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| Hong Kong is home to eight virtual banks, some of which are expanding into small business lending. |
Lending to small businesses, long underserved by traditional banks, is set to be a new growth engine for virtual banks in Hong Kong due to technology-enabled credit risk profiling and lower servicing cost.
The eight digital lenders in Hong Kong are leveraging a slew of technologies, such as big data and AI, to help build credit profiles for their customers, said Benjamin Quinlan, CEO of Quinlan & Associates, a Hong Kong-based consulting firm. By using alternative data, such as what time the application is submitted, virtual banks could potentially develop better credit assessments compared with their traditional counterparts.
"A consequence of this is the richer data that these virtual banks are able to process when arriving at a credit decision," Quinlan said. "As such, while these [small and medium-sized enterprises] may appear riskier than traditional banks lacking granular insight, the virtual banks' data advantage can help fulfill these underserved or unserved SMEs, while mitigating the risk of incurring bad debt."
Livi Bank Ltd. has plans to expand into lending to SMEs after Ping An OneConnect Bank (Hong Kong) Ltd., Ant Bank (Hong Kong) Ltd., ZA Bank Ltd. and Airstar Bank Ltd. entered the HK$100 billion market over the last two years.
Ping An OneConnect Bank (Hong Kong), also known as PAOB and backed by Ping An Insurance (Group) Co. of China Ltd., has been leading the race. It held a market share of about 25% in terms of loans issued under two government-guarantee programs for SMEs between July 2021 and December 2021. Loans approved under the two programs totaled HK$103.1 billion as of the end of 2021, according to Hong Kong government data. The lender secured its virtual bank license in May 2019.
Virtual banks in Hong Kong began their operations two years ago, starting with the retail space, and have since expanded to wealth management and the SME sector to gain a leg up in profitability. In 2021, all banks reported a greater loss before tax compared with 2020, according to a June 15 KPMG report. Their net losses ranged between HK$214 million and HK$687 million in the 12 months ended Dec. 31, 2021.
Digital lenders can unlock HK$18 billion in revenues by 2025 by capturing a customer base of about 44,000 SMEs in Hong Kong, Quinlan & Associates estimated in a November 2021 report. There are currently more than 340,000 SMEs in Hong Kong, according to government estimates. The biggest sectoral contributors would be SMEs in the import-export and retail, especially e-commerce companies, Quinlan said.
Managing risk
Despite having less capital than incumbent banks, virtual banks usually begin their forays into the SME business conservatively, such as offering fee-based services instead of unsecured loans, analysts said.
"On the face of it, [virtual banks] have a slightly higher risk profile: new customers without a track record or credit history, entirely remote channels which present risks of potential financial crime and fraud, inherently higher exposure to cybersecurity risks and other resilience events around service disruption," said David Scott, Hong Kong banking and capital markets leader at EY.
As part of efforts to mitigate risk, PAOB uses an alternative credit-scoring model that reduces the bank's risk exposure during the loan assessment process, a spokesperson for the bank told S&P Global Market Intelligence. Upon receiving consent from an SME, PAOB can access data related to the SME's export-import activities and is not constrained by how often the company maintains its management accounts or submits its latest financial information, the spokesperson added.
At livi, the lender utilizes RegTech, data analytics and innovative technology to manage associated risks, said Peter Yim, head of SME at the bank. The bank supports its credit and onboarding decisions using a unique liquidity projection model and a simplified credit risk assessment model that enables it to offer financing swiftly.
In addition, some banks have turned to partnership synergies to lend more efficiently, which affected what types of SMEs they lend to, Quinlan said. PAOB, for example, has a partnership with trade-related processing firm Tradelink Electronic Commerce Ltd. to extend preapproved loans as much as HK$5 million to SMEs that are already a part of the Tradelink network, which are predominantly export-import-oriented.
Livi, on the other hand, is rolling out franchise financing solutions for entrepreneurs in partnership with convenience store chain 7-Eleven, which is operated by major livi shareholder Jardine Matheson Ltd. The company
"All lending inevitably poses a certain level of risk to a bank's risk profile," Yim added. "The important thing is to have stringent measures in place to manage the associated risks."
Virtual banks have opportunities to get ahead of traditional banks in Hong Kong due to newer technological capabilities that are not bogged down by legacy infrastructure issues, EY's Scott said. It is too early to see trends in bad loans just yet, but so far these digital lenders have attracted SME clients in the services industry, Scott added.
"We have a very prudent approach to risk management and always try our best to strike a balance between business development and risk management," said Devon Sin, ZA Bank's alternate chief executive. ZA Bank's SME loan portfolio had increased twenty-fold year over year as of June, having launched its SME business in 2021.
Cost and profits
A quarter of SMEs in Hong Kong perceive that it has been more difficult to gain credit approval from banks compared with six months prior, according to a first-quarter government survey published May 3.
"SMEs have always been a challenge for traditional banks to service cost effectively," said Zennon Kapron, director of financial technology research and consulting firm Kapronasia. "Due to typically thin credit files and a lack of physical assets, it becomes difficult for banks to accurately assess and price that risk."
PAOB said, as of the end of 2021, 26% of its SME borrowers had never obtained a loan from other banks. Among those that had secured bank loans before, 75% had never received an unsecured loan from a bank, it added.
"The profitability challenge for virtual banks will lie around whether they are able to acquire SMEs at a low enough customer acquisition cost, then manage the ongoing costs of servicing them, and hold on to them to generate significant customer life value over the period of their relationship to ultimately contribute positively to the bottom line," Quinlan said.