Research | Regional and economic development | 2010-09-03

Market-based SME Loan Guarantee Schemes

In a research paper released today (3 September 2010), the Bauhinia Foundation Research Centre (BFRC) called for an early introduction of a market-based solution to enhance financing for small and medium enterprises (SMEs) in Hong Kong, the idea of which was first raised at an SME forum organised by Economic Synergy in May.

The study analyses the corporate loan guarantee schemes in Asia, including Shanghai, Taiwan, Korea, Malaysia and Singapore, the operation of the existing SME Loan Guarantee Scheme (SGS) and the Special Loan Guarantee Scheme (SpGS) as well as the economic ecology involving the lending institutions and the SMEs. The study also involves a review of the possible features of the new market-based SME loan guarantee scheme (the New Scheme) and the likely market demand. As part of the study, a workshop was organised today jointly with Economic Synergy to collect the views of banks, SMEs and academia.

The BFRC Chairman Mr Anthony Wu said, “As a key component of our long-term competitiveness, the SMEs account for 98% of Hong Kong’s enterprises providing employment opportunities for 1.2 million workers, i.e. 48% of the total working population (excluding civil servants). That’s why we proposed increasing the guaranteed credit for SMEs as part of our submissions to the Chief Executive during the financial tsunami in 2008.”

The SpGS, which the Government introduced as a special and short-term measure during the financial tsunami in 2008, has helped many SMEs mitigate the impact of liquidity crunch and reduce the unemployment rate. The scheme will cease to accept applications from 1 January 2011.

Economic Synergy’s Mr Jeffrey Lam said, “We advocated very strongly the launch of the SpGS as early as the financial tsunami in 2008. Following the termination of the scheme, we do see the need for an early introduction of a market-based loan guarantee scheme to give SMEs more flexibility in business planning and development.”

Mr Wu said, “It is clear that the SpGS was never intended as a long-term measure given the use of public funding and potential moral hazard. In contrast, the New Scheme is a commercially viable scheme that can foster sustainable SME financing.”

With a third party serving as a guarantor for banks’ SME loans, the New Scheme can be more flexible in terms of the coverage, maximum loan amount as well as guarantee amount and limit. This will mean more choices for SME financing.

“The New Scheme can operate as a supplement to the existing SGS, which will continue to provide SMEs with a guarantee on 50% of the approved loan, subject to a maximum guarantee amount of HK$6 million, granted by participating banks after the termination of SpGS. It will also form part of Hong Kong’s long-term SME loan guarantee mechanism,” said Mr Wu.

According to the Bauhinia study, the New Scheme can be developed with the following three objectives:

• Minimising government subsidies;

• Providing banks or lending institutions with an additional risk-mitigating tool that would encourage them to sustain their scale of financing for SMEs; and

• Supporting enterprises in developing their businesses in Hong Kong in the long run.

To facilitate informed discussions, the paper sets out the following preliminary proposals regarding the features and operation of the New Scheme: Target Segment – The coverage of the New Scheme should be as broad as possible to benefit all non-listed enterprises and SMEs; Facility Type – It is desirable for the New Scheme to cover both term loans and revolving facilities to broaden support for SMEs. With more experience gained, there may be room to improve the coverage beyond that of SGS and SpGS to assist SMEs in their financing.

Underwriting/Coverage – In line with the SGS and SpGS arrangements, there may be advantages for the New Scheme to continue to rely on underwriting by banks, at least initially. In the long run, the guarantor should consider becoming involved in the underwriting process as this will lead to better understanding of the SME risks.

Risk-sharing Arrangement with Banks – In view of the potential risk of adverse selection, it would be reasonable for the New Scheme to consider guarantee coverage ratio from 50/50 to 70/30.

Guarantee Fee Structure – As a guiding principle, the guarantee feel level should be sufficient to properly reflect the underlying credit risk of the corporate borrowers having regard to the loan interest rate, the risk-sharing ratio and loan size. Guarantee Limit and Period – For risk management reasons, there should still be a limit applicable to each enterprise for the guarantee amount under the New Scheme.

Making reference to the existing schemes, the New Scheme may provide a maximum guarantee period of 60 months.

Choice of Guarantor – In order for the New Scheme to be viable, it is essential to have a guarantor of solid financial strength and preferably high credit rating, together with a sufficiently large pool of guaranteed loans to achieve scale economy and risk diversification. The Hong Kong Mortgage Corporation is one of the possible choices.

Mr Wu said, “The study, together with our preliminary proposals, aims at providing a basis for more in-depth discussions. We very much hope the New Scheme can be put in place as early as practicable for the benefit of the SMEs, banks and other market participants.”


Research Paper