Proportionate Regulatory Policies for the MSME Sector

1. BENEL P. LAGUA President and COO Small Business Corporation Philippines Proportionate Regulatory Policies for the MSME Sector Version as of 24-06-2011.

2. 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 author’s and do not necessarily reflect the position of the Small Business Corporation.

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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.

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

10. 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 small—8.5% 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 years—Negative real growth is observed. • Moral Hazard problem; Penalty structure for non-compliance is cheap/uniform and biased against smaller banks

11. 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

12. 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]

13. 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

14. 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?

15. 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

16. 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?

17. 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

18. 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

19. 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

20. Policy Execution • Bangko Sentral ng Pilipinas (BSP) Regulatory Framework on Microfinance • Issuance of circulars governing the practice of microfinance in the banking sector—rediscounting, 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.

21. Conclusion • Execution is opaque • Implementing rules not following the spirit of basic law • Under-funded and undersized programs—not commensurate to mandate; unwillingness to make the investment • Inter-agency conflict—apparent 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.

22. 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

23. 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”

24. References • ADB (2000), “The Role of Central Banks in Asia and the Pacific: Overview” (http://www.adb.org/Documents/Books/Central_Banks_Microfinance/Overview/chap_05.pdf) • 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 ] • CGAP (2011), “Recommendations for Proportionate Regulation and Supervision of Microfinance,” INCITRAL Colloquium on Microfinance • Clinton, Lindsay (2010), “India Journal: What’s Policy Got to Do With Social Enterprise?” (http://blogs.wsj.com/indiarealtime/2010/12/06/india-journal-whats-policy-got-to-do-with-social-enterprise/) • Fan, Qimiao (The World Bank), Presentation during the “Workshop on Improving Access to Finance for SMEs in Asia-Pacific Region, June 16-17, 2008 • http://blogs.worldbank.org/allaboutfinance • http://dnb.com.au/Header/News/Banking_on_SMEs/indexdl_7334.aspx • http://www.philstar.com/Article.aspx?publicationSubCategoryId=66&articleId=697537 • Sibold, S. (2005), “Addressing the Burden of Regulation in Canada—The Case for Proportionate Regulation,” (http://www.tfmsl.ca/Documents/StephenSiboldPropReg.pdf) • Thornley, B. et al (2011), “Case 12: Priority Sector Lending,” in Impact Investing, A Framework for Policy Design and Analysis (http://www.pacificcommunityventures.org/insight/impactinvesting/report/12-Priority_Sector_Lending.pdf) • Wikipedia, Community Reinvestment Act (http://en.wikipedia.org/wiki/Community_Reinvestment_Act)

25. END.THANK YOU!!! blagua@sbgfc.org.ph www.sbgfc.org.ph