1. Introduction
As part of a broader work programme in the area of access to finance, the Ministry of Economic Development ("the Ministry") has commissioned this study, which is focussed on bank lending practices to small and medium sized enterprises (SMEs).2
This report summarises the findings from interviews with seven major banks and from a range of quantitative data obtained from the banks.3 The interviews were conducted on a confidential and non-attribution basis implying that the findings from the interviews have, of necessity, been aggregated to provide an overall view.
Terms of Reference
The terms of reference for this study have two principal aims:
- To provide a detailed understanding of banks' lending practices to SMEs; and
- To review those practices from an economic efficiency perspective.
In respect of the first of these aims, the terms of reference have required that the study review:
- What constitute commercial lending practices.
- Bank lending systems and procedures including credit scoring techniques.
- Bank portfolio policies including sectoral and regional allocations.
- The differential treatment of loans backed by residential property, loans backed by other collateral and uncollateralised lending.
- Decision criteria and the use of discretion.
- Communication of decisions to customers.
The second of the aims for the study has involved:
- Describing the potential sources of "market failure".
- Assessing what actions the banks take to mitigate the potential causes of market failure (primarily asymmetry of information).
- Assessing whether there are any regulatory impediments to efficient bank lending to SMEs.
- Exploring opportunities for enhancing the efficiency of the market for bank lending to SMEs.
It should be noted that the focus of this study has been on the supply side of the market for lending to SMEs. Moreover, the focus has been limited to bank lending and has not extended to other sources of finance. Issues concerning the demand by SMEs for bank lending (or other sources of finance) have not been part of the study's brief.
Report Structure
To address the terms of reference, the report is structured as follows:
- Section 2 provides an overview of the SME sector, the banking sector and the scope of bank lending to SMEs.
- Section 3 discusses bank lending practices to SMEs.
- Section 4 outlines possible sources of "market failure" and comments on the measures taken by banks to mitigate potential "failure".
- Section 5 concludes this report by commenting on some options that could be considered to further improve the functioning of the market for bank lending to SMEs.
Several appendices are attached to this report. These cover the questions asked of banks during interviews (together with a copy of the worksheet detailing the quantitative data sought from the banks), international definitions of SMEs, an aspect of the regulatory environment governing banks (Basel II) and an overview of credit scoring (which is a tool for assessing risk).
Data and Information
This study has relied heavily on information provided to us by the seven banks involved. There are a number of caveats regarding the information and its use that should be noted:
- It has not been the purpose of this study to undertake a statistical survey of banking practices. The number of banks in this study is relatively few, although they represent a significant share of the SME market. While data provided to us by the banks has been aggregated to provide an overall picture, it would not be appropriate to take from this that the results are "statistically" robust or representative of the entire banking sector.
- We have not sought, or been required, to verify any of the information provided to us by the banks.
- There are a number of potential dangers associated with aggregating the data:
- Each of the banks uses different definitions of SMEs (although there is a degree of comparability at a high level).
- Some of the banks have changed their classifications of businesses including SMEs over time, which makes inter-temporal comparisons of data difficult.
- In many instances, not all of the banks have been able to provide the data sought. This reflects one or more of:
- commercial sensitivities;
- some data is recorded by type of product (e.g. in relation to residential mortgages) and it is not possible to ascertain whether the loan is for SME business purposes or something else (e.g. a home mortgage); and
- the time and costs involved in extracting the information from bank databases.
Disclaimer
Our report has been prepared with care and diligence and the statements and opinions in the report are given in good faith and in the belief on reasonable grounds that such statements and opinions are not false or misleading. As noted above, we have had to rely heavily on information provided to us by the seven banks. We have not undertaken any verification or audit of the information provided to us and make no representations as to its accuracy.
We reserve the right, but are under no obligation, to revise or amend our report if any additional information which exists on the date of our report, but was not drawn to our attention during its preparation, subsequently comes to light. We will not accept responsibility to any other party other than to the Ministry of Economic Development, to whom our report is addressed, unless specifically stated to the contrary by us in writing. We will accept no responsibility for any reliance that may be placed on our report should it be used for any purpose other than that for which it is prepared.
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