IF SOUTH Africa is to create the millions of jobs it badly needs, it will have to do more to finance small businesses, especially as small firms create by far the majority of the country’s jobs.
Between 1985 and 2005, 90% of all new jobs were created by small, micro and medium firms, according to Finmark Trust, while according to Neil Rankin of Wits University 73% of employed people work for firms with fewer than 50 employees. The National Development Plan, released last week, stresses the need for the government and the private sector to partner to create financial instruments for small businesses.
Many small businesses badly need easier access to finance to start up and expand. In this, banks are vital. In 2009, banks accounted for about 95% of all lending to small and medium-sized businesses, with about R410bn in exposure to the sector, according to a Banking Association presentation to Parliament in May.
However, banks are extremely risk adverse, demonstrated by the huge fall in lending to black small businesses with the onset of the 2008-09 global crisis, when lending to these firms fell 27%, from R2.6bn to R1.9bn a year, according to figures from the Banking Association.
This highlights the need for the government to step in. The best way is not by lending directly to businesses, but by backing bank loans to small firms, by way of a credit guarantee scheme. This is in step with the National Development Plan, which suggests a risk-sharing deal between banks and the state could help more small firms get access to finance.
Worldwide, there are more than 2,250 credit guarantee schemes in operation. Countries with the strongest policy and fiscal support for small businesses also have the highest use of credit guarantee schemes. Credit guarantees are in many ways preferable to the government lending directly to small businesses, as they involve banks, which are more skilled at financing businesses than civil servants are.
In Chile and Malaysia, credit guarantee schemes proved hugely successful in funding small businesses. But South Africa’s credit-guarantee scheme Khula (which now falls under the Small Enterprise Finance Agency) has been wracked with problems since its inception in 1996.
With the backing of Chile’s Fogape, banks lent out R24.3bn to small business owners between its launch in 1980 and 2000, benefiting 145,000 small firms between 2000 and the middle of last year.
Malaysia’s Credit Guarantee Corporation (CGC) has, since its inception in 1972, guaranteed more than 400,000 loans worth R127.2bn.
The scheme has been so successful, according to MD Wan Azhar Wan Ahmad, that 100,000 of the 450,000 borrowers that have used the scheme since its inception no longer have to depend on guarantee finance when they want to access finance.
In Chile, a 2006 study revealed that 14% of firms got access to formal finance for the first time after utilising the Fogape, while the amount of finance lent out by banks to small businesses has in recent years increased by 40% because of the scheme.
However, the Khula guarantee scheme ground to a near halt in 2009-10. There was a slight recovery by the following financial year, when it reported lending out 81 new loans to the value of R36.5m. But the loans disbursed remain very low. Even worse is that the scheme notched up an average default rate of 42.15% between 2006 and 2010, with four in five loans being defaulted upon during this period.
Over this same period India’s Credit Guarantee Fund Trust for Medium Small Enterprises notched up a default rate of just 2.5%, while the default rates for both Fogape and Malaysia’s CGC were multiples lower than that of Khula. Just as worrying is that the number of Khula guarantees has never topped 800 since the scheme was launched in 1996.
The government has long blamed banks, saying they are too conservative and dislike lending to small businesses. Banks in turn blame the red tape involved in the claims process, having to first seek a judgment in the courts before lodging a claim on a defaulted loan. This usually takes three months, or up to five years according to one banker.
Following this the scheme pays out in 30 days, but according to another banker, "it rarely takes less than a year to pay out claims". Because of this lengthy period, banks have little trust in the scheme’s ability to honour debts in time.
At Fogape, it can take less than a month for a claim to banks to get paid out, as Chilean banks only need to present Fogape with proof that legal proceedings are under way in court. Fogape must reimburse the respective lending organisation within 15 working days from the date of the request — or it must reject the request for payment within the same within 15 days.
Malaysia and Chile’s schemes have also benefited from various rounds of capitalisation since they were set up, with Fogape receiving a R1.1bn injection in 2008 and the CGC getting R396m recently, to stave off the effects of the global economic crisis. Khula’s only injection was R330m at its launch in 1996.
Khula’s first MD, Sizwe Tati, last year called for a capital injection of R1bn, which, geared by four to 10 times, could enable the scheme to lend out R4bn-R5bn.
But why should we be concerned with credit guarantees at this time? After years of stalling on plans to lend directly, the government, through the Small Enterprise Finance Agency, is now piloting a direct-lending model at three sites across South Africa. It’s a highly risky move as the government is not equipped to lend directly to businesses — it simply does not have the expertise banks do when it comes to judging business plans.
The government is also more likely to sacrifice quality for the sake of quantity. There’s also the risk that politically connected individuals will get funding rather than ordinary businessmen.
Ultimately, without banks’ ability to judge loan applications, the default rate will only get worse.
South Africa must investigate more ways to deal with the problem of default, for which some believe a culture of entitlement is to blame. The private sector has always proved more effective in lending to businesses than the government. Neglecting to fix the Khula guarantee scheme and moving to focus on direct lending may only end in disaster, with soaring default rates and substantial debt.
This article appeared in Business Day on 23 August 2012. Timm is the author of a Trade and Industrial Policy Strategies report, How the State and Private Sector Can Partner to Boost Support to SMEs: Lessons from Chile & Malaysia, released in July.
Stephen Timm is a