Reconciling SME lending quotas and risk-based loans

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The Ultimate Guide to Reconciling SME Lending Quotas and Risk-Based Loans A Framework for Safe and Sustainable Financing

As we navigate the complexities of small and medium enterprise (SME) lending, it's crucial to reconcile two seemingly contradictory approaches mandated credit quotas and risk-based loans. By rethinking the design of credit mandates and incorporating modern risk-mitigating tools, we can create a framework that strengthens SME financing while ensuring prudence.

The Problem with Traditional Quotas

Traditional fixed portfolio targets assume all banks face similar market conditions, possess identical capabilities, and serve homogeneous borrowers. This approach forces lending even when pipelines are weak, data is thin, or risk is poorly understood. As a result, banks respond by gaming the system, paying penalties, or booking low-quality credits that later turn out to be nonperforming.

Shifting from Volume Targets to Access Metrics

Regulators should shift their focus from pure volume targets to access-oriented metrics. Instead of asking how much banks lend to SMEs, they should ask whether banks have created safe, repeatable channels through which SMEs can access finance.

Measuring Access A Better Approach

International experience shows that measuring access – first-time borrowers served, credit approvals through cash-flow models, use of guarantees or onboarding through digital platforms – better aligns development goals with risk discipline.

Category-Sensitive Mandates A Solution

If mandates are retained, they must become category-sensitive. Large universal banks excel at structured finance and cash-flow lending, while rural and thrift banks have a comparative advantage in micro and small enterprises. Digital banks and fintech-linked institutions excel at alternative data, automated underwriting, and low-cost onboarding.

Risk-Mitigating Tools A Key Component

Regulators should allow risk-mitigating tools to count as meaningful compliance. SME lending becomes safer when banks are encouraged – not penalized – for using credit guarantees, movable collateral registries, cash-flow-based underwriting, alternative data scoring, and portfolio risk-sharing facilities.

Incentive Structure A Crucial Factor

The incentive structure also matters. Flat penalties for noncompliance often fail because banks rationally choose to pay them rather than invest in SME lending capability. Penalties should be proportionate to bank size and systemic footprint, ensuring they are not treated as a cost of doing business.

Positive Incentives A Path Forward

Lower capital charges for guaranteed SME loans, reduced reserve requirements for high-quality SME portfolios, or preferential access to rediscounting facilities can encourage compliance without diluting prudential standards.

A Safe-Pipeline Approach An Alternative Solution

A safe pipeline approach allows banks that cannot generate SME loans safely under risk-based principles to channel their shortfall into alternative development pathways – such as funding guarantee pools, contributing to SME development facilities, or investing in qualified SME bonds or securitizations.

Data The Foundation of Reconciliation

None of this works without strong data. Risk-based lending thrives on information, and quotas fail without transparency. A reconciled framework requires standardized SME reporting, clear distinctions between direct lending and alternative compliance, robust performance dashboards for regulators and policymakers, and borrower-level data sharing through credit bureaus.

Conclusion A Path to Reconciliation

In conclusion, the goals of mandated credit quotas and risk-based loans are not contradictory. Quotas seek broader access to credit for underserved enterprises, while risk-based lending seeks safety, sustainability, and discipline. By shifting from hard volume mandates to capability-based access requirements – supported by guarantees, proportionate incentives, differentiated targets, and modern risk tools – we can create a framework that reconciles these two approaches.

About the Author

Benel Dela Paz Lagua is an experienced financial professional with expertise in SME lending and risk-based lending. As a former EVP and chief development officer at the Development Bank of the Philippines, he has witnessed firsthand the challenges and opportunities in SME financing.

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