As growth slows in Chile (forecast at 3% this year), one of South America's most progressive nations is looking to ratchet up lending to small businesses. And doing it in what may be a very wise way.
In November Chile's President Michelle Bachelet signed into law a new bill (pictured left, doing so) to capitalise credit guarantee scheme Fogape with an additional $50 million. Its state bank Banco Estado (under which the scheme falls) was also granted an additional $450 million to lend to small businesses.
The extra capital helped the scheme to make available $366 million in guarantees in its latest auction, in December to 23 financial institutions. This will allow these organisations to lend up to $457 million to small businesses (up from $400 million in the previous quarter) between January 1 and March 31.
Credit guarantees make good sense. A government essentially underwrites loans that banks make to small businesses. This encourages banks, which are arguably more skilled at financing businesses than civil servants are, to increase lending to small firms. Worldwide there are over 2 250 such schemes.
The slowing economy in Chile saw fewer Fogape guarantees given out last year (48,299 valued at $840 million) than in 2011 (67,911 valued at $977 million), the scheme's latest report reveals. The new capital aims to tackle this by making it easier for more small businesses to access a guaranteed loan.
Under the new bill Fogape will be able to cover loans of up to $400,000, double its previous $200,000 threshold (loans above $120,000 will get 50% coverage rate - the percentage of a loan that is guaranteed by the scheme - while those below this amount will be able to get 80% coverage). The annual turnover threshold for recipients who can qualify for a guarantees has also doubled, to $2 million.
Unique auction system
What makes Fogape particularly noteworthy is its unique auction system, which has attracted attention from across the world (a fund in Mexico since 2005 uses a similar one), since it was put into use in 2000.
Fogape allows various banks and other institutions (including co-operatives banks and mutual guarantee funds) to put in bids for a certain amount of capital on offer. Bid participants are then assigned funds according to the coverage rates they can offer. A bid is presently held every quarter.
The idea is that the competition between banks allows for the funds to be better distributed when coverage rates are reduced – freeing up the amount of guarantees available. This allowed the coverage rate to fall from an initial 80% in 2000, to 62.2% in 2010. With the slowing economy conditions Banco Estado has intervened to raise it in an effort to get more financial providers to take up the guarantees.
Participants have three months to allocate credit. Those awarded with 15% or more of the allocations must lend out 90% of the amount (80% for those with an allocation of less than 15%). Those that fail to do so will not be able to apply for more than the amount that they were able to lend out in the current bid. No restrictions apply to those participants than win allocations of less than $1.5 million.
Old plans scrapped
As recently as 2011 there was talk of barring state-owned BancoEstado from being able to both bid for funds (as it presently does) and administer Fogape. This plan has now fallen by the wayside.
When the guarantee fund was established in 1980 the law provided for BancoEstado to both compete for funds and administer the fund.
“At that time probably the only place where you could staff Fogape probably was BancoEstado,” says Oscar Gonzalez Narbona (pictured above), who heads the up scheme at Banco Estado.
He said even though it could be seen as a conflict of interest, such a conflict has never arisen, as an external committee analyses the results of each bid, while the bid committee is made up of a lawyer and representatives of those participating in each bid.
With credit guarantees there is always the risk of moral hazard. As loans are underwritten by the state, banks and intermediaries can lend to bad clients in the belief that there's a good chance that they will get their money back should beneficiaries fail to pay back a loan. Beneficiaries themselves could also believe that because the loan has state money behind it, it won't be a problem if they default on it.
But so far the scheme's default rate remains low. Gonzalez Narbona says it's at 1.5%, with the historical high touching 3.5% in 2005/2006, which has come down as Fogape has begun reducing its stock. The credit pay-out period remains a remarkable 15 days.
By some accounts the scheme is helping. Fogape guaranteed $1.9 billion between 1980 and 2010, which helped firms receive finance totalling $3 billion. Since 2000 and up until the middle of 2011, Fogape has guaranteed more than 350 000 operations to 145 000 small firms (see this report by the author).
In Chile, a 2006 study revealed that 14% of firms accessed 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.
New kind of intermediary
Meanwhile, there is also a plan to get the market to offer guarantees too, through privately-run vehicles called SGRs (Sociedades de Garantía Recíproca).
Fogape's deputy head Alessandro Bozzo (pictured right) says the first SGRs began operating in 2009. Today they have a combined stock of $500 million, with 10 of the 14 now participating in Fogape bids.
Bozzo says the idea is that in the future the SGRs will not need any reinsurance from Fogape, which could improve the financial condition of the credit to small businesses. Presently SGRs can leverage their capital up to four times, and Fogape re-ensures about 40% of this amount.
Gonzalez Narbona says the idea is that societies will be able to form their own funds using their own contributions and those from Fogape and banks.
With the guarantee certificate they get from the SGR beneficiaries can approach any bank and translate that into a loan or they can move it from one bank to another, looking for the best interest rate on offer. This is because unlike usual bank loans, beneficiaries' collateral is not registered directly with one bank.
This facilitates more competition from banks, as it allows a business owner to go to any bank once they have the guarantee certificate.
A real lesson for South Africa
The example of Fogape shows how good management, some smart ideas and partnering with the private sector can create a credit guarantee scheme that can reach a meaningful number of small businesses and can provide them with a step into financial system.
South Africa's Small Enterprise Finance Agency (Sefa) which inherited an under performing and debt-ridden Khula guarantee scheme (read this article here), can do well to learn from Fogape - particularly as the SA agency's guarantee scheme dwindles into obscurity, with just a measly R13.7 million advanced to 21 firms in the 2013/14 year.
Timm is the author of Trade and Industrial Policy Strategies (TIPS) 2012 report ‘How the state and private sector can partner to boost support to SMEs: Lessons from Chile & Malaysia. Click here to view the report. Click here to sign up to his monthly newsletter. Follow him on Twitter at @Smallbinsight and on Facebook.
Stephen Timm is a