Credit guarantee scheme holds the key to successful implementation of stimulus packages

The government has allotted more than Tk 1 lakh crore, which is 3.7 per cent of the GDP, under 19 different 'stimulus packages', to mitigate the economic effects of the coronavirus pandemic and kickstart our economic recovery.

The Bangladesh Bank (BB), has also taken various policy measures to enhance the banking sector's liquidity and support the roll-out of these stimulus packages and many other customer-friendly initiatives.

These government stimulus packages are extraordinary initiatives, the effective implementation of which, we believe, will contribute strongly to the recovery of the Bangladesh economy.

The majority of the stimulus packages are designed to be delivered to affected enterprises in form of credit (or loans) at subsidised rates.

The BB will lend funds under the stimulus package to banks, who, in turn, will be responsible for the roll-out of the loans to individual customers.

In other words, the banking sector will take on board all customer credit risk.

This pandemic comes at a time when Bangladesh's banking sector is already reeling from the effects of many years of high unproductive loans and tight liquidity.

On top of it all, the BB imposed a 9 per cent lending rate cap from April 1, which resulted in banks losing between 20 per cent to 35 per cent of their customer lending interest income.

The lending rate cap gives the banking sector little or no room to implement any commercial risk premium in loan pricing and there is justifiable apprehension that, in this environment, few banks will have any risk appetite for the inherently riskier cottage, micro, small and medium enterprise (CMSME) business segment.

What can help here is a credit guarantee scheme (CGS), which provides third-party credit risk mitigation to lenders through the absorption of a portion of the lender's losses on loans made to different client segments in case of a default, typically in return for a fee.

The CGS is particularly used to encourage banks to lend to comparatively riskier segments such as the CMSME.

Most countries in the world have some sort of CGS for CMSMEs and these schemes have invariably been very effective in exponentially growing CMSME credit in those countries.

A look around South and South East Asia, not to mention more developed countries, will give one a pretty clear idea as to how the CGS is used to encourage banks to get into and then grow the CMSME business.

The banking sector has been asking for a CGS for many years now and, in the current circumstances, the need for such a scheme appears even more relevant. 

It is reliably learnt that the World Bank is now offering a $300 million support to the BB to form a CGS for CSMEs.

The central bank has recently put together a first cut CGS and has shared the same with relevant stakeholders for their feedback.  It is expected that a CGS will be rolled out shortly.

An effective CGS will be key to the overall growth of the CMSME segment in Bangladesh and, in particular, the successful implementation of the government's CMSME stimulus package.

Of course, the CGS must be designed such that the overall proposition is commercially viable and easily accessible by both the end user customers and the participating banks.

A poorly designed CGS will not be accepted or executed by relevant stakeholders and will not serve any purpose.

We believe this is a very opportune moment to share Brac Bank's many years of experience in the Bangladesh CMSME segment and our ideas on how an effective CGS should be designed. The CGS should:   1. Clearly define eligibility and qualification criteria for Financial Institutions (lenders) & CMSMEs.  

i) Focus on the micro, cottage and small segment with special incentives for women-owned businesses. 

ii) Cover both the working capital (i.e. operational expenditure) and longer-term investment (capital expenditure). It is difficult to differentiate between capital and working expenditure in a CMSME entrepreneur and one should not try to do so. Access to credit is most important for the CMSME entrepreneur and he/she will know how to utilise the funds. 

iii) Not be restricted by sector classifications, all sectors of the CMSME segment (manufacturing, service and trading) should be equally covered   iv) Accommodate the re-structuring and re-scheduling of bank loans for better portfolio management.  

2. Ensure that CGS is customer- and bank-friendly and can be quickly rolled out. 

i) There are two main approaches to a CGS: the individual approach (guarantees provided on a 'loan by loan' basis) and the portfolio approach (banks are allowed to report guarantees on a portfolio basis). We strongly recommend that the portfolio approach is used in Bangladesh because it will allow the bank to respond quickly and reach a larger number of smaller ticket SME borrowers. The size and scale of the Bangladesh CMSME segment are such that a 'loan by loan' approach is impractical  ii) The loan ticket size of SME borrowers in Bangladesh ranges between Tk 5 lakh and Tk 1 crore. The CGS should accommodate this range of SME loans. 

3. Issue partial guarantees that comply with prudential regulation and provide capital relief to lenders.  

i) The CGS should mitigate banks' risk through the guarantee coverage ratio, which is usually expressed as a percentage of the underlying loan exposure. The guarantee coverage ratio should be high enough to actively encourage banks to participate. In the current economic condition, the guarantee coverage ratio should not be lower than 80 per cent. 

ii) CGS should also set a cap on the maximum amount claims that will be accepted by the CGS. Our experience, and the portfolio health of the banking sector's current CMSME segment, suggests a cap of 30 per cent is appropriate for normal times. In the current pandemic situation, the BB could even consider extending the CGS up to 50 per cent.  iii) The CGS should provide capital relief to the banks for the proportion of the underlying loan exposure covered by the guarantee. 

iv) The CGS should not impose new credit assessment requirements (e.g. 2/3 years' financial, business length, etc.); it should rely on the bank's internal credit assessment system.  

v) The loans guaranteed by the CGS should comply with the prudential regulations for loan loss classification.  

vi) CGS should allow lenders to exclude the portion of the loan guaranteed by CGS during loan loss provisioning. 

4. Set a transparent and consistent risk-based pricing policy to ensure that the guarantee programme is financially sustainable and attractive for both SMEs and lenders.  

i) The pricing should be variable and should promote prudent credit culture across the financial industry by offering lower fees to banks with lower default loans. 

ii) CGS fees should be commercially viable, and no more than 00.5 per cent for banks with low default loans. Higher guarantee fees will make the CGS unattractive to lenders.  

iii) The CGS should allow financial institutions to reimburse the credit guarantee fees from the borrowers (SMEs) themselves.  

5. Design an efficient, clearly documented, and transparent claim management process providing incentives for loan loss recovery, and be aligned with the local legal and regulatory framework.  

i) The procedure of inclusion of loans in CGS and triggering claims should be fast, efficient, and transparent -- the entire process should, ideally, be digitised.  

ii) The credibility of the CGS largely depends on how claims are handled once they have been submitted. The precise circumstances under which a claim can be made should be clearly articulated in the contractual agreement between the CGS and the lender. 

iii) The CGS should have a minimum mandatory waiting period after loan disbursement before a claim can be entered. Our experience suggests this waiting period should be 180 days, as the tenor of the loans made to the CMSME segment is generally short-term.  

iv) The CGS should have the capability to check and restrict multiple claims from a single entrepreneur through different lenders.

A well-designed CGS will be a big step forward in the country's efforts to grow the overall CMSME lending, which, by itself, is a key developmental agenda.

We believe that an effective CGS will accelerate not only the disbursement of funds from the government's new CMSME stimulus package, but also give impetus to the existing portfolios at different banks and, at the same time, encourage banks, who have not yet tried out this segment, to launch their new portfolios.

The author is the managing director of Brac Bank