Credit Guarantee Corporation Malaysia Berhad Steering SME Development in Malaysia

Credit Guarantee Corporation Malaysia Berhad Steering SME Development in Malaysia pp. 15-30 Credit Guarantee Corporation Malaysia Berhad Steering SME Development in Malaysia Credit Guarantee Corporation Malaysia Berhad Abstract This article is presented with the sole purpose of providing an insight into SME sector development in Malaysia, Credit Guarantee Corporation Malaysia Berhad s (CGCMB) role in nurturing SME development and the various initiatives being undertaken to assist SMEs access to financing. Briefly, CGCMB is the leading provider of credit enhancements in Malaysia and it has been instrumental in the establishment of more than 365,000 SMEs since its inception 35 years ago. The SMEs are considered as the engine of nation s economic growth and as such, their continued growth and contribution are promoted and monitored by various ministries and government agencies. In recent years, SMEs have received greater attention from the government as was evident with the increased allocation of funds and resources for the development of identified sectors that have great potential for growth and prominence given in the Ninth Malaysia Plan. Institutions that are entrusted with the task of nurturing SME development such as CGCMB are expected to step up efforts to strengthen the infrastructure of SME financing. The initiatives undertaken by CGCMB in further expanding its SME outreach as well as its move to achieve financial sustainability are addressed in this article. Key Words: Transformation, Financial Sustainability, SME Outreach, Guarantee Beneficiaries, Islamic Guarantee, Securitization, Equity Funding and Venture- Capital Investments 15

5 I. Introduction Credit Guarantee Corporation Malaysia Berhad (CGCMB) was incorporated on 5 July 1972 under the Companies Act 1965. Its shareholders are Bank Negara Malaysia (the Central Bank of Malaysia) (76.4%) and the financial institutions (23.6%) operating in the country. It was established with the primary objective to assist SMEs, especially those without or with inadequate collateral and without business track record, gain access to financing from the participating financial institutions at a reasonable cost. It is also to assist the government with its efforts in promoting and developing identified business sectors. In the early years, CGCMB focused on helping small enterprises in the agricultural, commercial and industrial sectors. It first introduced the Credit Guarantee Corporation (Small Loans) Guarantee Scheme in 1973. Credit facilities eligible for guarantee under the scheme could be used for working capital or for capital assets. The maximum for individual loans ranged from RM5,000 to RM75,000, depending on the purpose and size of the enterprise. Since 1994, CGCMB s target groups have been expanded to include medium-sized businesses so as to better complement the government s efforts in promoting and developing businesses in certain industries. The loans guaranteed now ranges from as low as RM10,000 to RM10 million. II. Industry Analysis A. SMEs and their Growing Importance to Malaysian Economy SMEs have a significant presence and role in the Malaysian economy as there are more than half a million of them, making up 99.2% of total business establishments in the country. According to the Census of Establishments and Enterprises 2005 1, a census carried out on business enterprises in major sectors of the economy namely, agriculture, manufacturing and services, SMEs are the major source of employment, providing employment for over 5.6 2 million workers and accounting for 56% of total employment. Though SMEs form a bulk of business enterprises and remain the biggest employers, their contribution is still relatively small, contributing only about 19% to total export value and 32% 1 SME Annual Report 2005, Bank Negara Malaysia (Central Bank of Malaysia). 2 Annual Report 2006, Bank Negara Malaysia. 16

Credit Guarantee Corporation Malaysia Berhad Steering SME Development in Malaysia pp. 15-30 of gross domestic product. Similarly, their productivity levels are also found to be significantly lower than that of large enterprises with average value added per employee of just RM14,740, compared with RM47,830 generated by large enterprises. The SMEs are largely family-owned businesses and are generally small-scaled with 77% of them employing less than 50 employees. Due to their small-scaled size, majority of them cater to the domestic market with only 8% exporting their products and services. During the period 1996-2005 3, output by SMEs in Malaysia registered an average annual growth rate of 5.1%, increasing from RM52 billion or 22.1% of total manufacturing output in 1996 to RM80.5 billion or 29.6% in 2005. During the same period, SMEs registered an average annual growth of 5.4% in terms of value-added. In 2005, the growth of value-added by SMEs was 9.2%, against the overall growth of 9.8% for the manufacturing sector. In the manufacturing sector, the textile and apparel forms the bulk of the SMEs representing 18.2%, while food and beverages (15.2%), metals and metal products (14.8%) and wood and wood products (14.1%). In terms of location, majority of the manufacturing companies are located in the central region of Malaysia and around the major industrial areas. Table 1 Distribution of SMEs in the Manufacturing Sector (by Sector) in 2000 Source: Small and Medium Industries Development Corporation (SMIDEC) 2004 3 SME Annual Report 2005, Bank Negara Malaysia. 17

5 According to the Department of Statistics year 2000 census, of the 192,527 establishments in the services sector, 96.7% were SMEs and 88% were in retail and wholesale, 4.4% in education and health, 2.9% in professional services and 2% in transport and communication. B. National Plan for SME Growth Recognizing the critical role of the SME sector in the economic development of the nation, the government of Malaysia has made SME development as one of its priorities. In its ninth 5- Year Plan (2006-2010), the government undertook a holistic and comprehensive approach to support the development of competitive and resilient SMEs in all sectors. It encompasses three broad strategies of strengthening the enabling infrastructure; building the capacity and capability of SMEs; and enhancing access to financing. With these initiatives in place, the government hopes to upgrade SMEs in a systematic and sustainable manner, and enhance their contribution to Malaysia s economic expansion and development. Essentially, this is to develop its own domestic enterprises, in particular SMEs to have significantly higher value-added contribution to the economy. Table 2 Public Sector Support for SMEs Source: SMIDEC and Small and Medium Industries Development Plan (SMIDP), 2001-2005. Following the report by Bank Negara Malaysia entitled A Comprehensive Framework For The Development of SMEs, the government set up an inter-ministry Steering Committee in October 2002 to examine the areas in which efforts were needed to enhance the institutional framework for the development of SMEs. One of the important recommendations of the report was the establishment of the National SME Development Council in June 2004 as there were a 18

Credit Guarantee Corporation Malaysia Berhad Steering SME Development in Malaysia pp. 15-30 number of Ministries and government agencies involved in SME development and coordination was apparently lacking. The Council is chaired by the Honorable Prime Minister of Malaysia and members of the Council comprise representatives of the Ministries and agencies which play a role and contribute to SME and entrepreneurial development in the country. The high-powered Council provides the direction for comprehensive and coordinated development of SMEs by- 1. Formulating broad policies and strategies and providing strategic direction for the development of SMEs across all economic sectors; and 2. Overseeing coordination and ensuring effectiveness in policy implementation. The Council has approved a number of strategic initiatives under three main areas for SME development as follows: 1. Strengthening the Infrastructure a) Establishment of a comprehensive national SME database that would facilitate more effective policy formulation; b) Establishment of a standard SME definition to ensure no SME is excluded from development efforts; and c) Framework for SME policy formulation and evaluation which is performance driven and would give greater strategic focus in the government s efforts to develop SMEs. 2. Building the Capacity of Domestic SMEs a) Coordination of training and human resource development by a dedicated agency (Pembangunan Sumber Manusia Bhd.), under the Ministry of Human Resources to coordinate and oversee training and human resource development programs for SMEs; and b) Measures to enhance marketing and promotion of SMEs and their products by the Ministry of International Trade and Industry and the Ministry of Domestic Trade and Consumer Affairs. 3. Enhancing Access to Financing by SMEs a) The establishment of the SME Bank by the government to complement the banking institutions through the provision of financial and non-financial services; b) Interest subsidy on loans to SMEs as a strategic initiative to further extend accessibility to financing at more reasonable costs to SMEs; 19

5 c) Securitisation of SME loans to provide greater flexibility to banking institutions in managing their SME loan portfolio and further enhancing their capacity to provide lending to SMEs; and d) New trade financing arrangements to encourage SMEs to participate in the export markets. NSDC National SME Development Council MITI Ministry of International Trade and Industry MECD Ministry of Entrepreneurial and Cooperative Development MOF Ministry of Finance MOSTI Ministry of Science, Technology and Innovation MHR Ministry of Human Resources ICU Implementation and Coordinating Unit, Prime Minister s Department BNM Bank Negara Malaysia (the Central Bank of Malaysia) Figure 1 Relationship between CGCMB and Related Government Agencies 20

Credit Guarantee Corporation Malaysia Berhad Steering SME Development in Malaysia pp. 15-30 C. Standardization of SME Definitions As there were a large number of Ministries and agencies involved in SME development, the definitions of SME were varied with each Ministry and agency defining SMEs based on their own criteria, generally based on annual sales turnover, number of full time employees and shareholders funds. With no standard definition, the government was confronted with much difficulty in collecting and compiling SME data for assessment of development needs and business performance across the economic sectors. To assist in better identification and more effective targeting of SMEs in terms of formulation of policies and programmes, the National SME Development Council issued in 2006 standard definitions for SMEs in the manufacturing, agriculture and services sectors. Two main criteria were used in defining SMEs - annual sales turnover and number of employees. For a broader coverage, businesses that meet either one of the criteria qualify as an SME. Table 3 SME Definitions Based on Number of Full-time Employees Source: SME Annual Report 2005 Table 4 SME Definitions Based on Annual Sales Turnover Source: SME Annual Report 2005 21

5 III. CGCMB s Role in SME Sector Development A. CGCMB in the Context of the Overall Scheme of SME Sector Initiatives and Focus With the establishment of the National SME Development Council to further enhance the government s role and greater coordination and focus in SME development across the various stakeholders and with the release of SME Development Blueprint, the existing infrastructure on access to financing for SMEs was strengthened to ensure a more effective channeling of funds, provision of financial advisory support and enhancing awareness on financial products and assistance programmes to SMEs. One of the initiatives to strengthen the infrastructure of SMEs financing access is the transformation of CGCMB, which entailed the enhancement of the Corporation s role and the expansion of its products and services to meet the changing needs of SMEs. CGCMB took a holistic approach in terms of its expansion of products and advisory services on financial and business development. These services are aimed at facilitating greater lending role to SMEs as well as promoting sound financial management practices among the SME community. B. Attaining Financial Sustainability CGCMB embarked on its 3-year business transformation plan in early 2006 to transform itself from a traditional guarantee provider into an effective and financially sustainable institution that offers a broader range of products and services for SMEs at competitive terms. The major focus of its new mission is for the Corporation to achieve financial sustainability. Financial sustainability in the context of CGCMB is to achieve financial independence by weaning itself from its current dependence on subsidized funds from the government and Bank Negara Malaysia. CGCMB has identified a number of strategies to help it to achieve financial independence, critical one being the expansion of the range of its products which incorporate a pricing methodology that imposes guarantee fee based on SME borrowers risks. Through risk-adjusted pricing methodology, CGCMB is essentially recognizing and mitigating its risks as the risk sensitive pricing mechanism is based on breakeven point whereby risks are valued in terms of costs. SMEs with better risk rating would welcome the new pricing mechanism being incorporated in the loan approval process as it will enable them to enjoy more competitive guarantee fee compared with high risk borrowers. In addition to the adoption of risk-adjusted 22

Credit Guarantee Corporation Malaysia Berhad Steering SME Development in Malaysia pp. 15-30 pricing mechanism, CGCMB is also exploring to embark on capital market activities to help it to achieve financial sustainability. Moving forward, CGCMB will fundamentally be a commercially driven institution. However, the social development role that it assumed since its inception in the early 1970s would not be sidelined. Its future involvement in social development role in the SME sector would hinge much on the extent of government funding. C. SME Outreach 1. Guarantee Schemes As Malaysia s leading credit enhancer for more than three decades, CGCMB has todate been instrumental in the establishment of more than 365,000 businesses, guaranteeing over RM36 billion worth of loans. It currently offers both conventional and Islamic guarantee facilities for SMEs from the various sectors of the economy and the guarantee coverage ranges from 30% to 100%. a)conventional Guarantee Schemes (1)Direct Access Guarantee Scheme (2)Small Entrepreneur Guarantee Scheme (3)Flexi Guarantee Scheme (4)Credit Enhancer Scheme b)islamic Guarantee Schemes (1)Islamic Banking Guarantee Scheme (2)Islamic Direct Access Guarantee Scheme 2. Scope of Guarantee Beneficiaries As a part of its transformation plan, CGCMB took several initiatives to further enhance the outreach of its credit guarantee schemes to benefit a wider cross-section of the SME community by expanding its beneficiaries to non-shareholder financial institutions. a)expansion of Scope of Guarantee Beneficiaries to Islamic Banks Prior to 2006, only those financial institutions which are shareholders of CGCMB could avail of the guarantee schemes and facilities offered by CGCMB. In 2006, CGCMB made the strategic move to open its scope of guarantee scheme beneficiaries 23

5 to also non-shareholder financial institutions operating in the country. In line with this liberalisation move, CGCMB forged strategic alliances with the Islamic financial institutions in Malaysia to reach out to SMEs that prefer Islamic products for their financing needs. CGCMB saw great potential in this partnership as Islamic finance has not only experienced significant growth but is increasingly becoming a more competitive form of financial intermediation in Malaysia as evident by the encouraging performance of the Islamic banking sector. Over the last five years, the Islamic banking industry registered double-digit growth rate of about 20 percent. Financing to SMEs extended by the Islamic financial institutions registered an increasing trend, growing at an average annual rate of 34.2% during the period 2001 to 2006 4. As at the end of 2006, Islamic financing to SMEs reached RM10 billion, representing 9.6% of total SME loans outstanding of the banking system compared with only RM1.7 billion in year 2000. Pursuant to a recent announcement by the government to establish Malaysia as an international Islamic capital market center, the involvement of CGCMB in supporting Islamic financial system is expected to become more vital. b)expansion of Scope of Guarantee Beneficiaries to Development Financial Institutions Recognizing the increasing focus and emphasis given on the role of the development financial institutions (DFIs) that were set up to accelerate the growth of strategic sectors identified by the government, CGCMB also initiated efforts to expand the beneficiaries of its credit enhancement facilities to include these institutions, currently numbering about 13. Bringing these institutions on board will not only provide additional conduits for CGCMB to reach out to more SMEs but also provide alternate avenues for SMEs to source their financing needs. In 2006, six DFIs had approved RM6.9 billion of financing to more than 18,000 SME accounts. Loans extended by DFIs to SMEs increased by 9.9% to RM13.2 billion as at end 2006. 3. Expansion of Product Range 4 Bank Negara Malaysia Governor s Keynote Address at The Launch of Strategic Partnership between CGCMB and Islamic Financial Institutions - Feb 2007. 24

Credit Guarantee Corporation Malaysia Berhad Steering SME Development in Malaysia pp. 15-30 With increasing demand from SMEs for more customized and differentiated financial products and services that accommodate their unique financial requirements, a reflection of the diversified nature of the Malaysian economy, CGCMB undertook various initiatives to provide not only innovative products but also attractive financing packages and alternate sources of funding. a) SME Loan Securitization The Malaysian government has been continuously supporting SMEs in availing access to credit at reasonable cost via its various funds. With the increase in demand for such funds, the government has to consider other alternatives in the long run. One such alternative form of financing is securitization of SME loans of financial institutions. Securitization of SME loans provides an alternative-financing mode for SMEs and enhances access to financing at a lower cost via the capital market. It helps to provide better risk diversification and enhances financial stability. The securitization framework and its capital impact for the originator are premised on the expectation that securitization is used to transfer significant level of credit risk to the capital market. Table 5 Benefits of Securitization of SME Loans 25

5 CGCMB has in early 2007 entered into the first ever SME loan securitization in Malaysia, a move that paves the way for SMEs to secure funds from the capital market through the issuance of bonds, asset securitization and collaterised loan obligation. This initiative provides the originating financial institution with capital relief to reduce the normal level of its own funds set aside against its credit exposure to cover unexpected losses. The economic capital therefore, is a function of the underlying loan portfolio risk as well as the financial institution s policy to provide capital cover for unforeseen events. The financial institution is able to transfer its credit risk to the capital market, thereby enabling the capital relief from this transaction to be channeled back to the SME sector. Figure 2 Structure of the First Synthetic Securitization Deal and CGCMB s Participation b) Equity Funding The growth in the private equity industry of the Malaysian economy has been slow since its inception in the 1980s, with only around 17 major private equity type transactions completed since the Asian Crisis of 1997. Such transactions have also been very few in the SME sector. However, the increasing interest in the SME sector resulting from increased resources and investments since 2004 has boosted the investor confidence in the industry. The government views venture capital as an important alternative to traditional sources of financing. As a result, Malaysia s nascent venture-capital (early-stage private equity) 26

Credit Guarantee Corporation Malaysia Berhad Steering SME Development in Malaysia pp. 15-30 industry has been expanding rapidly, with most of the venture-capital firms linked to or backed by the government. The government accounted for 37.8% of total venture funds as at the end of 2005 5. In line with the government s efforts, venture capital investments from domestic private sector entities increased by 20% in 2005 (2004: 35.1%). In 2005, foreign sources recorded the highest growth in investments (over 50%), totaling RM262.2 million. This is followed by banks and other private sector entities. According to Bank Negara Malaysia, a total of RM432 million was invested in 101 companies in 2005 6. This brought the total venture-capital investments as at end 2005 to RM1.4 billion. The main beneficiaries were the Information and communications technology firms, receiving 45.9% of all funding, followed by manufacturing sector (20.3%) and companies in the life sciences (18.8%). In line with the need for providing another avenue of financing to SMEs, CGCMB ventured into equity funding activities. It had recently signed a joint venture agreement with Aureos Capital Ltd to pave the way for greater access to SME financing. Aureos Capital was identified as CGCMB s strategic partner as it is a leading global manager of 24 SME private equity funds in Africa, Central America and Asia/Pacific with a total committed capital under management of more than US$570 million. The joint-venture agreement culminated in the establishment of a new company called Aureos CGC Advisers Sdn Bhd. The aim is to provide equity funding (Fund) to selected SMEs to not only grow and expand their business domestically and across the region but also penetrate newer markets by leveraging on the wide global network presence of Aureos. The Fund is contributed by both local and international institutions. The fund s first closing of USD25 million was in July 2007. With this collaboration, CGC hopes to create a platform for a wide spectrum of investors to participate in the Fund to reach out to SMEs requiring equity investments. The Fund s focus is on equity and quasi-equity investments in SMEs in Malaysia. The Fund will concentrate on expansions, replacement capital transactions and acquisitions, including management buyouts (MBOs). The Fund would generally take significant minority equity stakes in investee companies, with board representation and the right to participate in or influence the conduct of management. 5 Annual Report 2005, Bank Negara Malaysia. 6 Annual Report 2005, Bank Negara Malaysia. 27

5 c) SME Credit Bureau Historically, SMEs are considered a high risk group lacking in financial discipline and unable to provide trustworthy financial track records. In view of the general lack of positive perception, a major reason cited for their poor credit rating and bankability by the financial institutions, SMEs found it rather difficult to gain greater access to financing facilities. To overcome this perception, adequate and reliable credit information mechanism, such as SME credit bureau was deemed a necessity to serve the needs of both the SMEs as well as the potential lenders. Recognising the need, CGCMB took the initiative to establish an SME credit bureau in partnership with Dun & Bradstreet, a global operator and provider of credit bureau and risk management solutions. One of the most important roles of the bureau is to make available SME information, which includes their operational and financial status to potential lenders. In addition to relevant and timely information, potential lenders could also take comfort that the information is independently provided, hence increasing its reliability. Currently, information available for lenders to assess the creditworthiness of SMEs in Malaysia is generally fragmented. Although there are a number of parties providing information on SMEs, the information are mostly tailored towards specific requirements and does not add the necessary values required from the perspective of potential lenders. To bridge this information gap, the SME credit bureau would effectively consolidate the fragmented information. This convergence of data from various sources would result in a convenient, timely and efficient access to SME information and credit ratings to assist the potential lenders to make a more objective evaluation of loan applications. With the establishment of an SME credit bureau, significant opportunities exist to increase lending activities to SMEs in Malaysia. The SME credit bureau also aims at promoting greater transparency, professionalism and sound credit culture among SMEs. It is indeed a big step towards a more sophisticated and transparent financing environment for SMEs in Malaysia. IV. Challenges Ahead The upside potential of the SME sector, further enhanced by government s concerted efforts and focus in the sector, is generating greater interest among the financial institutions to 28

Credit Guarantee Corporation Malaysia Berhad Steering SME Development in Malaysia pp. 15-30 gain a bigger share of the growing pie of SME financing. To remain relevant in the increasingly competitive environment, CGCMB will have to continuously introduce innovative products and services for SMEs and at the same breath able to manage the risk implications to ensure that the net returns are in favour of CGCMB. Transforming from an institution with high content of social consideration to a commercially driven and self sustainable institution, by itself poses a major challenge to CGCMB. Over the past three decades, the Corporation s role and focus on promoting SME sector development has generally been social developmental in nature, with guarantee fees imposed very much subsidized. Following the recent change in strategies and directions under the transformation plan, the Corporation is moving towards being a commercially-driven, self sustainable credit supplementation institution. Various initiatives are needed to enable CGCMB to wean itself from its current reliance on subsidized funds from the public sector. To better serve the SMEs, the commercially-driven CGC would need to offer products and services that are complementary to those provided by the financial institutions, and offer them at competitive and not subsidized terms to enable CGCMB to achieve financial sustainability. This in itself necessitates the Corporation to strike a right balance between the risk to be undertaken and guarantee fees to be charged against the overarching objective of promoting SME sector development. CGCMB has been the sole provider of credit guarantees for SMEs whereby financial institutions rely on CGCMB s guarantee schemes for loans to SMEs, particularly those without collateral and track record. However, with the change in the financial institutions credit policies, the financial institutions are now stepping up effort to secure the SME market. With robust credit assessment systems in line with the BASEL II requirements, the institutions have a much higher risk appetite. The challenge for the Corporation is to remain relevant to SMEs as well as the lending institutions. CGCMB, nonetheless, welcomes healthy competition as it can only benefit the SMEs and indirectly the overall market, thus meeting the nation s objective of creating access to financing with attractive cost for SMEs. References Bank Negara Malaysia, Annual Report 2006. 29

5 Bank Negara Malaysia, SME Annual Report 2005. Credit Guarantee Corporation Malaysia Berhad, Annual Report 2006. Malaysia Rating Corporation Berhad, Credit Analysis, July 2007. Small and Medium Industries Development Corporation (SMIDEC), 2004. SMIDEC and Small and Medium Industries Development Plan (SMIDP), 2001-2005. Ninth Malaysia Plan, 2006-2010. 30