kunt, T. Beck (2003) "Small and Medium Enterprises across the Globe: A New Database" World Bank Policy Research Working Paper No. 3127. World Bank, Washington, D.C.
Bank of Thailand (2009) "Financial Services: Corporate and Banks' Perspectives.", Stat Horizon, November.
Demirguc-Kunt, A. and V. Maksimovic, (1998) "Law, Finance and Firm Growth, Journal of Finance, Vol.53, December.
Office of Small and Medium Enterprises Promotion (2009), White Paper on SMEs 2008 and Trends in 2009 (in Thai)
Office of Small and Medium Enterprises Promotion (2010), White Paper on SMEs 2009 and Trends in 2010 (in Thai)
Paulson, A. L. and R. Townsend, (2004) "Entrepreneurship and financial constraints in Thailand," Journal of Corporate Finance, Elsevier, Vol. 10, No.2, pp. 229-262.
Sinswat, W. and T. Subhanij, (2010) "A Cross-Country Survey on SME Financial Access and Implications for Thailand", Discussion paper DP/03/2010, Bank of Thailand.
World Bank (2008) Finance for all: Policies and Pitfalls in Expanding Access, World Bank Policy Research Report.
Ms. Tientip Subhanij
Chief Researcher
Research Department
Monetary Policy Group
Source: Bank of Thailand