When small is profitable

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Emerging Markets

SMEs have been causing something of a stir in Turkey as banks increasing come to view them as a new source of revenue. According to research published by the European Commission, Turkish SMEs tend to be small by European standards, with annual turnover of less than €10m, illustrating their need for capital and their potential for growth.

They represent an underleveraged and underbanked sector in Turkey. Credit only became available to them relatively recently, when the tax regime imposed on SMEs was adapted. Now the sector is taking on debt in a way it previously couldn’t, and banks are thinking carefully about how best to position themselves to benefit from this new market.

Changes to the tax system in 2007 provoked this seismic change. Small and medium-sized businesses had previously been gagged with red tape, creating a formidable disincentive to any business looking to tap banks for increased funding. The amount of information necessary in order to qualify for financing through the banks created a huge extra regulatory and reporting burden, which added significant time and cost to the business. The new regime for SMEs swept away this problem.

Now more SMEs are looking to expand and be more open about their businesses. New products aimed at the sector have sprung up, including warrants; private placements; and bilateral loans for stronger companies.

Some of this debt is being taken to finance consumption, and presents real growth potential to the banks. It is an attractive avenue of growth because although it may result in an increase in non-performing loans as the economy slows, the sector is likely to suffer less than the larger corporations, which will be hardest hit in a more severe economic environment, predicted Fazil Zobu, head of research at Standard Unlu.

HSBC has singled out SME business as a major area of potential growth. The bank has hitherto not achieved its desired level of penetration to date, admitted Mehmet Mazi, head of HSBC’s emerging markets group for EMEA, who declined to disclose the bank’s current market share. However, with its extensive branch network and experience gleaned from other markets, HSBC believes it is well positioned to fill a long-standing vacuum in services to the SME sector.

Because the sector is still very underleveraged, banks see SMEs as relatively low risk. Some of them have grown very fast, meaning there will be failures amongst them, but developing relationships with those that emerge as the country’s success stories will be a key strategy for banks wishing to access the best of Turkey’s growth in coming years.

It is not just banks but international investors of all denominations that are having their interests aroused by the potential of Turkish SMEs. “There is a good demand for this kind of exposure from international institutional investors,” said Mazi. “Five years ago you wouldn’t have believed a small company in South East Turkey would be borrowing money from hedge funds, but that is exactly what we are seeing. HSBC has all the distribution in place.”

However, it is a long way from being a trend that is likely to sweep through the whole sector. Hedge funds and other investors looking for specific and unique exposures are only attracted by the best in breed. It will not be without its risks either, Mazi conceded.

The World Bank is also playing its part in funnelling funds to Turkish SMEs. It has made a loan of €160m and US$48m to Turkey over five years running from 2007 to 2011 “to increase Turkish SMEs access to medium term finance.”

TSKB and Halkbank are the borrowers in the project and each received a €100m equivalent credit line to be intermediated to SMEs. The Turkish Treasury issued a guarantee to the World Bank for the borrowers’ repayment.

Halkbank will disburse at least US$25m in sub-loans to SMEs in the central and eastern part of Turkey, where credit is less well developed, via a financial intermediary loan, using IBRD funds. It is a fixed spread loan in euros with a 15-year maturity and five-year grace period, with an embedded conversion option for swapping into Turkish lira.