The Financial Services Commission has unveiled a plan to reform the present system of supplying credit guarantees to small and medium-sized enterprises. The reform is welcome as serious abuses have long been waiting for remedy

The current credit guarantee system was introduced in the 1970s to provide government guarantees to SMEs that had difficulty accessing bank loans due to their lack of tangible collateral.

Since then, the system has remained virtually unchanged, although the business environment surrounding SMEs has changed considerably. The absence of reform has resulted in serious inefficiencies in allocating financial resources.

The FSC data shows that about 50 percent of the guarantees thus far extended has gone to companies that were established more than 10 years ago. This contrasts with the practices in other countries where guarantees are usually provided to start-ups.

Furthermore, the share of guarantees provided to certain companies for more than 10 years reached 25 percent of the total as of end-2014. This suggests that government guarantees have become a virtual lifeline for many otherwise insolvent companies.

The FSC proposal seeks to address these and other problems. In the first place, the commission intends to increase the share of guarantees allocated to start-ups from 21 percent in 2014 to 27 percent by 2019.

This is a step in the right direction. But the commission needs to go a little further in expanding the share for start-ups. The proposed increase does not seem to be a bold move.

Yet the FSC’s decision to arrange for start-up entrepreneurs to get loans from banks without having to find guarantors deserves praise as it will greatly facilitate business establishment and operation.

Not a few entrepreneurs are forced to give up running their companies due to their inability to get guarantors for bank loans. The commission says its decision will increase the number of entrepreneurs who can get bank loans without guarantors from the present 1,400 to about 40,000.

The joint surety requirement needs to be gradually abolished as it is a serious constraint for entrepreneurs.

For companies that have long relied on government guarantees for their survival, the FSC plans to put their fate in the hands of their creditor banks.

Presently, these companies negotiate the extension of their guarantees with the Korea Credit Guarantee Fund or Korea Technology Finance Corp. Under the reform plan, they are required to negotiate directly with their creditor banks. It is up to banks whether to roll over the guarantees, scale them back or stop supplying them altogether.

Yet whether this mechanism will work as intended remains to be seen. Under this plan, banks are encouraged to do more credit analysis. This is desirable as they have to enhance their credit evaluation expertise.

But banks can still be tempted to keep insolvent companies above water by rolling over government guarantees, because cutting the lifelines entails setting up loan loss reserves, denting their balance sheets.

For more efficient corporate restructuring, the government ultimately needs to gradually wind back credit guarantees, given that they are the main obstacle to weeding out zombies.

And there is little evidence that the current credit guarantee system is useful for SMEs to grow into midsized corporations. The FSC data shows that among the SMEs benefiting from guarantees, only 0.009 percent, or 20, firms climb the growth ladder each year.