The Tribune

• IDB tells Bahamas: Build ‘bridge to real economy’

• VAT/Stamp Duty elimination for SME financing

• Total private sector credit ‘less than third of peers’

By NEIL HARTNELL

Tribune Business Editor

nhartnell@tribunemedia.net

The Bahamas has been urged “to find creative means” to allow so-called ‘offshore’ financial institutions to participate in the local economy and help narrow an estimated $748m small business “financing gap”.

The Inter-American Development Bank (IDB), in its latest Caribbean Quarterly Bulletin, argued that such reforms would develop a “potentially valuable bridge between the real economy and the offshore financial sector” - especially when it came to financing micro, small and medium-sized enterprises (MSMEs) that are frequently capital starved. It also urged that this sector be exempted from VAT and Stamp duty levied on financial instruments when seeking funding.

Noting that total outstanding private sector credit, at 58 percent of gross domestic product (GDP), was “less than a third of that of” The Bahamas’ peers, the report said exchange control restrictions and reserving certain sectors for 100 percent Bahamian ownership only deterred foreign investment that could prove an invaluable source of business financing.

With the ‘offshore’, or international banking sector, possessing total balance sheet assets of over $153bn at end-2020, the IDB said: “There is potential for these ‘offshore’ assets to play a more active role in the Bahamian economy, especially in the provision of much-needed financing. Since 2018, the fisheries industry has received almost no credit from domestic banks yet, according to the Bahamas Investment Authority (BIA), this sector is reserved specifically for Bahamian nationals.

“Furthermore, like the fisheries sector, agriculture has received negligible financing from the domestic banking industry but, with respect to food security, only agro-industries, mariculture and food processing are explicitly listed by the BIA as areas targeted for international investors.”

Noting the regulatory barriers that limit foreign investor participation in the Bahamian economy, the IDB report added: “Foreign direct investment requires the approval of the BIA, and large foreign investments require the approval of the National Economic Council (NBEC), which includes members of the Cabinet and thus may also be susceptible to lobbying by local interests.

“Decisions can take on average 60 days, and the process would benefit from increased transparency. Additionally, non-Bahamians need a permit to buy land. Both requirements discourage investments in land-intensive sectors such as agriculture by non-Bahamians.

“Furthermore, due to strict foreign exchange controls to maintain the current currency peg, international banks are not allowed to invest in domestic securities, are only permitted to hold Bahamian dollar balances for the purpose of paying local expenses, and are not allowed to have Bahamian customers.”

The Bahamas has traditionally kept the international financial services industry walled-off from its domestic counterpart, although these barriers were somewhat broken down by compliance with the European Union’s (EU) demands for the elimination of so-called ‘ring fencing’ which previously saw tax breaks and incentives offered to the so-called ‘offshore’ sector that others were not able to access.

“There is an opportunity to find creative means to allow offshore entities to participate more closely in the Bahamian economy while maintaining their offshore status and privileges,” the IDB argued. “Not only is there a need for financing, but traditional means of financing are inadequate for a variety of reasons such as collateral requirements, size of financing,and terms of financing.

“As of 2017, there were approximately 800 investment funds with over US$85bn in assets [domiciled in The Bahamas], and many of these funds are familiar with complex and non-traditional financial instruments such as venture capital and private equity. Therefore, these entities not only have the capital, but also possess the expertise and interest.

“One potential avenue of exploration would be connecting promising non-bank financial institutions, such as those involved in private equity, with offshore financial entities interested in investing locally. These offshore financial entities would invest with approval from the Central Bank to ensure that inflows of foreign currency are adequately regulated, while local Bahamian investment funds, unhampered by rules targeting non-Bahamians, can invest freely.

“However, for this to occur, substantial regulatory reform and government support would be needed to create this narrow yet potentially valuable bridge between the real economy and the offshore financial sector.” The IDB’s theory is that this will increase financing options, and capital inflows, for MSMEs who have struggled to raise the required funding from domestic sources.

Estimates of the ‘financing gap’, or funding shortfall, for this sector range from the IDB’s $180m projection to the $748m derived by Canadian consultants who put together the Bahamas Development Bank’s (BDB) turnaround plan. 

International Financial Consulting, employed data obtained from the Small Business Development Centre (SDBC), IDB and commercial banks to come up with figures indicating that Bahamian SMEs suffer from a “financing gap” equivalent to between $8,000 to $30,800 per firm.

Meanwhile, the IDB report said VAT’s introduction in 2015 had only added to the costs and complexity facing small businesses when it came to sourcing debt financing. With the 10 percent levy applying to loan fees, as well as services provided by financial intermediaries, accountants and attorneys, it added that “the additional tax burden can incrementally accumulate for MSMEs”.

While these payments could be ‘netted off’, or reclaimed, as an expense against companies’ output VAT, the report said some may have to claim this as a refund or credit and therefore be subjected to an audit review. “

“Therefore, benefits of contracting an auditor are further compounded for businesses wishing to reduce their cost of accessing finance. Furthermore, the use of collateral to secure loans also incurs a stamp duty of 1 percent on the loan itself, which is another fixed up-front cost for MSMEs,” the IDB added. “Therefore, consideration should be given to making MSMEs exempt from stamp duty and VAT when seeking financing.”

It also said having to become a VAT registrant, for companies with an annual turnover of $100,000 or greater, and make quarterly filings and payments to the Department of Inland Revenue, “can be particularly burdensome” for MSMEs. 

“Although firms can then also benefit from VAT refunds for inputs, this would also subject them to potential audits. Over the last two years, only 63 percent of MSMEs and 44 percent of large firms indicated that they had applied for business licenses,” the IDB report said, referring to the results of a survey conducted of Bahamian businesses.