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In my 25 years banking experience, especially in the credit and recoveries areas, I have come across this question many a times. The subject matter has been a centre of focus in many forums and widely argued. Many customers have raised this question over and again. I am sure my article on this also will receive positive and negative responses. Yet in an economy which is bound to boom in the very near future this topic is timely and if discussed progressively will add value to the entire banking industry thereby increasing its contribution to the development of the economy in vast strides.
It is a well known fact that Sri Lankan bankers do not insist on immovable property as collateral from corporate entities (blue chips) for short term funding or small timers who are funded under micro finance schemes. Further on facilities such as leasing, hire purchase and pawning the security is the asset pledged and banks do not insist on additional immovable property for such facilities.
However, banks insist on collateral from SMEs (small and medium enterprises) almost always for working capital financing and term loans to finance fixed assets. SMEs refer to enterprises less than 600 million annual turnover and a maximum loan exposure of 200 million as per the latest CBSL guidelines. According to a report by OECD, SMEs account for over 95% of a countries business organisations. Then there is no doubt that the demand for credit from this segment is the largest in any country. Therefore the banks should be geared to cater this segment and need to be well versed with financing to this sector.
Now the question arises whether the Sri Lankan banks are equipped enough to identify the real pros and cons of SME lending. Further, the banks very well know that the Return on Assets (ROA) on corporate lending is around 1-1.5% whereas with SME lending it is as high as 2-3%.
Then why are banks insisting on immovable property as collateral for SMEs? There are a number of reasons for this;
1) SMEs rely on an individual or a couple of persons.
2) The majority of SMEs are start ups and closes down soon.
3) Non availability of reliable financial records.
4) Inadequate Risk capital (Equity).
5) Use of outdated technology.
6) Lack of managerial skills.
The above factors have put bankers on a difficult footing in analysing the viability of credit proposals to SMEs. It must be stated that the best of the best SME businesses have failed constantly which has left bankers facing a further dilemma.
This has resulted in the banks taking a defensive role in analysing SME credit. To overcome this, banks lay higher emphasis on collateral which is mainly immovable properties owned by the SMEs. To justify same banks suggest that “collateral will only be a means of hand twisting and not a means of debt recovery”, which in a way is correct as banks rarely recover their debts by selling the mortgaged properties. In a way the banks also cannot be faulted as they are also in a business and to sustain they need to make profits, more the nonperforming loan portfolio less the profits. It is assumed that wilful default will not occur when facilities are properly secured by immovable property.
However, eminent bankers speak of cash flow lending against security based lending which is rarely practiced in case of SMEs. The reason is that in majority of Sri Lankan SME businesses the financial records are inaccurate. Some businesses do not show actuals, some businesses manipulate to obtain credit and some do not have records at all.
In a situation like this and where the majority are SMEs, the trend of calling for immovable property as collateral for bank advances will continue, yet the banks that take calculated risks will have enough business opportunities with the SMEs.
References:A.L. Somaratne (2013), Access to Finance by SMEs in Sri Lanka, IBSL journal.
The Writer: Naleen Edirisinghe Msc Mgmt (USJ), AIB (SL), MCPM is Pan Asia Banking Corporation’s Assistant General Manager Branch Operations and Credit. He can be reached via [email protected]
