The turbulent global economy is increasing pressure on China's small businesses. The nation's banks, with encouragement from Beijing, may come to the rescue.

The Chinese government announced several policies to boost small-business lending in 2008. Banks are now beginning to take a closer look at the challenges—and opportunities—of serving more than 41 million businesses, comprising over a third of total GDP.

The past year has seen loans to small businesses begin to take off. As of September 2008, the small-business sector already represented more than 6 trillion yuan in outstanding loans—approximately 25 percent of all outstanding commercial loans in China, as well as substantial fee income for banks. At China Construction Bank, loans to small firms by year-end were up more than 20 percent from 2007.

E-commerce giant Alibaba.com announced in February it would launch an expanded loan-assistance program with eight major banks to help its paid members, most of them small businesses, secure over 6 billion yuan in financing.

This increased focus on small businesses is a boon to both the businesses and the banks.

Small-business owners were previously compelled to use pawn shops and other alternative funding sources, where they were charged up to double the average bank corporate interest rate.

Banks that provide small businesses access to loans and other services can potentially gain a significant share of small-business spending on financial products and small-business borrowers are likely to be more open to flexible pricing arrangements and product bundling.

Banks can profitably price loans to small businesses at annual rates of between 8 percent and 12 percent, for example, by levying credit-guarantee fees and higher charges for short-term borrowing.

But success in small-business banking will not be easy.

Most banks have done little to understand small-business customers' needs, instead relying on a traditional corporate banking approach.

This is time-consuming, costly, and ultimately unprofitable, as transactions generated by small-business customers are often relatively small, ranging in value from 300,000 yuan to 3 million yuan.

Small businesses frequently lack reliable financial statements, so banks have a hard time evaluating their credit quality.

Banks need to develop cost-competitive service models designed specifically for small businesses that allow them to achieve scale without compromising on risk.

Smart banks begin by carefully segmenting potential customers to identify attractive locations, industries and business types that become the cornerstones of their small-business banking operations.

Johnson Chng is a partner in the Beijing office of Bain & Company and a leader of the firm's China Financial Services practice. Alfred Shang and Keng Koay are managers in Bain's Hong Kong office.