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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

Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.

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Possible funding channels for CP

CommercialBanks

Company

Shareholders(equity offering)

Partners/owners

Leasingcompanies; equipment

vendors

Government-subsidized

credit

InternationalDevelopmentAssistance

• Environmental revolving loan funds

• Development banks & credit schemes

• Ex/Im finance guarantee schemes

Internal sourcesCommercialsources

Public/ODA sources

Cashreserves

Credit cooperatives/unions

Customerfirms


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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

!

!?


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Background: Commercial Banks

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


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their principal expertise is evaluating borrower credit-worthiness. . . not the performance of CP investments!

! Therefore:


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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.

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2


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Commercial bank loan procedures

Commercial banks’ loan procedures

have 4 basic

stages

Application

Review

Award

Paying back, with

interest

failure

1

2

3

4We will examineat each stage in

more detail

applicant prepares proposal and submits to bank

Bank evaluates application and sets or negotiates conditions


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Application

a. Before applying to any particular bank, research and review potential funding sources

b. Have initial informal discussions with bank loan officer

c. Fill out bank’s loan application form; obtain all necessary data

d. Submit the loan application and supporting documents to bank.

Application1

Establishing a personal relationship with the bank/loan officer is very

important!

!


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Application review and loan award

Review

Award

2

3

ReviewNegotiate

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:

Ap

pli

cati

on


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What is the basis of the bank’s review?

The bank’s review of the application is focused on two distinct aspects of risk:

economic viability of the specific project

the financial/economic status of the enterprise as a whole

Often more important!


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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?


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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:

LIQUIDITYIs there cash on hand to pay day-to day operating expenses?

SOLVENCYDoes the company have the ability to repay outstanding long-term debt?

Prospects for future PROFITABILITYand its implications for both liquidity and solvency over the expected term of the loan.


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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:


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It is true thatsome barriers to commercial bank loans and (other CP financing) cannot be addressed by the SME alone

!

BUT SOME BARRIERS CAN BE ADDRESSED


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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



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“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


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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

!


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Sustainable Banking

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”


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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.



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This presentation to be developed specifically for the host country context

8.4: Participants’ experiences in financing projects.



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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


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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


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Past funding experiencesGROUP

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?


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GROUP PRESENTATIONS.

Past funding experiencesGROUP

EXERCISE


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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


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General Advice

Some lessons learned by participants in past courses

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


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? Do we agree with these lessons learned?

What lessons learned can we add??Are these lessons fully relevant to CP financing??


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Point for discussions

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Documents

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