Over 95 percent of businesses in ASEAN+3 economies are small and medium-sized enterprises (SMEs). They create two out of every three jobs in the region and are important nodes in the global value chains, accounting for up to 30 percent of the region’s exports.
However, limited access to financing is one of the major challenges faced by SMEs which has led to many of them to default on their payments and become bankrupt. Most SMEs cease operations within five years. Tight resources – a low number of staff and shallow budget – make it difficult for the SMEs to establish proper booking keeping, which are critical for obtaining bank financing and government support. The lack of proper accounting also means financial institutions often set more stringent requirements, such as collaterals, to ensure the SMEs’ repayment abilities.
Even when the fortunate SMEs manage to secure financing, it frequently comes at a high cost. Financial intermediaries are not social enterprises and require compensation for taking on additional risks. Alongside rising interest rates, the cost of borrowing for the SMEs becomes heftier.
To support and pave the way for SMEs to thrive, governments can consider several initiatives to improve financial inclusion and offer affordable financing to the SMEs.
Enhancing credit guarantee schemes
Credit guarantee schemes (CGSs) are third-party credit risk mitigation mechanisms which are prevalent in the region and should be enhanced structurally. If done well, CGSs can play a key role by serving as a loss absorber in the event of an SME default, thus incentivizing lenders to extend credit to SMEs.
At present, only a handful of CGSs in Korea, Japan, and Malaysia are successful. This is due to having an appropriate incentive structure for stakeholders, more efficient application procedures, and good governance structure. One way to strengthen the CGSs is to find a good mix of public and private sector involvements. While government stakes often come with better regulatory oversight and management, higher private sector participation brings along a more advanced set of credit assessment expertise to better sieve out the deserving borrowers.
Another area for improvement is to ease the eligibility criteria to facilitate loan take-up. Meeting requirements such as collaterals could be relatively challenging for small firms, especially startups. Hence, the eligibility criteria should be reviewed from time to time.
That said, a priority for a well-functioning CGS is to have a clearly defined legal and regulatory framework. Setting up a credit information database could increase transparency, which helps identify borrowers who are more creditworthy.
Establishing policy banks
Economies without policy banks could consider establishing such institutions, while those already with policy banks could enhance governmental support or their operational mandates. Strong government backing enables the policy banks to extend loans at favorable terms to the SMEs. Unlike commercial banks, policy banks are often tasked with specific mandates. These include SME banks that focus on financial inclusion. For example, Small Medium Enterprise Development Bank Malaysia Berhad, and Small and Medium Enterprise Development Bank of Thailand. Others that provide support to specific sectors include Vietnam Development Bank, for example.
Building a robust ecosystem
While all SMEs are classified as small businesses by tax authorities, their reasons for formation and viability vary significantly.
Micro-enterprises are often established as an alternative work option or set up by people who have been displaced from the labor market. These businesses often face challenges in scaling up their operations efficiently. Effective labor market policies that facilitate job matching and provide appropriate vocational training are the way to go.
Medium-sized enterprises are typically led by visionary entrepreneurs who have experienced growth. These businesses often possess more advanced equipment, infrastructure, and slightly higher levels of management expertise, leading to more effective decision-making. With easy access to financing, they have the potential to turn into a big business if they have easier access to financing.
Further to the broader macroeconomic environment and government support, SMEs should also take responsibility for their own growth and development by strengthening their balance sheets, particularly through bolstering profits to reinforce their resilience. This can be achieved by working collectively with other SMEs in the same industry to lower market entry costs and build up the necessary network to penetrate new markets more effectively for expanding or maximizing their revenue streams. In a way, the group of SMEs could also share information on regulatory requirements, which would help them to adopt strategies quickly in response to changing demands.
Compared to larger firms, SMEs benefit from faster decision-making processes, including their ability to quickly adopt new technologies that have lower barriers to entry, for reducing business costs.
Michael Bloomberg, the Founder of Bloomberg LP, once said: “Small businesses form the backbone of our communities, and our utmost efforts are imperative to ensure their success.” Let us commence this endeavor to support the SMEs in the region without delay.