Suretyship has been an issue elsewhere and tweaks may be needed to the local loan guarantee scheme.
This column was first published in Business Day.
Applications are flowing in for the R200bn Covid-19 bank loan scheme, through which loans to businesses are guaranteed in substantial part by the government. The volume and adjudication of these applications will be crucial in determining the size of the scheme’s economic effect.
Banks have a challenge on their hands in administering it. Their risk is limited — if loans go bad, they absorb 6% of the losses and any losses that can be covered by the margin they earn — about 2% per year and a 0.5% guarantee fee. The rest of the loss is absorbed by the government. This should make banks quite relaxed in taking on exposure. While they won’t make any money out of it directly, the loans are subordinated and thus rank behind their existing exposures to clients. A Covid-19 loan therefore provides a buffer that reduces bank risk in their core books.
The scheme also can do much to soften the economic blow of the crisis, ensuring banks have a bigger economy to service in the long run.
But two factors will be important: how the banks deal with the risk that they err in providing a loan and therefore the guarantee is denied by the government, and whether applicants are willing to bear the additional liability. The latter will be particularly important.
Business owners have two choices: they can borrow money to survive the crisis, keeping their businesses open and staff employed, or they can shut down, save whatever assets they can and look forward to reopening when conditions improve.
The decision between these options will depend on many factors — a sense of loyalty to staff, how much of the business can function now, and how long they expect the crisis to last. But it also depends on their personal situation — how much of their own wealth is tied up in their businesses and what personal obligations, such as family, they have now. Like anyone else, business owners will be reticent about increasing the risks to which they expose their families.
Borrowing always increases risk. The subordinated nature of these Covid-19 loans means they rank alongside equity in a liquidation. The risk facing every other creditor is thus not affected, which is an important feature of the risk-reduction elements of the loans, but the risk to the owner is.
Banks can also require personal surety. Business owners must therefore think about how much they are putting their homes and other personal assets at risk. They also must think about effectively diluting their claim over the assets of the business.
As loans only cover three months of overheads and operating costs, another consideration is whether they will be enough. A loan must get one through the crisis or it is pointless. The last thing you want is to incur a liability that takes you to the brink of the other side of the crisis, but not all the way there.
There were 900,000 businesses that submitted tax returns last year. Not all of these will be operating entities, but about 200,000 will be in a position in which the loans could make an important difference to their chances. But borrowers must believe that too, with enough credence to take on the risk.
The rules also require banks to ensure that borrowers had a sustainable business before the crisis and that it will be sustainable when normality returns. When a bank claims in terms of the guarantee, the Reserve Bank will audit the bank to ensure “sound lending practices were applied”. Banks will be concerned about the risk guarantees being refused if there’s a dispute about whether a business was sound before the loan. That could make them overly risk averse.
Suretyship an issue
More than 50 other countries have implemented guarantee schemes of this sort and many have had to tweak the rules as they went along. Some schemes, such as Switzerland’s small business scheme — which lent up to R9m to small businesses interest free and based only on the business’s declaration that it had been affected — caused greater take-up than expected. But the UK’s scheme, which required personal suretyship when it began (but has since been tweaked), struggled to lend in any volume.
It is important that the Reserve Bank, the Treasury and the banks remain open-minded about changes that may be necessary. Suretyship has been an issue elsewhere. The three-month cost period also may need adjustment as greater clarity is gained about the duration of the crisis.
From an economic point of view, it is important that the market clears at the R200bn volume target. That is how to deliver on the economic stimulus promised by the wider R500bn economic package. We must do what’s necessary to shift the demand and supply dials, adjusting conditions on the scheme, to deliver that outcome.
• Theobald is chair of Intellidex, which services banks among other clients. Intellidex drew up a proposal for a bank guarantee scheme that influenced the design of scheme in operation.