How difficult is it for SMEs Singapore to get access to funding? Are SMEs being discriminated and seen as being too risky to lend by the financial industry?
In a recent research initiated by DP Information to find out exactly what challenges SMEs faced that hindered business development in Singapore, it was found that the cost of financing in Singapore is one of the main issues that many SMEs face. With a firm direction to uncover the root of the problem, the study showed the bank’s segmentation perplexity to be the main reason that SMEs were facing difficulties in securing business loans in Singapore.
From the standpoint of a bank, it seemed completely logical that the SME sector was viewed as being too insignificant to channel resources to. Compared to the wholesale or institutional banking departments that focus on multinational corporations, which provide for a more stable and profitable portfolio, the SME sector is one that is often seen as both risky and troublesome.
Why do the banks and financial institutions view SME lending as a relatively risky sector?
There is an old Chinese saying that states, ‘the world is a realistic place’, where it meant to say that if made to choose, people will always choose the better option that would give them the optimum benefit. Similarly, the wholesale and commercial banks need to ensure the safety and profitability of their loan portfolio for the management to see. As you would expect, assets as collateral play a big role in the commercial banking sector, where a single non-performance loan could amount to millions of dollars in losses. Furthermore, given that most SMEs would not be able to put up any assets as collateral, combined with the utter lack of any meaningful data available on SMEs in Singapore for banks to carry out deeper research and studies on, it is always going to be that the banks will try as best as they can to shy away from lending to the one segment that is most risky for them.
Therefore, given that most SME loans disbursed are unsecured, this places the SME lending sector with the greatest risk exposure in terms of percentage. An important point to understand about the banks and their credit assessment process, is that the role of credit departments is to look out for any red flags that may signal a potential defaulter. It is in the nature of their role protect the interest of the bank.
From a lender’s perspective, the credit assessment objectives will always boil down to 2 main considerations – a) whether the borrower has the means of paying back, and b) the willingness of the borrower to make timely repayments without defaulting. However, without any means to measure or quantify a borrower’s intentions, relying on a borrower’s repayment ability is the only way for credit departments to make their decisions.
One of the basic tenets of economics is that given limited resources, and no restrictions, people will naturally choose to maximize utility of their resources. As such, it is logical that banks and financial institutions will be naturally inclined to focus their resources on their portfolio of larger corporations, which are of a higher credit quality, as opposed to the riskier SME banking departments.
It is often said that the banking industry is a very conservative and clinical one. Banks do not have a soul, and are often ruthless and mechanical in decision making. The truth to the matter is that banks and financial institutions are in business to turn a profit as well. As such, it is the responsibility of borrowers to prove their credit worthiness to potential lenders.
Over the years, the small business financing segment has become an increasingly difficult market for lenders, what with the bearish economy and a significant global increase in non-performing loans amongst the SMEs. The majority of startups have short life spans and most banks will only consider lending to an SME with at least 2-3 years of operational experience. In spite of government initiatives to booster SME lending in Singapore, with schemes like the SME Working Capital Loan and the SME Micro Loan, where the goal was to provide SMEs with easier access to bank loans, it still does not solve the problem entirely. The most prominent problem that SMEs in Singapore face till date is still the lack of available credit, despite government efforts to introduce initiatives like the various grants and programmes that are targeted to help SMEs re-invent themselves amidst a new economic climate. These measures and initiatives are among the most generous in Asia.
A plausible way to work around the problem of credit unavailability for SMEs, is to incorporate a hybrid of model of debt and equity financing, such as with convertible loans. While perceived as risky, the smallish nature of the small medium enterprise would also mean that there is a good chance for growth, perhaps even to exponential levels. As such, in an event that the borrower is unable to keep up with monthly repayments, holding equity in an SME could possibly turn out to be a good investment if the borrowing company performs well eventually. However, most SME owners would prefer debt over equity as most do not want to dilute their shareholding and ownership of the company.
While providing funds to businesses is the function of venture capitalists, equity investors and the banks, the approach that venture capitalists and equity investors take is entirely different from that of the banks. Unlike the banks, venture capitalists and equity investors do not have the pressure of ensuring timely repayments from the businesses they provide funding for. To the investors, they view their returns as a long term gain, while the banks view their earnings as ranging from short to mid-term gains.
Equity investors tend to spread their investments across a wide span of startups, as they know that the wider the scope of their portfolio, the higher the chances of at least one of these startups becoming hugely successful. The general idea of the equity investor is that he/she does not need to be correct in all investment choices, because all that is needed is to get ONE right, and the returns from that one startup could very well make up for losses incurred from previous investments.
A good example of a successful equity investment can be seen in the case of the stake that Masayoshi (son of family owned SoftBank) bought into Alibaba, which ultimately gained him a profit of 2,500 times his original investment.In the case of debt financing however, the success of a company has absolutely no bearing on the returns to the lender.
Finally, in order to alleviate the problem of inadequate financing for SMEs in Singapore, it is imperative for the government to work closely with the SMEs, banks and financial institutions. A deeper and more recent study should be done to thoroughly understand the financial availability of credit, especially for SMEs that have to operate in the midst a dull global climate. A big issue that remains, is that such a prolonged period of economic staleness is unprecedented. No one really knows when the economy will recover and perhaps, even boom again.
Therefore, the question remains, for how much longer can the government continue to encourage the banks and financial institutions to continue lending to the SMEs in Singapore?