Getting buy-in from banks (literally) - by having them contribute capital to a fund which capable technocrats can then use to finance small businesses many times over - has been the secret to one of the world's best run credit guarantee schemes, the Credit Guarantee Corporation (CGC) of Malaysia.
The CGC has played a key role in getting banks to lend more to SMEs, notes a recent booklet by the organisation. It's such that Malaysia was ranked second last year by the World Economic Forum on the ease of getting finance.
At the beginning of the 1970s, Malaysia’s economy was still heavily reliant on primary commodities, rubber and tin in particular. To help diversify its economy, the government in 1972 set up the CGC to assist SMEs in obtaining finance from banks at reasonable rates.
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. .
Getting banks involved
Borrowing on what other countries were doing at the time, the government decided that the CGC would be jointly operated by the reserve bank (Bank Negara Malaysia) and all banks (initially the reserve bank held a 19.2% share, and commercial banks operating in Malaysia held the balance of 80.8%).
It meant as shareholders, the banks had an interest in the success of CGC. In the arrangement banks would assess the application for loans submitted by borrowers. In addition they could also act as financial advisors to borrowers and as facilitators in disbursing loans through their network of branches.
In an effort to encourage banks to lend to small businesses, the reserve bank also set a requirement for commercial banks to lend at least 3% of their savings deposits to the sector by 1974. This requirement was gradually increased to 12% by 1981.
The ‘penalty’ funds from banks that did not comply were placed with other financial institutions allowing CGC to earn interest arbitrage.
India has similar requirements in place for banks in lending to certain vulnerable groups (including SMEs). There penalty fees are paid to a fund which targets farmers (see this earlier post).
Awards to get buy-in
To incentivise banks to lend out to small firms, the organisation organised annual awards to recognise those financial institutions which have participated in CGC’s credit guarantee schemes.
In 2008 the CGC helped set up the SME Credit Bureau in partnership with rating agencies to assist SMEs to build, maintain and enhance their credit standing, and to ultimately facilitate wider and easier access to financing. As at the end of 2012, the Bureau had issued over 800,000 SME-related credit reports and rated over 400,000 SMEs.
Move to self-sufficiency
In 2005 as part of a three-year plan to transform the institution into one that is self-financing, a decision was taken that the CGC would no longer has to depend on capital injections from the state (these would be limited to specific purposes such as disaster relief or to fund specific products).
In its 2013 annual report, the organisation's chairman, Agil Natt (pictured above, with former chief executive Wan Azhar Wan Ahmad on his right), reported that the CGC had been able to repay a 700-million ringgit ($193m) loan to the reserve bank by a November 2013 deadline, bringing to 2.2 billion ringgits the loans repaid to the bank.
Following various capital injections in recent years the Reserve Bank owns (76.4%) of shares in the CGC, while commercial banks and finance companies own the rest (23.6%).
By 2012 had underwritten close to 51 billion ringgits ($13.8bn) in guarantees to over 420,000 businesses. A further 2,368 loans totalling RM1.5 billion, were guaranteed in the 2013 financial year, reveals the CGC's 2013 annual report.
There is evidence that the CGC has helped broaden finance. Reserve Bank figures indicate that financing provided to SMEs as a percentage of total business financing by the banking system has increased from 27.1% as at end 1998 to 39.6% as at end December 2011, amounting to 140.6 billion ringgits.
Much of this post was drawn from a 2014 CGC booklet on the history of the fund (access it here). See this study by Timm for more on lessons from the CGC and this post on lessons from Chile's credit guarantee scheme Fogape.
Stephen Timm is a