Friday, August 21, 2015

World Bank, before Public Credit Guarantee Schemes (CGSs) help removing the obstacles to bank lending to SMEs

As a justification the document states something we can all surely agree on: “Financial inclusion, particularly for small and medium enterprises (SMEs), is widely recognized as one of the key drivers of economic growth and job creation in all economies. SME credit markets are notoriously characterized by market failures and imperfections including information asymmetries, inadequacy or lack of recognized collateral, high transaction costs of small-scale lending and perception of high risk.”

We also read: “In order to address these market failures and imperfections, many governments intervene in SME credit markets in various forms. A common form of intervention is represented by credit guarantee schemes (CGSs). A CGS provides third-party credit risk mitigation to lenders with the objective of increasing access to credit for SMEs. This is through the absorption of a portion of the lender’s losses on the loans made to SMEs in case of default, in return for a fee. The popularity of CGSs is partly due to the fact that they typically combine a subsidy element with market-based arrangements for credit allocation, therefore involving less room for distortions in credit markets than more direct forms of intervention such as state-owned banks.”

And I would want to draw your attention specifically to: “they typically combine a subsidy element with market-based arrangements for credit allocation, therefore involving less room for distortions in credit markets.”

That because the World Bank Group and the FIRST Initiative, are aware of the existence of risk-weighted capital requirements for banks which allow banks to leverage much less their equity when lending to “The Risky”, like SMEs than when lending to “The Safe” like sovereigns and the AAArisktocracy.

And they must also be aware that these regulations impede “market-based credit allocation, and cause huge distortions in credit markets”. We know that because already in the World Banks' The Global Development Finance 2003 (GDF-2003), “Striving for Stability in Development Finance” it had this to say on Basel II, pages 50-52

“The new method of assessing the minimum-capital requirement [proposed by the Basel Committee for Banking Supervision (BCBS)]… will be explicitly linked to indicators of credit quality… The regulatory capital requirements would be significantly higher in the case of non-investment-grade emerging-market borrowers than under Basel I. At the same time, borrowers with a higher credit rating would benefit from a lower cost of capital under Basel II….”

And so, though welcoming very much this initiative of the World Bank and the FIRST Initiative, I pray that it is not in substitution of getting rid of the portfolio invariant credit-risk weighted capital requirements for banks, which blocks SMEs from having fair access to bank credit. If it is, then let me assure you the “Public Credit Guarantee Schemes (CGSs) for SMEs” discussed amounts to a petty consolation prize for the SMEs, and could even increase the existing regulatory distortions.

We read the consultation invites “stakeholders -- governments, credit guarantee schemes (CGSs) and lenders” should not SMEs, or those who speak up for the borrowers’ rights of not being discriminated against by regulators, be specifically invited?