generally required for SME loans, particularly to smaller firms, while virtually all interviewed credit institutions state that guarantees are important because of the aforementioned factors that constrain SME creditworthiness<sup>49</sup> . In this realm, government guarantees (mostly FNG) are playing an important role, while use of personal guarantees (“ _aval_ ”) from the SME owners is also common because they can be used to ‘blacklist’ those individuals in the credit bureau.

Figure 5.13: SME Collateral Requirements Figure 5.14: Importance of Guarantees <!-- Start of picture text --> If collateral requirements are higher for SMEs than for larger How important are guarantees in minimizing loss given<br>corporates, indicate which of the reasons below apply default (LGD) for SME loans?<br>SM Es are more informal 6 3% Very important 50%<br>50%<br>SM Es are harder to evaluate 50%<br>SM Es have worse management 38% 25%<br>Important<br>38%<br>SM Es are more unstable 38%<br>Other 13%<br>0%<br>Irrelevant<br>SM Es’ collateral more difficult to seize in 0% 0%<br>case of default<br>SM Es are harder to prosecute. Explain why. 0% Personal Guarantees Government Guarantees<br><!-- End of picture text --> _Source: Authors’ analysis of bank questionnaires (simple averages across all banks)._ _Note: Figure 5.13 does not add up to 100 percent because some credit institutions provided more than one response. Figure 5.14 does not add up to 100 percent because some credit institutions did not answer the question._

# **_5.2.2  Monitoring and risk exposure analysis_**

Exposures are typically reviewed annually at individual SME borrower level. In all interviewed credit institutions, senior management has an annual approval cycle for individual SME credit exposures, although some banks also review limits at portfolio and product levels. Other credit limits might also be applicable to the SME portfolio, such as global concentration limits by economic sector. The authorization for credit approval limits differs by loan size, so the business line might be involved in approving small SME loans for some banks, while this function is completely centralized in others.

Both headquarters and RMs/credit analysts monitor risk exposures, primarily via a combination of traditional and automated techniques. Banks’ risk exposure is usually monitored via largely-automated indicators/triggers and on-site visits performed to oversee the client’s health (Figure 5.15). Indicators such as repayment frequency, cash flow generation, and total outstanding debt, as well as reporting from the borrowers and information collected from regular on-site visits (mostly for larger firms), represent the most common means of monitoring SME exposures. However, more sophisticated monitoring techniques and early warning mechanisms, such as management of SME exposures based on a portfolio approach and the use of stress testing (Figure 5.16), have not yet been adopted by banks in Colombia.

> 49 The value of having collateral does not necessarily stem from its seizure and liquidation. As one bank pointed out, collateral was “nice to have” but was primarily used to negotiate with borrowers in trouble.

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