Improving BSO Services and SME Performance Through Cleaner Production [DATE] [SPEAKERS NAMES]
8.1: Understanding loan approval at commercial banks Module 8: Financing Cleaner Production
Possible funding channels for CP Commercial Banks Company Shareholders (e quity offering) Partners/ owners Leasing companies; e quipment vendors Government- subsidized credit International Development Assistance • Environmental revolving loan funds • Development banks & credit schemes • Ex/Im finance guarantee schemes Internal sources Commercial sources Public/ODA sources Cash reserves Credit cooperatives/ unions Customer firms
Our focus: commercial banks
Difficulties in accessing commercial credit are one of the largest challenges involved in implementing CP capital investments, particularly for SMEs.
Many development organizations engaging in SME support projects and SMEs themselves have little experience in dealing with commercial banks
! ! ?
Background: Commercial Banks
Acquire funds by receiving money from savers: savings accounts, deposit accounts, etc. Provide funds to borrowers through term loans, lines of credit, bonds, etc The interest payments on loans are used to pay interest to depositors & are a primary source of profit for the bank To be profitable/sound, commercial banks focus on: maximising their returns & minimising the risks they accept
their principal expertise is evaluating borrower credit-worthiness. . . not the performance of CP investments! !
Commercial bank financing instruments
For SMEs, commercial banks offer two main types of financing instruments:
Term Loans Lines of Credit
Issued for a specific project/purpose
Specific amount and term (months or years)
Interest rate will reflect risk & may be fixed over time or variable
Can usually be used for any purpose
Approved up to a credit limit. The customer can use any amount up to the limit.
Higher interest rates than term loans. Interest is charged only on credit actually used.
Commercial bank loan procedures
Commercial banks’ loan procedures have 4 basic stages
Application Review Award Paying back, with interest failure 1 2 3 4 We will examine at each stage in more detail applicant prepares proposal and submits to bank Bank evaluates application and sets or negotiates conditions
Commercial bank loan procedures Application
Before applying to any particular bank, research and review potential funding sources
Have initial informal discussions with bank loan officer
Fill out bank’s loan application form; obtain all necessary data
Submit the loan application and supporting documents to bank.
Application 1 Establishing a personal relationship with the bank/loan officer is very important! !
Commercial bank loan procedures Application review and loan award Review Award 2 3 Review Negotiate terms* More information requested Commitment letter & term sheet Loan agreement signed Funds received Agreement on terms? YES NO *Terms include, e.g. interest rate, repayment period & collateral Review and award involve the following steps: Application
Commercial bank loan procedures What is the basis of the bank’s review?
economic viability of the specific project
the financial/economic status of the enterprise as a whole
The bank’s review of the application is focused on two distinct aspects of risk: Often more important!
Basis of Review #1 Economic viability of the project
How does the bank assess the economic viability of the project?
? NPV is the mostly commonly used overall indicator . HOWEVER, the bank will calculate multiple values for NPV using different assumptions regarding the performance of the project E.g. what is the effect on NPV of different sales, savings, schedules?
LIQUIDITY Is there cash on hand to pay day-to day operating expenses?
SOLVENCY Does the company have the ability to repay outstanding long-term debt?
Prospects for future PROFITABILITY and its implications for both liquidity and solvency over the expected term of the loan.
Basis of Review #2 Company financial and economic status How does the bank assess the enterprise’s financial and economic status? ? The bank assesses 3 Key factors:
Barriers to Commercial Bank Finance for SMEs
Small size of SME CP Projects
Means that the bank’s administrative costs are very high compared to the profit it can make on the loan
High perceived risk of lending to SMEs
Insufficient accounting and business documentation (poor record-keeping)
Limited banking track record (no history of obtaining and successfully repaying loans)
Lack of security (collateral)
For SMEs, access to CP finance is constrained by:
It is true that some barriers to commercial bank loans and (other CP financing) cannot be addressed by the SME alone
! BUT SOME BARRIERS CAN BE ADDRESSED
What can SMEs do to address these barriers?
Understand banks’ decision criteria and analyse CP projects in these terms
Improve record-keeping and management systems (utilize BDS services if available)
Identify banks that do have SME lending programs; request an informational interview with a loan officer before applying
8.2: General trends in CP financing in developing areas Module 8: Financing Cleaner Production
“Friendly trends” in commercial banking
We have now discussed many barriers to financing CP projects at SMEs
HOWEVER, THERE IS GOOD NEWS. Some current trends in commercial banking are “friendly” to CP financing: Increasing similarity among financial institutions Expanded commercial bank activity in developing countries Increasing interest in sustainable banking
Increasing similarity among financial institutions
Traditionally, different types of FIs specialized narrowly in their own areas.
This is still true to some extent, but becoming less so. Many FI’s are expanding their product-ranges into others’ areas
for borrowers, result is a wider range of potential sources of finance Be prepared to approach several different FIs of different types to raise finance on attractive terms !
FI’s are becoming more aware of their environmental responsibilities in lending. This emerging trend is focused in developing countries
Thus, at many international banks, we see a shift. . . Passive with respect to environmental issues. Resist responsibility for environmental impacts of projects they finance Reject financing of environmentally damaging projects. Recognize business & social benefits of environmental investments From traditional passive attitudes. . . . . .to “sustainable banking”
Policy & development approaches to overcome finance barriers
Business development service providers can work with
SMEs, particularly to improve record-keeping
FIs, to demonstrate that CP investments pay
Special financing facilities for SMEs and for CP investments
Civil Society & business associations: Lobby Government for supportive policies
8.3: SME Financing in XXX. Module 8: Financing Cleaner Production
This presentation to be developed specifically for the host country context
8.4: Participants’ experiences in financing projects. Module 8: Financing Cleaner Production
Group Exercise: Analyzing past funding experiences
You will identify one or more past funding experiences to CHARACTERIZE and ANALYZE, answering the questions on the following slides.
See exercise instructions in sourcebook
Past funding experiences
Analyze your funding experience by addressing the following questions:
GROUP EXERCISE ? The basics: What was the project? ? The financing search: Which sources of finance were considered? Which sources were then approached? ? The application: What information was required to make the application? Could you provide this information? AND
Past funding experiences GROUP EXERCISE ? The review: What were the funder’s criteria for approving or rejecting the application? Were these clear? Did any problems arise during the review process? ? The outcome; terms and conditions: Was financing obtained? What were key terms and conditions? ! Lessons learned: What do you think is the reason for your success/failure? What did you do right? What would you do differently? What advice can you offer from this experience? Do you still have unanswered questions from this experience?
Past funding experiences GROUP EXERCISE
Some lessons learned by participants in past courses PROBLEM Solutions that worked ! Project profitability is poor Re-evaluate profitability using total cost principles ! management is unable or unwilling to issue more shares or to raise debt Lease capital equipment rather than purchase it. ! the firm does not have contacts with commercial banks Make contacts through the chamber of commerce, BDS provider, accounting firm
Some lessons learned by participants in past courses General Advice Rejection from one FI indicates little. Search widely for alternative sources of finance. The larger the number of possibilities you consider, the more likely you are to obtain financing... and on better terms If you are rejected, apply again when the national economic situation improves / credit is loosened. Seek advice from experts and from contacts in other firms
? Do we agree with these lessons learned? What lessons learned can we add? ? Are these lessons fully relevant to CP financing? ?