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Vol.6, No.9, pp.41-94,





Abstract Small and Medium Enterprise (SMEs) are the backbone of all economies and a key source of economic growth. The important contribution of SMEs in Malaysia’s economy, employment and industrialization has been well documented. Although their role in the economy is substantial, many SMEs are facing difficulties to access to financing, human capital, technology and market. Given that there are an issue to finance this is one of the main reasons for the inability of SMEs to sustain their business. Henceforth, it is important that this challenge is to be explored in depth. One of the main reasons why banking and financial institutions are reluctant to disburse funds to the SMEs is due to lack of collateral and good track record of the company. With this scenario in place, they are left with limited financing choices. The objective of the study is to examine as to whether the character (or management’s knowledge of business) of having collateral and also the capacity of borrowing by the SMEs, which is measured by default in loan shown by CCRIS report (Central Credit Reference Information System), will have an influence on the loan approved by the bank officers. A 2 x 2 x 3 experimental within subject design was used in the study. This resulted in 12 cases to be answered by each respondent. Questionnaires were sent to bank managers and officers located in the northern region of Peninsular Malaysia (with centralized business centers) for respective loan applications. 63 bank officers participated in the study. Findings showed that all the three variables had significant effect on the likelihood of the loan approval by the financial institutions from the perspective of credit officers. SMEs should be better prepared when applying for loan with getting the collateral, good relationship with financial institution and having a good financial record. On the other hand government agencies assisting SMEs should educate them to ensure that they are equipped with the knowledge to prepare the required documentations required by the financial institutions. Keywords: Small Medium Enterprises, Collateral, CCRIS (Central Credit Reference Information System) Close Relationship of Management with Financial Institutions

Introduction The Small and Medium Enterprises (SMEs) play a vital role in the development of the Malaysian government’s economic growth. SMEs assist in regional and local development as they accelerate industrialization in rural areas by linking them with the more organized urban sector. This helps achieve fair and equitable distribution of wealth by regional dispersion of economic activities. In Malaysia, SMEs generally face difficulties in obtaining finance with lack of collateral and insufficient documents to support loan application. This lack of financial track record is the main constraint faced by Malaysian SMEs in accessing financing (Airs, 2007). SMEs are vital for economic growth and development in both industrialized and developing countries because they play a key role in creating new jobs. Financing is necessary to help them set up and expand their operations, develop new products, and invest in new staff or production facilities. Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business. But if they are successful, there come at times for all developing SMEs when they need new investment to expand or innovate further. That is where they often run into problems, because they find it much harder than larger businesses to obtain financing from banks, capital markets or other suppliers of credit. The global financial crisis have caused the financial institutions to be more cautious and credit processing has become more complex, that SMEs find it difficult to both understand the procedures and decisions when it come to the loan processing. The credit “crunch” appears to be even more severe among service providers. Many SMEs in the service sector do not own land and equipment, and as a result, it is difficult to provide any form of security or collateral to financial institutions. Reflecting that, Bank Negara Malaysia (2004) stated that demand for new financing by businesses was higher in 2004. Loan applications received from businesses were increased by 20% in 2004, a turnaround from the decline of 7.7% in 2003. Accessibility to finance is a major factor affecting the growth and success of SMEs, thus adequate access to financing is critical to enable SMEs to contribute to the economic development of the nation. From a bank’s perspective, the financing to SMEs is often regarded to be of higher risk due to the relative opaqueness of these firms as compared to larger firms (Berger & Udell, 2006). Previous studies have shown that management’s relationship and track record of payment to the bank or financial institutions, presence of collateral and capacity of the Small Medium Enterprises to repay the loan are some of the factors that are being assessed by the credit officers of the banks or financial institutions when issuing out the loan. Thus the objective of this study is to examine whether the factors have a significant influence on the loan assessment of the Small Medium Enterprises. Sections to follow will discuss the literature review, theoretical framework of the study, data collection, findings and finally will dwell on the implications of the study. Literature Review In Malaysia, the non-availability of finance has been the most frequently cited problem encountered by SMEs, and it is also a crucial issue to many of them. Chee (1986) noted that majority of SMEs indicated inadequate working capital and lack of access to commercial lending as their major problem. Small and Medium Industries Development Corporation (SMIDEC) defined SMEs in Malaysia as: · Manufacturing, Manufacturing-Related Services and Agro-based industries “Small and medium enterprises in the manufacturing, manufacturing related services and agro-based industries are enterprises with fulltime employees not exceeding 150 OR with annual sales turnover not exceeding RM25 million”. · Services, Primary Agriculture and Information & Communication Technology (ICT) “Small and medium enterprises in the services, primary agriculture and Information & Communication Technology (ICT) sectors are enterprises with full-time employees not exceeding 50 OR with annual sales turnover not exceeding RM5 million”. As shown in Figure 1, Economic Census 2011, it is found that most SMEs (55.9%) sourced their finance from internally-generated funds or from shareholders to finance their operations in the 2011 Census. However, majority of medium-sized firms (47.7%) were able to source their funds from financial institutions, including commercial banks, micro-credit organisation and development financial institutions. In the case for microenterprises and small-sized firms, their main source of funding was from their own internally-generated funds. About threequarters (75.6%) of SMEs financing was for working capital. The financing needs were similar across all sizes, namely microenterprise (74.6%), small-sized firms (77.8%) and medium-sized firms (74.2%). Other main activities which required financing (43.6%) were for purchase and lease of equipment, machinery, vehicles, computer hardware and software as well as land and buildings.

Factors Affecting Loan Approval and Hypotheses Development Factors affecting loan approval in previous literature is much in line with the principles o lending as shown in Table 2 and they are management/character, collateral and capacity/CCRIS report. Management/ Character Character refers to the probability in fulfilling and honouring obligations by the SMEs. Hasnah Haron, Ishak Ismail, Yuvaraj Ganesan and Suraiya Md Mustafa (2012) have found that character/management plays a significant role on the probability of loans approved by credit officers. Recent attention to the role of small and medium size enterprise in economic development are driving banks to refocus on their small business clientele. Banks are not only to seek out for new business opportunity in today’s competitive business environment but must also retain existing customers through relationship development. As stated by (Moriarty, Kimball & Gay, 1983) the relationship between small business firms and financial services providers has been the focus of much study in the management and marketing literature. As described by Moriarty et al. (1983) relationship banking is recognition that the bank can increase its earnings by maximizing the profitability of the total customer relationship over time, rather than seeking to extract the most profit from any individual product or transaction. The transfer from a transaction oriented to one long-term interactive relationship expected to exist in the banking environment. Therefore the hypothesis of the study is as follows: H1: Presence of character will increase the likelihood of loan approval. CCRIS/ Capacity In this study, capacity refers to the ability of the business to repay the loan. This is determined by looking at the Central Credit Reference Information System (CCRIS) report. Hasnah et al. (2012), has found that character/management plays a significant role on the probability of loans approved by credit officers. Chauveau, Deartini, & Moneva (1996) found that small business financial reports were most relevant to internal (management) and external (bankers) users. Hence, there is an evidence t show that financial capacity of the borrower does affect the loan assessment by the financial institutions in making decision for the loan approval. Thus it is hypothesise that, H2: Presence of capacity will increase the likelihood of loan approval.

Collateral In this study, collateral refers to security or guarantee for the loan borrowed. Collateral acts as an indication enabling the bank to attenuate or eliminate the adverse selection problem caused by the existence of information asymmetries between the bank and the borrower at the time of the loan decision. Although bank knows the credit quality of the customers, the collateral helps to alleviate moral hazard problems once the loan has been granted. Consequently, problem of moral hazard faced by the bank in lending could be restrained by having collateral. As stated by Aghion and Bolton (1992), collateral can therefore be seen as an instrument ensuring good behavior on the part of borrowers, given the existence of a credible threat. Hasnah et al. (2012), has found that character/management plays a significant role on the probability of loans approved by credit officers. In the case of Malaysia, SME financing is also relatively small, and thus, could not be the major source of income, or deposit, for the financial institutions. Moreover, it is difficult to obtain information and supportive documents to justify the validity and creditability of SME businesses since most SMEs do not keep proper records of their business transactions. Banks are starting point of external credit but they are reluctant to lend to small and medium enterprises (SMEs) due to the high credit risk involved. In view of that, Credit Guarantee Corporation (Malaysia) Limited (CGC) was set up to assist SMEs to secure loans from financial institutions in Malaysia. CGC is the only issuer of credit guarantees to SMEs, the performance of CGC directly reflects the availability of credit guarantees to SMEs. In 2006, CGC has shown commendable progress in providing wider credit enhancement products, advisory services on financial and business development and credit information services besides provider of credit guarantees. (www.bnm.gov.my) Collateral is less likely to be required for older, more established firms. Collateral also may be used to lessen some of the moral hazard related monitoring issues in business lending. As displayed by (Boot, Thakor & Udell, 1991), even after accounting for the cost of repossessions, banks may use collateral to reduce moral hazard problems when lenders are able to take unobservable ex post actions that affect project payoffs. Thus this study hypothesised that, H3: Presence of collateral will improve the likelihood of loan approval.

Management/ Character, CCRIS/ Capacity and Collateral Relationship development will reduce the gap between the two parties, which includes track records, forecasts and some form of collateral. Deeper understanding on the characteristics, objective and constraints will allow mutual expectations with a good relationship. Thus it is hypothesised that, H7: 3 ways interaction between character, capacity and collateral will influence the likelihood of loan approval.

Theoretical Framework Based on the previous literature, the theoretical framework of the study is as shown n Figure 2. The study consists of the following variables, management, capability (represented by CCRIS), collateral and likelihood of loan approval.



Methodology Population/sample The population for this study will be the credit officers responsible for providing loan for SMEs Malaysia. In terms of geographical location and distribution, most of the manufacturing companies are located in the central parts of Malaysia and around the major industrial regions. Penang is one of the major industrial regions as most of the manufacturing sector is located in Penang (island and mainland). Hence, this study uses Northern Peninsular Malaysia to represent Malaysia on the SMEs development. The population will be restricted to only Northern Peninsular Malaysia Bank that is: Penang, Kedah and Perlis in mainland and within Penang Island and Kedah. The sampling frame was the commercial banks, and SME Bank that currently participate in giving loan to SMEs. The sampling units were the bank managers and officers in these banks who are involved in business centre analyzing credit application. Firstly, SME Banks running their assessment via business centre (performing the loan evaluation functions) were identified. Four banks with centralized business centers were then identified. Secondly, these banks were contacted to ascertain their willingness to participate in this survey. Positive affirmation had been obtained on their willingness to be involved in this project. Bank managers and officers who are involved with the centralized business centers for respective loan applications are the best person to interpret the success of this evaluation method. These decision makers have the right information of how evaluation functions are done as they have done the evaluation. Questionnaires were distributed to 124 bank managers and officers but finally only 63 were returned and usable. According to Roscoe (1975), sample size larger than 30 and less than 500 are appropriate for most research (as cited in Sekaran, 2000), thus 63 is an appropriate sample size.

Findings Hypothesis 1 – Presence of management influences the likelihood of loan approval The results obtained from this study shows that the relationship of the SMEs with the financial institutions contributes to the decision process of the loan approval. Practically, the existing customer of the banks will have a better chance of the loan being approved. Hypothesis 2: Presence of CCRIS influences the likelihood of loan approval The level of CCRIS from this study also affects the decision on loan approval. The lesser the number of months the SME is in default of payment (in this study 1 month is minimum) will contribute to higher chances of getting the loan approved. Information from the CCRIS report has shown to have an affect on the financial institutions’ decision on the capacity of the SMEs to repay the loan. Hypothesis 3 –Presence of Collateral Influences the Likelihood of Loan Approval This study found that collateral is the most important factors in order to ensure the repayment of the loan. Collateral is considered as a security for the banks in cases where the primary repayment is adversely affected and the borrowers default. Hypothesis 4 –2 Way Interactions of management and CCRIS of the Likelihood of Loan Approval Figure 3 shows the two way relationship between CCRIS and collateral. The number of months default under CCRIS will also affect the loan approval process. When the collateral is absent, and there is 3 months of default under CCRIS, the percentage of getting the loan being approve is lowest as compared to when the CCRIS is at 1 month with the collateral is present. For the situation where the CCRIS is at 2 months, the chance to get the loan approval is equal whether the collateral is present or absent.

Conclusions The findings supported Hasnah et al.’s study (2012) that shows that character, collateral and capacity are factors that SMEs should equip themselves with when submitting their loans to the financial institutions as the study has proven that all three factors are assessed individually or simultaneously (as shown by 2 way and 3 way interaction effect) when assessing the loan of SMEs. This study has also shown that collateral which is a more “objective and tangible measurement” is more important than management/character which is a more “subjective and intangible measurement”.


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