Small and Medium Business Finance Challenges for the Future

Speeches

01 Sep 1995

Small and Medium Business Finance Challenges for the Future

Andrew Sheng, Deputy Chief Executive, Hong Kong Monetary Authority

(Address to the Hong Kong Management Association)

Mr. Chairman, Distinguished Guests, Ladies and Gentlemen,

  1. I am very honoured this evening to attend this dinner gathering organized by the Hong Kong Management Association. Your organizing committee has asked me to say a few words about the work of the Hong Kong Monetary Authority, the development of the financial sector in the future and factors that may affect the finance of small and medium business in Hong Kong. Since the small and medium business sector has had a brilliant record of contribution to the success of Hong Kong, this is a very challenging topic indeed. The small to medium business sector has an important role in Hong Kong's economy. In 1994, 32,552 or 95.6% of all manufacturing concerns in Hong Kong employ less than 50 persons, accounting for half of manufacturing employment.
  2. The functions of the Hong Kong Monetary Authority are threefold:-
    • the maintenance of monetary stability, through the linked exchange rate system;
    • the maintenance of banking stability, through bank supervision; and
    • the promotion of Hong Kong as an international financial centre, through the improvement of the financial infrastructure, especially the payment system.
  3. Hong Kong's future as an international financial centre is very bright for several basic reasons:-
    • It is strategically located in the heart of the fastest growing region in the world;
    • It has superior infrastructure in telecommunications and critical mass in skills, people and financial institutions, as well as a business friendly tax and regulatory environment;
    • It is already the fourth largest banking centre in the world, in terms of external assets of banks; the fifth largest foreign exchange market according to the latest BIS survey; the seventh largest stock market in terms of market capitalization; and one of the fastest emerging bond markets in Asia. Hong Kong's competitive edge in the financial markets in size relative to GDP can be seen from Table 1.
  4. What are the major financial challenges facing small and medium businesses operating in Hong Kong? I can see three key issues.
    First, as manufacturing businesses move into China and the region, the shape of business operating in Hong Kong will move increasingly into the service sector.
    Second, as owners and managers of businesses in China and the region, the financing requirements will change.
    Third, the mode of financing of small and medium businesses around the world is changing.
  5. Let me say a few words about the change into the services sector. Many international observers seem to suggest that when Hong Kong moves to become a more service-oriented economy, growth will inevitably become slower. With all due respect to them, I beg to disagree. I fully agree that the sources of growth will change, but one of the more controversial areas is that service-oriented growth is much more difficult to measure than manufacturing growth. In Hong Kong, we have seen that the manufacturing has to move to China and the neighbouring economies because of higher labour and rental costs. Hong Kong, however, has remained the headquarters of these manufacturing arms, providing the strategic direction, the fund management, marketing, transshipment and other services to assist the manufacturing process. All these services are difficult to measure statistically.
  6. In a sense, the software [the services sector] may be even more important than the hardware [the manufacturing sector] in the modern world. In the United States, for example, a survey of small to medium businesses with employees of less than 500 show that 78.3% are working in the services sector. In the UK, 90,000 medium sized business provide 33% of the workforce and 40% of private sector output. In Taiwan, over 778,000 small and medium businesses account for 46% of production and 71% of employment. I am very confident that the free market environment in Hong Kong will facilitate the growth of the services sector in Hong Kong as dynamically as it has facilitated the growth of the manufacturing sector in the past.
  7. Secondly, as your organizing committee has mentioned to me, the financing requirements of small and medium business as you move into China and the Region have also changed significantly. This is because the financial structure in China itself is changing because of major reforms. There is a saying that finance follows trade and investment. The very fact that Chinese banks seek to open branches in Hong Kong and Hong Kong and other foreign banks seek to open branches in China reflects the growing trade and investment integration of the Chinese economy with the rest of the world. For the moment, many small and medium business will not be able to find the same level of financing services in China as you find in Hong Kong. It is not possible, for example, as yet to borrow RMB funding in Hong Kong for investments in China to reduce foreign exchange risk. Indeed, the challenge is to finance the trade and investment in China with the resources and skills in Hong Kong.
  8. In fact, that individual challenge in the small and medium business area is also the larger challenge for Hong Kong as the international financial centre and the centre of finance for China and the Region. Hong Kong must generate the financial markets and instruments to respond to these business needs. The emergence of the secondary mortgage market in Hong Kong and the bond market, for example, are good examples of how the technology and infrastructure built in Hong Kong would be extremely beneficial for business in China and the Region. There will be cases not only of the "H" Bond market developing, that is, the Chinese enterprises borrowing in Hong Kong, but also Hong Kong businesses borrowing in the bond market for investment in China and the Region. We envisage this to develop not only in HK$, but also in the future in RMB and other currencies.
  9. Thirdly, the issue of small and medium business finance. The Hong Kong banking and equity markets have traditionally served the small and medium business well. However, the international experience (as shown in Table 2) is that small to medium businesses rely much more on internal finance (mainly retained earnings) for financing rather than on banks and the financial markets. There are signs that this is changing. We can see this from several trends.
  10. You may have noticed that there is a revolution going on in the small and medium business sector in the United States. With the growth of Internet or the Web, many small businesses are now able to deal directly with customers and suppliers through the Internet, and payment is often through credit cards. With superior communications, including courier packaging and home order, small to medium business are now reaching out to the consumer faster than before. In addition, banks in the United States are slowly beginning to appreciate how payment flows through the Internet could, if unchallenged, circumvent the banking system.
  11. I am not saying that tomorrow the Web will change business and banking in Asia. The Internet is still new to Asia, but its rapid growth in Hong Kong has shown how the market has grown in response to a need for cheaper and more convenient form of communications. The market works on a principle of competition in services and costs. What this implies is that previous financial goods and services that were not available to small and medium businesses would now become available at cheaper prices and greater convenience.
  12. I notice, for example, that Hong Kong has move towards greater Electronic Data Interchange (EDI), to facilitate transfer of business information. The TDC has also a Trade Enquiry Service to provide small companies with information on a network of overseas buyers and business partners. To what extent should this business information network be linked with financial services to facilitate both trade and payments in Hong Kong? Another capital market example is the fact that many investment funds are now beginning to develop what they call "Small Cap" funds, by investing in small growth companies with potential for listing in the future. As demand for higher returns increases, the asset managers are venturing into provision of equity funding in smaller companies in competition with the traditional fund providers, such as banks and the stock market. Banks are also more interested in securitizing loans to good customers, in order to improve their own liquidity. Thus, the funding of small and medium business is changing.
  13. Small businesses survive on good information, trust and performance. Traditionally, the larger businesses have better information, better credit ratings and larger capital resources, thus allowing them access to stock and bond markets that were exchange-based. However, the development of screen-based financial markets show that there is demand for financial assets offered by credit-worthy small and medium businesses. To meet this demand, the small and medium businesses must gear themselves up to provide good accounting information on performance, in order to improve their own credit ratings. The World Bank, for example, has recently suggested at the Emerging Asian Bond Market Seminar that to foster the bond market, you need bond rating agencies and possibly a bond guarantee agency. These ideas are worthy of consideration by the private sector. The intermediation of supply and demand for small and medium business finance in a changing world of financial technology is one of the key challenges facing financial markets around the world. This is also a challenge facing Hong Kong financial markets.
  14. Due to the free market environment of Hong Kong, there is no need for the credit allocation policies practiced in the Region. By providing a low tax, market-friendly regulatory regime and good, sound financial infrastructure, there has been no need for special financing instruments for the small and medium business sector. What is needed are ideas for the market to digest, so that Hong Kong can continue to innovate in this field. I am sure that the Hong Kong Management Association has many good suggestions on how to promote better information on small to medium businesses and to improve access to financial markets. Your research and suggestions will help considerably to push Hong Kong forward at the cutting edge of financial innovation.
  15. Thank you for your attention.

Table 1: Key Indicators of the East Asian Financial Markets, 1993

(Amount in US$ billion)

M21 Bank Assets1 Equity Market2 Bond Market3
US$ % GDP US$ % GDP US$ % GDP US$ % GDP
Chinaa 519 88 547 128 41 9 47 11
HK4 119 109 200 182 385 352 6 5
Indonesia 69 48 85 59 33 23 13 9
Korea 139 42 229 69 139 42 138 42
Malaysia 54 88 60 93 220 342 35 54
Philippines 22 42 28 51 40 74 24 43
Singaporeb 51 92 92 167 133 240 38 70
Thailand 98 79 118 95 130 104 10 8
Germany 1184 65 2766 145 463 24 1587 83
Japan 4633 111 6338 150 3000 71 2887 68
UK 885 96 2101 223 1152 122 311 33
USA 4013 64 3471 55 5224 83 6993 112

Sources:
1 International Financial Statistics
2 Emerging Markets Database, International Finance Corporation.
3 Country Reports and World Bank staff estimates.
4 Hong Kong Monetary Authority.
a) Specialised financial institutions only.
b) Deposit Money Banks only.

Table 2: Net sources of finance- 1970-89

Weighted Average, undepreciated, revalued

France Germany Japan UK USA
Internal 66.3 80.6 71.7 98.0 91.3
Bank Finance 51.5 11.0 28.0 19.8 16.6
Bonds 0.7 -0.6 4.0 2.0 17.1
Equity -0.4 0.9 2.7 -8.0 -8.8
Trade Credit -0.7 -1.9 -7.8 -1.6 -3.7
Capital Transfers 2.6 8.5 N.A. 2.1 N.A.
Other -14.9 1.5 1.3 -4.1 -3.8
Statistical Adj. -5.1 0.0 0.1 -8.2 -8.7
Notes 1970-85 1970-89 1970-87 1970-89 1970-89

Source: Unpublished flow of funds figures from the CEPR International Study of the Financing of Industry. Data Courtesy of Tim Jenkinson And Colin Mayer.

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Last revision date : 01 September 1995