Small and medium-sized enterprises (SMEs) have long been the backbone of Thailand's economy. According to official data from 2015, the country had 2.7 million SMEs valued at about 5.5 trillion baht or 40% of GDP, creating 10.7 million jobs or 80% of all employment.
By nature, SMEs face constraints from limitations on their owners' capital or equity. The only way to expand the business is to rely on borrowing or leveraging. But the critical issue of credit access, or the lack thereof, plagues almost every small business. Against this backdrop, leveraging is the key challenge for Thai SMEs seeking to grow.
A good measure of leverage is the debt-to-equity (DE) ratio. Based on a TMB Analytics study of registered companies in the Department of Business Development database, the average DE ratio for SMEs is 0.6, while for corporate businesses it is 3.5 times. In other words, given the same amount of equity, corporate businesses have a 290% leveraging advantage over SMEs.
From an international perspective, it is worth highlighting that the leveraging gap between SMEs and corporate businesses is much narrower. In Canada, the DE ratios of SMEs and corporate businesses are equal at around 1.4 times. In Germany, data from the Bundesbank shows that the figure for small business, at 2.6, was above that of corporate businesses at 2.3 times. The key question here is why the leverage level for SMEs in Thailand is significantly below that of corporate businesses.
Credit risk plays a major role in gauging the ability to leverage. In general, corporate businesses have a lower default risk than SMEs because of strengths that include solid financial status, healthy credit history and other factors. Nonetheless, these are not the key factors when it comes to explaining SMEs' limited credit access: after all, a lender can always charge a small business a higher interest rate to compensate for higher credit risk.
The real impediment to SMEs' ability to increase their leverage comes down to collateral. Pledging collateral directly reduces the credit risk of lenders. Since credit risk for SMEs is higher than that of corporate businesses by nature, lenders require a relatively higher value of pledged collateral in order to mitigate exposure. While larger corporate businesses can borrow on a "clean" basis, i.e. without collateral, banks typically grant loans to SMEs based on availability of collateral.
In the past, commonly accepted collateral types included fixed assets such as land, buildings and machinery. Such collateral is widely used in capital-intensive sectors such as manufacturing and real estate. Unfortunately few SMEs possess such collateral, as 80% of them are in the services and trading sectors. The majority of their assets are current assets such as inventories and accounts receivable.
According to the World Bank, the main obstacle to the growth of SMEs in most developing countries is collateral. It points out that in developed economies in North America and Europe, borrowers for decades have been allowed to use other sorts of assets as collateral. These include "floating charges", such as current assets -- accounts receivable, inventories, or patents and copyrights -- instead of fixed assets. This is the main reason why the leverage gap between SMEs and corporate businesses has been closed.
In Thailand, the new Business Security Act, which came into effect in July 2016, has raised the hopes of small-business borrowers. In essence, it allows businesses to pledge floating charges, as their peers in developed countries do. Therefore, a tremendous opportunity will open for SMEs, especially those in current asset-intensive sectors such as services.
Conditional on their ability to service debt, SMEs would be able to obtain more loans since they can pledge collateral beyond fixed assets such as accounts receivable, inventories, machines, ships, aeroplanes or even entire business franchises. Lenders will feel more comfortable because the increased collateral value will reduce the credit risk of borrowers.
The acceptance of floating charges as collateral in the few months since the Act took effect has been encouraging. According to the Thai Bankers Association, secured transactions with collateral excluding deposits have reached 500 billion baht, 80% of which were accounts receivable and inventories. Based on our projection, this could increase the growth of lending to SMEs to at least 6% year-on-year, instead of the 3% we have seen in recent years.
More importantly, the ability of small businesses to increase leverage will improve because of the augmented collateral value. As a result, about 7.5% of SMEs business will have the potential to expand faster and become corporate businesses in 10 years. This will close the financial needs gap between SMEs and corporate businesses and promote more widespread financial inclusion.
TMB Analytics is the economic analysis unit of TMB Bank. Behind the Numbers is co-authored by Panawat Innurak and Naris Sathapholdeja. They can be reached at tmbanalytics@tmbbank.com