For discussion
FCR(97-98)96
on 27 February 1998

ITEM FOR FINANCE COMMITTEE

HEAD 106 - MISCELLANEOUS SERVICES
New Capital Account Subhead "Grant to the Hong Kong Export Credit Insurance Corporation for a pilot Credit Guarantee Scheme"

Members are invited to approve a grant of $500 million to the Hong Kong Export Credit Insurance Corporation for setting up a pilot Credit Guarantee Scheme.

PROBLEM

Some small and medium enterprises (SMEs) 1 have difficulties in obtaining loans from lending institutions to finance their business activities.

PROPOSAL

2. We propose to make a grant of $500 million to the Hong Kong Export Credit Insurance Corporation (ECIC) for setting up a pilot Credit Guarantee Scheme (CGS) to provide guarantees for loans on pre-shipment expenses of goods and services by Hong Kong firms.

JUSTIFICATION

The case for a CGS

3. SMEs constitute about 98% of companies in Hong Kong. It is important to provide them with a favourable and business-friendly environment. To better identify issues affecting the development of SMEs in Hong Kong and suggest measures to support their development, the Government set up the SME Committee (the Committee) in July 1996.

4. The Committee has come to a view that one of the major difficulties faced by SMEs is their difficulty in obtaining finances. Compared with larger enterprises, it is more difficult for SMEs to obtain loans from lending institutions due to the lack of sufficient capital assets as collateral or long credit record to prove their credit worthiness. The Committee has proposed, therefore, that a CGS should be set up on the following principles -

  1. Manageable scope - i.e. confined to one area or one type of expense;

  2. Risk sharing - i.e. risk of non-payment to be shared amongst three parties : the CGS, the CGS client and the lending institution; and

  3. Risk capping - i.e. there should be an upper limit to the amount of money to be guaranteed under the CGS.

5. We agree that the establishment of a CGS would provide an incentive for lending institutions to approve loans to SMEs. With easier access to financing, SMEs will be more able to invest in new technology, move into higher value-added production and improve productivity. Given that SMEs constitute the bulk of the companies in Hong Kong, measures facilitating their further development would in turn facilitate the overall development of our economy. We therefore support the Committee's recommendation and propose to allocate $500 million to the ECIC to establish a CGS on a pilot basis. The ECIC will operate the pilot CGS broadly along the lines described in paragraphs 6 to 12 below.

Details of the scheme

Scope

6.The pilot CGS will focus on pre-export guarantee. This will help minimise the risk for both the guarantor and the lending institution as the borrower has a contract of sale (see paragraph 10(e) and (f) below) in hand which provides assurance of the transaction. In addition, the contract of sale carries a date of payment, thus making it easier to work out a more definite period of time during which a CGS coverage is necessary. As the total credit guarantee offered at any one time has to stay within the total capital available in the scheme, a more precisely defined period of coverage required by each application will enable the CGS to offer guarantee coverage to more SMEs in need.

Risk sharing and risk capping

7. Risks of the loans guaranteed are to be shared amongst three parties : the lending institution, the borrower and the CGS. The extent of the CGS coverage would be up to 50% of the loan amount approved or $2 million for each individual loan, whichever is the less. The total CGS coverage for an applicant at any one time should not exceed $6 million. We believe that these limits on the amount of loan guarantee would ensure that the facility is used by our target group, SMEs. On default, the CGS would pay the lending institution the outstanding amount according to the risk sharing factor 2 . On recovery of any sum from the applicant or other sources, the lending institution would share this sum with the CGS in proportion to the net amount outstanding to the institution (i.e. after deduction of the amount contributed under the CGS and any sums previously recovered and shared) and the outstanding amount of the guarantee contributed under the CGS (i.e. the amount originally contributed under the CGS less any sums previously recovered and shared) on a non-discriminatory basis. The total amount of loans to be guaranteed at any one time by the CGS would be capped at the amount of capital available in the scheme.

Administration of the scheme

8. The ECIC will administer the CGS. The ECIC is a statutory body set up in 1966 and empowered under its Ordinance to offer credit insurance and credit guarantee to Hong Kong's exporters, although hitherto it has concentrated on credit insurance business. To ensure the capping of the risk, the management and finances of the CGS by the ECIC will be entirely independent and separate from the existing business of the Corporation. A Memorandum of Understanding (MOU) will be signed between Government and the ECIC setting out, among other things, the scope and administrative framework of the scheme. The MOU will also stipulate that should Government decide to wind up the scheme, the ECIC would repay Government the balance in the CGS account after deduction of necessary expenses and costs in the winding up.

Participating lending institutions

9. All authorised institutions under the Banking Ordinance including licensed banks, restricted licence banks and deposit-taking companies will be eligible to participate in the CGS.

Eligibility criteria of applicants

10. Firms applying to the CGS must fulfil the following criteria -

  1. they are Hong Kong exporters of either merchandise goods or services and are the principal in a contract of sale involving export on credit terms of goods or services from Hong Kong;

  2. they are registered or licensed in Hong Kong;

  3. they are assessed by lending institutions to be credit-worthy on the basis of their usual prudent lending criteria if not for reasons such as the lack of collateral;

  4. in recognition of the increasing trend for Hong Kong exporters to source goods from other countries, the export of goods referred to in (a) above would include those transported directly from suppliers' countries to their destination with or without passing through Hong Kong, provided that the banking and shipping documents and the decision to extend credit to overseas buyers are done in Hong Kong;

  5. exports made under contracts concluded on payment terms such as Irrevocable Letters of Credit, Documents Against Payment, Documents Against Acceptance, and Open Account would be eligible under the scheme. Oral contracts, however, would not be eligible;

  6. in case of service providers rendering services to overseas clients on credit terms, contracts evidenced by documents such as financial documents which contain the material terms of a contract (e.g. name of the buyer and seller, description of the service required and terms of payment) would also be eligible. Oral contracts, however, would not be considered acceptable;

  7. only export contracts covered by the ECIC's credit insurance are eligible. This would bring about added security for the applicant on the one hand and lower the risk for both the lending institution and the loan guarantor on the other; and

  8. normally, only export contracts involving credit up to 180 days are eligible. This is in line with the current practice of the ECIC for post-shipment insurance and the banking practice in trade finance.

Nature of the loan and guarantee fee

11. There is no limitation on the specific uses of the loan as long as it is for pre-export expenses. The loan may be used for purposes such as working capital, purchase of raw materials, equipment and the like.

12. The ECIC will charge successful applicants a guarantee fee to cover the operating costs of the CGS and possible defaults. We originally intended to set the fee at 0.75% of the guaranteed sum. However, taking into account the views expressed during the consultation exercise, the prevailing economic situation and the fact that any assumption of the default rate in the absence of actual practical experience is arbitrary, we consider that there is a case for setting the fee at a lower level at the initial stage. We therefore propose that the guarantee fee be initially fixed at 0.5% of the guaranteed sum. This level is determined having regard to the estimated operating costs of the CGS and a notional default rate. The details are set out at the Enclosure. The ECIC may have to adjust the rate in future in the light of actual operational experience. Successful applicants will also have to pay premium for the credit insurance provided by the ECIC. We estimate that the guarantee fee plus insurance premium for the guaranteed sum will not exceed 0.75% of the guaranteed sum.

Review

13. We will review the pilot CGS after one year of operation, or earlier if necessary. The review will cover the number and nature of loan applications which require CGS coverage; the default rate among CGS clients and the underlying reasons; the feedback from CGS clients, the authorised institutions and the industry, as well as other interested parties.

FINANCIAL IMPLICATIONS

14. Assuming that SMEs will each require a loan of $2 million and seek a guarantee of 50% from the CGS for a period of 180 days, the proposed one-off grant of $500 million to the ECIC will provide sufficient capital to provide 1 000 guarantees annually. The ECIC may invest any funds not immediately required. Interest on capital will be ploughed back to the scheme. The long-term aim is for the guarantee fee to be able to meet the administration costs incurred by the ECIC and the cost of possible defaults of the loans guaranteed.

15. Subject to Members' approval, we will make the grant in 1997-98 through supplementary provision under delegated authority so that the scheme may commence operation as early as possible.

BACKGROUND INFORMATION

16. The Chief Executive announced in his Policy Address in October 1997 that Government had set aside $500 million to establish a pilot CGS to help SMEs seek loans from commercial banks to finance pre-shipment activities. The proposal has received considerable support from Members of the Provisional Legislative Council Panel on Trade and Industry and the business community. On 13 January 1998, the Chief Executive in Council approved, subject to provision of funds by the Finance Committee of the Provisional Legislative Council, the setting
up of a pilot CGS by the ECIC, with a one-off capital grant of $500 million, to provide guarantees for loans on pre-export expenses of goods and services by Hong Kong firms.


Trade and Industry Bureau
February 1998

1.We define SMEs as companies in the manufacturing industries employing less than 100 persons and firms in other sectors employing less than 50 persons.

2.The risk sharing factor is defined as the amount guaranteed under the CGS over the initial bank loan for the respective applicant.

Enclosure to FCR(97-98)96

Guarantee Fee of the Credit Guarantee Scheme

(a)

Sum of loan guaranteed 1

:

$1,000.0 million

(b)

Operating expenses 2

:

$2.8 million

(c)

Provision for call on guarantee 3

:

$2.2 million

(d)

Total expenditure

(b) + (c)

:

$5.0 million

(e)

Guarantee fee per loan

(d)/(a)

:

0.5%

1. It is assumed that the average loan guarantee period is 180 days. Given the capital of $500 million, the total amount of loans to be guaranteed by the Credit Guarantee Scheme (CGS) is estimated to be $1 , 000 million per annum.

2. The breakdown of the estimated operating expenses is as follows -

Staff cost $1.75 million
Administration cost $1.05 million
Total $2.8 million

The above estimates are based on the assumption that the average size of a loan is $2 million and a guarantee of 50% is required from the CGS for a period of 180 days. The number of guarantees issued is 1 000 per annum.

3. Without actual experience of running the scheme, it is difficult to estimate the necessary provision to cover calls on the guarantee. The present provision is just a notional figure. It will have to be reviewed in future in the light of actual experience.