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Widening and Diversifying SME

through Capital Market
Deputy Dean
Asian Development Bank Institute
Financing SMEs: Sharing Ideas for Effective Policies
Capacity Building and Training Workshop
Jointly organized by ADB Institute and Bank Indonesia
Jakarta, Indonesia, 15-16 October 2014
The views expressed in this presentation are the views of the author and do not necessarily reflect the views or policies of the Asian Development Bank
Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the
data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB
official terms.

Trends in SME Financing and Challenges

Comparison between OECD and ADB
SMEs account for more than 90% of
total enterprises in number and
employ more than half of national
labor forces on average in both
ADB and OECD countries.

Trends in SME Finance and Policies

in ADB and OECD countries*

In OECD countries, access to

finance represents one of the most
significant challenges for
entrepreneurs and for innovative
small businesses.
In Asia, the issue of how to enhance
the lending accessibility for SMEs
has become the core of the SME
access to finance agenda.

* Note: Calculated based on data of the ADB Asia SME Finance Monitor 2013 and
the OECD Scoreboard 2013.

Source: ADB and OECD.

Trends in SME Financing and Policies

Government Support Measures in Asia

Given the largely bank-centered financial systems established in Asia,

three issues have become the priority of policy agenda:
1. Enhancing the bankability for SMEs;
2. Raising more bank lending efficiency for them; and
3. Filling the supplydemand gap in SME finance.
Accordingly, governments have developed a variety of measures to
support SME access to banks. (i.e. public credit guarantee schemes)
In addition, policy measures supplementing the promotion of bank
lending to SMEs include:
1. Concessional direct lending: by policy banks/government authorities;
2. Refinancing schemes for bank: by development organizations or
government; and
3. Government interest rate subsidies.

SME Financing and Financing Gap

The sources for SME financing is limited, and there is a
financing gap in SME financing
Majority of SMEs experience a financing gap, often defined as the
difference between demand for funds by SMEs and supply of funds
available to SMEs, even in developed countries.

SME financing gap is particularly prevalent in developing

As past financial crises raised Asian DMs consciousness against global
uncertainty, growing access to SME finance to reduce the supply-demand
gap has becoming a priority for sustainable and inclusive growth.
OECD countries do not report any generalized SME financing gap. They
reported financing gap primarily in equity financing, which is concentrated
in certain sectors such as startups and high-tech firms.

SME Financing: Major Source of Funds

In most countries, commercial banks are the main source
of SME financing
In Asia, the lending scale to SME is relatively large (double-digit to GDP)
in several countries, including Korea (38.9%), Thailand (33.7%), and
Malaysia (20.1%) in 2012-13. (ADB-OECD, 2014)

In Korea, most SMEs heavily depend on bank loans

More than 70% of their funding is from bank loans.
Bank loans (71.9%) and policy loans (24.8%) together consist more than
96% of SME financing.

SME Financing: Diversification of Sources

SMEs heavy reliance on bank loans as a mean of longterm financing, however, is not desirable since there is a
possibility of failure in roll-over for the maturing loans
when banks face liquidity problems.
Therefore, development of diversified financing models
to help SMEs raise long-term growth capital has become
a key challenge in SME finance.
Capital markets are one of the best candidates as
alternative sources of long-term funding for SMEs.

SME Financing through Capital Market:

SME Financing through Capital Markets is desirable
for long-term financing
However, most countries have problems in SME
financing especially through capital markets
e.g. SMEs illiquid financial instruments hard to find

Sources of SME Financing in Korea

Most Korean SMEs heavily depend on bank loans

More than 70% of their funding is from bank loans.

Bank loans (71.9%) and policy loans (24.8%) together consist more than 96% of SME

SME financing from capital market is mere 0.7% of total

Sources of Financing for Korean SMEs in the Manufacturing Sector
equities, 0.3
corporate bonds,
Private debts, 0.9non-bank financial
foreign borrowing,
, 1.5
policy loans, 24.8

banks, 71.9

Source: Korea Federation of Small and Medium Business

Major Obstacles for Capital Market Financing

Hurdles to be overcome in order to facilitate SME
financing in capital markets includes
having an adequately developed capital market in terms of depth
and liquidity
There exist severe information asymmetry in this segment of
SMEs, in essence, have relatively high credit risk. (more
vulnerable to sudden changes in economic and competitive
SME financing in capital market is inherently associated with a
higher implementation cost per deal. (smaller size of funding,
higher information cost)

Governments Role in Capital Market

Thus, government and policy makers not only have to
focus on the development and growth of capital market
But also search for a means to overcome the obstacles
inherent to SMEs in order to facilitate active SME
financing in capital market: that is
To provide access to credible corporate information on SMEs
To alleviate higher credit risk and higher transaction cost

SME Financing in Bond Market: P-CBO Program in Korea

P-CBO is a type of ABS with newly-issued corporate
bonds as underlying asset
P-CBO resolves the credit mismatch and high cost

P-CBO pools bonds with different levels of risk; and with sufficient
number of firms, the overall risk as well as transaction costs
Credit enhancement further reduces the credit risk of CBO.
Basic Structure of P-CBO Issuance


Variations of P-CBO in Korea

First P-CBO program by SBC

Credit enhancement by Korea Housing Bank

SBCs additional enhancement by repurchasing the subordinate tranche
Senior tranche was sold to investors in the market

P-CBO issuance utilizing credit guarantee funds

With credit guarantees by KODIT or KIBO, the percentage of the senior tranche in the total PCBO deal went up to 93-97%

First P-CBO Program by SBC

P-CBO Program with Credit Guarantee


Variations of P-CBO: Cross-Border P-CBO

Cross-border P-CBO in Dec 2004
46 Korean SMEs participated in the P-CBO issuance in Japan in 10 billion yen
Credit guarantees by IBK and JBIC
Subordinate tranche of the CBO issued by the domestic SPC was purchased by SBC,
providing additional credit enhancement
Senior tranche of the CBO was acquired by the foreign SPC established in Japan and
then distributed to investors in the Japanese market
Cross-Border P-CBO Issuance with Dual SPCs Structure


SME Financing in Equity Market: Venture Capital

Basic structure of venture investment by venture capital Co.
Venture capital company makes a fund, and operate it as a GP
Other investors join the investment as a LP
- Structure of Equity Investment to SMEs VC Company

Angel Fund




Other Investors
Government including
Korea FoF
Pension Fund
Financial Institutions


Venture Capital in Korea: Fundraising Stage

Central and local government are the largest investors to
venture investment funds
The share of institutional investors is expected to grow
Recent removal of restrictions on banks, insurance companies, mutual
savings banks
The soundness in the venture capital market would be enhanced if
institutional investors actively participate in the market with monitoring
funds management
VC market gains another reliable source of investment, and
institutional investors have a high-risk, high-return investment
instrument => mutually beneficial


Venture Capital in Korea: Investment Stage

Recent rebound of venture capital market
Venture capital industry is in recovery due to the govts effort to
rehabilitate VC market since 2004

Share of investment to early stage companies is

Average size of fund is also growing.
Investment in early stage companies is associated with higher
risk and longer time to exit.


Venture Capital in Korea: Exit Stage

IPO is the main exit channel
Only 10% of venture capital investment depends on M&A

Venture firms IPOs with venture capital

investment is increasing
The ratio of IPOs with venture capital investment to total IPOs
has increased : 50.5% (2002) 81% (2007)
Average time-span with venture capital investment to IPO is 7.9
years, while that without venture capital investment is 11.5 years.


Korea Fund of Funds

In 2005, Korea FoF was introduced as a stable and unified
source of venture investment
Government is not directly involved in investment procedures.

Since the govt and experienced manager are fundraiser and fund manager, respectively, the
fund operates more efficiently and for public interests.
The fund may protect the venture capital market in recession.
Structure of Fund of Funds
Investor 1

Investor 2

Investor N

Fund of Funds

Sub-Fund 1



Sub-Fund 2



Sub-Fund N




Korea Fund of Funds (cont.)

Korea FoF makes more transparent VC market and provides
a stable investment source to venture firms

Since KFoF selects sub-funds with good track records, sub-funds have incentives to
manage their assets efficiently.
KFoF is expected to raise 1 trillion won over five years, and creates new VC ranging from
500 to 600 billion won each year.
The scheme is more efficient than when the government directly selects venture
companies and makes investment decisions.
Government SME Financing through Capital Market

Direct investment
decision making
Lack of specialty, moral
hazard, corruption




decision making
and management
follow up



Effective Risk Sharing and

Screening Mechanism need to be

Source: Park (2005)


Implications from the Korean Experience

Needs to set specific targets within SME sector in which
financing gap is most serious
If a government does not set a specific target sector, then governments funds may
direct to sectors which does not need financing support.
Early-stage innovative SMEs are most likely to have a financing gap

Innovative efforts with various financing tools is crucial

P-CBO was attractive to investors because the overall default risk decreased.

Even in VC market, governments role was important in

rehabilitating the market and KFoF will play an significant
Rather than direct intervention in the market, construct investor friendly, incentive
compatible and efficient infrastructure


Policy Recommendations
Building a credible SME information sharing system

Removing information asymmetry is an important first step.

Policy makers should search for a way to utilize information currently scattered around
the banking sector, in credit guarantee schemes, and other existing government and
commercial lending programs.
The government must take the initiative and play a major role in the data collection
The credit information on individual consumers will also play a significant role since the
credit assessment of SMEs often depends on an individual, namely the owner and/or
manager of the company.

Facilitating SME financing through bond market

For corporate bond issuance, pooling a group of SMEs may provide a plausible solution to the
inherently higher credit risk and transaction costs associated with SMEs.
If a deal is structured with number of tranches, the base of potential investors will be broadened with
different levels of risk preferences.
The liquidation of bank loan assets in the market via CLO will provide another indirect way of
tapping into the debt capital market.


Policy Recommendations
Fostering venture capital market

For the equity market, fostering venture capital and providing an incentive compatible
environment throughout the whole activity cycle of venture capitalists are the first
Search stage: credible information sharing system and networks of technology and
business assessment industries are crucial.
Raising value of portfolio firm: venture capitalist can play an active role in raising
corporate value through cooperation with the management of the company.
Exit stage: there should be a viable number of exit strategies for the venture

Cooperation and coordination between public and private

Governments role is crucial in alleviating SME financing gap in the capital market.
However, governments role is a necessary but not sufficient condition.
Without active participation from the private sector and investors, the whole endeavor
cannot be a success.
The government should focus on constructing an investor-friendly, incentive
compatible, and efficient market infrastructure in order to promote more active
participation from the private sector.

Thank you