Unlocking access to funding support for Thai SMEs

Now she believes she is in the right position to give her business a more international facelift and expand her coverage possibly to international buyers, as well. She figures that she needs funding for the investment and reaches out to a commercial bank for it. 

At the bank, she gets presented with two typical options: either use real estate or a cash deposit as collateral for the loan, receiving a reasonable business interest rate; or take out an unsecured personal loan, with an interest rate possibly up to the ceiling of 28 per cent. 

Given that her company is a digital SME in a rented office space, and with not a lot of cash to deposit or real estate, she has little option but to go with unsecured lending and face a stiff interest rate, or forego the investment completely.

Though fictional, this story is very typical for SMEs. In fact, Somsri is actually one of the lucky ones, as at least she was presented with financing options. Many SMEs are completely shunned by commercial banks due to their lack of collateral required for lending. Indeed, a survey done by the Office of SME Promotion in 2012 showed that the biggest obstacle to SMEs accessing finance is their lack of collateral. Of those denied access, almost one-quarter said it was due to insufficient collateral. 

The next most important reasons for rejection were being more of a credit risk, including the ability to pay, and lacking financial management, each at one-tenth of the respondents. 

Simply put, requiring collateral is the biggest obstacle for SMEs in accessing the needed finance. 

At this point, many are quick to point out that the culprit is the commercial bank, but there is an apparent dilemma in the moral of this story. Virtually all Thai commercial banks are focusing their loan growth on SME lending, yet SMEs still face such difficulty in accessing the needed finance. Since both facts shouldn’t really coexist, something must be off – and by a lot.

The fact of the matter is that even if commercial banks want to be more lenient for SMEs, they actually cannot. Current Thai law allows only two types of collateralised transactions: pledging and mortgaging. 

Think of pledging, more commonly referred to as pawning, as if you are visiting a pawnshop. That’s a transaction with whatever collateral you take to the shop. While for mortgaging, as the name suggests, you should think of a real-estate mortgage for buying a house. Are the two different? Definitely. 

With the intention of oversimplifying, in pledging, you give up your collateral to the lender, while in mortgaging, you keep your collateral with you.

Why does this matter for SMEs? Well, it’s the real spectre behind their lack of finance in Thailand.

In pledging, the law requires that you must hand over your collateral to lenders, which means that whatever business is depending on the collateral, it must be stopped completely. For example, you cannot pledge your delivery van if you still need it for making routine deliveries. This clearly does not work for financing a business need.

Therefore, the term collateral is much more business-friendly under mortgaging, as businesses can continue to utilise their collateral after the contract. Unfortunately, the law only allows limited classes of assets to be mortgageable – such as real estate and 5-tonne seafaring ships – not the types of assets SMEs would have lying around. 

So, economic assets in the hands of SMEs, like machinery, receivables, inventory, intellectual property, and even the ownership of the business itself, are rendered valueless as collateral for mortgaging and can only be pledged to lenders. These assets are what SMEs have on hand, but what banks cannot accept as collateral to secure lending.

This is where the newly drafted Business Security Act (also referred to as the “Business Collateral Act”) comes in. This law attempts to patch this loophole and unlock financing for businesses by allowing them to use other “movables” as collateral to secure lending. 

Secured lending is a win-win solution for business financing. Under secured lending, creditors face a lower credit-risk cost from the transaction as they receive the right to the collateral posted in case of default. 

So, lenders are almost always certain that they will receive the sum of money back, with only the matter of time for completing the legal process being an issue. Hence the lending is in that sense “secured”. 

With lower credit cost, borrowers also reap the benefits of gaining more access to finance, and at a cheaper price. In addition, in contrast to pledging, borrowers will have uninterrupted access to their collateral, hence continuing their businesses with additional financing. 

The movable economic assets in their hands will now serve two purposes: first is as a part of the productive unit within the businesses, generating output, revenue and income for their owner; and second, they serve to secure the needed finance for the business, providing the necessary leverage for liquidity and expansion. 

In economics lingo, you can think of this as increasing the multiplier for business investment with a financial leverage as an accelerator.

The draft Business Security Act is one of the key pieces of legislation heading towards the National Legislative Assembly, possibly by the end of the year. 

If successful both in passing and implementation, the law will open up new access to finance for many businesses, especially SMEs, and allow Thai entrepreneurial activities to thrive. Somsri and other SMEs will finally get their break and be able to excel with their entrepreneurial endeavour. 

 

Benjarong Suwankiri, head of TMB Analytics, the economic analysis unit at TMB Bank, can be reached at [email protected] [email protected]. Views expressed in this article are those of the author, and not of TMB Bank or its executives.