Proportionate Regulatory Policies for the MSME Sector

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• Proportionate Regulatory Policies for the MSME
  Sector

BENEL P. LAGUA President and COO Small Business
Corporation Philippines
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Presentation Outline

• Importance of MSME Sector
• Role of Government
• General Practices on Proportionate Regulatory
  Policies
• The Philippine Response
• Policy Execution
• Conclusion
• The views expressed herein are the authors and
  do not necessarily reflect the position of the
  Small Business Corporation.

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Importance of MSME Sector

• The economic impact of MSMEs
• MSMEs make up 99.6 of total Philippine
  establishments and makes the following
  contributions to the Philippine economy
• 61 of employment
• 32 of value-added
• 60 of exports
• MSMEs are largely dependent on the banking system
  for financing
• MSMEs are disadvantaged due to size, higher unit
  transaction cost, perceived risks, and financial
  infrastructure distortions

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The Role of Government in MSME Development

• Facilitate MSMEs access to credit from formal
  institutions by
• Crafting policies that will allow for a
  borderless credit access by MSMEs and ensuring
  effective implementation of such policies
• Creating a regulatory environment for banks
  conducive to MSME lending
• Capacitating both banks and MSMEs
• Absorbing some costs of programs aimed at
  increasing MSMEs access to credit
• Addressing market failure, leveling the playing
  field

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Proportionate Policies

• One size does not fit all
• Regulation and supervision can be expensive to
  implement, and costly when it fails
• Need for affirmative action and tiered
  regulation
• Differing regulatory requirements based on market
  capitalization
• Reduce discrimination
• Scale regulatory treatment

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General Practices on Proportionate Policies
World Bank, CSBFA, RBI, SBA, CRA, CGAP

• Guarantee Schemes (more than half of all counties
  in the world have a guarantee program)
• Directed Credit Programs
• Interest Rate Subsidies
• Regulatory Subsidies, e.g. lower provisioning
• Regulations Concerning Documentation
• Establishment of Credit Registries to address
  information asymmetry
• Priority Sector Lending, e.g. mandatory credit
  laws, PSL in India, Community Reinvestment Act in
  the USA

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The Philippine Response

• Magna Carta for MSMEs or RA 9501 (2008)
• Required that banks allot at least 8 for micro
  and small and 2 for medium enterprise in their
  total loan portfolio
• Strengthened the Small Business Corporation, a
  specialized financing and guarantee institution
  for MSMEs
• Barangay Micro Business Enterprise (BMBE) Law
  (2002)
• Provides income tax exemption, minimum wage
  exemption, and other benefits such as special
  credit window and other forms of assistance
  programs for micro enterprises

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The Philippine Response

• Credit Information System Act or CISA (2008) or
  RA 9510
• Mandates the creation of a credit information
  bureau that will serve as a central registry of
  repository of credit information including credit
  history and financial condition of borrowers
• Promotes an efficient credit information system
  that will address financial institutions
  concerns on all their credit-related activities
• Bangko Sentral ng Pilipinas (BSP) Regulations and
  Circulars on SME Lending
• Capital requirements, loan documentation, risk
  weights
• BSP Regulatory Framework on Microfinance
• Encouraged the establishment of
  microfinance-oriented banks and has a specialized
  microfinance regulatory unit. This allowed
  non-collateralized lending to the sector based on
  cash flow.

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• In theory, the Philippines is adopting the menu
  of proportionate regulatory policies.
• What is the problem?

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Policy Execution

• a) Magna Carta for MSMEs or RA 9501 (2008)
• On the mandatory credit allocation
• Compliance report too broad / Not transparent
• Overall, banking sector appear to be compliant
  with the requirements of the law, but at the
  margin especially in micro and small8.5 vs.
  mandated 8.0
• Individual performance of banks reveal, however,
  that many big banks remain under-complied
• Some banks cover for the deficiency of other
  financial institutions
• Lending figures to micro and small business
  sector is flat over the past 10 yearsNegative
  real growth is observed.
• Moral Hazard problem Penalty structure for
  non-compliance is cheap/uniform and biased
  against smaller banks

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Policy Execution

• b) Magna Carta for MSMEs or RA 9501 (2008)
• On SB Corporation
• Self-sustaining. No government infusion in the
  past 19 years. Declares Dividends.
• No sovereign guarantee. Another GFI whose main
  mandate is guarantee for (large) export firms has
  a sovereign guarantee feature.
• Limited capitalization when benchmarked against
  guarantee corporations in Asia multiple
  objectives. Recent increased capitalization
  remains in paper
• Supervision not much different from standard
  prudential supervision of banks

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Policy Execution

• b) Magna Carta for MSMEs or RA 9501 (2008)
• On SB Corporation
• No clear appreciation of nature of guarantee
  corporation
• Costs incurred by the government in implementing
  MSME financing programs (e.g credit guarantees)
  may not be directly recoverable using revenues
  per se as a measure
• Full cost recovery could not be achieved without
  compromising the objective of facility finance to
  small business.
• Cost-recovery can be measured through the
  underlying economic impact of MSME programs (i.e
  taxes for government, productivity, employment,
  income, economic growth, etc.)Canada SBFA
  Report

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Policy Execution

• Barangay Micro Business Enterprise (BMBE) Law
  (2002)
• Reluctance from executing agencies (i.e DOF and
  LGUs concerned about losses due to tax exemption
  granted to BMBEs)
• Credit Information System Act or CISA (2008) or
  RA 9510
• Still awaiting full implementation after almost 3
  years that the law has been signed
• Lack of funds to support the mandate, including
  the creation of the credit information corporation

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Policy Execution

• a) Bangko Sentral ng Pilipinas (BSP) Regulations
  and Circulars on SME Lending
• On Loan Documentation
• Requires the submission of BIR-submitted Income
  Tax Return (ITR) upon loan application, including
  its waiver of confidentiality and its annual
  submission
• Moratorium on submission granted for MSMEs, but
  to expire in December 2011
• After 2011, small business loans without
  documents to be classified as especially
  mentioned
• ITRs rarely reflect true condition of an
  enterprise. Should the exemption be extended?

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Policy Execution

• b) Bangko Sentral ng Pilipinas (BSP) Regulations
  and Circulars on SME Lending
• On loan classification
• Reduced risk weight of MSME portfolio from 100
  to 75
• Subject to conditions like meeting certain
  prudential norms, including PDR of not more than
  5 and a highly diversified portfolio with not
  less than 500 accounts
• Questions on appropriateness of conditional
  prudential standards to enjoy risk weight
  reduction benefit

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Policy Execution

• c) Bangko Sentral ng Pilipinas (BSP) Regulations
  and Circulars on SME Lending
• On loan classification
• Loans to exports to the extent guaranteed by SBC
  with 20 risk weight
• Loans to exporters to the extent guaranteed by
  GFSME with 0 risk weight so long as these are
  outstanding upon merger
• Loans to exporters guaranteed by SBC in
  post-merger as 20 risk weight though these may
  be renewals
• Is the reduced risk weight sufficient incentive
  to banks utilizing the guarantee?

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Policy Execution

• d) Bangko Sentral ng Pilipinas (BSP) Regulations
  and Circulars on SME Lending
• On unsecured loans
• In theory, no technical prohibition for granting
  of loans without collateral except for DOSRI
  limits
• However, an unsecured loan for banks risk-based
  CAR is a 100 risk weight on capital
• Also, in the event the loan turns past due, loan
  loss provisioning is immediately high
• Not eligible for rediscounting
• Effectively, there is disincentive to lending
  without collateral

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Policy Execution

• e) Bangko Sentral ng Pilipinas (BSP) Regulations
  and Circulars on SME Lending
• Supported the creation of independent Credit
  Surety Fund (CSF) set aside by LGUs
• Provides guarantee which secures the loan of
  MSMEs with local banks and facilitates lending
  without collateral
• CSFs are too small and without muscle model is
  not cognizant of how guarantee programs work

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Policy Execution

• f) Bangko Sentral ng Pilipinas (BSP) Regulations
  and Circulars on SME Lending
• Reserve Requirements
• PFIs of SB Corp are exempted from reserve
  requirements by BSP under SBC Wholesale Lending
  Program, encouraging banks to expand their MSME
  loan portfolio
• However, BSP also runs its rediscounting window,
  sometimes at concessionary/subsidized rates, in
  competition with GFIs wholesale lending programs

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Policy Execution

• Bangko Sentral ng Pilipinas (BSP) Regulatory
  Framework on Microfinance
• Issuance of circulars governing the practice of
  microfinance in the banking sectorrediscounting,
  recognition of microfinance (no collateral, loan
  documentation), allow branching, etc.
• Modified Manual of Examination
• Promotion and Advocacy
• Philippines cited by EIU as having the best
  overall regulatory environment for microfinance
  on banks. However, BSP does not cover NGOs and
  cooperatives.

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Conclusion

• Execution is opaque
• Implementing rules not following the spirit of
  basic law
• Under-funded and undersized programsnot
  commensurate to mandate unwillingness to make
  the investment
• Inter-agency conflictapparent weakness in
  coordination
• Business model inconsistent with program
  objectives
• Costs and benefits of some proportionate
  regulatory schemes not well-measured
• Objectives are at cross-purpose
• Major changes in Microfinance Uneven policy
  execution in SME Finance.

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Conclusion

• Government intervention by way of proportionate
  regulatory action must
• Focus on reducing risks and transaction costs
  associated with MSME lending
• Balance the benefits of regulation/supervision
  against the costs and risks of no
  regulation/supervision
• Aim for consistency across stakeholders and
  institutions

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Conclusion

• Government intervention by way of proportionate
  regulatory action must
• Serve as co-investor, thus, a source of risk
  capital
• Educate private capital on how to lend to SME
  (capacity building)
• Channel capital in strategic directions
• Be designed for effective implementation,
  execution, and enforcement
• Be enlightened

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References

1. ADB (2000), The Role of Central Banks in Asia
   and the Pacific Overview (http//www.adb.org/Doc
   uments/Books/Central_Banks_Microfinance/Overview/c
   hap_05.pdf)
2. Canada Small Business Financing Act (2009),
   Comprehensive Review Report 2004-2009),
   http//dsp-psd.pwgsc.gc.ca/collections/collection_
   2010/ic/Iu188-1-2009-eng.pdf
3. CGAP (2011), Recommendations for Proportionate
   Regulation and Supervision of Microfinance,
   INCITRAL Colloquium on Microfinance
4. Clinton, Lindsay (2010), India Journal Whats
   Policy Got to Do With Social Enterprise?
   (http//blogs.wsj.com/indiarealtime/2010/12/06/ind
   ia-journal-whats-policy-got-to-do-with-social-ente
   rprise/)
5. Fan, Qimiao (The World Bank), Presentation during
   the Workshop on Improving Access to Finance for
   SMEs in Asia-Pacific Region, June 16-17, 2008
6. http//blogs.worldbank.org/allaboutfinance
7. http//dnb.com.au/Header/News/Banking_on_SMEs/inde
   xdl_7334.aspx
8. http//www.philstar.com/Article.aspx?publicationSu
   bCategoryId66articleId697537
9. Sibold, S. (2005), Addressing the Burden of
   Regulation in CanadaThe Case for Proportionate
   Regulation, (http//www.tfmsl.ca/Documents/Stephe
   nSiboldPropReg.pdf)
10. Thornley, B. et al (2011), Case 12 Priority
    Sector Lending, in Impact Investing, A Framework
    for Policy Design and Analysis (http//www.pacific
    communityventures.org/insight/impactinvesting/repo
    rt/12-Priority_Sector_Lending.pdf)
11. Wikipedia, Community Reinvestment Act
    (http//en.wikipedia.org/wiki/Community_Reinvestme
    nt_Act)

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END.THANK YOU!!!

• blagua_at_sbgfc.org.ph
• www.sbgfc.org.ph