The SME finance gap during the pandemic

The DTI MSME Development Plan accomplishment report has very revealing data on MSME access to credit from formal financial institutions. Recall that in 2008, Republic Act No. 9501 prescribes that banks must set aside 8% of their total loanable funds for micro and small firms while 2% should be allocated for medium-sized companies.

The law has lapsed on 16 June 2018 but BSP continues to monitor the exposure of the banking industry to MSMEs. Clearly, the allocation has been on a major downward dive, with the following data: a) 2017: 3.32% micro and small enterprises (MSEs) and 5.03% medium enterprises (MEs); b) 2018: 3.12% MSEs and 4.55% MEs; c) 2019: 2.8% MSEs and 4.3% MEs and d) Q12020:2.09% MSEs and 3.31% MEs.

Even before the 2020 pandemic, the share of MSME loans in the total banking portfolio has been on a major decline. Mandatory credit alone was already not working to push this initiative and it is even getting worse without the mandate. The pandemic with its lockdown is hitting hardest the small and medium firms which suffered from the lack of economic activity and people mobility.

Nationwide lockdowns have disrupted economic activities and slowed down overall growth. Companies, in general, are finding it difficult to repay loan dues to losses and bleak outlooks. This has translated to slower loan growth of the banking sector as the banks have to be more risk averse and discerning in the grant of credit. And when the banks slow down in credit, the first set of clients disenfranchised are those deemed small, vulnerable and with very little lifelines by way of equity capital backing.

This author has monitored the mandatory compliance history of the banking sector in his previous positions, and historically, the compliance mandate has helped MSMEs in its early implementation.

In 1991, the law required banks to set aside 5% of their net loan portfolio for small enterprises. This was revised in 1997 to 6% for small enterprises and 2% for medium enterprises. By 2002, the compliance rate was a high 30%, 17.40% for small and 12.60% for medium. While it tapered off, it was still 8.46% for MSMEs and 7.94% for MEs by 2010.

Let me digress a bit by categorically stating that in this writer’s opinion, the mandatory law worked for SMEs because there is a ready market that can be serviced. The same cannot be said, however, of the agri-agra 25% compliance law which is unrealistic and not commensurate to the number of potential clients. This is especially true of the agrarian part of the law with its untenable requirements as it is obvious that there are not enough ready borrowers in proportion to the overall demand for credit. Mandatory compliance laws must be rational, reasonable, proportionate and implementable. It cannot be based on a pipe dream.

Having made this position clear, one must do an extensive study of what happened in the past 10 years or so for the MSME clientele to have been disfavored by the banking sector in the credit allocation decision. Considering that statistically the large enterprises count of all Philippine business represents 0.49% of the total, is it asking too much to request a mandatory allocation for the rest of the 99.51%? The 2020 Philippine Statistics Authority (PSA) survey recorded a total of 957,620 business enterprises operating in the country. Of these, 952,969 are MSMEs. And the latest tally of bank loans to them is a mere total of 5.4%.

A March 2021 study by the Asian Development Bank Institute of Southeast Asian countries revealed that one-fourth to one-half of the sample MSMEs experienced temporary lockdowns and one-third to two-thirds faced cash shortage. The impact of the pandemic on the employment and the sustainability of businesses was quite severe. MSMEs are prone to using up liquid assets and to cutting employment.

From a banker’s perspective, it is understandable that such firms will be de-prioritized. Thus, the recent downtrend is not a surprise. However, note that this decline has been happening even prior to the pandemic. We cannot therefore use the present circumstances as an excuse, although it is now a major contributor.

Policy makers must study why the mandatory allocation policy worked between 1991 to 2010, and what contributed to its inefficacy over the past 10 years. Among the issues worth exploring are the following: One, what monitoring mechanism was employed? Is the identification of the MSME market correctly done? Two, was the penalty structure commensurate enough to motivate attention to the sector? Could it be that paying penalty is an easier way out? Three, what supporting regulations have been promulgated in support of the sector? Could there have been contrary policies in place? Four, were the agencies assigned to monitor compliance provided with enough power and authority to review real compliance? And finally, did the MSME sector get representation in the development of guidelines and regulations so that their interest is safeguarded?

MSMEs will be the key to the Philippine recovery once we are able to evolve into the new normal. Their financing needs must somehow be addressed in this march to reviving our economy if they are indeed the Philippine’s economic backbone.

The views expressed herein are his own and does not necessarily reflect the opinion of his office as well as FINEX.

Benel Dela Paz Lagua was previously Executive Vice-President and Chief Development Officer at the Development Bank of the Philippines.  He is an active FINEX member and an advocate of risk-based lending for SMEs.