At a June 19 fair on banking financing for small and medium-sized enterprises (SMEs) in Shanghai, the discussion inside was just as heated as the temperature outside.

"We hope that banks' lending policies will not change," said Mr. Wang, who runs a retail shop selling electrical appliances in the Putuo District of Shanghai. "Just a small shift and there goes our cash flow. With the increase in interest rates, we are concerned that loans to SMEs will be even harder to get."

Wang, who spoke at the fair held in the Shanghai Exhibition Center with the help of the local arm of the China Banking Regulatory Commission, where bank officers met with SME owners, could be the poster boy for small business owners everywhere. SMEs have long complained about difficulties in borrowing funds.

According to a survey conducted by the World Bank, some 50-60 percent of the funds at China's SMEs are internally generated cash. Less than 1 percent is from external fund-raising through corporate bond or equity. Bank loans make up about 20 percent of the mix of funds.

But things are starting to change as banks revise their assessment of these potential customers.

Here's the evidence: in Shanghai, banks are actively courting this sector and some 30 different credit products aimed at SMEs have emerged. And despite his gripes, Wang, for one, has been a primary beneficiary.

Banks seizing the initiative

"SMEs contribute nearly 60 percent of our country's GDP," said Xu Mingfei, a senior manager in the SME development department of the Shanghai Pudong Development Bank.

"Just in Shanghai, there are over 300,000 SMEs. It's a huge cake."

But traditionally, banks have held up credit for SMEs, Xu said.

SMEs usually don't have enough assets that can be provided as the mortgage for loans, and their financial statements often don't meet bank standards. At the same time, banks also lack the business acumen needed to spot worthy smaller businesses.

"If we can break away from the traditional mode of how we evaluate SMEs, we'll find there is a very attractive market there," Xu said. "Financial statements are naturally a major part of the process of evaluating whether loans can be granted to a large-sized enterprise. But with the smaller firms this is not always the case."

Wang, the appliance shop owner, is a typical example. He left a secure job at a bigger electrical appliance firm two years ago to go into business for himself. It was smooth sailing at first but then one of his business associates ran into sudden financial difficulties. That meant badly needed cash wasn't available. Wang didn't have the funds to pay for his supplies. With only a week to go before he needed to make some big payments, he decided to take a chance and see what banks could do for him.

To his surprise, one local bank told him that he could use his inventories as a mortgage for a loan. If that wasn't enough to pay his bills, he could get an outside guarantor to back a larger credit. With the guarantor ratifying the purchase contract, he could get credit from the bank.

Wang filled out all the required forms, and showed bank officers his business license, tax receipts and financial statements. Within five days, he got a loan of 500,000 yuan from the bank.

Actually Shanghai's banks have all begun changing their practices when it comes to lending to SMEs. Now they are actively looking to develop this market, and there are at least 30 different credit products designed especially for SMEs.

For example, the Shanghai branch of Bank of Communications has a service aimed at SMEs: In three days, a company with assets of less than 40 million yuan can obtain credit of up to 10 million yuan.

The Bank of Shanghai and China Minsheng Bank have set up special departments or sections for SME businesses while China Everbright Bank has an SME management center directly under its headquarters.

Not only local banks are eyeing this potential, as foreign banks also are taking an active interest in developing this market. The Standard Chartered Bank, for example, has rolled out its un-mortgaged micro-loan product, bringing competition for SME clients to a new level.

Meanwhile, banks are setting up a whole new system for assessing creditworthiness of SMEs, with early warning systems in place for potential problems after the loan has been granted.

The Shanghai Pudong Development Bank has some 70 criteria for evaluating loans to large-sized companies and 18 aimed at SMEs. Each branch has a department for SMEs in charge of market development and risk control.

Key indicators

So far, banks still don't have a lot of trust in the financial statements of SMEs. To investigate their real performance, banks often seek other information.

"If a company came to us and said its business has risen 50 percent during the past year and its financial statements seemed to support this claim, we would still want to see other evidence like its tax bills and even its electricity bills," said a bank client manager with more than 10 years of experience. "If there was no change in electricity bills, it meant that there were no big changes in its capacity, which would raise doubts about the company's claim."

Wang later discovered that the speedy processing of his loan was largely due to his own efforts in building his business. His goodwill in the sector had spoken for itself.

"We attach great importance to the quality of management, the time spent in the business and the business reputation, or comment from suppliers and customers," said Lu Wenping from China Everbright Bank's SME management center. "Financial stability and guarantees are also important factors to be considered."

But how does a potential borrower establish a credit history?

In addition to maintaining a good reputation, a track record with the lending bank is critical. The bank officer who handled Wang's account frequently reminded him that borrowing is easy for the client who repays on time. By repaying loans on schedule, the borrower adds to his score in the bank's credit rating system. To Wang, this translated into a bigger credit line, faster processing and a better interest rate.

"Our selection process towards SMEs relies on a pre-set evaluation formula, but in the process the lending officer relies to a great extent on personal experience and the specific situation of the enterprise to make a comprehensive judgment," said Lu Qijie, deputy director of the China Everbright Bank's SME management center. "We can't be completely reliant on a fixed formula that does not allow some room for adjustment. And in the end, the market is key."

Normally, there are some minimum requirements for SMEs to get loans from banks. An enterprise must have been in business for at least two years. Most loans should be less than 10 million yuan and the upper limit is 30 million yuan.

Requirements for guarantees have also become more flexible. Now they can take the form of bank deposits, real estate, treasury bonds, corporate bonds, and of course an outside professional guarantor.

Value-added services

At the Shanghai banking financing fair, SME owners may not have had a lot of leverage that would have let them reduce their banking costs. But this doesn't mean that the bankers were calling all the shots. At the fair, many SME owners stood in front of local banks' booths asking lots of questions, but not many were signing up for new services just yet.

An exporter from Ningbo, Zhejiang Province, said that obtaining a slightly lower interest rate was not his main objective. More important was whether a bank could provide more value-added services, whether it could offer more comprehensive import and export services and whether this could reduce his settlement costs. These were the key factors that determined his choice of banks. Having one bank help him with more of his financial needs could mean savings of time and money.

For banks, the mounting competition means they need to increase their flexibility and create new products with an emphasis on value-added services.

The banks not only use value-added services to expand their business but also gain new insight into their customers. And in turn this helps them reduce risk. Many banks have discovered that with the proper risk controls in place, the quality of business from SMEs is anything but poor.

For the Industrial and Commercial Bank of China (ICBC), loans to SMEs had surpassed 100 billion yuan as of the end of the first quarter of this year, with loan quality considered to be good.

ICBC's Shanghai branch is one of the 12 main operations for extending loans to SMEs. As of the end of last year, its outstanding loans to SMEs exceeded 7.6 billion yuan, up 213 percent from the beginning of that year, with a non-performing loan rate of merely 0.05 percent. Its outstanding loans to SMEs had reached 8.5 billion yuan as of the end of the first quarter of this year. The bank had some 2,500 SMEs among its customers, an increase of about 300 from the beginning of this year.

Figures from the China Everbright Bank also show loans granted to SMEs by its five branches in the Yangtze River Delta had totaled 50 billion yuan as of the end of last year, representing 60 percent of their total lending volume. Non-performing loans accounted for only 1.8 percent.

Many industry observers estimate that the outstanding loans to SMEs will exceed 1 trillion yuan in the next five years.

"We are not afraid of competition and we don't plan on starting price wars just to get more customers," said an SME department manager of a bank, who requested anonymity. "It is a huge market and these enterprises are getting bigger. The number of our customers is growing and by keeping close tabs on our clients we are really in a win-win situation."

(Xinhua Finance)

DISCLAIMER: The information contained herein is based on sources we believe to be reliable, is provided for informational purposes only, and no representation is made that it is accurate or complete. This briefing should not be construed as legal, tax, investment, financial or other advice, and is not a recommendation, offer or solicitation to buy or sell any securities whatsoever.