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A Lifeline for Small Businesses
Access to financial instruments for small businesses is key to promoting sustainable growth in the Pacific region according to ADB's latest Pacific Economic Monitor.
Ermelindo Ero Bara, a 44 year old barbershop owner in Dili, Timor-Leste, now has double the staff he had when he set up shop 11 years ago using $400 of his own money. He twice borrowed money from the Commercial Bank of Timor-Leste to expand his business, and due to his daily profit of about $60 and the bank’s reasonable pay back conditions, Ermelindo says that he is now able to support his family of seven - he even pays the university tuition fees for one of his staff.
Improving access to credit
Ermelindo is not alone in benefitting from easier access to credit in Timor-Leste enabled by a so-called 'secured transactions framework' that was put in place with technical assistance from ADB’s Private Sector Development Initiative. The framework is the legal, regulatory, and technical system that enables borrowers the use of movable property as collateral for loans.
Forty-two year old Alfonso Xavier from Gleno, a rural coffee-growing village about 45 kilometers from Dili, set up a small kiosk 12 years ago with his own money. Borrowing money from the Commercial Bank of Timor-Leste enabled him to transform his small business into a larger enterprise that allows him to comfortably support his wife and nine children. Alfonso plans to borrow money from the bank once again to diversify his business, as he intends to make a foray into producing bricks and sand for the construction sector.
These are but two of the growing businesses that have taken advantage of secure transactions and related financial reforms in developing member countries (DMCs) in the Pacific, one of the topics touched on in ADB’s recently published Pacific Economic Monitor.
Experts believe that access to financial instruments to fund working capital and investment for small business is a key component in promoting sustainable growth. But for the longest time, many would-be entrepreneurs in the Pacific have had to face the challenge of securing capital to start a business.
A major reason for limited credit to businesses is that financial institutions in general are reluctant to lend to borrowers who do not have collateral to secure loans. Real estate, which is the common form of collateral for entrepreneurs in many countries, is often unavailable in the Pacific because much of the land is communally held. Other reasons include weak and outdated legal systems, poor enforcement mechanisms, restrictive financial regulation, and lack of credit information, among others.
Making lending more secure
What lenders are wary of is whether they are likely to be repaid – firstly through payment of the principal and interest taken from borrowers’ cash flows, and secondly in the event that the business fails or defaults on the loan.
The introduction of secured transactions laws (also known in the region as personal property securities acts or PPSAs) is the result of recent reforms in the region. Pacific countries will make use of electronic registries to keep pace with the needs of lenders and borrowers. The electronic registry is searchable to ensure that the borrower has not pledged the same assets as collateral for a loan, or to other lenders. Standardized loan documents help reduce the transaction costs of borrowing and the time to process a loan.
The report notes that in the countries where the reforms have been implemented, access to credit has markedly improved. This is only the start, though, since simply passing a law will not bring about the desired results immediately. Intensive implementation will be needed before the reforms can transform the lending landscape.
So far, though, experience in countries that have started these reforms for extended periods have been promising, indicating that entrepreneurs like Ermelindo Ero Bara and Alfonso Xavier will have an opportunity to start their own businesses without worrying about securing capital.
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