14/5/2012: Russian Banks Credit Supply to SMEs

Moody's latest note on Russian banks, titled SME Lending in Russia: Growth Supports Profitability, but Cyclical Credit Risks Remain is available in Russian.

The note argues that since 2010-2011, Russian banks' origination of credit to SMEs has grown on the back of banks' strategic expansion within the SME sector that sees growth in lending to SMEs exceeding that for larger corporates.

"Overall, we believe that the banks' expansion of their SME portfolios and their plans to further this expansion are credit positive. The SME sector supports the banks' net interest margins, provides cross-selling opportunities and contributes to further diversification of banks' risks," explains Olga Ulyanova, a Moody's Vice President and author of the report. "However, if the economic cycle enters another phase of downturn, SME loans are likely to be the segment most vulnerable to weakened conditions, and credit losses might reach levels seen during 2008-09," adds Ms. Ulyanova. Doh, as Homer would say. See this note and this to check the likelihood of the Russian economy contracting...

On a serious note, of importance to anyone trading in Russian markets: Moody's said that relative to other asset classes, SME lending poses greater risks to banks credit profiles, due to:

1. Weak corporate governance and financial reporting practices of many SMEs; 
2. Their concentration and dependence on a small number of large customers and/or suppliers; 
3. Fewer refinancing options available to SMEs as opposed to large corporates; 
4. SMEs' elevated exposure to domestic currency fluctuations; 
5. Poor track record of SME loan recoveries, partly because of the low realisable value of collateral; 
6. Weak court and legal systems for settling debt; and
7. Weak enforcement mechanisms for court judgements.

I would agree with the above risks assessment. However, interestingly, Moody's reported that credit losses generated by SME loans originated after 2008-2009 crisis are currently running below those for pre-crisis vintages, "reflecting post-crisis economic stabilisation in Russia and the somewhat tightened credit underwriting procedures that the banks implemented".

Moody's identify key trends in Russian SME lending over the next 12-18 months:

• The total volume of bank loans to SMEs will exceed 10% of the country's GDP (compared with 9.3% at year-end 2011). 
• By 2015, SME lending will likely stabilise at around 15% of GDP, a level comparable with that of peer countries. 
• Net interest margins improvement is the core objective for banks diversification of lending to SMEs.
• Credit losses on loans issued in 2011-2012 to be contained within overall lower losses trend since 2010.