Lending to SMEs

inSight

28 Oct 2004

Lending to SMEs

Hong Kong's Commercial Credit Reference Agency, which starts operation on Monday, will provide an auditable source of information about the credit history of SMEs and make it easier for SMEs to obtain financing.

The importance of small and medium-sized enterprises (SMEs) as a pillar of our economy cannot be overlooked. SMEs account for over 98% of business establishments in Hong Kong and provide job opportunities to over 1.3 million people, or about 60% of total employment (excluding the civil service). A thriving SME sector is thus vital to the economic growth of Hong Kong. However, the economic significance of SMEs has so far not been fully reflected in the balance sheet of our banks. Furthermore, we often hear complaints from SMEs about the difficulties encountered in securing financing from banks. Some have said that banks have been overly conservative in lending to this sector and have placed too much reliance on collateral lending.

The HKMA is acutely aware of these concerns. While lending business is primarily a commercial decision for the banks, the HKMA is keen to strengthen the banking infrastructure so that banks are able to carry out their main function: to turn savings into productive investment. Two developments in particular will help in this direction.

The first is the planned implementation of the New Basel Accord, or Basel II as it is commonly known in the financial community, at the end of 2006. Readers familiar with Basel II will know that, under the Standardised Approach to Credit Risk, which will be adopted by the majority of banks in Hong Kong, the risk weighting for lending to retail borrowers including SMEs will be reduced from 100% to 75%, provided that the retail loan portfolio is sufficiently diversified and certain other criteria are satisfied. In other words, for one dollar of capital, a bank adopting this Approach would be able to extend as much as $16.7 credit to SMEs, as opposed to $12.5 currently, representing an increase of 33%. I should clarify that lending to SMEs would not necessarily increase by 33% immediately after the implementation of Basel II. What I want to point out is that capital would become less of a constraint for lending to SMEs under the revised capital framework.

However, even with lower capital requirement for SME lending, banks may still feel cautious about expanding into this line of business if they are not fully equipped to manage the risks associated with it. In fact, a major reason why banks have been conservative in lending to SMEs is the difficulty that banks have encountered in assessing the creditworthiness of SME customers. This brings me to the second initiative, which is the establishment of the Commercial Credit Reference Agency (CCRA).

Readers may recall that the HKMA first proposed the establishment of a CCRA - an institution that collates the credit information of SMEs and makes it available to lending institutions - back in 2000. The experience of other financial centres such as the US and the UK shows that a CCRA can help bridge the information gap between banks and SME borrowers. It can provide an auditable source of information about the overall indebtedness and credit history of SMEs to allow better credit assessment by banks. This in turn makes it easier for SMEs to borrow from banks and on more competitive terms.

I am therefore delighted to learn that after more than a year of preparation, the CCRA jointly established by the Hong Kong Association of Banks and the DTC Association will start providing services next week.

The establishment of the CCRA comes at a time when the net interest margins of banks fell to a record low of 1.66% in June 2004 and the competitive pressure on banks to diversify their income source is growing. SME lending is clearly a growth business. From our observations and discussions with banks, we notice that most banks engaged in SME lending have reported double-digit growth in this line of business since the beginning of this year. A number of banks have also indicated to us that they are planning to substantially enlarge their SME lending team so as to secure a bigger market share. As a result, a greater variety of products have been offered to SMEs, from traditional overdraft and trade finance facilities to more sophisticated products, such as credit insurance and currency options. We are hopeful that, as the CCRA further develops and our financial system becomes more sophisticated, the perception that banks are too cautious in lending to SMEs will fade.

 

Joseph Yam

28 October 2004

 

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