Small business loans
We greatly welcome the new small business loan scheme to be launched next month by state banks. But observation of past schemes warns against premature optimism. Instead, a note of caution seems in order: The new program should not be designed to simply allay the mounting criticism of the widening disparity in the distribution of income and ownership of economic assets. If this is the case, the new lending scheme will only dissipate, not solve, the inequality. The program would then crumble after a year or so, leaving behind new trails of bad credit.
It is encouraging that the new lending scheme features several characteristics which are especially designed to address the biggest obstacles encountered by small businesses in obtaining bank loans. Under the new program, as Minister of Finance Mar'ie Muhammad explained on Wednesday, loan applications will be simplified by reducing the number of documents required. The abolition of the need to produce a taxpayer registration number is also productive. Loans of up to Rp 50 million (US$22,450) will not require collateral and can be extended wholly against the feasibility of an enterprise.
The government was also right not to subsidize the interest on small business loans, except in the micro-loan program which will provide credit of up to Rp 5 million with interest rates set at one to two percentage points below the market rate. This micro- loan scheme, designed to only serve businesses with assets under Rp 2 million, will be financed by a Rp 50 billion revolving fund.
The success of small credit schemes with negligible bad debt rates illustrates that small businesses need convenient and fast procedures to obtain loans to meet their financing requirements. They feel uncomfortable and sometimes find it difficult to fill out mounds of documents. Most owners of small businesses do not have fixed assets to secure their borrowings or, if they do, they do not have legal title or legal ownership documents. The interest rate level does not matter much to them as long as they can get a loan quickly and conveniently. In most rural areas small borrowers are charged up to five percent a month and the bad debt rate is very small.
The biggest challenge in implementing the small business loan scheme lies in the assessment of viability. Even though Minister Mar'ie said that the government, as the shareholder in state banks, is responsible for bearing the risks of the unsecured loans, state banks must not be allowed to treat the small credit as charity. To make the loan scheme sustainable, the bad debt rate must be kept at a tolerable level.
Bank branches should therefore set up small task forces to deal specifically with small businesses. The credit officers should develop good rapport with the businesspeople and closely monitor their businesses to quickly detect any problems. They may sometimes have to resort to character references to assess borrowers. Therefore, the program requires a highly decentralized organizational structure and bank branches should be given full autonomy to manage the scheme.
All this work makes lending to small businesses more costly than lending to big companies, but that is a consequence of nurturing small businesspeople. Small business loans, however, do not only mean high transactional costs. Well-managed loan programs, however small the credit might be, are rewarding. Small borrowers, for example, can be required or easily prodded to open savings or demand deposit accounts at the lending bank. Small borrowers usually remain loyal to their bank even after they get wealthy and become prime clients.
The biggest potential cause of bad debts within the small business loan program is dishonest medium or big businesspeople using small firms in collusion with credit officers as a front for obtaining unsecured loans. Therefore, the local autonomy and decentralized organizational structure of bank branches must be blended with an overall credit quality control system.