The FINANCIAL — Currently the Georgian economy is working on establishing the local capital market in order to find an alternative to bank lending, which has become inaccessible to the majority of businesses in Georgia.
The inaugural Georgian Lari Bond is going to be launched by EBRD in cooperation with National Bank of Georgia this week. However, the development of capital markets is a long-term strategy which cannot solve the existing problems faced by SMEs in the short run. Experts believe that a more appropriate and effective way to improve credit availability for SMEs is “cheap credit” programmes. A key difference between regular bank lending and the capital market is that with a regular bank loan, the lending is not securitized. The second difference is that lending from banks and similar institutions is more heavily regulated than capital market lending. A third difference is that bank depositors and shareholders tend to be more risk averse than capital market investors.
The previous three differences all act to limit institutional lending as a source of finance. Two additional differences, this time favouring lending by banks, are that banks are more accessible for small and medium companies, and that they have the ability to create money as they lend.
In the 20th century, most company finance apart from share issues was raised by bank loans. But since about 1980 there has been an ongoing trend for disintermediation, where large and credit worthy companies have found they effectively have to pay out less in interest if they borrow direct from capital markets rather than banks. The tendency for companies to borrow from capital markets instead of banks has been especially strong in the US. According to Lena Komileva writing for The Financial Times, Capital Markets overtook bank lending as the leading source of long term finance in 2009 – this reflects the additional risk aversion and regulation of banks following the 2008 financial crisis.
The ratio of commercial bank loans to GDP reached 38.5% as of December 2013. The same rate in 2004 was 10% lower.
“Development of local capital markets could mitigate financial constraints, and provide a much-needed source of liquidity for Georgian banks as well as corporations,” Ia Vardishvili, Researcher at ISET Policy Institute, told The FINANCIAL. “However, the development of capital markets is a long-term strategy and cannot solve the current problems faced by SMEs in the short run. A more appropriate and effective way to improve credit availability for SMEs is “cheap credit” programmes which could be provided by the Government. In addition, the Government can also provide long-run credit with low interest rates. These programmes have been effectively practised by many other developing and already developed countries (for example in the EU). In Georgia it will give the chance to those in the private sector to expand their business activities in different sectors of the country. Finally, as a result of the policies the country will achieve long term and inclusive growth of the economy,” Vardishvili said.
“The newly established co-investment fund and Venture Capital Fund will also help with the exploring of new industries and diversification of the business sector. However, we should note that this fund mainly serves large businesses/corporations which means that again SMEs are outside of the target range. As well as the Government’s cheap credit programme we think that developing special venture capital funds for SMEs will be an additional support for their development,” said Vardishvili.
“Commercial banks supply businesses with credit resources. However for future growth , including receiving bank credit, companies need to have sufficient amount of equity capital. Companies that are well capitalized and have transparent accounting do not have a problem of attracting bank credit, however attracting other types of capital for long-term financing is another issue,” said Archil Mestvirishvili, Member of the Board of the National Bank of Georgia, Vice-Governor.
According to Mestvirishvili, attracting equity capital is more difficult for start-up business due to their higher perceived risk.
“Therefore it is important to develop other segments of financial market from which attracting equity, including venture capital, will be available,” he added.
“The development of capital market is a long-term and routine process. Stock market development requires lots of prerequisites. The existence of sufficient liquidity on the “lower” segments of the market is very important. Liquid money and foreign exchange markets are necessary preconditions for liquid short and long term Government bond markets. Which itself is a precondition for liquid corporate bond market. Existence of this market are necessary for liquid stock markets But this are necessary not sufficient for equity market development” said Mestvirishvili.
In his words, important steps have been taken for the development of financial markets during recent years. Money, foreign exchange and governmental bond markets have sufficient liquidity at this stage.
“The development of corporate bond market is the next step. Issuance of corporate bonds on domestic market denominated in GEL international financial institutions will help this process. However, for the full-fledged development of corporate bond market there is a long way to go,” said Mestvirishvili.
“Creating relevant legislative, regulatory and technological infrastructure in parallel is also important. Upon this we are actively working with international financial institutions, Government and other interested parties,” Mestvirishvili told The FINANCIAL.
In December 2011 the ratio of commercial banks’ loan portfolio to GDP was 30.9%.
Commercial banks’ assets to nominal GDP totaled 64.4% as of December 2013.
Share growth of commercial banks in the economy will depend on many factors. Mestvirishvili expects that this year business will be more active comparing with the previous year. It will increase the demand for credit resources. By the end of 2014 it is expected that the ratio of total assets of the banking sector to GDP will reach 67%.
“Since the banking system is highly integrated with the international financial market, being a banking-reliant country contains risk in being a follower of the international environment, in regard to sharing the burden during bad times,” said Maya Grigolia, Senior Researcher at ISET Policy Institute.
“The lacklustre growth of the private credit market is indicative of low private investment activity and problems related to high cost of finance. The availability of domestic credit for the private sector in Georgia is below the regional average. According to the World Bank enterprise survey data 2013, the main obstacles for the private sector in Georgia are access to finance. More particularly, the high cost of funds and low economies of scale in the banking sector create inefficiencies and result in high market interests rates, which creates great constraints for SMEs in taking out credit; furthermore, due to the low levels of domestic industrial development, banks are reluctant to diversify their portfolios across economic sectors and across regions. This again results in high interest rates for new industries,” said Grigolia.
“In addition, the high interest rates on commercial bank loans and non-developed capital markets imply that no source of additional funding exists for local corporations, which in turn necessitates their reliance on indirect financing, and contributes to the higher leverage of the firms. These factors also adversely impact on the banks’ asset quality. In conclusion, high interest rates and the low supply of financing to diverse industries keeps demand at low levels and undermines growth potential. Additional financing via stock exchange is unavailable due to the inefficiency of the small market size,” she explained.
Like Grigolia, Irina Gurululi, Programme Manager at Economic Policy Research Center (EPRC), believes that the existing credit interest rates are high. She estimated the demand for collateral as another significant obstacle for entrepreneurs.
“Banks require real estate as collateral in most cases. Business loans are rarely issued with the collateral of movable property. This can be explained by their complicated liquidity and lack of markets. Small business owners rarely have real estate to provide as collateral for a loan. Entrepreneurs quite often mortgage their own homes, which then often ends in their loss. It is hard to find an alternative source for loans besides the bank,” she said.
“The sectors that are mostly financed with banking loans are also important. Banking loans cannot cover the sector’s GDP, with the exclusion of industry, construction and trade. Agriculture is one of those sectors. It is one of the most backward fields, despite government efforts. Economic growth will be difficult without allocating credit for agriculture and SMEs. 65% of workers are self-employed in the agriculture and SME sectors,” said Guruli.
Discussion about this post