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SME Policy Financing in Korea
According to the Korea Federation of Small and Medium Business (Kbiz),
bank loans accounted for 98% of SME financing in Korea in 2009 at 443.5
trillion won, while direct financing like stocks, corporate debentures, etc.
accounted for 2% at just 9 trillion won.
Since the 1998 foreign exchange crisis, bank lending to SMEs has
increased steadily, affected by shrunken lending to major conglomerates
and stiffer regulations on household loans. As of May 2010, outstanding
bank loans to SMEs totaled 448.2 trillion won, accounting for 46.6% of
aggregate won-currency lending.
Bank lending to SMEs is characterized by “blue-chip” loan practices and
loans backed by mortgages and certificates of credit guarantee. This
environment presents financing bottlenecks that stifle micro-enterprises
as well as promising SMEs with competitive technology and growth
potential but weak financial structure.
Meanwhile, SMEs also face hurdles in the direct financing market due to
low credit ratings. In fact, SME capital formation from the direct
financing market in the first six months of 2010 was just 1.7 trillion won,
about 8% of that of large corporations. Signs point to a recovery in angel
investment this year, but it is projected to remain significantly lower than
in 2006 and 2007.
While SMEs continue to be the backbone of the national economy,
accounting for the vast majority of number of companies and employment
as well as 46.3% of manufacturing production and 32.4% of exports,
mortgage-based lending practices and private financing institutes’
avoidance of assistance are a recipe for market failure. This is the
reason why policy financing is so critical.
To compensate for the shrunken lending environment stemming from
business fluctuation as well as the global financial crisis, policy financing
supports business start-ups and areas where market failure have
cropped up. It also is fostering excellent new and green technologies in
next-generation growth sectors that are facing bottlenecks in access to
mainstream financial markets.
The main forms of policy financing consist of policy capital loans, credit
guarantees, on-lending, and aggregate ceiling lending, the scale of which
has increased significantly in the wake of the global economic crisis that
began in late 2008.
SME policy financing began to take shape in the 1960s and 70s when
Korea turned to large enterprises and the heavy and chemical industries
to lead the national economy with export-oriented policies.
During this period, the government also realized that it would be
necessary to protect SMEs. Therefore, it established financing and
support organizations to carry out SME policy financing, among which
were. the Industrial Bank of Korea, Korea Credit Guarantee Fund and the
Small and medium Business Corporation.
In 1965, a mandatory minimum lending ratio system for SMEs was
introduced, which led to an increase in SME loans at provincial banks
from 30% to 40% in 1972.
The 1980s through 1997 was a high-growth period for Korea, but it led
to structural imbalances in the economy between heavy and light
industries and between large and small-medium enterprises.
Despite this fact, awareness of the critical role and functions of SMEs
increased, leading to incorporation of a provision in the national
constitution regarding protection and cultivation of SMEs. As a result,
bank lending to SMEs expanded, with the SME loan ratio at commercial
banks rising from 30% to 35%, at provincial banks growing from 40% to
55% and at domestic branches of foreign banks starting at 25%.
Centering on provincial and special banks, SME access to household
loans began to increase.
In the wake of the 1997-98 foreign exchange crisis, banks began to
reinforce loan marketing for households and blue-chip SMEs as large
enterprises shied away from loans in order to reinforce their financial
positions. Into the early 2000s, the risk-avoidance trend prevailed and
the household loan ratio began to outpace the corporate loan ratio. Then,
in 2005, the government, concerned about a real estate bubble, started to
implement restrictions on household lending, which subsequently boosted
the SME loan ratio sharply from 258 trillion won in 2005 to 444 trillion
won in 2009.
Today, the key players in the SME financing support system are the
Small and medium Business Corporation (SBC), which primarily
facilitates investment and loans from start-up and promotion funds as
well as credit guarantees, the Bank of Korea, which implements the
aggregate credit ceiling system, and the Korea Policy Banking
Corporation, which oversees the on-lending program.
The support for policy loan funds from SBC consists of the supply of
long-term-low-interest funds to SMEs, which are avoided by private
banks due to weak credit and collateral despite their technological and
business viability.
SBC has revamped its corporate evaluation system to focus on
technological and business viability, including future marketability and
growth potential, rather than on financial status, while strengthening
complementary functions related to market-failure areas.
The corporation supplies long-term (3-8 years) funds at low interest
rates compared with banking institutions. The policy fund interest rate in
the second quarter of 2010 was 4.03-4.40%. The areas supported by the
fund include initial period of start-up, long-term facility investment, and
micro-businesses, among others.
SBC offers access to two types of loan, direct loan and proxy loan.
Under its direct loan program, the corporation performs all of the related
procedures, receipt of loan applications, loan examination and post-loan
management. Under the proxy loan system, it conducts the preliminary
loan examination while banks carry out the final loan examination, loan,
and post-loan management functions. In 2009, 46.3% of SBC’s loan
activities were of the direct loan type involving 2.2 trillion won, while
53.6% were of the proxy type involving 2.6 trillion won.
This year, SBC has a total loan support budget of 3.14 trillion won and as
of the end of June had 16.5 trillion won in outstanding loans.
SBC’s role is to contribute to SMEs’ stable capital management and
reduction of capital expenses as well as to supply funding for SMEs in a
timely manner and minimize damage to SMEs when shocks occur due to
non-economic factors such as natural disasters or sharp international
raw material price hikes.
In terms of job-creation effect, a secondary benefit of the SBC loan
program, more than 39,000 new jobs were created in 2009, an average
employment growth per enterprise of 3.21 and representing a 0.77 job
creation effect per 100 million won. The targets for 2010 are 44,500 new
jobs created for an average of 3.64 per enterprise and a 0.88 job
creation effect per 100 million won.
A second program in place to facilitate SMEs’ access to financing is the
credit guarantee support system, which provides guarantees for SMEs
that are experiencing difficulties in obtaining loans from private banks
due to a lack of collateral. The implementing agencies for this program
are the Korea Credit Guarantee Fund (KODIT), Korea Technology
Finance Corporation (KOTEC) and the Korea Federation of Regional
Credit Guarantee Funds (KFRCGF).
The three implementing agencies respectively serve SMEs operating in
different categories: KODIT supports non-technology-oriented SMEs –
start-up firms, exporting firms and green-growth firms; KOTEC serves
technology-oriented SMEs – venture firms, INNO-BIZ firms and greengrowth firms; and KFRCGF supports regional micro businesses – small
firms, self-managed micro firms and unregistered micro businesses.
The basic procedure for obtaining credit guarantee support starts with
the enterprise that requires funds submitting an application to one of the
guarantee agencies for consultation on guarantee. The agency will then
contact the enterprise to collect data, conduct a credit inquiry and
examine the guarantee request. After satisfying the agency’s
requirements, the agency will issue a guarantee certificate to a banking
or other supporting financial institution, which will in turn provide the
loan to the applying enterprise.
In the first six months of this year, the credit guarantee support scale
reached 71.1 trillion won (compared to 67.6 trillion won for all of 2009).
By guarantee agency, the first-half figures were 41.0 trillion won (39.2
trillion won for all of 2009) for KODIT, 17.5 trillion won (17.1 trillion
won) for KOTEC and 12.6 trillion won (11.2 trillion won) for KFRCGF.
With expanded policy financing through the credit guarantee program, as
well as other sources, SMEs were able to overcome the recent financial
crisis at an early date, as the guarantees facilitated loans to reduce SME
market failure, while contributing to the reinforcement of the national
economy.
The credit guarantee system is seen as having positive effects on
government, bank and SME activities.
In the case of the government, the system strengthens the public benefits
of financing functions by supporting viable technologically innovative
enterprises with growth potential despite relatively weak collateral and
low credit ratings.
With respect to banks, the credit guarantee program reinforces financial
health while supporting SMEs smoothly in accordance with a downward
adjustment of risk weight (10%-0%) in Basel II.
The system benefits SMEs by increasing accessibility to bank financing
and facilitating the smooth supply of business capital in a timely manner,
compensating for weak collateral and credit ratings through the
guarantees.
The third program designed to increase SME access to financing is
support through on-lending, or re-lending, which refers to funds that are
recorded as a deposit to a supporting financial institution but the original
lending bank and the contractual borrower (the supporting financial
institution) agree that the loan proceeds will be made available to thirdparty SMEs.
Under this program, the Korea Policy Banking Corporation (KPBC)
suggests guidelines regarding SMEs targeted for support and supplies
on-lending funds to financing institutions. The financing institutions then
examine applicant SMEs and decide whether to provide loans or not, as
well as the loan interest rate. KPBC provides credit and liquidation
underwriting to ease the risk to the financing institutions.
In 2009, the on-lending program provided 230 billion won to applying
SMEs. This year, the budget for the program was increased sharply to
2.1 trillion won.
In a fourth pillar of support, the Bank of Korea (BOK) ensures systematic
support for SMEs under two key programs – the aggregate credit ceiling
system and the mandatory minimum SME loan ratio system.
In the aggregate credit ceiling system, the BOK allocates funds to 17
banks after determining aggregate credit ceilings quarterly based on the
results of loans provided to SMEs by the banking institutions. In July
2007, the aggregate credit ceiling support provided by the BOK was 6.5
trillion won, but in response to the economic crisis, the central bank
increased the ceiling sharply to 10 trillion won by March 2009.
The BOK applies lower than prevailing market interest rates to its
aggregate credit ceiling loans to achieve policy goals, including
expansion of SME lending and balanced regional development; for
example, the rate was lowered from 3.5% per annum in August 2008 to
1.75% in December 2008 and further to 1.25% in February 2009.
The positive effects of the aggregate credit ceiling system have been to
accelerate banking institutions’ selective financial support for SMEs,
reduce SME loan-related expenses with the application of preferential
interest rates and increase banking institutions’ issuance of loan products.
However, while still positive, the system offers lower economic benefit
to SMEs during times of low market interest rates like at present.
The second BOK program that assists SMEs is the mandatory minimum
SME loan ratio system. The central bank encourages lending banks to
provide more than an established ratio of loans from the won-currency
finance fund to SMEs: for commercial banks the ratio is more than 45%,
provincial banks over 60%, and domestic branches of foreign banks over
35%. Those banks that do not achieve these ratios are disadvantaged
when the BOK allocates aggregate credit ceilings by having 50% of the
amount not achieved cut from their respective aggregate credit ceilings.
The Small & Medium Business Administration (SMBA) augments and
supplements the foregoing programs by providing additional support to
facilitate SMEs access to financing. Two of these programs are related to
bond issuance by SMEs.
First, SMBA supervises a system that insures SME sales bonds. SMEs
may purchase insurance from the Credit Guarantee Fund for the supply
of goods or services with sales bond to purchasing enterprises, thus
protecting the rights of the purchasing enterprise and instilling
confidence in the SME.
Second, as SMEs face difficulties in issuing non-guaranteed corporate
bonds in the financial market based on their own credit rating as 99.3%
of the issuing enterprises have a credit rating lower than BB (speculative
rating), SMBA assists by issuing asset backed securities (ABS). Between
2000 and 2009, SMBA provided about 2.75 trillion won in funds for 1,053
SMEs, including 152 billion won for 64 SMEs in 2009.
Going forward, SMBA intends to continue to develop SME financing
support programs. It will work to maintain an optimum level of liquidity
supply, in connection with expanded policy financing, to support the
growth and development of promising enterprises. In the meantime,
SMBA also will strengthen its technological viability appraisal system to
provide access to financing for those enterprises that possess excellent
technology and business success potential but which lack sufficient
financial and collateral capacity.
In addition, SMBA will sustain its efforts in smoothing the way for SMEs
to raise capital in the direct finance market and in helping microenterprises stand on their own feet by developing an appropriate
financing support system.