THE COLLATERAL LENDING TRAP AND BUSINESS DEVELOPMENT SERVICES (BDS)
Cambodia’s economy is on the upward trend for several years, and has continued to grow and attract investors. In the words of Eric Sedgwick, Asian Development Bank Country Director, “Private consumption, exports and investment, including strong and diversified foreign direct investment will all drive economic development in 2013 and 2014.” Among the top contributors to the developing economy are the manufacturing sector, the service sector particularly tourism and the agriculture and fishery sector. As the economy grows, its ripple effect infused fresh vigor to the informal sector and motivates entrepreneurship among the people. Livelihood activities and small businesses mushroomed throughout the country transforming once sleepy provincial towns into vibrant commercial centers.
Microenterprises are generally characterized by its informal nature:
- not registered with any government agency;
- minimal recording system that cannot be used as a basis for financial analysis;
- mixed funds for household needs and business operations;
- absence of relationship with formal financial institutions that will provide sustained financial resources;
- perennial need for working capital, etc.
These features make microenterprises risky making them “non-bankable” and ineligible for loans from formal financial institutions. Informal moneylenders fill-in the gap, until microfinance institutions (MFIs) entered the scene. Initially started as development programs of international non-government organizations in the 90’s, the microfinance industry has matured and has attracted socially-responsible commercial investors, infusing much needed resources for the marginalized poor and emerging entrepreneurs.
The growth of the microfinance industry runs parallel with the increase in the number of microenterprises. It was placed under the control of the National Bank of Cambodia (NBC) monitored and regulated just like ordinary banks in the country. As of May 2013, there are 39 MFIs, with a consolidated loan portfolio of more than $1Billion servicing 859,772 clients. The potentials for microfinance are still huge considering the estimated 4million poor people in the country and the continuously increasing number of microenterprises.
Most MFIs are providing basic financial services to its microenterprise clients: loans, deposits (for those with licensed deposit-taking functions), and domestic money transfer. Financial education is one of the main non-financial service and some corporate social responsibility projects done in partnership with other development institutions. Risk remains a major concern, but most of the MFIs were able to manage their portfolio-at-risk (PAR). Industry data as of May 2013 placed the PAR at 0.298%. So how are the MFIs addressing the issue of risk among its microenterprise borrowers? The answer is simple – collateral. The credit staff, or the officers involved in loan assessment may require the borrower to provide details of how the enterprise operates and some financial data, but in the final analysis, the value of the collateral remains to be the basis for loan approval. Over time, as the process becomes routine, there are possibilities that the assessment process may be glossed over, with the value of collateral taking precedence over the cashflow of the enterprise or the actual operating capital needs of the entrepreneur in deciding loan approvals.
This is what we call the “collateral lending trap”, when the primary basis for loan approval is the value of collateral instead of the capacity of the enterprise to generate profit. The nature of the enterprise and the financial condition are but requirements to be complied with. We may see MFIs with several loan products – agricultural loan, small business loan, enterprise expansion loan, etc. – but if we look closely at the basis of for approval, it boils down to one main factor – collateral.
This is not to say that collateral is not important. It is important and necessary to mitigate the risk inherent in loans especially the bigger ones. Microenterprise loans however has to be viewed from the perspective of how it operates and its potential for growth. How the enterprise generates income, how well the inventory is being managed, how good is the entrepreneur in managing cashflow, these are but some of the things that should be the considered in providing loans to microenterprises. Collateral comes only as safety net when the enterprise fail for reasons beyond the control of the entrepreneur.
This is what is lacking in most MFIs – the intervention to assist in enhancing and scaling-up operations of microenterprises is minimal or totally absent. Risk, being inherent in microenterprises, can be addressed by providing business development services (BDS). This means working out formal registration, setting up basic systems like inventory management, installing a financial recording system, segregating personal funds from business funds and other similar activities that will make it mainstream. This will facilitate growth as hired workers can have specialized functions and the entrepreneur can be freed from functions delegated to staff and instead focus on higher level management responsibilities and later, expansion. Scaling-up of the enterprise will even result to increased absorptive capacity, and hence bigger loans to provide. It is in this context that the provision of business development services should be part of the non-financial services of MFIs as it face the challenge of increasing number of microenterprises.
The Cambodia Microfinance Association (CMA) in partnership with PF Technical Advisory Services (PFTAS) is offering a course that will address this issue. The course titled How to Provide Business Development Services to MFI Clients will be conducted on August 21-22, 2013, designed to give an overview of the whole mSME sector and enable the MFIs to design a support program for its borrowers involved in enterprises. The course is divided into three modules.
Analysis of the market. This module covers the discussion of the current state of mSME in the country. The picture of the mSME will be interfaced with the financial services provided to the sector.
The concept of BDS. The second module will be a discussion on the concept of BDS and the rationale for providing the service
BDS as a non-financial service of the MFI. The last module deals with the details on how an MFI can include BDS among the array of their non-financial services. Topics include:
- Types of BDS
- Determining the segment requiring BDS
- Instruments in providing BDS
- Basic considerations in providing BDS
- Options for MFIs in providing BDS