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Issues in the Financing of Small and Medium Enterprises in China
Yoon Je Cho
Graduate School of International Studies
Sogang University
I. Introduction
In most developing countries, small and medium enterprises (SMEs) get highest priority of the
government policy supports, including the measures to improve the access to formal credit. In China,
however, it has been only recent years that the government started to introduce measures to promote the
growth of SMEs. The policy emphasis on the SME sector in China is based on the growing recognition
that the growth of SMEs is important for the sustained economic growth and social stability in the process
of the restructuring of state owned enterprises.
The relative decline of the large state owned enterprises and the expansion of the non-state small and
medium enterprises has been and will continue to be the trend of the Chinese economy. They have become
the main engine of growth in the Chinese economy during the last two decades of rapid economic
transformation. Between 1991 and 1997, for instance, the number of siying qiye1 grew at an average
annual rate of 46 percent, employment in siying qiye grew at 41 percent, and output grew at 71 percent.
The SMEs have, therefore, become an important source of job creation, absorbing a significant number of
workers laid off from the SOE sector.2 In 2000, they contributed 70% of employment (53% by small firms
only), and 43% of fiscal revenue (29% by small firms only)3.
Realizing the importance of the SMEs, the Chinese authorities have taken several important measures
to facilitate the development of SMEs in recent years. They include favorable tax treatment for certain
types of SMEs, local governments’ funding for credit guarantee schemes, increase of the interest rate
margins for SME loans, lowering the threshold of listing high-tech SMEs in the stock market, and etc.
Nevertheless, SMEs in China still face many obstacles to development. Above all, difficulty of access
to finance is one of the major constraints to their development. The survey of Chinese small firms shows
that the main source of finance for SMEs has been self finance and informal market with very little access
to bank loans or other formal institutions’ funding. The difficulty to access to formal finance is increased
as the size of the firm gets smaller. According to an IFC survey (2000), about 40 percent of the firms,
having less than 51 employees, consider access to financing a major constraint to their development,
whereas about 30 percent of larger firms (having more than 500 employees) think so. In the case of
organizational structure, about 49 percent of sole proprietorship and 28 percent of corporations in the
sample mention access to financing as a major constraint to their development (IFC 2000). Comparisons
*This study is an outcome of the author’s participation in the World Bank mission team to China. The author is grateful for
comments and suggestions by David Scott, Millard Long, Jacob Yaron, and Wang Jun. The views expressed herein are those of
the author and should not be attributed to the World Bank. The remaining errors are all the author’s.
1
Siying qiye is defined as privately owned enterprises employing more than eight people, and distinguished from smaller getihu
(Individual enterprises).
2 The majority of this private sector is composed of the small and medium enterprises (SMEs). During the period 1990-97, new
jobs created in the private sector accounted for 38 percent of all new formal employment, or 56 percent of new formal
employment in urban areas (IFC 2000).
3 Development Report of China’s SMEs, 2001
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with similar surveys in other countries, the surveys in China show that Chinese entrepreneurs have to rely
to a greater extent on personal savings and insider financing than do their counterparts in transition
economies (IFC 2000).
This paper discusses strategy and options to improve the SMEs access to finance. The range of
targeted firms considered here mainly includes the SMEs with employment size above 8 (Siying giye) to
be distinguished from smaller individual enterprises (getihu). Thus, the main theme of the paper is how to
improve the overall financial environment and how to build effective institutions in order to facilitate
SME lending. Micro-finance and rural finance will not be considered in this paper, but their issues are in
large extent, overlaps with the issues involved in urban SMEs4.
The paper will be composed as follows. In the second section, it will assess the main elements which
are serving to constrain access of small firms to finance under the current situation of China. In the third
section, it will suggest the strategy and options to improve the SME financing in China. The last section
will provides brief concluding remarks.
II. Assessment of the Current Constraints
The current financial sector environment in China is not conducive to the lending to small firms. In
fact, there are many obstacles. Under the current circumstance, there is not much incentive for the banks
to expand lending to small firms, or even try to reach promising small firms. Most SMEs, on the other
hand, have not even tried to get loans from the banks, with the perception that it would be impossible to
get credit from banks without qualified collaterals.
The current financial system in China provides reasonably good access to deposit and payment
service to the Chinese people. Chinese banks have extensive branch network. The total branches of the
four SCBs are about 120,000. If branches of RCCs (about 38,000) and postal offices which offers postal
savings business (about 32,000) are added, population per branch is about 6,600. This compares favorably
with other developing countries. This extensive reach of financial institutions has contributed to the rapid
growth of deposits in China. Total deposit at financial institutions exceeds 150 percent of annual GDP in
China surpassing the ratio of most developing economies as well as many advanced industrial economies.
In the lending service side, however, most of the deposits mobilized has been allocated to large SOEs
many of which are loss making. This implies, if the portfolio of the banking sector is reallocated with
increasing share of loans to private SMEs, it is likely that the overall efficiency of credit allocation and
growth potential would be increased. Not all small firms are efficient and have high business prospect. But
many of them deserve for the lending service by the formal financial sector. Once the financial institutions
acquire the technology and skills to select them, not only the profitability of the financial institutions but
the overall efficiency of credit allocation of the Chinese economy would be improved.
The current constraints to finance for small firms can be discussed in the context of policies,
institutions, and market infrastructure.
Interest rate and regulatory policies
The most significant constraint on the lending to small firms currently seems the interest rate ceilings
and lack of commercial orientation of the banks. Currently the one year loan rate by the banks is set 5.31
percent by the PBC. The PBC allows an additional 30% of this amount thus up to 6.90% for lending to
small and medium firms. RCCs are allowed an additional 50% thus up to 7.98%5. However, according to
4
See xie(2002) and Tsai(2001) for the discussion of policy options for rural financing.
Recently, the authorities announced the Interest Rate Reform Pilot Project for RCCs. Eight counties/cities were chosen, and
for RCCs in villages/towns of these counties the deposit rate can float up to 20% above the benchmark stipulated by the PBC. In
the few places whre the informal borrowing and lending rates are high, the ratescan rise appropriately and reach a ceiling of 50%
5
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various estimates, this level of interest is much lower than the level which would secure the profitability of
lending to small firms.
According to a recent estimate by the IPC study (2001), the lending rates that are required for a new
financial institution to obtain break-even point over the first five years of operations are much higher.
With an average outstanding loan of about RMB 86,000 (about U$ 10,000) the lending rate will have to be
13.6 percent, more than twice the imposed ceiling lending rate to achieve internal rate of return of 3
percent (or lending rate of 12.3 percent to achieve IRR of zero percent) over the first five years of small
firm lending operation.
There are also other regulatory constraints. According to the current regulation, the banks should
secure collaterals for all loans; and only tangible assets are qualified for the collaterals. In fact, Chinese
banks are lending only on collateral basis or on the guarantee by other large companies. But small firms
usually do not have significant tangible assets to provide as collateral. Even though they are available it is
very costly to efficiently repossess the collateral when judicial process and the size of the loan are taken
into account. The regulatory policies also foster a credit culture in favor of secured lending, as unsecured
lending, if goes sour, is more likely to be suspected of collusion between credit officer and client.
Institutional weakness
One of the key reasons for the poor financial service for SMEs is the weakness of the existing
institutions. In order to introduce an effective and sustainable lending programs for SMEs, it is essential,
first, to make the lending business potentially profitable to the involved financial institutions, and second,
financial institutions are enthusiastic to take this profit opportunity. Currently, the ownership, governance
structure, the internal organization, the management practice of most Chinese banks lacks full commercial
orientation. Furthermore, poor credit analysis technologies, personnel managements, training of staff,
information production and monitoring of the banking sector have not leveled up the banks to the capacity
of commercially oriented SME lending.
The Chinese banks have large amount of NPLs, and financially weak. Making the banks sound and
operate in fully commercial basis will be key to the completion of transition to the market economy. This
will also be a key element to establish an effective and sustainable lending to SMEs. In the past, the
incentive structure to the bank managers, especially in the SCBs was tilted toward lending to large SOEs.
As a result loans by SCBs are highly concentrated on SOEs and the lending to small borrowers is not well
taken care of by the existing institutions. Even the city banks and small private commercial banks, whose
targeted borrowers are SMEs, are favoring lending to large SOEs. In the case of lending to SME they are
targeting larger ones—the average size of their loans to SMEs are several million or above 10 million
RMB in most of these banks. This implies that SMEs are not well served by the existing financial
institutions.
Poor development of financial market infrastructure
As is common in most developing economies, lack of adequate market infrastructure also constrains
the lending to small firms. Poor credit information production and flows, inefficient court system which
makes the recovery of collaterals costly, opaque proprietorship of borrowers discourage the lending to new
borrowers. The poor management information system (MIS) in most banks is another impediment. Under
this circumstance, smaller firms are disproportionately in disadvantage, since the information on them is
scarcer and the lending to them is perceived to be more risky.
Credit registration system has been established within the Statistics Department of PBC and has been
collecting information on borrowers from the banks (including RCCs). The system has not expanded to
above the benchmark. The lending rate can float up to 70% above the benchmark stipulated by PBC. In some places where cost of
funds is high and demand for loans is overwhelming, the floating spread can be raised within a threshold of 100%.
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the national level yet, but includes the 31 Provinces. Currently, it has information on about 4 million
borrowers and the information is available to banks on line. Credit information system for personal loans
has not been established yet. If this system is connected on line in the national level, and if the system
improves the quality and credibility of the information, it will become a very valuable source of credit
information.
Currently, it takes long to enforce the claim of collateralized property when loans become nonperforming. Even though collateral can be easily enforced, there is no/little market for collateral seized by
the banks through foreclosure, and prevailing practice is not for banks to dispose of collateral below par
value.
Loan repayment ratio of at least 94-95 percent should be achieved. Otherwise, it would be almost
impossible to sustain the commercially based lending operations. However, the current rate of nonrepayment of lending to small firms is much higher than this.6 One of the reasons is the wide-spread moral
hazard of borrowers. The system to punish the defaulted borrowers has been loose. The owners/managers
of many defaulting firms intentionally do not repay bank loans. They create new firms which take over the
business of the defaulting existing firms. This has become quite common in China. Some local
governments benignly neglect (or even encouraging?) this kind of practices especially in the cases where
the borrowing is from SCBs since they think this would be good for the local economy. This increases
the NPL ratio and the reluctance of banks to lend to SMEs. In fact, interviews with the city banks
confirmed that the NPL ratio of SME loans was higher than loans to large firms and households. In the
case of RCCs, the default rate of town and village enterprises (TVEs) was higher than loans to individual
because of lack of clear ownership and accountability of the borrowers in repaying loans.
III. Policy Options
In order to improve the access of SMEs to formal finance, the government efforts should concentrate
first on the improvement of the financial environment to encourage the existing institutions to expand their
business down the market, and second, on building well-capitalized, viable institutions through allowing
the establishment of the small and medium sized banks targeting the financial services to SMEs. The first
will include the relaxing policy and regulatory constraints, building market infrastructure, and the
comprehensive bank restructuring including changes in governance structure, internal organization,
recapitalization, and so on. But, under the current situation of China’s banking sector, they will take time
and they alone would not be sufficient either. The government at the same time should support the
emergence of new viable institutions, which are subject to less strict interest rate controls, but well
supervised for their asset management.
In a decade from now, for example, the portfolio of Chinese banks should be substantially rebalanced,
reflecting the pace of growth of private sector and SMEs and their expected future role in the Chinese
economy. The loans to SMEs and households should be significantly increased, perhaps taking about onethirds, or more, of total lending by the commercial banks. Large firms should finance increasingly from
the securities markets. The commercial banks and the nonblank financial institutions specializing in SME
lending such as finance companies, factoring companies, would be the main source of funding for SMEs.
This implies that measures need to be taken to stimulate the expansion of financial services to SMEs
now. The government should not expect that sustainable finance for small firms is going to develop on its
own. It will require concerted effort by the government and the financial institutions to promote that
outcome. But government needs to have a clear vision on the future financial system and the existing
problems, and have a strategy that is based on the experiences in other countries as well as the China’s
reality.
6
According to one private commercial bank, the NPL ratio of loans to SMEs is about 20%, significantly higher than loans to
large firms and individual.
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According to the international experiences, the key reasons for the failure of government attempts to
promote lending to priority borrowers was channeling funds under preferential credit programs in
subsidies through poorly operated state-owned credit institutions. They lacked training for credit analysis,
incentives for the staff for profit-making lending, and had poorly designed incentive for borrowers to
repay loans. International practices suggest that, if there is paradigm shift in such a way to provide
financial services (loans, deposit and payment) while fully covering the cost and not to be engaged in
subsidizing ‘priority’ clients or sectors, it is possible to establish sustainable lending institutions that
outreach small firms.
Banks in China require strategic reorientation and operational restructuring. In some cases, this
would be appropriately focused on developing a profitable market niche in serving the financial services
needs of SMEs. That target market is not likely to be soon saturated, and could be source of high return on
investment. In some cases this would require creating new institutions or transformation of the existing
institutions with clear vision and commitment.
The areas on which the government needs to pay attention to in this regard are: building institutions;
relaxing the policy constraints; and improving the financial market environment for lending to small
firms.
1. Institutions Building
Institutions building can be pursued in two fronts. On the one hand, the existing banks should be
reoriented to serve SMEs more effectively on the commercial basis. On the other hand, the government
may allow the entry of financial institutions dealing mainly with SMEs, such as small- and medium-sized
banks, finance companies and factoring companies whose business operations are less strictly restricted
than banks, but closely supervised by the authorities. The institutions building can also include
establishing an effective and sound credit guarantee schemes.
Small and Medium Banks
In order to enhance the access of SMEs to bank loans, the Chinese authorities may consider the entry
of locally based private small and medium banks. However, it has to be highlighted that it is crucial to
provide a proper supervision to these banks and the operation of these banks should be commercially
oriented. Many attempts to establish institutions specializing in SME lending have not been very
successful in other countries. In India for example, state-sponsored, region-based and rural oriented banks
called Regional Rural Banks (RRB) have been established since 1975 with the mandate to mobilize rural
savings and to make available credit to weaker sections of the economy. The RRBs have played a
substantial role in expanding access to financial services by small borrowers. However, their NPL ratio
has been higher than larger commercial banks and there are concerns about the financial viability of many
of these banks.. In China also, former UCCs and RCCs were not the successful cases which had very poor
loan collection records and ended up with large amount of NPLs.
It seems to be crucial that, if small and medium regional banks are allowed to enter, they should be
established with private capital and operated under less restriction on interest rates, types of collateral
taken and their lending business. Same can be said to the financial companies and leasing companies. If
the emphasis on the SME lending is over-bureaucratized, it can interfere with the efficiency of financial
institutions and eventually undermine the viability of them.
The minimum equity required to establish a new commercial bank, at RMB 1 billion, seems to be
high for an institution specializing SME lending. The authorities may consider allowing smaller equity
capital for a pilot scheme. But the authorities should ensure that these institutions are, compared to the size
of total lending, adequately capitalized to absorb the shocks and adequately supervised to protect the
safety of deposits.
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In order to help develop skills for SME lending, the government may provide some supports during
the initial years of institutional building/reorientation. For example, the government may establish a pool
of funds for technical assistance, and then manage the use of the funds to maximize potential to achieve
desired results. The management of the funds and the actual technical assistance should draw heavily on
international experts initially, while training a pool of Chinese staff to expand the reach of the program
over time. In such a case, the government should define clearly the criteria for access to those funds.
These criteria may include the cost sharing with the recipient banks, some measurable progress in internal
organizational reforms, plans for credit-related training of staff, financial incentives given to the loan
officers, the governance structure of the institutions and so on. Such initial supports by the government
may be necessary to transform the system from the “old paradigm” to the new one.
Credit Guarantee Schemes (CGS)
Credit guarantees for supporting lending to SMEs have become a mainstay in many countries. The
main objective of credit guarantee scheme is to encourage banks to undertake lending to underserved
SMEs. The idea is that lenders would learn that the some SMEs are less risky than perceived. Hence,
some of the credit guarantees funds try to guide the lenders how to better screen clients and use new
technologies that ensure improved financial performance and loan collection. But it has been difficult to
measure the real impact of such guarantees on the increase in the number and amount of loans to SMEs.
Despite debates on the usefulness of credit guarantees they are very popular in both developed and
developing countries.
Currently there are about 300 credit guarantee schemes (CGS) in China the majority of which are run
by the local governments. The total volume of capital is about RMB 8 billion and total guarantee provided
is about RMB 40 billion. The government is considering to establish CGS in the national level which can
provide the re-guarantee to locally managed CGS. The challenge will be how to establish an incentive
compatible national scheme so as to prevent moral hazard of the local CGS and transferring their loss to
the national CGS. If the local CGS is operated poorly, it will incur great budget burden to the state
government.
CGS has some potential role to play to improve the access of the small firms to the banking sector in
China. If well designed and regulated, the CGS in the current banking environment in China can
contribute to the improvement of SMEs’ access to bank loans. Some private-owned CGSs have shown the
possibility that they contribute to the increased access of SMEs to banks while being profitable. If they
select the borrowers to be guaranteed carefully and monitor them closely, say through weekly visit to the
firms, and employ every possible means to get paid, and if the fees on guarantee is further deregulated,
CGS could be profitable business exploring the market niche created by the current banking environment
(interest rate ceilings, fully collateral or guarantee based lending, poor incentive structure, etc).
But the potential downside costs seem to be also high at this moment. Some fully privately
established CGS seem to have started a cautious and prudent guaranteeing business, exploring the market
niche as mentioned above. But most local government-sponsored CGS are exposed to very high risk of
moral hazard and potential fiscal costs. They have inexperienced and inadequate human resource
(mostly former government employees) to deal with guarantee business. Thus, it seems important at this
moment that the state government do not rush for the expansion of the CGS, but focus on the
improvement of the operation of the existing CGS through training of staff, improved supervision, internal
capacity of credit analysis, and incentive system etc. It will increase the fiscal costs without much
improvement in SME finance if the state government makes any commitments beyond extending the tax
exemption of the locally operated CGS at this environment.
Thus, it is important to establish effective regulatory rules and system for local CGSs and to protect
the schemes from severe moral hazard. It is also very important to protect these schemes from local
political interventions. If these schemes are used to channel bank loans to those favored borrowers well
connected to local administrations, creating national CGS may end up funding the cost of reckless local
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operation through state budget.
The CGSs are considered more successful when only partial guarantee is extended and risk is shared
with the financial institutions involved. Usually the guarantee fund should not cover more than 70 percent
of the credit risk. Reducing the risk coverage over time is instrumental in ensuring that the financial
institutions concerned overcome gradually the issues that stem from asymmetric information and use the
track record of veteran borrowers to increasingly make independent decisions regarding their credit
worthiness and how to set lending interest rate to compensate for risk. Though difficult, the performance
of the guarantee fund should be closely monitored to ensure that scarce public funds are not wasted.
2. Relaxing policy and regulatory constraints
The most significant policy constraint on SME lending in China is interest rate control. Lending
interest rates should be set to cover the costs associated with lending to small firms including credit risk,
cost of funding and administrative expenditures. The interest rate policy is highly related to the financial
institution’s self-sustainability. The “old paradigm” considered that small businesses are not capable of
paying market interest rate that fully cover the relatively high administrative cost and risk involved in
servicing the SMEs. This notion has been refuted by the experiences of many other countries which have
successfully promoted lending to small borrowers. Being able to apply appropriate level of interest rate is
essential for financial institutions to service this group of borrowers. According to the international
experiences, small borrowers are able and willing to pay rates substantially higher than the prime rate that
exists in unregulated interest rates regime or higher than the imposed ceiling interest rates when such rates
are controlled. They wish to have an easy access to flexible and efficient financial services. Often the
demand is for working capital in the areas of services, trade and simple processing and manufacturing.
If the authorities consider the full liberalization of lending rates premature at this time, they may
gradually increase the band for small firm lending. But, for institutions dealing mainly with SME lending,
this constraint has to be more aggressively released.
Allowing reasonable level of fees can also be used to contribute to bridge the gap between controlled
lending rates and the minimum rates required for the long term sustainability of the lending institutions. In
view of the present approach to interest rate policy one option is to seek permission to test a higher
effective SMEs lending rates in a limited pilot program that does not threaten the present system today but
if implemented successfully could be replicated rapidly and make use of the vast banking branches
network that exists in China.
The requirement of tangible collateral for lending should also be relaxed for lending for small firms.
Traditional collateral is difficult to obtain from small borrowers and when available it would be very
costly to efficiently repossess the collateral when the size of the loan and judicial red tape are taken into
consideration7. Increasing the variety of collateral options (e.g. family dwelling or the right to use the
dwelling for a long period) can increase creditors security and flow of credit. But there is no substitution
to the positive incentives structure, namely, the ability of the small firms to grow together with the
financial institutions concerned and benefit from eligibility and access to larger loans at lending rates that
are much below other alternatives.
Under these circumstances the loan assessment should focus more on the cash flow analysis that
determines the ability to repay and much less on the collateral issue. Lack of audited financial statements
or just reliable accounting data pose a problem that is common to many SMEs in developing countries.
However, a standardized cash flow analysis of the business concerned and the derived repayment capacity,
carried out by trained staff should lead to a short processing time and even an immediate approval for
repeated borrowers with solid repayment record. Reducing the loan processing time is highly regarded by
7
However, insisting on collateral and going after it in some cases of default could generate an important deterrence effect that
reduces the number of future defaults and ensure financial discipline.
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SMEs, and could contribute significantly to efficient financial intermediation by saving SME clients’
transaction costs.
3. Improving the market infrastructure
In the long run, the improvement of the market infrastructure for efficient credit information flows
and credit analysis will be the most effective way of increasing the small firms’ access to finance. The
government may prioritize initiatives for reduction of financial market imperfections by identifying the
most binding factors that impede flows of credit to small firms. Some areas that require the government’s
initial efforts are improving the credit reporting system, helping the growth of the market for factoring
service and commercial bill discount.
Credit Information System
The strengthening of the credit reporting system is currently on progress under the initiative of the
PBC. The PBC may accelerate the process of establishing the on-line service in the national level and the
establishment of the credit reporting system for personal loans. Furthermore, the establishment of reliable
credit rating agencies will also help for some larger SMEs to finance from non-bank financial institutions
and commercial paper market.
Factoring services
Factoring is a way to get credit based on accounts receivables. For example, if a small firm sells raw
materials to its large firms, it generally offers trade credit and reports this as account receivable. In
countries where it is possible to “assign” accounts receivables (i.e., sell intangibles), it would be able to
turn around and obtain credit based on this accounts receivable-usually 80%. Factoring allows small firms
to borrow at the interest rate of their more creditworthy large customers. When the factor receives
payment, the small firm will receive the rest of the money minus service charges. The factoring is reverse
if the financial institution deals with the large firms, instead of small ones. It would purchase the accounts
receivables payable by the large firm from many small suppliers-this means it would only need to collect
credit information about the large firms. The government in China may help creating the market for
factoring services by allowing the commercial banks to do this business with increased interest rate
margin or allowing the establishment of institutions specializing in this business.
Rediscount scheme of commercial paper
Another way of improving the access of small firms to formal finance is helping the growth of
market for commercial paper discount. Currently the banks’ lending to SMEs through the discount of bills
they hold through the real transaction (such as suppliers credit) is very small (about 2-3% of lending to
SMEs). PBC may think about the establishment of the rediscount schemes of the commercial papers
discounted by the commercial banks in relation with the SME finance.
An effective scheme for SME lending in Korea was the central bank’s rediscount of a certain portion
of the commercial papers (issued in relation with the real transaction involving the SMEs) discounted by
the commercial banks at the rates profitable to the banks(Cho,1997). For instance, if a commercial bank
has discounted $100 of commercial paper held by SMEs, BOK rediscounted some portion of the amount
at the interest rate which was lower than the cost of the deposit mobilization. The proportion of rediscount
and the rediscount rate could be adjusted depending on the monetary situations. This has been an effective
scheme to encourage SME lending by the commercial banks. But this also limited the flexibility of the
monetary policies by the central banks. As a result, Korea has gradually phased out this system as the
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interest rates are fully deregulated and the commercial banks seek themselve SMEs as their profitable
clients.
IV. Concluding Remarks
With large amount of non-performing loans, Chinese banks now have to go through the restructuring.
Bank restructuring inevitably accompany credit crunch. Strengthening of regulatory standards on the
classification of loans, provisioning, and capital adequacy ratio lead the banks to curtail their loans to
firms. As a result, during the period of the bank restructuring, the growth and investment of corporate
firms will be adversely affected. This has already been taking place in China and likely to be intensified.
During the period of credit crunch, SMEs access to credit is more severely affected than large firms, since
the credit to the former is perceived more risky. Thus, the access of SMEs to the bank lending will
continue to be limited, or even aggravated in the coming years, unless some efforts are made. This can
also lead to the intensified unemployment problems. Rapid urbanization will add problems of urban
unemployment and social stability while many large SOEs will have to go through restructuring and have
to reduce the employment.
Private enterprises in China, most of which are SMEs, have in general made more efficient use of
capital. The average capital-to-output ratio for private and individual enterprises is only about half of that
of SOEs8, which suggests the improvement of the access by private SMEs to formal financial sector is
likely to enhance the potential of future economic growth and accelerate the progress of economic
transition toward market-oriented economy. It will also help make the transition path more stable by
reducing the unemployment problems.
The international experiences suggest the most effective way of improving the SMEs access to
finance is to improve the financial sector environment, especially the banking environment(Cho,1997).
The government’s efforts to improve the SMEs access to finance can be successful only if it is based on
the market principles and through the commercially oriented financial institutions. Directed credit
programs at subsidized interest rates often ended up with substantial costs to the banks and the
government without benefiting the targeted borrowers(World Bank 2001). Loans would go to those who
are politically well connected or who have friends in the banks. Such loans are often not repaid, as
reflected in the experience of the RCCs and UCCs in China.
Without financially sound and properly managed institutions, China cannot build an effective system
to finance small firms. The Chinese banks, during the last two decades of transition from the planned
economy to a market economy, have assumed many quasi-fiscal role of channeling resources to state
enterprises which in turn have taken care of many social welfare issues. As a result, they have large
amount of NPLs, and financially weak. Making the banks sound and operate in fully commercial basis
will be key to the completion of transition to the market economy. This will also be key to establish an
effective and sustainable lending to SMEs.
Banks need to re-orient their business practices to make them more compatible with lending to
smaller firms. They need to improve their ability to do credit analysis and assess risk. They must learn to
base more of their lending on cash flows rather than collateral and government guarantees. In the past, the
incentive structure has rewarded bank managers for lending to SOEs, even loss making SOEs. Banks will
only change if the incentive structure rewards managers for making profitable loans to smaller enterprises.
The financial market infrastructure needs to be improved in terms of enforcement of contracts and in the
quality of information available to those making lending decisions. Interest rates must be flexible enough
to accommodate lending to more risky borrowers and to cover the higher costs of administering small
loans.
8
IFC, “China’s Emerging Private Enterprises: Prospects for the New Century,” p.17, 2000.
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But this will take time. Moreover, the government should not expect that sustainable finance for
small firms will develop its own. The government should encourage the banks to adopt new credit
technologies and related personnel policies, target small firms as part of strategic reorientation in the face
of growing competition for lending to larger firms. The basic objective is not to favor small borrowers
over large, but to see that small firms are not disadvantaged by a variety of factors.
References
IFC, “China’s Emerging Private Enterprises: Prospects for the New Century,” p.17, 2000.
World Bank, 「Financial for Growth : Policy Choices in a volatile World」,Oxford University Press,
2001
Yoon je Cho, “Policies on Small and Medium Firms in the Era of Economic opening and Globalization.”
Korea Economic journal Vol.36, No.3·4, Seoul National University, December 1997 .
Kellee Tsai, “Beyond Banks: The Local Logic of Informal Finance and Private Sector Development in
China,” September, 2001.
Xie Ping, “Reforms of China’s Rural Credit Cooperatives and Policy Options,” September, 2002.
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