Peterson Institute for International Economics

Can Microcredit Lenders Fill the Gap?

The Chinese press is full of stories documenting the difficulties small and medium enterprises (SMEs) have obtaining financing. Contrary to popular belief, the problem is not that SMEs are being crowded out by large enterprises. The SME share of total business loans has been relatively stable in the past several years. Moreover, the pace of loan growth to small enterprises has been faster than that for medium or large enterprises.

That said, it’s still possible that China’s fast growing SMEs are demanding more financing (and on better terms) than banks are able to offer in the current credit-tightening monetary environment.

The problem facing small and medium enterprises has not escaped the attention of the Chinese government and has been a topic of interest at the National People’s Congress (Chinese language). The Ministry of Industry and Information Technology (MIIT), estimates that only 15 percent (Chinese language) of SMEs have been able to get loans from banks, and the ones that do typically pay a penalty interest rate of 20 to 30 percent greater than large enterprises, sometimes as much as 50 percent greater.

For years, Chinese regulators have called on banks to make more loans to SMEs. There have also been several government initiatives aimed specifically at increasing access to financing for SMEs, such as the collective bonds and credit guarantee programs. One of these efforts, the promotion of small loan companies (小额贷款公司), also known as microcredit/microfinance lenders, stands out as a somewhat overlooked success.

Between 2008 and 2011 the number of small loan companies increased seven fold. Quarterly data shows that over the past year and a half the industry has progressed rapidly in terms of both loans outstanding and number of companies.

Funding for small loan companies come primarily from three sources: shareholders, loans from banks, and donations. Loans are typically below 2 million renminbi and the tenors of the loans are quite short. Seventy percent of loans made are three- or six-month loans and only 30 percent are one year or longer.

Despite these signs of progress, the reputation of the industry was damaged by the crisis that swept through private lending in China last year. High interest rates and high-profile takedowns of private loan brokers, typified by the Wu Ying saga, have shaken confidence in private lending and cast a cloud of regulatory uncertainty over the industry. That small loan companies have continued to grow quickly while operating in such a challenging environment speaks to the intense demand from small companies for loans.

Comments made recently (Chinese language) by Zhejiang Vice Governor Mao Guanglie may be indicative of the government’s approach to transforming the industry. Mao was colorfully quoted as saying his approach to private finance was to “open the front door, close the back door, and smash the doors used for dishonest practices.” He elaborated that government’s strategy was to bring private finance out from the underground and let small loan companies transform into official village banks.

Transforming into village banks, of which there were 349 at the end of 2010, might be a good step forward in increasing transparency and reducing fraud.  It would also increase the ability of small loan companies to extend credit by allowing them to accept more deposits. Currently, small loan companies are currently prohibited by law from taking deposits from the general public and their capital from financial institutions may not exceed 50 percent. Becoming village banks, however, would reduce their interest rate flexibility as village banks are only allowed to charge up to two and a half times the benchmark rate, compared to four times for small loan companies.

Small loan companies are still small potatoes when compared to the massive state-owned commercial banks, but they are growing quickly and may help alleviate the much-acknowledged small, micro, and medium enterprise financing gap.

This post originally appeared at the Peterson Institute.

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