Santiago Dumlao


Santiago F. Dumlao, Jr. is a past president of the Financial Executives Institute of the Philippines (FINEX) in 1989 and the present Secretary General of the Association of Credit Rating Agencies in Asia (ACRAA)

past articles


BEPS - What are we headed for?

July 2015

From the International Tax Committee

Contributors: Piergiorgio Valente and Filipa Correia


Barriers to CFOs as Strategists

July 2015

by Wilma Inventor-Miranda-FINEX member


China: An Upside Down Investment Bank

June 2015

From the International Treasury Committee

Contributor: Dominique Chesneau


CFO as Technology Evangelist

June 2015

by Reynaldo C. Lugtu Jr. - FINEX member

Credit Rating for SMEs

September 2015

By Santiago F. Dumlao, Jr.

We shall make a case for promoting the credit rating of SMEs as a way to facilitate the granting of loans to them without the need for hard collateral to guarantee the obligation.

Typically, banks and other institutional lenders require real estate and similar physical assets to collateralize loans, and most especially those to be granted to SMEs. But SMEs are owned by upstart business entrepreneurs who usually have no properties to offer as collateral, but they do have viable business plans and products, and all they really need is start-up capital. What a pity and a waste if a good business idea matched by a venturesome, capable entrepreneur, is too early and too quickly aborted for lack of a supportive lender.

The need then is for greater access to financing. But, if there is no hard collateral to guarantee the loan and to exert the continuing pressure to fulfill loan repayments, how might the creditor have a measure of reasonable protection from an SME borrower who might default?

CREDIT RATING can be the answer.

A credit rating is a credit opinion rendered by a third party, the Credit Rating Agency, which makes an objective, independent evaluation of creditworthiness, expressed through a published credit rating scale that compares the degree of creditworthiness among credit ratees. If the credit opinion is CREDIBLE, then this credit rating should suffice to support an informed credit decision, dispensing with the need for hard collateral.

Collateral-based lending enforces loan repayments by instilling a fear of loss of the collateral. A credit rating substitutes the fear of loss with an informed, analysis-based expectation of cash flow from the borrower’s business.

The substitution of credit rating for hard collateral, as the basis for the granting of loans to SMEs, can be effective in achieving its purpose only if, as has been adverted to, the credit rating is credible. Credibility in turn comes from COMPETENCE (the rating agency knows what it is doing) and from the INTEGRITY of the whole rating process (the rating agency observes high standards of ethical conduct and best practices).

The credit rating industry has come a long way to establish its credibility in domestic and international markets, and the industry players continue to reinforce their individual and collective credibility in various ways. (There have been, admittedly, some lapses of behavior by some rating agencies.) That is precisely why we have regulators to enforce discipline. And why there are Asian regional industry organizations like ACRAA to enforce self-discipline.

But how do we assure the credibility of the credit ratings?

In the first place, rating agencies are required to be accredited by government regulators, like the SEC, to be able to offer their services to the public. There are minimum requirements of capital, management qualification and analytical staff. To be able to qualify a credit rating for use for bank supervisory purposes, the rating agency must likewise be accredited by the Bangko Sentral or Central Bank.

Operationally, a credit rating agency must observe rating methodologies and follow credit rating criteria which must be consistently applied, and must be published for transparency. There are rules and norms on confidentiality, independence, objectivity and avoidance of conflict-of-interest. There are best practices on how the credit rating process must be conducted so the users of credit ratings will know how ratings have been arrived at. All these are aimed at establishing accountability and fairness.

A rigorous credit rating system would understandably be relatively expensive to maintain, which has been the most frequently expressed objection to requiring an SME credit rating for any bank loan application.

The SME, small that it is, does not have the financial capacity to pay for the services of a credit rating agency. This is the usual complaint. But credit rating does not have to be expensive for the SME. Take the case of India, which has had a long successful experience with SME credit ratings. The government subsidizes the rating fees of small scale industries (SSIs) through the National Small Industries Corporation, Ltd. The subsidy is only for the initial rating that is valid for one year. CRISIL, the credit rating agency with long experience in SME ratings, explains that “A good rating from CRISIL carries weight with lenders, and helps SMEs/SSIs get faster and cheaper credit.” The ratings by CRISIL are used by banks to facilitate the credit evaluation of SMEs. CRISIL claims it has “working” arrangements with 39 banks and financial organizations many of which extend concessional pricing to their borrowers based on these ratings.”

It is indeed possible to do away with collateral-based lending, as the Philippines’ Bangko Sentral is trying to encourage. And a good, credible SME credit rating system can take the place of collateral requirements. To jump-start this proposal, an SME-dedicated credit rating agency might be considered, coupled with a government-sponsored credit rating fee subsidy arrangement patterned after the Indian model.

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