FINANCIAL SUPPORT FOR MICRO AND SMALL ENTERPRISES (MSEs) IN THAILAND

MICRO AND SMALL ENTERPRISE DEVELOPMENT & POVERTY ALLEVIATION IN THAILAND
Project ILO/UNDP: THA/99/003
WORKING PAPER 4
FINANCIAL SUPPORT FOR MICRO AND SMALL ENTERPRISES (MSEs) IN THAILAND
Mark Paetkau
SERIES EDITOR: Gerry Finnegan
July 1999

Download the "word" version of the paper:thai4.doc

Foreword

I am pleased to see this series of reports as outputs from the recent collaboration between ILO and UNDP in Thailand in the form of the Micro and Small Enterprise Development and Poverty Alleviation in Thailand Project. As the UN agency with special responsibility for employment matters, the ILO is concerned about employment in all sizes of enterprises, in both the formal and informal sectors. The ILO is equally concerned about the quality, as well as the quantity, of jobs created. This point is well amplified in the recent report, Decent Work, by the ILO Director-General, Mr Juan Somavia.

From related studies carried out by the ILO following the financial crisis in East Asia, it is apparent that both the level of employment and the quality of employment conditions in Thailand have been adversely affected by the crisis. Consequently, the work being undertaken by this project is most timely, assessing as it does the role of micro and small enterprise (MSE) development in poverty alleviation and employment creation.

Perceptions of the role played by governments have changed; they are no longer expected to be the principal providers of jobs – jobs are created by successful, well-managed private sector enterprises. However, governments do have a vital role to play in ensuring that the policy environment is ‘enterprise friendly’. The path into enterprise should be smooth, and entrepreneurs should be able to receive relevant advice and support (both financial and non-financial) in a highly effective manner from both government and private sector agencies. The needs of the micro and small enterprise sector should be clearly identified, and linked with a better understanding of the scale and scope of the enterprise sector and its role in national development.

All of these important aspects are addressed in this set of six working papers. Together they provide a substantial body of knowledge and significant inputs for policy-makers and decision-makers in Government, the private sector, international organizations and the donor community, as well as for entrepreneurs themselves.

Given the prominence of the small and medium enterprises (SME) sector in Government policy, this information is being made available at an appropriate time. It is also highly relevant, coming as it does at a time when the ILO is carrying out a Country Employment Policy Review in Thailand, as well as providing support to make its Start and Improve Your Business (SIYB) training materials available for extensive use in Thailand.

W R Simpson

Director, ILO/EASMAT

Bangkok, Thailand

July 1999

Preface
This working paper, Financial Support for Micro and Small Enterprises in Thailand, prepared by Mark Paetkau, has been produced as part of the ILO/UNDP project on Micro and Small Enterprise Development and Poverty Alleviation in Thailand (THA/99/003). A full description of this project can be found in the project document which is available on request.

This series of six working papers is the combined output from the team of national and international consultants engaged by the ILO in Thailand between March and June 1999. Preliminary findings for each of the reports were shared with a group of key informants at a workshop/consultation, held at the Royal Princess Hotel, Bangkok, in May 1999. We are indeed grateful for all comments and feedback received at that workshop. While every effort has been made to ensure the accuracy of the information in these reports, we regret any omission or error contained herein. These working papers are intended as a means of advancing the public debate on the small enterprise sector in Thailand, and the ILO is eager to share this information with the widest possible audience.

The term "micro and small enterprise" (or MSE) is not commonly used in Thailand, as more frequent reference is made to the designation, "small and medium enterprise", or SME. Each of the ILO consultants has made some reference to the issue of definitions of micro, small and medium enterprises, and Paper Six in the series is dedicated to this topic. Therefore, to facilitate a clear and unambiguous understanding of these working papers, we have been at pains to make distinctions between different categories of small enterprises. We believe that the issue of definitions is not simply one of semantics.

One basic premise of this project is that there is a significant number of smaller enterprises which do not fit into the conventional enterprise support programmes of the Royal Thai Government. With targeted forms of support, these enterprises could improve their productivity and competitiveness, make a greater contribution to generating wealth and alleviating poverty among the families of owners and workers alike, and create more jobs.

The ILO has been supporting micro and small enterprise development for more than three decades. In 1998, in a significant landmark event for the Organization, the ILO's Conference - at which Thailand was represented - unanimously adopted a new Recommendation on Job Creation in Small and Medium-sized Enterprises (No.189). Because of its extreme relevance to the subject of our enquiry, we have reproduced this Recommendation as an Annex. Particular attention is drawn to sections 11 (sub-sections a, l, p and q) and 14, dealing with finance and credit for small enterprises. In addition, to coincide with this new Recommendation, the ILO launched a global International Small Enterprise Programme (ISEP) to provide technical assistance for member countries, including Thailand. The work carried out under this ILO/UNDP project is also part of the ILO's ISEP programme.

Gerry Finnegan

Senior Specialist & Series Editor

ILO/EASMAT, Bangkok

July 1999

CONTENTS

Foreword

Preface

Contents

Executive summary

1. Introduction

1.1 Background

1.2 Micro and small enterprises — Defining and distinguishing

1.3 The impact of the financial crisis

2. Sources of finance

2.1 Available resources — Comments and comparisons

2.2 Department of Public Welfare

2.3 Urban Community Development Organization (UCDO)

2.4 Bureau of Cottage Industries and Handicrafts

2.5 Credit unions

2.6 Special government institutions

2.6.1 Bank for Agriculture and Agricultural Cooperatives (BAAC

2.6.2 The Government Savings Bank (GSB)

2.6.3 The Industrial Finance Corporation of Thailand (IFCT)

2.6.4 Small Industry Credit Guarantee Corporation (SICGC)

2.6.5 Small Industry Finance Corporation (SIFC)

3. A comparison of Thailand’s experience with other countries

3.1 Group lending for micro finance

3.2 The role of non-government organizations (NGOs) in micro finance

3.3 Guarantee schemes for smaller enterprises

3.4 Market versus non-market interest rates

3.5 Banking for the Poor (BFTP) Network

4. Recommendations

4.1 Publicize

4.2 Coordinate

4.3 Lower the threshold in specialized financial institutions (SFIs)

4.4 Assess the need for money

4.5 Link finance with training

4.6 Identify the entrepreneurial poor

Annexes:

I Contacts

II Bibliography

III Book review

IV The "credit crunch" in East Asia?

V ILO Recommendation concerning General Conditions to Stimulate Job Creation in Small and Medium Enterprises, 1998 (No.189)

Executive Summary

The terms of the consultancy outlined by the International Labour Organization (ILO), called for a review of existing sources of finance for micro and small enterprises with particular reference to major urban areas, and for recommendations for improvements in the provision of credit and other forms of financial support services, so as to meet unsatisfied demand for credit and to identify innovative approaches to credit provision and "best practices", with case studies as appropriate.

I believe there are adequate resources to accommodate increased lending to micro and small enterprises. In the Government Departments, other organizations and institutions profiled in this report - not an exhaustive list of micro and small enterprise finance sources - I found there is a very significant capacity to expand lending through an impressive network of offices throughout Thailand.

Further investigation needs to be carried out before I can confidently conclude that there is unsatisfied demand for credit. A preliminary and descriptive needs survey of 76 micro and small enterprises in Bangkok completed by this same ILO project ranked difficulties in arranging start-up funding as the major obstacle, but not by a wide margin as compared to other difficulties such as location and staffing.

Existing institutions with a mandate to finance small and medium size enterprises (SMEs) could expand lending activities to cover some of the smaller enterprises than are now routinely considered. The steps necessary to do this include policy changes, the addition of micro and small enterprise (MSE) advisory units and staff training.

Existing institutions, organizations and Government Departments which lend to microenterprises need to publicize their services, and they need support to enable them to provide vital training to micro entrepreneurs. Market knowledge, marketing skills and very basic business management skills are priorities.

Best practices in micro finance include: group-based lending in which loans to individual members are guaranteed by the group; a requirement that loan amounts be based on a multiple of a members’ savings in the programme; the application of market rates of interest to at least cover operating costs; and intense and transparent monitoring. In many cases non-government organizations (NGOs) have proven to be most effective in micro finance delivery.

In Thailand’s case, group-based lending is a feature of a number of micro finance programmes. A savings requirement is not common and below-market rates of interest are charged by most Thai micro finance lenders. NGOs are not involved to any large extent in micro finance lending, perhaps because Thailand has a well-developed network of finance providers throughout the country.

Guarantee schemes to support small and medium-sized enterprises who cannot meet banks’ collateral requirements have been used in many countries. Thailand’s Small Industry Credit Guarantee Corporation (SICGC) provides guarantees to banks but the qualifying conditions exclude small enterprises with no conventional collateral. Risk sharing, another key element of successful guarantee schemes, is missing in Thailand’s case. For small loans SICGC will guarantee the entire unsecured amount.

Note: Recommendations are listed in section five.

1. Introduction

1.1 Background

This is the fourth working paper commissioned by the International Labour Organization (ILO) under its UNDP-funded Support for Policy and Programme Development (SPPD) Project on Micro and Small Enterprise Development and Poverty Alleviation in Thailand. The companion working papers in this series (a set of six in all) look at the problems and needs of micro and small enterprises (MSEs) in Thailand, outline the activities of support agencies and best practices in MSE development and review the policy, legal and regulatory environment.

This report is based on a four-week assignment during which the consultant met with a range of Government departments, organizations and institutions that offer financial support to MSEs, and researched some of the considerable volume of writing on micro finance. The report also draws on the consultant’s experience as a commercial banker in Canada, Japan and Thailand, and more recently as a consultant to development assistance projects supporting small and medium-sized enterprises (SMEs) in Viet Nam and Lao PDR.

This report begins with observations on some of the organizations active in lending to MSEs. The list of organizations reviewed is not exhaustive; however, I believe that many of the issues in micro and small business lending are evident in this review. The report then suggests recommendations which might improve access to finance for MSEs. Lest this seems presumptuous on the basis of the limited time available for research, let me say that these recommendations are offered only to begin serious discussion and to invite further investigation. Dialogue is critical in that any recommendations will succeed only if adoption is supported by the necessary policies and regulation, and if they are consistent with the Thai business and cultural environment. The report concludes with

Add precision to the definition of micro, small and medium sized enterprises, a subject addressed in an earlier working paper prepared for this SPPD project. From a financing perspective, a sharper definition is important because as the characteristics differ, so too do the methods of financing differ as between micro and small, and small and medium enterprises.

Clarify the structural and operational differences between microenterprises and small enterprises so that enterprises can be matched with the most appropriate sources of finance.

Look at and research the needs of enterprise owners. A small survey was completed as part of this project but much more could and should be done. Furthermore, such studies need to be carried out on a continuous basis, rather than in an ad hoc manner.

In terms of definitions, the case for clarity is well made in another working paper commissioned by this project. In terms of expanding financial support, clearer definitions might encourage existing institutions with a mandate to lend to SMEs to include some smaller enterprises than are now routinely considered. [Expanding this further to microenterprises would seem unlikely - Editor's note] For example, I believe Thai leaders think of SMEs as small manufacturing companies, probably export oriented - if not directly, then through a sub-contracting link with a larger manufacturing enterprise that is exporting. This definition is quite limiting. If lenders were encouraged to consider SMEs defined only by size, as a combination of capital and number of employees, more enterprises might qualify for loans.

There are important differences between financing microenterprises and smaller businesses which follow from the smaller transaction sizes and lack of operational structure inherent in microenterprises. In fact the use of the term "microenterprise" implies more structure than may actually exist. Some microenterprises are likely not to be enterprises at all, according to current common definitions of SMEs.

We can look for a moment at certain types of individual or family-based microenterprises. The microenterprise is probably owned by an individual, perhaps supported by one or two family members, engaged in income-generating activity. It is likely to be a trading activity; selling food or clothing in street stalls or making and selling handicrafts up-country. There is likely to be very little investment in fixed assets, inventory investment would be minimal, and the business may operate on a cash only basis as there may be no trade credit extended by suppliers. Enterprise sales may not be distinguished from any other kind of income the individual or household earns. These "enterprises" may be quite unstable and footloose. If better opportunities arise or if costs cannot be covered the individuals involved may move on. This situation can be based very much on a "hand-to-mouth" existence.

To a banker, financing a microenterprise is effectively seen as personal lending. Micro financing seems to work best on a group basis; that is, with individual loans guaranteed by group members who have a strong common bond and where loans are linked to a savings component. In this situation borrowing becomes a right for the group member who has accumulated savings. Given the smaller transaction sizes, the pressure not to let down the group and, usually, quite intensive monitoring by a micro finance organization, the process works well. Borrowers can at a minimum improve their personal situation and the risk of non-payment is relatively low.

A small business, by contrast, usually has an existence separate from that of the owner. The business may be incorporated or conducted as a sole proprietorship. Continuity would be anticipated. There would be some level of investment, if not in fixed assets then in inventory. It is likely that employees would include non-family members. One would expect business finances to be separate from the finances of the owner and her or his family.

Financing a small business usually involves lending to a separate entity with loans supported by a guarantee of the principal(s). The lender assesses the borrower’s financial information, past record, value of collateral, and a simple business plan.

This report examines the sources for financing micro and small enterprises - the supply side of MSE development. I do not at this stage have a clear picture of the needs of MSEs - the demand side of the equation. However, this SPPD project did carry out a survey in an effort to get a preliminary understanding of the issues and concerns facing MSEs. Seventy-six micro and small enterprises were surveyed. In addition to descriptive questions, the survey asked enterprise owners to:

list sources of investment;

categorize the difficulties experienced in starting and registering their businesses;

describe the technology applied;

classify sales ranges;

list institutions which had provided financial support;

define business development assistance received and desired;

state whether they were members of associations of like-minded enterprises and whether association support would be useful;

describe any legal and regulatory constraints they faced; and

answer questions designed to assess entrepreneurship potential.

Difficulties in arranging start-up funding generated 36 per cent of all responses, when owners were asked to identify problems experienced in establishing their businesses. By comparison, 29 per cent of the responses reported difficulties in finding a location as the greatest difficulty, 26 per cent reported no difficulties and 10 per cent reported difficulties in finding skilled workers as the most important issue.

In terms of sources of investment, 55 per cent of the respondents funded their enterprise with their own funds, 13 microenterprises, or 17 per cent of the survey group, obtained funding from a government source, and 15 small enterprises, or 20 per cent of the survey group, borrowed from a bank.

It is often assumed that lack of financing is a major constraint for MSEs, thereby limiting the growth of smaller enterprises. The responses to the project survey are not definitive in confirming this assumption. Even if true, there is a need to confirm that lack of financing means exactly that. It could mean that enterprise owners lack the necessary skills to manage with the capital they have or to manage enterprise cash flow. The "lack of financing" answer may also reflect the principals’ inadequate market knowledge when setting up their enterprises. That is, sales may grow more slowly than assumed and the initial funding may therefore not be sufficient to finance operations in the meantime.

1.3 The impact of the financial crisis

In the best of times SMEs frequently have difficulty getting loans approved. Enterprise owners believe that banks are too focused on collateral. Bankers agree that the bsence of usual collateral is an issue but add others: the inherent higher risk of business failure among SMEs, a lack of complete and accurate financial information, lack of marketing know-how, and the absence of business plans. The current financial crisis has made it even more difficult for SMEs to arrange loans because banks now have an exceptionally high per centage of non-performing loans (NPLs) which weigh heavily on lending officers. In this situation, lenders become very risk averse and extremely cautious in assessing new lending proposals, even if the conditions present would have justified approval prior to the financial crisis.

The devaluation of the Baht in July 1997, preceded as it was by a significant slowdown in export growth and a build-up of excess capacity, caused severe problems for borrowers and banks which have been well described in the national press, and thoroughly analyzed by academics and development institutions both nationally and throughout the world. Non-performing loans, now defined as those loans on which interest has not been paid for at least three months, are reported to average between 40 per cent and 50 per cent of total commercial bank loan portfolios.

In order to begin to deal with the problem, the Bank of Thailand has directed the banks to set up reserves for losses on their loan portfolios. All loans are to be classified in one of six categories: pass, special mention, substandard, doubtful, doubtful or loss, and loss. Banks are to deduct a specified percentage from each category and credit the aggregate amount to a reserve for losses account. A deduction of one per cent is to be applied to loans rated "pass," two per cent is to be deducted from loans rated "special mention," 20 per cent from loans rated "substandard," 50 per cent from loans rated "doubtful", and 100 per cent from loans rated either "doubtful or loss" or "loss."

Immediate application of the new rules would have an extremely negative effect on bank earnings and capital. Therefore, the Bank of Thailand is phasing in the new rules; at the end of 1998 banks were to set aside at least 20 per cent of the full allowance required. The reserve for losses for most commercial banks now exceeds the Bank of Thailand minimum, but the gap between a prude nt level of reserves based on what the banks are reporting to the media and actual reserves is understood to be immense. Narrowing the gap depends on a combination of strong earnings and raising new share capital.

Loan growth has slowed dramatically from the double-digit rates which were customary before the financial crisis. Deposits at banks have increased significantly, partly because the closure of 56 non-bank financial institutions caused depositors to move their accounts to relatively safe institutions. In addition, immediate post-crisis interest rates were high to defend the currency, and the absence of safe alternative investments added to the attractiveness of bank deposits.

The combination of lower-to-flat loan growth and the increase in deposits has created surplus liquidity in the banking system. An ancillary effect has been a significant increase in banks' interest margins as deposit rates have dropped further than lending rates. The spread between the fixed deposit rate and the minimum lending rate, for example, is now between 4-5 per cent, which is exceptionally high. What would seem a great benefit to bank profits is not however, since interest is not being collected on a large per centage of the portfolio - i.e. the non-performing loans.

Banks are totally preoccupied with the bad debt problem. In addition, it would appear that opportunities to invest surplus liquidity are limited. Considering the excess capacity in the industrial and real estate sectors, good lending opportunities are hard to find. The excess capacity directly affects many SMEs to the extent they act as suppliers to many major manufacturers most severely affected by the crisis. In this climate, it may be unrealistic to expect bankers to expand their lending to any sector, least of all to SMEs which are perceived to represent higher risk lending. [And still less to MSEs - Editor's note.]
The resolution of this situation is not easy to find. One need only look at Japan where banks have yet to fully deal with non-performing loans which originated some 10 years ago. In Thailand loan restructuring is proceeding slowly, and new legislation governing bankruptcy and foreclosure has been passed. Apparently the necessary operating regulations to make the new laws effective are still pending.

The greater challenge to effective resolution of the non-performing loan problem might well be a cultural one. In some countries business failure is routine, as is foreclosure action by lenders with a court judgement or under the terms of loan agreement. Shareholders and management accept the losses as part of the occupational hazard of being in business, and get on with their other activities. Companies are institutionalized: that is, they are separate legal entities that have a life beyond that of their owners. In Thailand, by contrast, it is hard to separate the personality of the owner from the actual business, regardless of the size of the latter. Foreclosure action, or even accepting a price for assets lower than book value, is likely to be seen as a personal insult and therefore can be very hard to accept. Effective dispute resolution is not common in Thailand, and this is only partly a function of legislation and regulation. It remains to be seen how lenders and borrowers will manage the bad debt problem which is an essential prerequisite to the growth of new loans, including an expansion of lending to SMEs.

[Note: Quite a lot has been written about the possibility of a "credit crunch" in Asian economies, following on from the financial crisis. However, as stated in 2.3 above, there is significant over-capacity in Thailand at the moment. For readers interested in this subject, I have added a recent article on this topic in Annex 6.4 - Editor.]

2. Sources of finance

2.1 Available resources — Comments and comparisons

The government departments, organizations and institutions reviewed here were selected because of their specific focus on lending to micro, small and medium-sized enterprises. [Note: Schemes operated by the Ministry of Interior are not included in this report – Editor’s note.] I did not interview commercial banks, partly because time was limited, and partly because I believe, as explained in 2.3 above, that banks are not currently likely to be receptive to expanding their lending to this sector. I also believe that the more formal small enterprises do have access to commercial bank financing, provided usual collateral conditions can be met.

At present the Royal Thai Government is strongly encouraging all lending institutions to increase lending to micro, small and medium size enterprises. For example, the Ministry of Finance has set targets for 1999 for SME lending at the Government-owned specialized financial institutions (SFIs) as follows: BAAC - 500 million Baht; Government Savings Bank (GSB) - one billion Baht; Industrial Finance Corporation of Thailand (IFCT) - 12 billion Baht, and Small Industry Finance Corporation (SIFC) - three billion Baht.

My findings suggest that there are sufficient resources to finance a very significant increase in loans to micro and small enterprises. Admittedly, we do not have a thorough survey of needs so as to be able to speak confidently about any gaps that exist between the supply of funds and the demand. I can say that there are substantial funds available through the departments, organizations and institutions reviewed here. I can also say that with their extensive networks of offices and branches — the financing sources reviewed here have in aggregate in excess of 2,800 offices and branches — no area of Thailand is without actual and potential financing sources.

The following table (Table 1) summarizes the supportive role played by departments, organizations and institutions that are reviewed in this report, in terms of four key factors:

Table 1.

Organization	Below market interest rates	Lend to micro-enterprises	Lend to SMEs	Non-traditional collateral
Bank for Agricultural and Agricultural Cooperatives		yes		yes
Bureau of Cottage and Handicraft Industries	yes	yes		yes
Credit Unions		yes
Department of Public Welfare	yes	yes		yes
Government Savings Bank			yes
Industrial Finance Corporation of Thailand	yes		yes
Small Industry Credit Guarantee Corporation			yes	yes
Small Industry Finance Corporation			yes
Urban Community Development Organization	yes	yes

2.2 Department of Public Welfare (DPW)

The Department administers five small enterprise promotion loan and grant projects which, as expected and consistent with the Department’s mandate, are designed to alleviate poverty and to empower the poor and disadvantaged. Although funds are often given as non-repayable grants or interest-free loans, DPW monitors repayment and even takes guarantees in some cases in an effort to encourage a business-like approach by recipients.

In addition to existing programmes to assist the poor, the Department earlier this year proposed setting up a Bank for the Poor. An article in the March 14, 1999 edition of the Bangkok Post, reported that the proposed bank would offer long-term loans with lower rates than those charged by commercial banks, and that clients would also be offered financial advice. I understand this idea has now been shelved. Instead, the Department’s Fund for Mitigating the Impact of Lay-Off and Unemployment will be expanded by 2 billion Baht. The maximum individual loan will be doubled from the current 15,000 Baht.

Ministry of Finance officials subsequently advised that as an alternative to the Bank for the Poor, legislation has been drafted to establish a Community Organizations Development Institute which is to be modeled on the Grameen Bank concept. The Grameen Bank is a non-government organization established in Bangladesh in 1976 which focuses on lending small amounts of money to women in rural villages. No further details of how this new initiative will function were known at the time of writing.

The Department of Public Welfare’s Small Enterprise Promotion Loan/Grant Projects are summarized below.

Figure 1.

Project:	Amount:	Target group:	Laid-off workers and unemployed; people adversely affected by economic conditions
Description:	This programme, started in 1998, was recently expanded to include group lending. The maximum individual loans can be pooled to operate a group business where profits are shared. Activities that groups have begun to date include: hawker trade, flower making and food processing. The Community Services Department of DPW monitors results through a quarterly questionnaire administered to recipients.
Figure 2.
Project:	Occupational Assistance Revolving Fund
Amount:	Up to 10,000 Baht, interest free, repayable over five years
Target group:	Low income individuals who are caring for a child or other person, who have the capacity to repay from the investment, who are unemployed, and who have repaid any other loans from the DPW.
Description:	The fund is designed for investment in small enterprises, although a borrower can use the funds to repay previous debts caused by a business loss. To date, typical investments have been in selling food or snacks, small grocery outlets and lottery ticket sales. Since August 1998, an average of 150-200 people per day have applied for loans under this programme.

Figure 3.

Project:	The Fund for Mitigating the Impact of Lay-Off/Unemployment
Amount:	Up to 15,000 Baht, interest free, repayable over five years
Target group:	Unemployed or laid-off workers who do not have their own funds for investment and who can arrange a guarantee from a state official or other employed person.
Description:	The fund is designed for investment in small enterprises, although a borrower can use the funds to repay previous debts caused by a business loss. To date, typical investments have been in selling food, groceries, clothes, accessories, handicrafts and repair shops. DPW reports that loan recipients lack skills in management and marketing.

Figure 4.

Project:	Revolving Fund for Job Creation for Women
Amount:	Up to 15,000 Baht, interest free, repayable in one year.
Target group:	Women who meet the following conditions: - are members of a group who have taken DPW vocational training; - have low income and no savings for investment; - who intend to apply their vocational skills in their communities; - who agree to follow the DPW’s loan conditions; and, - the group has received an order for their production.
Description:	The intent is to encourage women who have completed DPW’s vocational training to group together in their communities and borrow money to invest in a home-based business. Businesses started to date include: gem-stones, dress-making, leather products, traditional weaving and trading. DPW reports that the demand for products made by the groups is too small, although the Government has directed State Enterprises to purchase fabrics made by the groups.

Figure 5.

Project:	Loans for Self-Employed Business Investment Projects for People with Disabilities
Amount:	Up to 20,000 Baht per person, interest free, repayable over five years.
Target group:	Registered disabled persons over 15 years old.
Description:	Experience to date indicates that the income-generating activities considered by the target group are as described for the other projects, with the addition of farming and animal raising.

Since DPW financing is based on need and not on the business case, its experience might be useful in identifying the characteristics of successful microenterprises. That is, one way to develop lending criteria is to give a loan to anyone who applies and then track the results to determine which characteristics and conditions present at the outset best correlate to eventual repayment and to business success. Lessons from the DPW experience could be applied by institutions whose mandate is to lend to micro and small enterprises on a sustainable, commercial basis.

2.3 Urban Community Development Organization (UCDO)

The UCDO was established in 1992 under the National Housing Authority to implement an urban poor development programme. UCDO seeks to work with the estimated 1.4 million urban poor residing in more than 2,000 low-income communities. The major issues faced by the urban poor are a lack of security in housing, and the lack of opportunities and financial resources. UCDO’s mandate can be summarized as follows:

To encourage development of savings groups, cooperatives and savings group networks;

To support group development through skills training and training in savings group mechanism;

To support income generation within the community;

To provide loans for development to savings groups; and,

To support communities in preparing a sustainable development plan.

UCDO funds the urban poor through providing four types of loans to groups, which in turn lend to their members. (Table 2.)

Table 2. UCDO Loans for groups

Loan Type	Purpose	Rate	Term
Revolving	Emergency loans	10%	Up to one year
Income generation	Business investment	8%	Up to five years
Housing projects	Land and building: - up to 150,000 Baht - 150,000 to 300,000 Baht	3% 8%	Up to 15 years
Housing renovation	Repair and extension	10%	Up to five years

As at 31 March 1999, there were 822 member communities/organizations in UCDO; 436 in Bangkok. Some 534 members reported savings activity with deposits totalling 459.62 million Baht ($13.2 million).

Since its inception the UCDO has approved loans totalling 787.78 million Baht ($21.3 million), and reports a loan recovery rate of 91.5 per cent and non-performing loans of 25.59 million Baht ($692,000). By category, loans for housing projects accounted for 53.8 per cent of approvals, and loans for income generation - the probable microenterprise component - accounted for 23.4 per cent and constituted the second-largest category.

For the year ended 30 September, 1998, UCDO reported net income of 95.49 million Baht ($2.6 million) on revenue of 150.60 million Baht, 84.9 per cent of which came from funds UCDO has on deposit with other institutions. Expenses including loan loss provisions of 27.45 million Baht totalled 55.12 million Baht, or 36.6 per cent of revenue.

In UCDO’s experience there are significant differences in developing the group concept in urban settings, as compared to rural settings where micro finance institutions such as the Grameen Bank have been so successful. As UCDO sees it, the common bond is much stronger in a rural village where group members are likely to be engaged in production of the same crop or engaged in the same activity. Rural communities are quite stable and members have common needs, such as marketing support and training in the same skills.

Urban groups on the other hand are more fluid. Members move out in response to job opportunities or loss of jobs. The common bond is not strong; income generating activities can be quite varied and there is no long history of relationships to draw on. The kind of support services needed may not be common among group members. UCDO faces a challenge in building sustainable groups, since group activities may be quite different and in some case members may even be in competition.

The financial crisis has increased the volume of problem loans which has in turn contributed to the failure of some groups. Members have lost jobs as factories closed or have been forced to operate at a lower capacity, and many have returned to their up-country homes. Groups have also failed due to a "fake savings" problem. In order to quickly qualify for loans, members in some new groups apparently raise money elsewhere to meet the savings criterion of the group. The source of the savings needs to be paid back, leading to what bankers call a "kiting" scheme, using one loan to pay off another. Another effect of the crisis has been a reverse migration; urban poor who now have few job prospects are returning to family homes up-country, and this too makes it difficult to sustain group development in poorer urban communities.

It is interesting to note that community groups are apparently not capable of evaluating larger income generating loans. That is, initial small loans are given as a matter of right to group members. Loans for business purposes however, depend on the feasibility of the proposal. Not only are group members not sufficiently knowledgeable to make an assessment of a business proposal, but UCDO does not have the expertise to train them. There is a strong need for advice and assistance on how to manage and how to plan with the market in mind.

In my view, UCDO is well placed to expand support for microenterprises. UCDO has experience in group development, the problems particular to urban groups are well understood in UCDO, and the organization has the financial resources to expand its activities. UCDO reports that it has 822 member communities which represents 41.1 per cent of the reported 2,000 urban poor communities in Thailand. There is room to grow. Also of note, UCDO has total assets of 1,669.04 million Baht ($45.1 million), 67.9 per cent of which - or 1,133.77 million Baht ($30.6 million) - is invested in cash or bank deposits. This would suggest there is room to e xpand the lending portfolio as well.

2.4 Bureau of Cottage Industries and Handicrafts

The Bureau of Cottage Industries and Handicrafts, part of the Department of Industrial Promotion, Ministry of Industry, administers a revolving fund established 10 years ago to support microenterprises up-country. While some loans are made in Bangkok, this would only be the case if annual targets for loans could not be met in up-country areas. Outstanding loans now total approximately 200 million Baht ($5.4 million) and borrowers number about 2,000.

Loan amounts, collateral, terms, rates and the approval process, can be summarized as follows:

Approximately 80 per cent of loans approved are for 50,000 Baht ($1,351) or less. Conventional collateral — land and equipment the former with a lending value of 80 per cent of the value as established by state land office — is required for loans of 100,000 Baht and above. For smaller loans group guarantees are taken. Personal, direct guarantees are the weakest of the three forms of collateral.

Loans of 50,000 Baht and below must be repaid in 2 years; larger loans can be extended for up to 10 years. The current interest rate is six per cent per annum, except for larger loans made to villages for community development — up to 10 million Baht — which are charged a rate of 4 per cent.

There is a long queue for loans, the turn down rate is negligible, and the approval process takes 2-3 months, although regulations require approval in 15 days. Eligible borrowers who must have been a group member for at least six months, are those in the handicraft business or running small-scale enterprises with less than 100 million Baht in fixed assets.

Borrowers may apply at any of the 75 Provincial Offices of the Ministry of Industry or through one of 11 Regional Centers. Provincial offices can approve loans up to 50,000 Baht, Regional Centers up to 100,000 Baht on the authority of the office head, and 300,000 Baht with approval of a regional credit committee. The head office credit committee deals with loans above 300,000 Baht, up to a maximum of one million Baht. There is a special limit of 10 million Baht for loans for Community Development which are also approved at Head Office.

Loans are funded by the Government and through regular repayments of the existing portfolio. Some 20 per cent of the loans are in arrears, although arrears are not precisely defined. No loans are written off. It seems that legal action is taken against delinquents but that settlement is usually achieved before judgement. Typically it takes four years to get to this stage.

As a Government fund, it seems borrowers feel they have the right to a loan; hence the fact that very few loan applications are declined. Thais seem to feel that support from their Government must be on more favourable terms than the market - i.e., that is the presumed nature of the operation of governments; hence a below- market rate is expected on loans from the fund.

Subsidized loans may not be an issue from a poverty alleviation perspective, but could be from a development perspective. If a microenterprise is to grow and graduate to the point where access to the formal financial sector is possible, it needs to be successful in paying market rates, otherwise it has no commercially viable future. In other words, it might be argued that if a micro-entrepreneur cannot make a case for her or his business based on market rates, she or he should not be in business.

2.5 Credit unions

Credit unions, with a history of 150 years internationally, and 30 plus years in Thailand, were engaged in micro finance before the phrase was commonly used. It could also be argued that credit unions pioneered the concept of combining savings and credit — one must be a share owner and depositor in order to qualify for a loan. Since members' savings and share purchases are usually the only source of funding for loans, credit unions are designed to be self-sustaining, although credit unions sometimes fail due to weak management or adverse economic conditions in the community where the credit union is based.

There are some 1,267 credit unions in Thailand grouped in two organizations: the Credit Union League of Thailand (CULT) with 642 member unions, and the Federation of Savings and Credit Cooperatives of Thailand, Ltd., FSCT, with 625 member unions.

There are no minimum loan sizes and the maximum loan depends on each credit union’s policy. Current interest rates are 12 -15 per cent p.a., and the maximum term is usually three years. Borrowers, who must be members of a credit union for six months before being eligible for a loan, are required to pledge their share capital and provide at least 2 guarantors. Loans are made to individual members only [and, therefore, presumably groups or group-based enterprises are not eligible for loans - editor's note]. I understand regulations prohibit loans to corporate borrowers.

Soon Klang Thewa Credit Union Cooperative Limited, formed in 1965 to get the residents of the Din Daeng community in Bangkok out of the grips of money lenders, fits the traditional model of a credit union. Membership is open to community residents only. There are 1,028 members now, a figure that is quite stable historically but down since the crisis as community members have moved out of the district to seek better opportunities. Some features of the membership of this credit union are: 71 per cent of the members are women, 67 per cent are under 40; 61 per cent are wage earners and 25 per cent are merchants and vendors.

In each of the past three years "loans for investments" — which represent microenterprise financing — constituted the largest number and value of the 10 categories of new loans made. For example, in 1998 some 1,342 loans totalling approximately 19 million Baht ($514,000) were granted. Loans for investments represented 27 per cent of the number of loans, and 33 per cent of the value. The average loan size in the investment category was 16,925 Baht (or $457). Loans for housing and debt repayment are the next largest categories.

Lending authority is vested in the five-member credit committee. The manager can only approve emergency loans to a maximum of 5,000 Baht, and can lend up to 10,000 Baht provided loans are within 90 per cent of the value of the borrowers' share investment. Current lending rates are 13 per cent for emergency loans and 14 per cent for all other categories. The interest rate on savings deposits and share investments is five per cent. The spread is wide because of high "service" costs. This includes life insurance to cover outstanding loans on the death of the borrower, and a further payment of two times the share investment; medical costs for members up to 3,000 Baht each per annum; and death expenses — 10,000 for burial expenses and 3,000 Baht to each immediate family member.

Credit unions are governed by the Cooperative Law administered by the Ministry of Agriculture, with the Cooperative Promotion Department and Cooperative Auditing Department having direct responsibility. It seems that there are few regulations affecting credit unions - e.g. the amount of reserves maintained and collateral requirements depend on each Credit Union’s policy. There is no effective central bank for members of the Credit Union associations, but there is an "inter-lending" programme to enable member unions with excess liquidity to lend to union members elsewhere.

Branch managers have very limited credit approval authority, normally for emergency loans only. Other loans must be approved by the credit committee of each credit union. CULT advised that their credit union members do not report in sufficient detail to enable one to determine how much of the lending is to or for microenterprises. Loans are classified as "productive", which would include MSEs and loans for self-employment, and "prudential", which would include loans for education, health and general consumption.

Credit unions try and identify the entrepreneurial poor. The process seems to depend on their members building a track record through small initial loans, with the Credit Union providing some training in business planning and management — entrepreneurial enhancement — at an early stage. Credit committees judge the entrepreneurial skills of borrowers, and the committee’s judgement determines whether a borrower graduates to the point where her or his needs should only be handled by the formal banking sector.

My contacts in the credit union movement identified the following issues as most critical for micro-entrepreneurs: lack of marketing skills; no focus on what can be sold; limited ability to build networks; and lack of technical skills, especially in manufacturing which tends to lead to low quality. Finance was not mentioned as the major issue.

As an immediate new source of micro finance, credit unions are likely to have some limitations: growth depends on members building collective deposits, members need to be trained in the credit union principles, and this takes time. Credit unions could be effective in lending for poverty alleviation but less so in lending to smaller businesses. Lack of professional management can be an issue particularly in the assessment of loans for business. A credit committee of peers may not be the best judge of a new business proposition.

2.6 Special government institutions

The following analyses of five Government-owned specialized financial institutions, which have a mandate to lend to SME’s or SMIs, review each institution’s mandate, its lending terms and conditions and briefly describe each institution’s current portfolio. I include a financial analysis and my comments on the present and possible future role of these institutions as providers of financial support for MSEs. My analyses are based on the most recent annual reports available in English.

Bank for Agriculture and Agricultural Cooperatives (BAAC)

i)Mandate The BAAC is a Government bank which extends financial assistance to farmers and farmer institutions through loans for investment in agriculture and in farm-related activities to earn additional family income. BAAC cooperates with Government agencies to promote dissemination of technical knowledge and to prepare several types of development projects for farmers and supports farmers in their marketing efforts.

ii)History

The BAAC was established in 1966.

iii)Ownership The BAAC is owned by The Royal Thai Government

iv)Terms, conditions and process

Terms and conditions for usual lending are as follow:

Interest rate: eight per cent up to 16.5 per cent, average 12.5 per cent. Higher rates apply for larger loans.

Operating loans are based on the crop or livestock cycle but longer term loans are made to finance equipment — medium term 3-5 years and longer term up to 10 years.

Loans are based on a group guarantee principle.

The BAAC takes collateral over equipment being purchased with loan proceeds and requires land collateral for loans over 60,000 Baht. The BAAC has 667 branches serving 4.5 million farm family clients — 85 per cent of Thailand’s farm population — through 200,000 groups.

v)Portfolio summary

Outstanding loans by recipient and % of total portfolio are as follows:

Farmers 177 billion Baht ($4.8 billion)91.8%

Agricultural co-ops 16 billion Baht ($4.3 million) 8.1%

Outstanding loans by term, as a percentage of total portfolio are as follows:

Short term 24.4%

Medium term 23.8%

Long term for investment 26.4%

To co-ops for on-lending 7.7%

Financial results Total revenues for the year to 31 March, 1998 were 24.7 billion Baht ($666.7 million), up 31.6 per cent from the previous year. Non-interest income accounted for 6.5 per cent of the 1998 total. Provision for doubtful accounts and debts written off totalled 2.8 billion Baht ($75 million), up 72.7 per cent from 1997.

BAAC’s average interest spread, interest earnings on loans and securities, less interest costs on deposits and borrowings, divided by average interest earning assets, was 2.66 per cent in 1998. This is considerably lower than that reported for commercial banks and lower than that of SIFC. Operating expenses were 80.5 per cent of operating income, exceptionally high by commercial bank standards but perhaps understandable given the high cost of administering smaller loans. It may also be that BAAC may not be permitted to charge for all its advisory, marketing and group development services.

vii)Commentary on BAAC’s actual and possible role as a lender to MSEs At the present time I would not expect that BAAC would be a source of finance for urban MSEs, the main focus of this ILO/UNDP SPPD Project. My interest was based on two factors: (a) I understood that the Minister of Finance requested the establishment of two "windows" for MSE financing, at the BAAC and the Government Savings Bank, and I wanted to understand the details; and (b) I wanted to determine whether the BAAC’s successful approach to rural lending on a smaller scale could be replicated in an urban setting. [The implications and potential for replication of the GTZ-assisted loan scheme for microenterprises and traders engaged in rural non-farm enterprises are also of interest to ILO - Editor's note.]

The MSE financing window at the BAAC means small loans for non-agricultural purposes will be made to the BAAC’s mandated customer base - i.e., farmers. The purpose is to increase non-farm income. Apparently, farm income is sufficient for most of the BAAC’s customers to live, but off-farm income is needed to enable them to develop and grow. Any size of loan will be considered. Collateral will consist of a group guarantee, the usual practice for all of the BAAC’s loans, with a personal guarantee or conventional collateral as required for larger loans. The BAAC has a target of 2 billion Baht in MSE loans starting July 1, 1999. Staff training is underway. Lending officers, who are used used to assessing loans for farming purposes, will need to be trained in assessing non-farm business applications.

It seems that the BAAC has been quite successful in applying the group guarantee principle in its traditional lending business. In the past five years the ratio of repayment to principal matured - a measure of the recovery rate - has averaged 86.5 per cent. The BAAC has some 4.5 million farm family clients, 85 per cent of Thailand’s farm population, in some 200,000 groups, and it has trained 400,000 group leaders who are elected by members.

Groups can have 5-50 members; the average is 15-20. Groups are based in the same village, and members are engaged in production of the same crop. There is no savings requirement to qualify for a loan; members lose their membership if they default and the group must pay on their behalf.

The BAAC’s mandate is clear and its efforts seem quite focused. As noted earlier, there are some advantages in setting up groups for credit purposes in rural areas. Groups are quite stable and the common bond, such as all being engaged in production of the same crop, is very strong. It is not easy to replicate these conditions in an urban setting. Poor communities in the city tend to be more fluid and transient, and members can be engaged in a wide variety of activities.

The Government Savings Bank (GSB)

i)Mandate

The GSB's 1997 Annual Report defines its mandate as follows: "Infrastructure development is intended to better people’s quality of life according to the GSB’s mission as the people’s bank. Priority is given to the public and private sector which contribute to the national development." The GSB is expanding its lending to community organizations for income-generating activities, together with technical support - e.g. management accounting and preparation of financial statements. Housing loans are also expanding and GSB manages the social investment fund, set up with a World Bank loan, and created following the financial crisis which began in mid-1997.

ii)History

The GSB was established in 1913.

iii)Ownership

The GSB is owned by the Royal Thai Government.

iv)Terms, conditions and process

Terms and conditions for usual lending are summarized below:

Loan sizes: to a maximum of 10 million Baht ($270,000) in the case of private sector borrowers.

Loan purposes: working capital and fixed asset acquisition.

Repayment terms: a maximum of 10 years.

Interest rate: the commercial banks’ minimum overdraft or minimum lending rate plus a spread ranging from 0 to 3.5 per cent. The average yield on loans and fixed deposits with banks in the year ended December 31, 1997 was 15.62 per cent.

Collateral: land, buildings and equipment.

The GSB serves clients through 557 branch offices (as at the end of December 1997).

v)Portfolio summary

Information in the Annual Report for the year ended 31 December 1997 — the 1998 report will be available in September 1999 — is quite limited. Loans on the books of the GSB account for 41.6 per cent of total assets, a significantly smaller percentage than for commercial banks. It is estimated that loans to the private sector, including SMEs, account for 30-35 per cent of total loans. The report records that housing loans account for 18.34 per cent of total loans, and welfare loans to government employees and the general public account for 8.51 per cent of total loans.

vi)Financial results

The GSB’s results and balance sheet differ in several ways from the results and balance sheets of typical commercial banks. As a Government-owned bank, the GSB does not have to maintain reserves. This means the bank can invest more of its liquidity in earning assets, mainly Government and Government-guaranteed securities as well as listed securities. In addition, the Government has directed the GSB to fund public infrastructure projects which probably carry a lower risk than a commercial loan portfolio would. Loans account for a small percentage of total assets - 41.6 per cent at the end of 1997 - although this represented a sharp increase from the previous year and from the average of the past four years which was 19.7 per cent of total assets.

These differences are reflected in very positive results for 1997. The bank recorded a net profit of 6.2 billion Baht ($167 million) or a return on assets of 2.41 per cent, high by most standards and significantly higher than the four year average of 1.53 per cent. The GSB’s interest margin - interest income on average earning assets, less interest expense on interest bearing liabilities, divided by average interest earning assets - was 4.08 per cent. This is also high by most standards. The GSB's efficiency ratio - operating expenses as a percentage of operating revenue - was 39.05 per cent. In sum, GSB is a bank with low cost funds investing in lower risk assets, which in 1997 yielded a high return because of the high interest rates imposed to defend the Thai currency.

The dramatic increase in loans in 1997 — a 108.8 per cent increase from 1996 — may signal problems in the future. Clearly, the GSB was under pressure from the shareholder (RTG) to expand lending, including lending to borrowers having difficulty servicing loans at commercial banks who suffered from the onset of the financial crisis. A rapid increase in loans at any time often raises questions about loan quality, but even more so in the current problems of over-capacity in Thailand.

vii)Commentary on the GSB’s actual and possible role as a lender to MSEs

An article in the Krungthep Thurakit of 3 June 1999, reported on the failure of the GSB to meet its target for SME lending. The article mentions that only 50 million Baht in loans to SMEs had been advanced to date as compared to a target for the year of 1 billion. The reasons given were: general economic conditions, poor public relations, and lack of proficiency on the part of credit approval staff.

Credit training has been given, but the result is not apparent. It seems that the GSB is known as a savings and not as a commercial bank. This has two implications: potential customers may not be aware of the expanded lending activity, and the GSB does not have much institutional experience in private business lending.

Expansion of lending to the private sector generally is a recent change. It will take time for the GSB to re-orient. The potential exists: the bank has a good branch network and a good deposit base. Recently the bank has dramatically expanded its loan portfolio, although at the end of 1997 total loans were still only 46.1 per cent of deposits. This would suggest considerable room to accommodate SME lending. Extensive staff training will be required.

The Industrial Finance Corporation of Thailand (IFCT)

i)Mandate

The IFCT is a Government established bank whose objective is to promote private sector industrial and capital market development. The IFCT provides term and working capital loans, equity investment, loan syndications, guarantees, and financial and investment advisory services.

ii)History

The IFCT was established in 1959.

iii)Ownership

The IFCT is listed on the Thai Stock Exchange - 51.53 per cent of the shares are owned by Thais, 48.47 per cent by foreign shareholders. The Royal Thai Government owns 30.63 per cent through the Ministry of Finance, 13.42 per cent, The Government Savings Bank, 11.78 per cent and Krung Thai Bank PCL 5.43 per cent.

iv)Terms, conditions and process

A summary of usual terms and conditions follows:

Loan purpose: loans must be project-based, although working capital loans will be considered if combined with a project loan;

Transaction size: the minimum loan size is 1 million Baht ($27,000);

Repayment terms: from 5-10 years but are sometimes shorter;

Interest rate: the commercial banks’ minimum lending rate less 1 per cent for loans in Baht; cost of funds plus a margin for loans in foreign currency.

Collateral: fixed assets with a value of 140 per cent of the loan. (The IFCT is the largest single beneficiary of guarantees provided by SICGC which cover that portion of the IFCT loan which cannot be secured by conventional collateral.)

Process: The IFCT offers services through its head office in Bangkok, and 23 regional and provincial offices. Technical staff appraise project proposals.

v)Portfolio summary

Approved loans 1960-1998:

By amount: 59.6 per cent exceed 100 million Baht ($2.7 million); 4.4 per cent are less than five million Baht ($135,000);

By region: 63.2 per cent to regional borrowers, 36.8 per cent to greater Bangkok borrowers;

By type of industry (outstanding loans): The IFCT classifies its portfolio in 27 categories. The two largest are basic metals - 10.9 per cent of the total; and transport, storage and communications - 9.1 per cent.

vi)Financial results

Total income in 1998 from interest on loans, investments in promissory notes and from the securities portfolio, totalled 17.5 billion Baht ($473 million). Borrowing expenses were 16.4 billion Baht; provision for doubtful accounts, 3.1 billion Baht; other expenses were 2.0 billion Baht; and operating expenses were 0.7 billion Baht. The result was a loss for the year ended December 31, 1998 of 4.7 billion Baht ($127 million).

The effects of the well-publicized financial crisis on the IFCT are reflected in the following expenses that are included in the above figures.

1.4 billion Baht provision for the decline in the value of long-term investments in securities;

2.3 billion Baht representing the IFCT’s equity in the net loss of subsidiaries;

3.1 billion Baht provision for doubtful accounts, which brings the accumulated allowance to 4.7 billion Baht. The latter amount exceeds the minimum specified in accordance with the Bank of Thailand (BoT) classification, but is 56 per cent of the amount suggested by BoT.

The IFCT’s capital adequacy ratio is 9.1 per cent; however, it is reported that non-performing loans are 35-40 per cent of the total portfolio, which suggests a need for a substantial increase in capital.

vii)Commentary on the IFCT’s actual and possible role as a lender to MSEs

The IFCT’s 1998 Annual Report features a special section on SMEs. In addition to recognizing the economic contribution of the sector, the report reviews constraints and experiences in various economies including the United States and Japan, and offers ideas on the role of the public sector which it sees as an important player, including its role as a "…development catalyst, providing comprehensive financial and infrastructure assistance such as improvement of technology, skills and information."

The IFCT suggests that technology and management upgrades for SMEs are critical and recommends that a new public agency be established to better coordinate the assistance already available through various ministries and agencies. Other suggestions are that information centres be set up as well as credit bureaux and that SMEs be encouraged to form cooperatives.

In the first of five business strategies for 1999, states that the IFCT "…will emphasize enhanced financial support to SMIs, particularly manufacturing export industries." The report also mentions that SMIs accounted 87 per cent of new project approvals in 1998. It is my understanding that the IFCT does or will target 25 per cent of its lending — I assume as measured by volume — to SMEs.

In my view, the use of the word "industry" as in SMIs, the IFCT’s strategy of focusing on manufacturing exporters, and the average loan size, suggest that a small enterprise to the IFCT is much larger than a "small enterprise" as often defined by most international development organizations. The question may be: does the IFCT have the corporate will and the capability to expand its lending to smaller companies than at present? The answer may depend on several of the following factors.

The quality of the current loan portfolio, as lending to SMEs carries some inherent risk. Expanding higher risk lending is a real challenge at a time when non-performing loans are a major financial issue, as well as preoccupying lending officers at all levels;

Profitability: The IFCT has a relatively high funding cost since it finances through borrowing, not deposits. The lower margin has been adversely affected by the crisis. For example, the net interest margin in 1998 - i.e., net interest income as a percentage of average net loans - was a negative 1.4 per cent. Profitability depends on other revenue from securities trading and investment, and to a lesser extent, fees and other services. Expanding SME lending will mean higher administrative expenses without the prospects of earning significant additional fee income.

Assessment capability: As loan sizes decrease, the reliance on subjective factors in the loan approval process increases. Instead of relying on cash flow projections, feasibility studies and detailed technical appraisals (as a lending officer would do when financing a larger project), a loan to a small borrower may depend on the personal qualities of the principal, business experience, management ability, honesty and past record. Lending officers need to be trained accordingly, and the reasons why some SMEs succeed and others do not need to be identified.

Many of those encouraging the development of smaller businesses assume that the responsibility for expanding access to credit is exclusively that of the lenders - the banks. As the IFCT and others point out, there are fundamental difficulties in lending to SMEs that need to be addressed by small business operators themselves, or in cooperation with organizations supporting them. Some of these issues are:

Failure to disclose complete, accurate financial information.

Financial management skills - for example, basic financial analysis, managing cash flow and systematic monitoring are often lacking.

Inability to separate business finance from personal finance - although this problem is not exclusive to the MSE or SME sectors.

Business planning is weak.

Marketing skills and market knowledge are limited. In many cases SME owners are more focused on what they can make, than on who might buy the product.The SICGC’s report to shareholders also reports plans to shorten the process of "…recovery from debtor and guarantor...", which suggests that beneficiaries of SICGC guarantees may find the claim process cumbersome. There are frequent reports concerning the very slow process of the Thai legal system which would lead one to think that the claims process would take considerable time since judgement must be obtained first. As noted under section 2.3 above, what are seen as institutional differences in some countries may become quite personal in Thailand, and dispute resolution is therefore difficult and time-consuming.

The SICGC’s report states that "…great emphasis will [be placed] on closer supervision of all guaranteed projects [so that SICGC will be better] informed of their current status, performance, problems [and] the lender’s proposed solutions." This step is a necessary prerequisite to extension of services to smaller borrowers where the rate of failure is likely to be high.

Small Industry Finance Corporation (SIFC)

i)Mandate

To provide financial support to small industries with the objective of stimulating modernization and employment, particularly in the regions outside greater Bangkok.

ii)History

The SIFC was established in 1991 as the successor organization to the Small Industry Finance Office of the Department of Industrial Promotion within the Ministry of Industry.

iii)Ownership

Ministry of Finance 25.00%

Government Savings Bank (GSB) 18.33%

Crown Property Bureau 13.33%

Members of the Finance Company Association 13.33%

Members of the Thai Bankers' Association 13.33%

Industrial Finance Corporation of Thailand (IFCT) 10.00%

Krung Thai Bank PCL 6.67%

iv)Terms, conditions and process

Eligible borrowers: SMEs with an investment in fixed assets of less than 50 million Baht ($1.3 million).

Eligible purposes: Capital expenditures, working capital and debt repayment. The applicant must have an equity of at least 20 per cent in the case of project loans.

Transaction sizes: From a minimum of 500,000 Baht ($13,500) to a maximum of 25 million Baht ($675,000).

Terms of repayment: Maximum 10 years, with two-year grace period.

Rates and fees: SIFC charges a project evaluation fee of 0.5 per cent of the loan requested. Interest rates are based on a spread over commercial banks' minimum lending rate: a 2 per cent spread applies for loans made in the greater Bangkok area, a 1 per cent spread applies for loans made in more distant regions, and a 2-3 per cent spread is charged for working capital, debt repayment and vehicle acquisition loans where the loan exceeds 50 per cent of the purchase price.

Collateral: Land and buildings, machinery or a guarantee from a financial institution including SICGC (see above).

Application: Through any of six up-country offices, as well as through 11 regional investment centres of the Ministry of Industry. The approval process is estimated to take 1 month.

v)Portfolio summary

Number and amount of loans approved: 1993-98, some 922 totalling 3,513.53 million Baht ($95 million).

Average loan amount: 3.8 million Baht ($103,000).

Percentage of loans approved in Bangkok: 24.5 per cent

Average loan in Bangkok: 5.2 million Baht ($141,000).

The annual report does not provide other details on the loan portfolio, such as by type of industry, for example.

vi)Financial results

Total income in 1998 was 87 million Baht ($2.3 million), 9.2 per cent of which came from non-interest income. Operating expenses were 57 million Baht ($1.5 million), resulting in a net income of 30 million Baht ($810,000). Net loans outstanding were 2 billion Baht ($55 million).

The SIFC’s interest margin in 1998, being net interest income as a per centage of average net loans outstanding, was 4.92 per cent. Operating expenses were 65.4 per cent of operating income, and the return on assets was 1.12 per cent.

Net loans as at 31 December, 1998 were 2 billion Baht ($54 million). It is interesting that in a year when loans in the banking system declined and when the impact of the financial crisis was hitting hardest, SIFC expanded its loan portfolio by 73 per cent.

The SIFC follows the Bank of Thailand regulations in establishing an allowance for doubtful accounts. The steps in the process and the results are as follows:

Loans are classified in six categories with a specific percentage of each category to be deducted for allowance purposes: "pass" - 1 per cent; "special mention" - 2 per cent; "substandard" - 20 per cent; "doubtful" - 50 per cent; "doubtful or loss" - 100 per cent; and, "loss" - 100 per cent.

Applying these percentages to the relevant categories and summing up the results establishes a "full allowance set-up." By the end of December 1998 the Bank of Thailand required that banks set aside at least 20 per cent of the full allowance set-up.

SIFC calculates a full allowance set-up of 216.96 million Baht and has an accumulated allowance for doubtful accounts of 65.09 million Baht, 30 per cent of the full allowance and more than the Bank of Thailand minimum.

Notes in the 1998 Annual Report record that "…the Corporation had non-performing loans as defined to the amount of Baht 806,819,325 [as at December 31, 1998]." As is the case with Thai commercial banks, SIFC meets the Bank of Thailand requirement but is far short of adequately reserving for its own estimate of non-performing loans. This estimate exceeds current net income levels by a factor of 27 times, and exceeds shareholders equity by a factor of 1.4 times.

vii)Commentary on the SIFC’s actual and possible role as a lender to MSEs

The financial results for 1998 raise some interesting questions as to SME lending. For example, the SIFC’s interest margin at 4.92 per cent, is very high by the standards of most banking systems. However, profitability as measured by the return on shareholders equity, 5.3 per cent, is very low. The ratio of operating expenses to operating income - a common measure of bank efficiency - is 65.4 per cent, which is very high for an industrializing country. A wide interest margin, high costs and low profitability may reflect the higher administrative costs associated with lending to SMEs. It may also be that SIFC’s emphasis on its "incubator" role - fostering new businesses to the point of graduation to conventional lenders - with its attendant higher risks and monitoring costs, contributes to this lower profitability. SIFC is working to reduce its operating costs.

In remarks in the 1998 Annual Report, SIFC notes the increasing attention paid to the organization by various Government ministries, the media and international development organizations. This seems to demonstrate even more evidence of the increased emphasis on development of the SME sector in Thailand.

As in the case of IFCT’s Annual Report, both the terms SME and SMI are used in SIFC’s report. For example, under "Structure of SMEs," SIFC reports that "…there is no in-depth study of SMEs' structure. Therefore, the number of enterprises, fixed assets, sizes of employment and other characteristics cannot be clearly specified. The existing study involves only the small and medium industries (SMIs) of which value of fixed assets is not exceeding 100 million Baht or employment not exceeding 200 workers. At the end of December 1997, there were 130,000 factories of SMEs (within this definition), or 98 per cent of total number of factories in Thailand".

In addition to the substance of the quote, the alternating use of SME and SMI suggests at first that they are synonyms, but I believe SIFC would want to make a distinction. In my own view, SMI refers to a smaller manufacturing company, the support for which is in line with the SIFC’s original mandate. Later on in the report, it is noted that while SIFC was established to promote small industry development and that loans were therefore not provided to "general enterprises," SIFC will provide loan facilities in response to the Government’s policy. I take this to mean that loans to smaller "general enterprises" will now be accommodated.

Expanding lending to smaller enterprises will take a significant act of corporate will, but the SIFC seems to be the right institution to help smaller enterprises, that is, enterprises which are smaller and more diverse as to purpose than is now the case. The advantage SIFC has is that lending officers are experienced in project assessment, and analyzing cash flow and business prospects - a process which is likely to favour smaller, newer enterprises. However, it may prove to be too much of a change to expand even further by lending to microenterprises.

3. A comparison of Thailand’s experience with other countries

3.1 Group lending for micro finance

The concept of group lending, as exemplified by the Grameen Bank, a Bangladesh based non-government organization, is widely touted as the most effective approach to micro finance. The operating principles are: establish and train small groups; specify individual savings targets; take guarantees from the group for each individual loan; charge market rates of interest, and reward successful repayment with a larger subsequent loan. Any successful programme is usually measured by the loan recovery rate, in Grameen Bank’s case, reported to be over 90 per cent.

As described in Section 3 above, the Department of Public Welfare, the Urban Community Development Organization, the Bureau of Cottage and Handicraft Industries, and the Bank for Agriculture and Agricultural Cooperatives (BAAC), all apply the group lending concept in financing microenterprises. In contrast to the Grameen Bank, all except BAAC charge less than market rates. However, recovery rates for the Thai micro finance lenders named here are reasonable, although lower than in the Grameen Bank’s case.

3.2 The role of non-government organizations (NGOs) in micro finance

NGOs are very active micro finance lenders in a number of countries. NGOs engage in direct lending of funds raised by the organization, and in some cases act as an intermediary for banks. In this case a bank lends to the NGO which on-lends to individual borrowers, and consequently it absorbs the high cost of administering a micro finance portfolio. However, it would appear that NGOs are not active micro finance suppliers in Thailand (see section 4.5 on Banking with the Poor - BWTP - for more information on NGO networks in Thailand).

As described in Section 3, Thailand has a very significant network of finance institutions, particularly in the rural areas where in other countries NGOs have filled a gap. There may be cultural reasons why there is not the same strong need for NGO finance activities in Thailand. For example, when Grameen Bank was established there was a real need to meet the needs of poverty stricken rural women who were very subjugated by traditional culture. Some suggest that women in Thailand have not been as severely discriminated against and therefore the same need has not been as great.

The important point is that the development of new organizations and institutions is not the main issue in Thailand. It is more a matter of training lenders in existing institutions on how to assess and manage micro finance, and how to address and cater for the needs of the microenterprise sector.

3.3 Guarantee schemes for smaller enterprises

Guarantee schemes represent a well-tested method to assist small enterprises that are unable to meet the usual collateral requirements of commercial banks. The features and principles of successful guarantee programmes seem to be these: willing and well-run banks; a formula for sharing risks between a guarantee agency and lenders that encourages the latter to participate, but which is also meaningful; clear criteria for loans which qualify for a guarantee, and a straightforward claims process so that there are no undue delays in paying claims.

In Thailand’s case, there are differences between the principles commonly applied in other countries and those applied by the Small Industry Credit Guarantee Corporation (SICGC). The formula for risk-sharing as formulated by SICGC - guaranteeing the whole portion of the unsecured credit not exceeding 50 per cent of the total credits with the lender - suggests that borrowers must have at least some conventional collateral. The formula also means that for smaller loans beneficiary banks do not take any risk. In successful schemes elsewhere, some portion of the bank’s loan is unsecured and at the bank’s own risk.

In successful schemes elsewhere, some portion of the bank's loan is unsecured and at the bank's own risk. This has the affect of building the lending bank's experience in lending to smaller enterprises. Reasonable risk-sharing creates an incentive for the bank to monitor loan servicing and to recognize borrowers who establish a good repayment record. If the bank's risk is fully covered, this incentive may disappear.

Another issue in the case of the SICGC is the potential for conflict of interest. The banks who benefit most from SICGC guarantees are the same banks which own most of the shares in SICGC and which are represented on the Corporation's board. It might be perceived that those who set policy benefit from the policy. With a clear separation between those who own shares and those who benefit from the guarantees, the Corporation could be more pro-active and more forceful in monitoring and expanding its guarantee programme.

The approval time – it takes 2 months for a guarantee to be approved – and the claim process – lenders must have a court judgement in order to claim under the guarantee – are other factors that may mean that SICGC is less effective than it might be in encouraging smaller enterprises to pursue this source of support.

3.4 Market versus non-market interest rates

Successful micro finance organizations such as the Grameen Bank, believe it is important to charge market rates of interest. The rationale is that access to finance is more important than the cost of finance. As administration costs are high and the transaction sizes are small, this means that nominal rates of interest don’t amount to very much in hard cash terms. For example, a 60 per cent annual rate on a $150.00 loan repaid in three months means an actual cash cost of $22.50. In many cases these terms may be more favourable than the terms from money-lenders, a common alternative to a micro finance lender.

Micro finance organizations usually aim to operate on a sustainable basis. Charging a market rate of interest is critical to this objective. Additionally, the application of market rates of interest seems well suited to the development of micro enterprises as ongoing and commercially viable businesses. The argument is that a good business is by definition one which does not need direct subsidies. It may be that some micro finance programmes are offered on a welfare basis, perhaps because there are gaps in the social "safety net". In this case there may be sound political reasons why a lower than market rate must be applied.

Micro finance in Thailand is offered on both a below-market and a market-rate basis. One of the difficulties follows from Thai culture which suggests that Government assistance is expected to be delivered at more favourable terms than similar assistance from non-Government sources. There is no clear explanation for this other than the traditional patron/client relationship between Thais and their subordinates. The questions that Thai officials need to address, therefore, is whether the financial sustainability of such schemes is an important issue. If the answer is yes, the Government may have to find a way to encourage the private sector to expand micro and small enterprise lending as opposed to having the Government directly involved.

3.5 Banking with the Poor Network

Although there does not appear to be much involvement of the NGO sector in microfinance, the regional Banking with the Poor (BWTP) Network also covers Thailand. In its latest Newsbrief (Issue 5, March 1999), the ILO's Social Finance Unit provides useful information on the network, as well as the details of websites to obtain more information (see Box 1).

Box 1.

Banking with the Poor (BWTP) is a network of commercial banks and non-governmental organizations (NGOs) in nine countries in Asia - namely Bangladesh, India, Indonesia, Malaysia, Nepal, Pakistan, Philippines, Sri Lanka and Thailand, whose members’ common objective is to increase the access of the poor to financial services, especially through sustainable linkages between commercial banks, NGOs and self-help groups for the poor. A number of central banks and other umbrella organizations are associated with the network as well.

The work of the Network, especially in respect to Banking with the Poor (1992) and Best Practice of Banking with the Poor (1995), has played an instrumental role in proving the ability of the sector to reach a large number of poor households on a sustainable basis, thereby gaining the support of governments and donors.

The network pursues its goal through research activities, advocacy, policy dialogue, awareness raising, information sharing and capacity building. It conducts regional workshops, publishes papers and produces a newsletter that reports on the progress of the network and its individual members. Most recently, it commenced a survey to investigate the impact of the Asian Financial Crisis on microfinance institutions in the region. While the findings are only tentative and preliminary, they provide early insight into the affects of the crisis that will be useful for policy makers and microfinance practitioners. ("The Asian Financial Crisis - Some Implications for Microfinance" by Paul B. McGuire, 1998) The key findings of the survey are:

– the countries in Asia with the greatest concentrations of poverty have been the least affected by the crisis;

– programmes focusing solely on the poor appear to have withstood the crisis better than programs not specifically targeted at the poor;

– in general, microfinance appears to have suffered most where it is linked to the formal financial system, but with some important exceptions (i.e. BRI); and

– a number of policy reactions to the crisis have had unintended adverse consequences for microfinance and should be reviewed.

For more information, contact: Banking with the Poor (BWTP), The Foundation for Development Cooperation (FDC), 232 Adelaide Street, Brisbane QLD 4000 Australia, Tel: 61-7-3236-4633; Fax: +61-7-3236-4696; e-mail:; Internet:

Source: ILO Social Finance Unit Newsbrief , Issue 5, March 1999.

4. Recommendations

4.1 Publicize I feel the capacity in Thailand in terms of lendable funds, choices of institutions and networks of offices and branches, is adequate to finance the demand for loans from micro and smaller enterprises. However publicizing the support that is currently available would be a useful step. For example, press reports suggest that one reason why the Government Savings Bank’s 1999 target for MSE lending is behind plan, is that entrepreneurs do not realize that GSB may be a source of funds. The GSB is seen only as a bank that mobilizes savings from smaller customers.

4.2Coordinate It is not clear that those who administer the financial support programmes within various ministries are aware of what other departments are doing. There would be value in sharing experiences in terms of loan assessment and administration, as well as promoting greater coordination between agencies and institutions - both government and non-government - involved in lending to the MSE sector. In addition, there should be some planned progression for beneficiaries from the schemes of the "non-economic " line ministries (such as MOLSW and the Ministry of Interior), to enable them to graduate to the higher-value schemes of the economic ministries, such as the Department of Industrial Promotion within the Ministry of Industry.

4.3 Lower the threshold in specialized financial institutions

In the current preoccupation with expanding lending to micro and smaller enterprises, the focus has been on small industries and not on small enterprises. It seems that Thai officials are keen to support new manufacturing businesses – companies that are larger and more narrowly defined than those which are usually encompassed in the term SME.

I suggest the specialized financial institutions (SFIs) reviewed in this report could lower the threshold for qualifying smaller enterprises. One way to manage this would be to create new advisory units within each institution. The job of these units would be to assess the business case, provide market information, furnish or provide links to basic training in marketing and financial management - if that was lacking - and to assist the entrepreneur in the preparation of a business plan and financing proposal. It would be best if these new advisory units did not have lending authority. They would assist only. The entrepreneur would be expected to "sell" her or his own case to the lending officers in the particular SFI. Training and advice need not be lengthy and complex: often enterprise owners’ needs are very basic, and many of the lending institutions have the accumulated corporate experience to be useful in this area.

Initial funding for advisory units may well have to come from Government, but I would argue that this is an effective way to expand lending to smaller enterprises. Better prepared SMEs mean lower loan losses for lenders, and a more lasting contribution in terms of job creation and tax revenue.

4.4 Assess the need for money

The survey of micro and small enterprise owners completed as part of this project (and referred to in section 2.2), suggests financing is not a major constraint. Those engaged in lending to micro and small enterprises who were interviewed for this report, suggest that lack of finance is not the main reason why micro and small enterprises fail. Training and information needs may be more important. [The results of this small survey also show that very few microenterprises obtained finance through established commercial financial institutions. The funds came from Government programmes, as well as their own resources and from private money-lenders - Editor's note]
Many entrepreneurs would say that the lack of capital is a major constraint. By itself, this answer is not really helpful unless the intent of a micro finance programme is only to alleviate poverty. If the intent is to develop microenterprises into sustainable businesses, the "lack of capital" answer needs to be elaborated [perhaps by asking for the "second most serious constraint" - editor's note]. In this case, there is an important role for owner's capital - including funds supplied by family and friends - as a measure of commitment by the owner(s) of the enterprise. The prospects for successful development are greatly enhanced if the entrepreneur has even a small stake in the business venture. Annex I:
Contacts

Organization

Phone/Fax

Contact

Association of Asian Confederation of Credit Unions (ACCU)

374 3170

374 5321(f)

Ranjith Hettiarachchi

General Manager

Bank for Agriculture and Agriculture Cooperatives

281 4830 (DL)

280 0180

280 2038(f)

Supachai Sathakarn

Vice President, Human Resource Development

Bureau of Cottage and Handicraft Industries Development, Department of Industrial Promotion (DIP), Ministry of Industry

202 4477

246 1157(f)

Vim Roonggrout

Director

373 0020

Panya Srithongsook

General Manager

Government Savings Bank (GSB)

299 8000

Ext. 2110/2

299 8453(f)

299 9331

299 8480(f)

Khun Nillawan Lekcharoensuk

Assistant Manager, Business Finance Division

Pisnu Wuittiprasit

Head Division 1, Project Finance Department, Regional Urban Development Fund (RUDF)

Joint Research Project, University of Geneva and Sasin Graduate Institute of Business Administration of Chulalongkorn University

218 4026

218 4061

Bancha Chumchaivate

Junior Researcher,

Research Division

Ministry of Finance

273 9020

618 3371(f)

Pongpanu Svetarundra

Senior Expert for Finance

Fiscal Policy Office

Ketsuda Supradit

Economist, Monetary Policy and Financial Institution Division, Fiscal Policy Office

Sun Vithespongse

Director, Loan Policy and Management Division

Craig Steffensen

Resident Advisor,

Asian Development Bank

Ministry of Labour and Social Welfare, Department of Public Welfare

281 3199, Ext. 5809 281 3231(f)

281 0969

282 8883(f)

Sujintana Hematasin
Social Worker/Foreign Relations Officer, Social Studies and Planning Division

Saowanee Khomapatr

Chief, Occupational Assistance Division

Small Industry Credit Guarantee Corporation

308 2741-8

308 2749(f)

Niramol Tawee

Vice President, Business Promotion Department

Small Industry Finance Corporation (SIFC)

201 3700

201 3723-24(f)

Chongchet Boonkerd

Senior Executive Vice President

Bunjong Chinskul

Department of Audit

Small-Scale Industry Promotion Project, DIP

Ministry of Industry

202 4582-3

246 4300(f)

Arnulfo Itao

Deutsche Gesellschaft fuer Technische Zusammenarbeit (GTZ) Adviser

Soon Klang Thewa Credit Union Cooperative Limited

277 3468

277 9109

275 4771(f)

Urai Pathumchantarat

Manager

The Industrial Finance Corporation of Thailand

(IFCT)

253 7111

253 7018(f)

Patara Vasantasingh

Vice President,

Business Promotion Office

Urban Community Development Office (UCDO)

716-6000

716 6001(f)

Somsook Boonyabancha

Managing Director

Annex II:

Bibliography

The following documents and publications were reviewed in the preparation of this report:

The Bank for Agriculture and Agricultural Cooperatives (BAAC): Annual report,

The Government Savings Bank (GSB): Annual report,

The Industrial Finance Corporation of Thailand (IFCT): Annual report,

Small Industry Credit Guarantee Corporation (SICGC): Annual report,

Small Industry Finance Corporation (SIFC): Annual report,

Committee of Donor Agencies for Small Enterprise Development: Business development services for SMEs: Preliminary guidelines for donor-funded interventions, January 1998

ILO: Collateral, Collateral Law and Collateral Substitutes, A contribution to the Donor’s Working Group on Financial Sector Development, Frankfurt, 17 April 1996, (Geneva, 1996)

Bastuaebebm, M. and van Rooij, P.: Guarantee funds and NGOs: Promises and pitfalls, a review of key issues, Working Paper No. 18, International Labour Office, 1997

ILO: ILO’s microfinance portfolio — An overview, Social Finance Unit, (Geneva, 1999)

Levitsky, J.: Innovations in the Financing of Small and Microenterprises in Developing Countries, Small Enterprise Development Section, International Labour Office, 1993

ILO: ISEP competencies and staff track record methodologies and instruments, International Labour Office

Webster, L.: Lending for Microenterprises — A review of the World Bank’s portfolio, FPD Note, World Bank, 1996

Jain, Pankaj S.: "Managing credit for the rural poor: Lessons from the Grameen Bank", World Development, Vol. 24, No. 1, pp. 79-89, Elsevier Science Ltd., 1996

White, S.: Micro and small enterprise development in Thailand, Working Paper 3: A report on the policy, legal and regulatory environment for micro and small enterprises in Thailand — draft, International Labour Office, East Asia Multidisciplinary Advisory Team, (Bangkok, 1999)

Krahnen, J.P. and Schmidt, R.H.: On the theory of credit cooperatives: Equity and onlending in a multi-tier system — A concept paper, Enterprise and Cooperative Development Department, Working Paper No. 11, ILO, (Geneva, 1997)

Revolving loan and guarantee funds — Checklist for a better design and management of ILO technical cooperation programmes, Enterprise and Cooperative Development Department, ILO, (Geneva)

Leenabanchong, C. (ed.): The development of small and medium enterprises (SMEs) in some APEC countries, papers and proceedings of a conference held at Shangri-La Hotel, Bangkok, Thailand, 30-31 July, 1997, APEC Study Centre, Thammasat University. Organized by the Department of Industrial Promotion, Ministry of Industry in Cooperation with the APEC Study Centre and the Federation of Thai Industries

Morris, K.J.: The effects of using credit unions as onlending agents for external lines of credit: The experience of the International Credit Union Movement, Enterprise and Cooperative Development Department, Working Paper No. 14, ILO, (Geneva, 1995)

Annex III: Review of a recent publication

In its March 1999 Newsbrief (Issue 5), the ILO's Social Finance Unit provides a short review of a highly relevant text dealing with factors affecting microfinance schemes. The review is reproduced below for further information on this subject.

Getting the Framework right - by Paul McGuire, John Conroy and Ganesh Thapa (1998)

Recent years have seen microfinance recognised as an important tool for reducing poverty in developing countries. In Asia, leading microfinance institutions such as the Grameen Bank and the Bangladesh Rural Advancement Committee (BRAC) have achieved an international reputation.

Considerably less is known about the impact of the external environment on microfinance institutions. This book seeks to fill that gap, examining how governments in the region and external agencies can establish a policy and regulatory framework supportive of microfinance. Many of the conclusions, drawn from the Asian experience, will prove to have wider applications.

The authors conducted more than 250 interviews with microfinance practitioners, bankers, regulators and policy makers in nine countries in South and Southeast Asia. Detailed country studies underpin the analysis of the main report.

As well as reviewing the current policies of governments and donors, the book analyses regulatory and prudential frameworks for both non-bank microfinance institutions and banks offering microfinance services. Its recommendations are both practical and far-reaching, and will prove an invaluable guide for policymakers, as well as for donors, practitioners and other supporters of microfinance.

To get a copy of the book, contact the Foundation for Development Cooperation, Brisbane, Australia.

Source: ILO Social Finance Unit Newsbrief, Issue 5, March 1999

Annex IV: The "Credit Crunch" in East Asia?

‘Credit crunch’ as a concept is often ill-defined and casually employed. Many people use the term loosely to describe a variety of phenomenon including ‘tightening of monetary policy’, ‘shortage in the supply of funds’, and ‘credit rationing by banks’ etc. Even in the literature concerning credit crunch, there doesn’t appear to be a general consensus on a precise definition of the ‘credit crunch’ concept. It is, therefore, useful to explore more carefully the concept of ‘credit crunch’ and to differentiate various terms describing credit conditions, particularly the difference between credit slowdown and credit crunch.

The term ‘credit crunch’ is perhaps best understood as a situation in which, at prevailing interest rates, there is an unsatisfied excess demand for credit. When a credit crunch occurs, it alters the relationship between credit availability and interest rates. A credit crunch mostly occurs in two forms: (1) a leftward shift of the credit supply curve at a given interest rate level (price mechanism) and (2) rationing of the credit supply, irrespective of interest rates (non-price mechanism).

On the other hand, a credit slowdown can be defined as a general decline in credit growth that may have been generated by demand or supply factors, or both. Broad changes in the demand for credit may be cyclical (varying with the pace of economic activity) or structural (induced by changes in the tax code etc.). Credit supply can be influenced by changes in financial regulations, structures and institutions. Monetary policy and autonomous shifts in lender and borrower psychology will have an impact on both credit supply and demand. Unlike credit slowdown, which is a fairly general term, credit crunch specifically refers to a reduction in the available supply of credit.

In recent months, there has been much discussion about a "credit crunch" in the East Asian economies - most notably in Korea, Thailand and Indonesia. While there was clearly a sharp fall in external finance available, the debate has centered on whether domestic credit conditions tightened significantly, and perhaps excessively. While there is anecdotal evidence that even good firms are finding it difficult to obtain credit to finance production and investment, macroeconomic data on monetary and financial developments does not unequivocally support the assertion that a credit crunch is occurring. This issue of a credit crunch appears to pose serious threats particularly to the financing of small and medium enterprises, a sector particularly affected by information asymmetries.

A review of the currently available empirical evidence shows that the region is not suffering from an overall credit crunch, although the situation differs considerably across the countries in question. In Korea, where banks adjusted their rates more rapidly to rising money market rates, the wedge between lending rates and risk-free assets yields has significantly widened, indicating an increasing strain on credit supply by banks through the price mechanism. However, in Indonesia and Thailand, the credit squeeze has been rendered more through quantity rationing than through increases in lending rates.

Source: ILO Social Finance Unit Newsbrief – Issue 5, March 1999 (ILO Enterprise Department), also carried on the ILO website, at http://www.ilo.org/public/english/employment/finance/index.htm

Annex V: Recommendation No. 189

Updated by GT. Approved by HH. Last update: 24 January 2000.