Can Credit Derivative Instruments Be Utilised By South African Banks To Effectively Hedge The Credit Risk They Face In Lending To The Small, Medium And Micro Enterprise Market?
The objective of this research proposal is to explore the extent to which credit derivatives can be used effectively by domestic financial institutions, in particular, Commercial Banks to hedge the credit risk associated with lending to the Small, Medium and Micro enterprise (SMME) market segment, thereby making lending to this market segment an attractive and viable banking proposition. The financial services sector in South Africa has come under severe criticism from Government, trade unions and the unbanked, low income earners for not fulfilling their social responsibility, in terms of, not banking the Small, Medium and Micro enterprise (SMME) customer base. In particular, financial institutions have been accused of ignoring or not giving sufficient attention to the financial/credit needs of this market segment. These parties have argued that many of the domestic financial institutions are applying standard credit criteria to this market segment, which they feel is incorrect. This has often resulted in SMME's having their requests for credit facilities declined by domestic financial institutions and then having to resort to approaching unscrupulous "loan sharks" for credit facilities, which facilities are often made available to them at exorbitant interest rates. The alleged reluctance on the part of domestic financial services institutions to make available credit facilities, in the form of start-up business loans and asset-based finance to the SMME segment has possibly hindered economic growth, productivity, employment and resulted indirectly in a host of other social anomalies. Alister Ruiters of the Department of Trade and Industry has been publicly vociferous in his attack on domestic financial institutions (Business Day, August18, 1999). It would appear these financial institutions are only prepared to do business with this market segment in partnership with Government, where Government bears a large proportion of the risk by providing guarantees or indemnities on behalf of the client. Examples of such guarantees include Khula and Sizabantu guarantees issued by agencies controlled within the ambit of the Department of Trade and Industry. Financial service institutions have defended their actions by countering that the credit risk attached to making loans available to the SMME market segment is often unacceptable to them. Many of these potential clients are characterised by adverse credit records, show little stability, in terms of, employment and domicilium and often do not have any tangible collateral available to support their loan requests. That is, the risk from lending to this market segment far outweighs the potential returns. Further, these financial institutions have argued that with South Africa having been accepted into the international fold and following the accelerated pace of globalisation, new markets have opened up for their shareholders. Hence, shareholders are requiring improved returns (capital gains and/or dividends); else they are at liberty to move their funds to other investment destinations. The pressure on domestic financial institutions to deliver consistently better returns on equity has been and continues to be a difficult one. This is exacerbated by the increasing competitive pressure from both retail competitors who are now offering financial services, such as Pick 'n Pay Financial Services, Woolworth's, and foreign financial institutions, who have entered the domestic scene. For many of the retail competitors the offering of financial services is seen merely as an extension of their product line. Existing infrastructure, in the form of, branches /outlets and technology are largely already in place. Further, they are not bound by the same liquidity reserve requirements imposed by the South African Reserve Bank (SARB), as are the domestic financial institutions they now compete against. Hence, the retail competitors' profit margins are likely to be higher. Further, as many of the foreign f