Risk sharing by government and financial institutions is key to better loan service for MSMEs
By Chen Ke
February brought exciting news for China’s manufacturing industry. The sector logged its first positive contribution to the country’s gross domestic product (GDP) in a decade. Totaling 31.4 trillion yuan (US$4.7 trillion), China’s manufacturing output has been the world’s largest for 12 consecutive years. However, growth momentum couldn’t be sustained due to the resurgence of COVID-19 pandemic in April. Industrial experts have generally reached consensus that manufacturing companies are now experiencing difficulties with production and operation to varying degrees and that many micro, small, and medium-sized enterprises (MSMEs) hit a low point and could not obtain financing.
On May 26, the People’s Bank of China, the country’s central bank, issued a notice to establish long-term mechanisms to encourage financial institutions to serve micro and small businesses. Experts in the banking industry believe that efforts such as policy support, risk sharing, and digital technology can help MSMEs climb out of the current situation.
Most agree that MSMEs have a much harder time accessing finance than larger enterprises.
Zeng Gang, deputy director of the National Institution Finance and Development of the Chinese Academy of Social Sciences, explained that the long-term performance and high credit rating of large companies, especially state-owned enterprises, makes obtaining financial support easier than MSMEs. Because of the risk, financial institutions are reluctant to loan money to small businesses with insufficient collateral and a low credit rating.
China is a major manufacturing country with about 3.84 million such enterprises operating in 2020. Data from the latest national economic census of China, conducted every five years, showed that by the end of 2018, 3.24 million of the 18.07 million MSMEs registered in the country were in the manufacturing sector.
“It’s generally difficult for MSMEs to get loans,” opined Gu Weiyu, director of the Financial Innovation and Risk Management Research Center at the Central University of Finance and Economics of China. “But manufacturing MSMEs are not the weakest borrowers. They can use their fixed assets like production equipment and factory buildings as collateral, which makes them look more favorable to lenders than trading or customer-centric companies.”
Gu also emphasized that contrasting other fixed assets like real estate, production equipment usually has a very specific purpose, making it harder for banks to liquidate such assets. “Normally, small manufacturing businesses are wary about financing because of interest rates, but during hard times like the COVID-19 pandemic, securing a bank loan becomes like a pipe dream.”
Xu Hongcai, deputy director of the Economic Policy Committee of the China Association of Policy Science, identified two main factors contributing to the current difficult situation for manufacturing companies. Epidemic containment measures disrupted the supply of parts and components and consequently brought production to a halt. At the same time, rising prices of raw materials such as oil and gas, steel, cement, and food led to higher operating costs. Such pressure built up along the industrial chain, pushing downstream MSMEs into a precarious position.
“Minor downstream players in manufacturing have nowhere to escape,” explained Xu. “Overcapacity and fierce competition make it impossible for MSMEs to offset the increased production costs by raising prices. Also, because many of their products and services are related to daily life, they are restricted from charging more.” When confronted by soaring costs and disrupted supply chains, most manufacturing MSMEs hardly had a choice other than to cut production or even shut down.
Higher costs for metal, oil, and labor, coupled with clients demanding lower prices, have led to serious cash-flow problems, said the head of a new material processing company in Shantou, Guangzhou Province. “The economy remains sluggish, and our specialized equipment cannot be used to produce other types of products,” he sighed. “So why would the banks lend money to weak borrowers like us? This will worsen the situation for small businesses which survive on loans.”
To relieve the financial burden on MSMEs, a series of government policies have been implemented. Specific measures include tax cuts, fee waivers, tax deferral, tax rebates, and tax exemptions. In 2022, total tax rebates and reductions in China reached 2.5 trillion yuan (US$373 billion), the highest in history, and manufacturing companies and micro and small businesses in other sectors have benefited from such tax relief.
The May 26 notice issued by the central bank of China, which focused on factors discouraging financial institutions from lending to weak borrowers, is part of government efforts to help minor market players. Several banks now provide special services such as temporary delayed repayment for qualified MSMEs running into liquidity problems.
Experts interviewed by China Report ASEAN attributed the difficulties MSMEs have been experiencing in raising capital to several aspects. Some enterprises were rejected by banks because of insufficient disposable assets and high asset-liability ratio. The 2020 annual reports from the six major state-owned banks of China showed that wholesale, retail, and manufacturing had a high non-performing loan ratio and that the non-performing loan ratios of China Construction Bank and Agricultural Bank of China in the manufacturing industry were 6.03 percent and 5.08 percent, respectively.
Xu Hongcai noted that insufficient capital is also a problem for some banks themselves. And when business risk increases due to downward pressure from the macro economy, financial institutions are likely to become more cautious about lending. The life-long accountability system of banks constrain loan officers from lending without careful consideration. From the perspective of business development, a lack of employee incentive within financial institutions deters more inclusive finance.
Gu Weiyu has focused on the stability of the financial system for years. According to him, MSMEs in China borrow primarily from banks and other instruments like equity financing and debt financing provide about 20 percent of social financing. Considering the higher operational risks of MSMEs at present, banks are placing more attention on risk control. “When bad debt risk arises, bank profits decline,” Gu explained. “If the risk runs high or grows out of control, it can disrupt capital flow of banks and even trigger a systemic crisis.”
A stronger government role in using capital as leverage is needed, said Gu. He suggested establishing a risk fund for governments and banks to share risks. “If the risk can be mitigated through a risk-sharing mechanism, banks will more readily lend money to weak borrowers and focus less on profits,” opined Gu.
The importance of digital technology was highlighted in the May 26 notice, which encouraged usage of financial technology to realize enterprise-related credit information sharing and construct more detailed profiles of micro and small businesses.
As a Chinese national strategy, inclusive finance could benefit MSMEs in every sector. Experts agreed that inclusive finance has now become a primary service in nearly all commercial banks of China and that advancing the digital transformation of the manufacturing industry and promoting better usage of digital technology by financial institutions are two main issues being considered.
Digital technology, especially the Internet of Things, enables financial institutions to obtain data on micro and small enterprises, produce more accurate evaluation, and monitor their operations, which helps reduce risk for loan providers, according to Gu.
Zeng Gang believes that digital innovation in inclusive finance would satisfy the need to serve the real economy and enhance weak points in the supply-side structural reform of China in the financial sector. Some banks have made encouraging attempts. China Construction Bank took a proactive approach to allocating financing to companies on its white list and provided quick loans for micro and small businesses through its full-process online financing service. MYBank, a Zhejiang-based private bank specializing in online financing, has served 45.53 million owners of micro and small companies so far. The bank promises a three-minute loan application and one-second withdrawal without any face-to-face conversation.
Digitalization is still not a magic cure-all, Gu emphasized. To offer optimal solutions, different groups of customers need to be identified and differentiated products to be developed, which means financial institutions must hire more account managers. An ideal scenario for credit companies would be data collection and risk management conducted entirely online. But MSMEs, especially those in the manufacturing industry, usually do not have a database or a strong will to build one, so it is harder for them to leverage digital technology as much.
“Development of digital economy infrastructure and digital transformation of enterprises will make financial technology play an increasingly important role in raising capital for manufacturing MSMEs and other companies alike,” Gu said. “Digitization should be a priority if financial institutions want to overcome problems of information asymmetry and perform more accurate risk assessment and management.”