Aug 20, 2019 02:27 PM

Editorial: China Must Harness Market to Solve Small Business Financing Woes

New social financing in July came in below market expectations, and the strengthening of financial supervision and deleveraging on small and midsize banks could have the side effect of further increasing financing costs for small and midsize enterprises. Photo: VCG
New social financing in July came in below market expectations, and the strengthening of financial supervision and deleveraging on small and midsize banks could have the side effect of further increasing financing costs for small and midsize enterprises. Photo: VCG

China recently published economic data including its second-quarter monetary policy implementation report and July social financing figures. The Chinese economy has shown “marginal improvement.” However, the scale of new social financing in July was lower than the market expectation, and the strengthening of financial supervision and deleveraging for small and midsize banks could have the side effect of further increasing financing costs for small and midsize enterprises (SMEs). The first special section of the latest policy implementation report concerns the topic of “reducing the financing costs of SMEs,” which shows that the authorities consider this an urgent task.

The problem of difficult and expensive financing for SMEs is an old one. The central government has placed great importance on solving this problem in recent years, and has taken many measures and has achieved some results. For example, the central bank has adopted measures including differentiated deposit reserve ratios, targeted refinancing, rediscounting and medium-term lending to facilitate operations. The China Banking and Insurance Regulatory Commission has relied mainly on the mechanisms of window guidance, regulatory requirements and index-based assessment, and has placed rigid requirements on banks in terms of the quantity, ratio and interest rate of loans to SMEs. According to central bank data, new loans to SMEs reached 1.2 trillion yuan in the first half of the year, an increase of 647.8 billion yuan year-on-year. By the end of June, the growth rate of the value of such loans was 22.5%, an increase of 7.3 percentage points from the end of the previous year, and 9.5 percentage points higher than the growth rate of all loans during the same period. This is progress worthy of recognition. However, we should acknowledge that China has yet to cultivate an effective mechanism to solve the financing difficulties faced by SMEs. Perhaps, after years of hard work, but without achieving the desired results, the authorities should promptly reflect on their thinking and path. We believe that the fundamental solution is to develop the market, encourage the healthy growth of institutions that truly serve the financing needs of SMEs, and remove the institutional barriers to their development, instead of relying on methods like campaign-style supervision and administrative assessment indicators to achieve regulatory goals.

Cultivating multilevel capital markets and encouraging the healthy development of institutions supporting SME financing should be the key areas of emphasis. When setting incentives for different types of financial institutions, bringing the “cow” to water and then forcing it to “drink” when it doesn’t want to do so always involves more work than the results are worth. Why should banks abandon higher interest rates, higher lending efficiency, and give up business with government platforms and large state-owned enterprises in order to cultivate SMEs? This question has long gone unanswered.

Compared with mature market economies, China faces the constraints of being an emerging, transitioning economy. It is difficult for the financing needs of SMEs to be met under the indirect financing model led by banks. SMEs are shut out at many stages, including banks’ credit standards, approval, performance appraisal, and pursuing accountability. On a deeper level, due to the combined effects of the current economic system, government-business relations, the banking system, and interest rate mechanisms, this lack of access is not entirely based on market competition, and may even have nothing to do with interest rates. For this reason, the problem of “difficult financing” is actually more difficult to solve than that of “expensive financing.” In a well-established financial market system, although loans to SMEs are risky, financial institutions can rely on high interest rates to compensate for losses. However, in a market with a severely distorted structure, instituting formal “equality” and even special treatment for SMEs could actually cause serious inequalities.

Different financial institutions serve different enterprises, based on size, capital cost and business characteristics. Compared with regulatory pressure on financial institutions, market development takes much longer to become effective. However, precisely because it takes a long time to bear fruit, it must be grasped early and worked on persistently. The theory behind this is simple — most people, including experienced government officials, know this. The key is to actually put this into practice.

To this end, China should accelerate the internal reform of financial institutions, and the regulatory authorities should implement greater market access. The approval process should be put in order and a system of smooth integration with SME financing should be established as soon as possible. Serving SMEs requires a flexible and effective approach. Some experts suggest that large state-owned banks should set up independent micro-credit banks, rather than remain trapped within the framework of existing institutions. Since the relationship between small and midsize banks and SMEs is more intimate, the government should vigorously promote and give clear policy support for the development of private banks and community banks. The lack of local financial supervision ability is a real problem, but it can only be improved through regulatory practice. If the authorities hesitate to open private banks due to the fear of getting into trouble, SMEs will not find a solution to their financing troubles anytime soon.

After all, it is necessary to broaden the variety of financial instruments and financial products and to use capital to solve a problem involving capital. The expansion of a pilot program for private enterprise bond-financing support tools, the issuance of SME financial bonds, the promotion of SME accounts receivable financing, and the increase of bill financing support for SMEs are all measures that are gradually being explored. China should also make it a top priority to vigorously develop direct financing options that can compete with the indirect financing provided by banks, and extend multi-level capital markets. The one-dimensional quality of China’s current financial market is one of its shortcomings, and direct financing including private equity and venture capital can help SMEs. In addition, regulation needs to be prudent and tolerant, and financial innovation should be supported. Financial technology is growing in importance. Big data technology can not only improve the credit mechanism of SMEs and improve credit management technology, but it can also use new methods to enrich financial products. Due to the high risk, low efficiency and high management costs of the micro-credit business, the establishment of a complete financing structure requires the support of financial technology.

The regulatory authorities have encouraged financial institutions to lend money to SMEs. However, some policies confuse policy logic with business logic, and have counterproductively softened the budget constraints of banks and SMEs. In the long run, this causes financial and economic risks to accumulate. Therefore, it is difficult for us to agree with the idea of the state covering so-called “credit relief costs.” The importance of SMEs to the Chinese economy cannot be overemphasized, but they are, after all, companies that need to obey market rules. As the downward pressure on the economy continues to increase, it becomes even more crucial for China to solve the problem of difficult and expensive financing for these companies. Assuming that the necessary regulations are already in place, the path ahead should now be firstly focused on market development, and secondly on technological improvement.

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