New credit guarantee scheme approved by Bangladesh Bank

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In a bid to support the cottage, micro, and small enterprises (CMSEs) mired in financial difficulty due to Covid-19, Bangladesh Bank approved a credit guarantee scheme (CGS) worth Tk 20,000 crore on July 23, 2020. Subsequently, the CGS Unit of BB issued a circular on July 27 defining the scope and detailing other areas of the scheme such as for example, the eligibility conditions for scheduled banks and finance institutions (FIs) as well for enterprises, application procedure, fee structure, tasks of the scheduled banks and FIs, claim settlement, etc. Following implementation of the scheme, CMSEs which neglect to meet up with the collateral requirements of the banks or other FIs, could be given the support from the CGS. Although late, it has taken care of immediately the long-standing market demand for such a scheme providing third-party credit risk mitigation to CMSE lending institutions.  

The timing of the CGS introduction marginally follows those introduced in Kenya and Colombia. At the same time when credit risk is heightened and lenders have become more risk-averse, especially when it involves lending to the CMSEs, the introduction of CGS holds promises. However, I would like to discuss several factors that the Bangladesh Bank should think about in order to make certain that the CGS achieves its expected goals.

The CGS in Bangladesh, modelled as a Hybrid Portfolio Partial Credit Guarantee Scheme is, generally, a well-designed scheme that ensures all parties have a skin in the overall game. To avail themselves of the CGS facility, first, banks and non-bank finance institutions (NBFI) have to make an application for participation in the CGS programme. After signing up for a 5-year long agreement, FIs will need to pay an initial gross annual fee called guarantee fee of just one 1 percent of the total value of a person loan to avail themselves of the guarantee for that loan. This payment will be lower for subsequent years for a guaranteed loan if the FIs can maintain a non-performing loan (NPL) rate of 5 percent or less. If financing beneath the CGS goes bad, a participating FI are certain to get 80 percent coverage of a credit directed at an individual or a company while the FI will have to bear the chance of 20 percent of the loan amount. While assessing loan applications, FIs are required by the CGS to adhere to their internal loan policies. As the newly introduced CGS is predicated on these conditions, there are other nitty-gritties of the scheme an interested reader can simply research from BB's SMESPD Circular No 03.

As the design of the CGS is mainly in line with international best practices, there is an chance for the CGS to benefit from certain reparameterizations. One of the main eligibility standards that an FI must fulfil to be able to take part in the CGS is at the least three years of SME lending experience. As the intent is clear from BB-ensure that the guarantee is open to appropriate FIs which know how to manage SMEs-the policy will not give a clear guidance as far as the definition of "SME lending experience" can be involved. Will an FI that has been lending to SMEs for 5 years, with SME loans constituting only 0.05 percent of their portfolio, meet the requirements to take part in the scheme? Let`s say that the response to this question is yes. Next consider another FI which started lending to SMEs only 24 months ago, but already comes with an SME portfolio that makes up about ten percent of its total loan portfolio. Why would the next FI not qualify for the CGS facility despite having a more substantial share of SME portfolio? They are some practical conditions that may arise down the line and BB have to consider them in advance in order to avoid hiccups during full-fledged rollout of the scheme.

Another CGS eligibility criterion for FIs stipulates that only those FIs which maintained an NPL rate of 10 percent or less in the preceding year will qualify for CGS participation. However, this criterion along with the aforementioned one usually do not connect with state-owned banks. It has an essential implication for creating a non-level playing field for banks. Specifically, this sends a wrong signal to the marketplace where commercial banks may see themselves at a disadvantage in comparison to the state-owned banks. To put it differently, a state-owned bank with subpar performance obtaining a guarantee fund will cause a crowding-out influence on the funds that may be offered for better performing non-state-owned FIs. Moreover, this differential policy may further exacerbate the moral hazard that state-owned banks in developing countries often exhibit. As the very least, BB may consider imposing conditions on state-owned banks (with NPL rate exceeding 10 percent) to improve their internal control and loan underwriting policies before allowing them to avail themselves of the CGS facility.

Another design related aspect that requires attention may be the claim settlement process whenever a guaranteed loan defaults. The success of any CGS scheme depends critically on the simple this process. As a way to motivate the FIs to use CGS, the claim settlement process shouldn't be complex, time-consuming, or costly. Consistent with international guidelines, the CGS in Bangladesh requires the lending institutions to make all possible efforts to recover a loan as they would have done for non-guaranteed loans. In addition, the lending institutions must file cases in line with the Money Loan Court Act 2003 (Artho Rin Adalot Ayeen 2003). However, this requirement may act as a deterrent to issuing small loans by FIs.

Commercial banks, specifically, may not find it financially appealing to lend to small borrowers if they must resort to legal recourses when these borrowers default. Therefore, the CGS may neglect to support the most underserved portion of the borrowers. In this regard, BB may follow the CGS policy germane to claim settlement process stipulated by the federal government of India. According to India's CGS policy, "initiation of legal proceedings as a pre-condition for invoking of guarantees will be waived for credit facilities having aggregate outstanding up to Rs 50,000, at the mercy of the condition that…a Committee of the Member LENDER (MLI) headed by an Officer not below the rank of General Manager should examine all such accounts and have a decision for not initiating legal action, and for filing claim under the Scheme." Bangladesh Bank also needs to consider establishing such a threshold aggregate outstanding for credit facilities.

In order to make certain that lack of interests do not mar the potential of CGS in Bangladesh, a strong awareness raising campaign ought to be designed and implemented to see both supply side and the demand side of the CGS facility. Otherwise, information asymmetry between your lender and possible borrowers may bring about suboptimal use of the CGS funds. In this regard, Bangladesh should take lessons from recent international experiences. For instance, Colombia launched a partial CGS in April 2020 which still has not been in a position to sensitise the banks that have become more risk-averse in terms of lending to the SMEs through the pandemic. While one-time seminars or workshops are useful to introduce the brand new facility, FIs ought to be communicated to at different levels (CEO, manager etc.) regularly such that they are able to retain their rely upon the CGS facility. The same holds true for CSMEs which will be the target of the scheme in Bangladesh.

While CGS gets the potential to channel funds to the portion of the economy which has limited usage of finance, it isn't a panacea for all CSMEs. Reportedly, more than 90 percent of the CSMEs in Bangladesh are informal that are not registered with any government authority and don't maintain any financial records. Subsequently, these CSMEs are highly unlikely to take advantage of the newly implemented CGS since commercial banks usually do not usually lend to informal businesses because of higher perceived risks. To be able to make sure that these CSMEs can buy support from CGS quickly enough, the government should think about designing, revamping, and aggressively implementing financial literacy programmes around the united states which will inspire more CSMEs to become formalised.

Finally, the government may consider enacting a Secured Transaction Law as was already done by several African countries (and in addition some Latin American and Southeast Parts of asia) with Ghana being the pioneer. This will allow the establishment of a collateral registry which will enable FIs to join up their claims on assets pledged as collaterals by borrowers. This will abate the FIs' concerns over the same collaterals being pledged by the borrowers at different FIs simultaneously. In addition to immovable properties such as lands or buildings, regulations may also allow movable properties such as for example laptops, accounts receivables, inventories, etc. to be used as collaterals for loans. Such a collateral registry might not exactly only bring about a reduction (probably a small one) in the risk premium charged by the FIs but may also encourage FIs to improve their lending activity in the CSME sphere without financial support from BB. That is an opportune time for the Bangladesh government to facilitate the establishment of the collateral registry that can be another milestone to attain following the rollout of the CGS. 
Source: https://www.thedailystar.net

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