Funding the little guys: Small businesses comprise the largest number of players

The development of financing for smaller companies is vital for the Mongolian economy. While resources-focused ventures have the potential to transform the country, it will be more modest enterprises that provide stable employment and income, long-term underlying growth and locally made products. Without a vital small and medium-sized enterprise (SME) sector, Mongolia could find itself with a perpetual underclass and constantly limited by the commodity cycle. A broader base of financing options is more than a luxury. It is needed to ensure that the overall economy grows in a sustainable and balanced way. The SME sector is of great importance to the country. Due to its history and geography, Mongolia has a great many people running and working for small-scale enterprises.

The country is so large and the population density is so low that SMEs exist out of necessity; remote areas of the country simply cannot support larger businesses. Much of the activity is related to agriculture and herding, but the country has a surprising range of small companies. They are involved in manufacturing, retail, trading, repair, processing, mineral exploration, construction and subcontracting, especially for the large mines. According to the Ministry of Labour, of the country’s 90,540 entities, 60,418 of them are SMEs and they employ 60.9% of the people in the labour market.

Those Most In Need Of Capital

Getting financing to these companies for investment and expansion, as well as to individuals wishing to establish new enterprises, is a challenge. In some ways, Mongolia has a rather advanced banking sector. It has a high rate of participation, a sophisticated payments system and a level of financial inclusiveness found in few developing countries. Mongolia is also quickly developing mobile banking solutions, in part to get the nomadic and rural population on the financial grid. Access to financial institutions and distribution of financial products are not major bottlenecks.

However, in terms of the actual financing of SMEs, the country faces an uphill battle. It suffers common developing world issues: lack of capacity, weak credit analysis skills and the lack of collateral on the part of those who most need loans. The additional challenges prevent money from getting to businesses in most need of it. Mongolia’s interest rates are high, meaning that the less creditworthy face repayments that could be impossible to meet. In one recent study citing data from 2010, SMEs were paying 72% interest because of the high interest rate environment, poor transparency on the part of the borrowers and lack of proper credit analysis on the lender side.

The country also has the mining sector to contend with. While some observers argue that the resource boom gets more money into the hands of entrepreneurs, because money flows through the economy and into the banks and the mining giants pay wages, make deposits and pay for goods and services, others believe that mining has the potential to crowd out more challenging opportunities. Banks will tend to dedicate human resources and assets to companies that have straightforward prospects and great quantities of resources to put up as collateral.

Historical Issues

The part of Mongolia’s financial system that would be expected to deal with SMEs the most went through a period of significant turmoil in the early 2000s. This basically hollowed out the segment and left it unable to support the needs of SMEs for a period of several years. By the end of 2006, the country had 955 savings and credit cooperatives (SCCs), together responsible for just 0.8% of the country’s financial assets. This sub-sector collapsed that year – with 29 of the institutions going bankrupt and many others just closing. SCCs had been in a regulatory grey area. They were created as a result of an Asian Development Bank project, but were not under the purview of the Bank of Mongolia. Rather they were covered by the Cooperative Law – which was more designed for agricultural cooperatives – and were overseen by the tax authorities (though the Bank of Mongolia provided some guidance). As a result, almost everything that could be done wrong was. SCCs regularly exceeded single borrower limits, lacked internal controls and were short on capital. They paid excessively high interest, reported false financial statements and often did not even have a compete list of members.

After collapsing, the sub-sector returned, with 52 licences initially being issued by the Financial Regulatory Commission, after it was created and took responsibility for SCCs. The number quickly increased from there to 209. But the damage was done. A key channel for distribution of SME loans was lost at an important time in the country’s development.

International Help

Most smaller businesses have had to rely on pawn shops, traders and individuals in order to access much needed credit. For many in Mongolia, financing has been informal and traditional. However, a wide range of international institutions have stepped into the breach to build an SME and microcredit sector. In 1998, the UN began to support microcredit in the country through its MicroStart programme. Indeed, XacBank emerged from this programme. Since then, a number of nations have offered credit guarantee schemes, such as the Netherlands, Japan, Germany and the US. The EU has also provided funding. These programmes allow banks to make loans at competitive rates and over longer tenors to borrowers who lack security.

In January 2012, the European Bank for Reconstruction and Development (EBRD) along with the EU began proving a wide range of assistance to SMEs in a five-year, €3.8m programme. Among the support being provided is: assistance in improving procurement procedures so that small enterprises have a better shot at government contracts; help to relevant organisations and institutions in developing capabilities important to SMEs (such as the Chamber of Commerce, banks, the Mongolian Management Consulting Institute and the Institute of Finance and Economics); and direct advice to entrepreneurs. One product of the initiative is an online course offered by the Mongolian Banking and Finance Academy that will teach bank loan officers international best practices of lending to SMEs. The training series went live in late October 2013.

The EBRD is also working – in cooperation with the International Finance Corporation (IFC), the Swiss State Secretariat for Economic Affairs and the Mongolian Bankers Association (MBA) – to encourage secured transactions reform, which will help the country develop the legal infrastructure to allow loans to be made backed by movable collateral. The hope is that a registry can be created for collateral of this type (such as farm equipment) so that current information on an asset can be accessed to prevent competing claims from being made against the same asset. Potential borrowers tend to be relatively poor, predominantly agricultural and sometimes nomadic, so very often all they have to pledge are movable assets. It is also important to note that land itself has not historically been easy to use to secure a loan because the market for land is so new; rights to property are not well established and clear title is not always easy to prove.

Government Help

The government has been very active over time in providing support for SME financing. It implemented the first law on non-bank financial institutions in 2002, started the first SME support programme in 2005, passed an SME law in 2007, formed an SME support agency in 2008 and exempted SMEs from value-added tax on imports in 2009. In 2011, a Soum Development Fund was established. Importantly, a Credit Information Bureau was formed in the mid-1990s and operated by the central bank since then and its software was updated in 2003 by utilising a World Bank grant. According to research on the subject, all major banks have participated for years and relied greatly on the bureau. It has been a vital tool in making loans to individuals and companies. While SMEs face difficultly in gaining access to financing, the existence of a good credit information system has certainly helped. Additionally, in 2011, a new credit information law allowed private entities to operate credit bureaus; however, a private bureau has not yet been established. According to the World Bank, 1.11m people were registered in the database as of 2012. Finally, in 2012 a Credit Guarantee Fund was formed. This fund, which is a partnership between the government and the private sector, will provide up to 60% of the collateral needed for loans made to small businesses.

Over the years, a semblance of an SME financing system has emerged, combining various public and private programmes. Small firms and entrepreneurs still struggle to get loans. As in most countries, the bank financing is still hard to come by for those starting out and undertaking early stage expansion. Still, the stage has been set and it is likely that more SMEs will be able to find support in the coming years.