Banks, NBFIs to pay 2% fee for SME loan guarantee

The central bank has proposed a 2 percent fee to provide credit guarantee for small and medium enterprises (SME) loans, as the risk associated with this type of financing is comparatively higher.

This was revealed in the draft manual of the Credit Guarantee Scheme (CGS). The Bangladesh Bank is collecting opinion on the draft CGS manual from stakeholders to finalise it.

The draft has recently been sent to the chief executives of banks, non-bank financial institutions (NBFIs) and experts.

The central bank proposed that for each portfolio limit, the participating financial institutions (PFIs) will have to pay a guarantee fee within seven working days after signing the memorandum of understanding (MoU) with the CGS.

From the next year on, the PFIs will pay the guarantee fee within the first seven working days at the rate of 2 percent on the reducing balance of the principal amount on 31st December of the previous year.

For example, if a PFI named "X" signs a MoU with the CGS on 20th January 2020 and the Portfolio Limit is Tk1 crore, then it will pay a 2 percent guarantee fee amounting to Tk2 lakh on that portfolio limit for 2020.

For the same portfolio limit, the reducing balance of the principal amount is Tk90 lakh on December 31, 2020. On January 2021, it will pay 2 percent of Tk90 lakh, which means an amount of Tk1.80 lakh.

All service charges and fees must comply with the Bangladesh Bank regulations. The overall interest rate of the guaranteed loans or credit will not exceed the normal market rate after adding the guarantee fee, read the draft CGS manual.

Any interest rate cap, if prescribed by the Bangladesh Bank, will apply to the CGS guaranteed loans.

The prescribed cap on the interest rate must be adhered to if the PFI obtaining the CGS coverage for a loan is allowed to participate in available refinancing schemes offered by the Bangladesh Bank or any other agency.

At the end of each calendar quarter, each PFI will provide the CGS with a statement on the outstanding balance of the guaranteed credits.

The CGS will verify whether the information on the PFI statement agrees with the CGS records in relation to the borrower, amount of the loan, interest rate and the guarantee coverage ratio.

In the list of guaranteed loans, the CGS will ensure that defaulted loans – for which the CGS has paid coverage amounts – are reflected, loans – that the CGS rejected offering guarantees for – are reflected and settled loans are excluded.

The CGS will review the balance of the loans and investigate any noticeable increase of the current balance from the previous balance to determine the cause. The PFI will also confirm the CGS that payment of the guarantee fees has been made.

Loans to be covered under CGS

The CGS will cover term loans for acquiring fixed assets and working capital loans not more than 80 percent of a business' working capital needs. Working capital loans will be defined as per the credit policy of the respective PFIs.

The threshold of loan for the CGS facility is minimum Tk5 lakh and maximum Tk30 lakh. The loan tenure cannot be more than five years, read the draft CGS manual.

The following business activities will be ineligible for the CGS – financing an existing portfolio in the form of renewal or enhancements where the SME has adequate collateral according to the PFIs policies, credit not in compliance with the Bangladesh Bank prudential regulations.

Manufacturing or selling of ammunitions articles or services, projects or businesses that violate workers' rights, illegal activities, environmentally, socially and ethically damaging projects, gambling, drugs and tobacco will also be ineligible.

Besides, alcoholic drinks, real-estate development companies and projects, currency or securities trading and any business activities not compliant with the Bangladesh Bank's Environmental Risk Management Guidelines will be ineligible too.

SME eligibility to qualify for CGS

According to the central bank, this guarantee scheme is not intended to cover start-ups, as other facilities are already providing this support.

Potential SME entrepreneurs with viable business expansion plans, constrained by the lack of adequate capital or collateral, will be covered by this guarantee scheme.

The scheme is available to small and medium existing businesses in the manufacturing and service category, as defined by the Bangladesh Bank through SMESPD Circular number 2 issued on September 5, 2019, and any subsequent amendments that may be issued.

A business that has been profitably operating for at least two years will be eligible. The borrower must contribute at least 20 percent of the total project cost as equity capital. This can only be determined at the time the loan is being processed, read the draft CGS manual.

If a SME wants to borrow Tk5 lakh from a PFI, their project cost must be Tk6.25 lakh.  Out of which Tk1.25 lakh must come from the SME's own source. Before loan disbursement, the PFI should ensure that 20 percent equity of the SME has already been invested in the project.

The SME must also have a business plan with clear cash flow plan showing how the loan can be repaid. For a loan exceeding Tk500,000, the company must have financial statements.

Besides, credit-worthy enterprises operating in an eligible category that is 100 percent owned by Bangladeshi entrepreneurs, entities that have Clean Credit Information Bureau (CIB) report and comply with the Bangladesh Bank's Environmental Risk Management Guidelines will qualify for the CGS.

Responding to query, a senior Bangladesh Bank official told The Business Standard, "The SMEs are perceived as a high risk group due to the lack of sufficient business information and collateral. Thus, a bank wanting to offer any SME a loan would need to either apply a rate that covers this risk, or demand a significant amount of collateral.

"So the reality is, in spite of having great potential, SMEs are deprived of financing due to lack of adequate collateral. Credit guarantee schemes can reduce information asymmetry and alleviate the high collateral requirements."

The Credit Guarantee Scheme (CGS) has been designed as a Hybrid Portfolio Partial Credit Guarantee Scheme.

In this process, all parties including the CGS, PFIs and SMEs will share part of the risks. There is also a safety feature limiting the CGS' contingent liability, reducing the moral hazard and enabling a more efficient use of the CGS Capital.

Potential banks and NBFIs operating in Bangladesh may participate in this programme by fulfilling some pre-determined criteria. The PFIs will have to sign a Participation Agreement with the CGS before submitting loan applications for the guarantee coverage.

PFI eligibility criteria

To be eligible, a PFI must be authorised by the Bangladesh Bank to conduct banking business in Bangladesh. Financial institutions that require more than the offered collateral to cover their perceived risk of lending to SME entrepreneurs are also eligible.

The bank/NBFI must have the ability to undertake capacity building programmes for borrowers in the area of business management, book-keeping and financial management.

The bank or financial institution must comply with the Bangladesh Bank prudential regulations. The Capital Adequacy Ratio of the bank or financial institution must also comply with the Bangladesh Bank requirements.

The NPL (non-performing loans) of any SME loan portfolio of the bank/NBFI must not be more than 10 percent. This may be changed at any point at the discretion of the CGS. SME NPL calculations will be based on the Loan Classification and Provisioning requirements for scheduled banks and financial institutions.

The bank or NBFI must be engaged in SME lending with an SME loan origination policy demonstrating a desire to ramp up the exposure in SME lending.

In case any guaranteed loans or instalments fall past due, it is imperative that the PFI is able to demonstrate that they have downgraded the loan on their books in accordance with the Bangladesh Bank Master Circular on Loan Classification and Provisioning, and any subsequent amendments that may be issued.

Claims under guarantee scheme

The PFI may claim the guarantee payment if the SME fails to make the due payment in full within 270 days of the due date, no arrangement is made between the PFI and the SME to resolve the default situation and the account has been classified as bad and loss.

The PFI must have declared the loan in default and informed the borrower in writing of the legal steps to be undertaken.

If any collateral was pledged to secure the loan, the PFI must begin legal proceedings to liquidate the collateral and recover the debt that has been presented to and accepted by the court in accordance with relevant act before claiming the guarantee payment.

Cash or cash equivalent collateral must be set off against the principal amount of the outstanding loan.