Wednesday, September 24th, 23:00 HKT
Over the past few years the shadow banking sector has expanded quickly to meet the needs of small and medium enterprises (SMEs), evidence that state banks are unwilling to lend to smaller private enterprises. Given that research shows SOEs are less efficient with fund use, most analysts recommend more funds are lent to SMEs. Chinese economists advocate this as a key driver for real economic growth, a point which the new administration publicly promotes.
In July the need to reduce the cost of funding for private enterprises was repeatedly mentioned at State Council meetings. In August the government pledged to ensure more credit is diverted to rural enterprises, SMEs, or investment in areas such as rail, which can provide stable economic growth. However as this China Times reporter discovered, in reality state bank lending isn’t reaching the government’s desired targets. Although the state banks have launched SME lending platforms, in reality their scale and effectiveness is severely limited.
“Since May, actually I feel credit has loosened a little, loan amounts have increased, but this is the case of relaxing credit to SOEs, whilst reducing credit to SMEs” said a China Construction Bank (CCB) branch manager in Central China to a reporter from the China Times. More loans were made to SMEs in the past, but this year almost all the non performing loans have been with SMEs, causing the banks to become more wary, slamming the door shut on SMEs.
“If we’re talking about SMEs, there’s no way we’ll lend to them, not unless we’ve already done business with them before”. He further added that especially in the current depressed economic climate, SMEs are less insulated from macro level risk, so are more likely to go bankrupt.
However previous reports have indicated that when banks issue loans to SMEs or entrepreneurs, they will always ask for collateral in the form of property or machinery. Why then would banks still be reticent to lend to small companies?
One reason, mentioned in research pertaining to the Chinese banking system, is an underdeveloped corporate credit ratings system. A state banker previously mentioned to chiecon that this is not the case, the bank can use a companies bank records and accounts to evaluate a borrowers risk.
But a banker told the China Times reporter the issue is a question of scale. A person in charge of lending at a state bank’s Hubei branch said “Whether it’s a loan for 100 million yuan, or 1 million yuan, the costs of risk assessment are the same. Why do SMEs find it hard to obtain credit? Because in order to avoid taxes, they operate different sets of accounts, which makes it more costly for banks to have a clear understanding of their credit situation”.
Yet the CCB banker mentioned to the China Times another reason for the reticence at state banks. He said “One failed loan is enough to put me in trouble, even if by seizing the company’s assets and recouping all the principle and interest owed, if the company fails to pay back according to the loan terms, it’s my responsibility, and I’ll be punished for it”.
Another concern surrounding China’s growth in loans, is the amount of money being channeled into the real-estate sector, which currently is experiencing consecutive monthly price falls. A Hubei property developer told the reporter that “that many property developers are setting up their own finance companies to act as fund raising platforms, diverting more funds into real estate”. This same developer reveals that he’s currently looking for such a finance partner to help raise funds, using his land and property as collateral. Once the credit is obtained, both parties can then separately invest their share of the credit.
Worryingly the actual destination of bank loans remains a mystery to even the banks themselves. One banker at China Merchants Bank (CMB) told the China Times reporter that the bank has no way to monitor how the funds are used. If they lend to a SME, perhaps the funds are diverted for other uses, or even lent out at higher rates of interest. Hence, to reduce risk, the bank prioritises lending to SOEs.
But are these all excuses, designed to hide the fact that state banks exist primarily to service government and SOEs. A state bank branch manager told China Times that the reason is due to the government ownership structure of state banks. He feels they’ll have a tendency to give credit to government platforms, SOEs and central government, as there’s no responsibility on the part of the banker if any problems arise. But lending to an SME, if the loan turns bad, the responsibility rests solely with the person in charge at the bank.
In fact CMB already started curtailing SME lending at the end of last year. The reporter investigated one CMB branch as an example. At the end of 2013, total outstanding loans to small enterprises stood at 404.7 billion yuan, an annual increase of 87.8 billion yuan. Yet by the end of the first quarter this year, the total amount of loans to small enterprises had only increased by 300 million yuan.
A bank insider revealed that “we are applying more strict requirements to SME loans. Even though there’s currently a period of monetary easing, but this doesn’t necessarily mean all the money must be lent to SMEs, at least two-thirds of credit goes to large enterprises”.
So what are the chances of an SME successfully obtaining bank credit? According to data from China’s National Bureau of Statistics for Hainan province, pretty slim. 61 small enterprises applied for bank credit. Of these, 9.8% were able to successfully apply for all their required loan amount, 8.2% received most of their required loan amount, and 9.8% were only able to borrow a small portion of their required amount. Therefore the remaining 72.2% failed to receive any loans from the banks.
The economic reality is that SMEs still find it tough to raise funds in China. And this will make it harder for the Chinese government to push through with last year’s Third Plenum reform plans to shift investment from state controlled industries experiencing oversupply and low returns, to the more productive and efficient private sector.
One solution is for banking sector reform. This year the government has taken small steps at state bank reform, including capping senior manager pay. But at the same time, released new rules which will restrict (but for the meantime not outlaw) shadow banking activity. As long as state banks prioritise lending to SOEs at the expense of SMEs, then this pushes private enterprises into the arms of shadow banks, raising average funding costs at a macro level. Thus making the situation for SMEs even worse, in an economy that’s already showing signs of a slowdown.
(Article not to be republished without permission or citation).
[…] SOEs – As reported previously on chiecon, SOEs are still the major recipients from bank lending, and government subsidies. But with declining production and orders, one method to generate […]