Shanghai Pudong Development Bank flagship office is positioned on the Bund, one of Shanghai's busiest tourist spots. Directly opposite, on the other side of the river, is the sprawling district of Pudong. On that side, the tall buildings of state owned banks, businesses and international bank subsidiaries dominate the skyline.
The development of Pudong is one of China’s proudest achievements. From swampland to a dynamic metropolis in 20 years, Pudong is China’s poster boy for successful and rapid economic development. SPD Bank has supported Pudong’s development since the bank’s founding in 1992. But now, as China desperately tries to stem its economic slowdown, banks might need to turn their sights away from solely supporting the development of vast state-owned enterprises and focus on smaller and more diverse privately owned businesses.
As Jamie Spence, principal of Asian Link, a Hong Kong-based company focused on strategic partnership opportunities in north Asia, says, China's small and medium sized enterprises are the powerhouses underpinning the domestic economy. It would follow that for continued economic growth, SMEs should be supported by banks in China. Still mostly marginalized, SMEs are still finding it hard to access mainstream funding from banks and are forced, as a result, to access shadow bank funding channels.
SPD Bank tells Euromoney why banks are deterred from lending to SMEs and what measures banks are introducing to turn this around.
Q: Why are banks in China reluctant to lend to SMEs?
A: Most small and medium-sized enterprises are privately owned and lack any meaningful collateral to back them up. From a commercial bank’s point of view, these types of businesses are very risky and as a result, commercial banks are generally less willing to lend to SMEs. Commercial banks prefer to lend to state-owned enterprises, which are backed by the state and have reliable guarantees.
Lending to risky companies is basically like taking a gamble on them. To offset the gamble, commercial banks will charge higher interest rates to SMEs than they would to state-owned enterprises. More often than not, SMEs are deemed too risky to lend to in the first instance: Chinese banks always err on the side of caution when it comes to offering SMEs credit.
But what’s important to understand is that it’s not high interest rates that discourage SMEs from accessing credit from banks. Strict rules on SME assessment and lending restrict banks from lending to SMEs in the first place and SMEs are forced to seek alternative sources of credit. Commercial banks charge, on average, 10% interest to SMEs. Underground banking systems will charge 25% interest at the very least. Again, the key issue is that SMEs are high-risk, and sometimes they are just too risky to lend to in the first instance.
Beijing needs to be more aware of the risk. The central bank issues incentives to commercial banks to lend to SMEs as a group – but they do not necessarily differentiate between high-risk SMEs and those with good fundamentals. If the government continues to push out policies for SME lending on a sweeping basis like this, smaller enterprises will remain marginalized and will find it difficult to access mainstream banking systems. This is highlighted in the numbers: only 15% of smaller businesses qualify for bank loans in China each year.
Despite these numbers, SPD Bank’s SME lending business is quite sizeable. If we categorize SMEs in the same way as government does, we lend about Rmb700 billion [$110 billion], which accounts for 46% of all SPD Bank lending, to privately owned enterprises of all sizes.
 |
| Wang Sunan, general manager of SMEs at Shanghai Pudong Development Bank |
Q: Has SPD Bank made it easier for SMEs to borrow?
A: SPD Bank made one of the biggest structural changes to bank lending last year when it set aside a separate quota of loans to SMEs. Previously, state-owned enterprises, with secure assets and collateral, would naturally be the first to get access to bank loans, leaving SMEs on the periphery once lending quotas had been filled. Now, SPD Bank has a completely separate quota of credit set aside for smaller, privately owned businesses, which means that they do not have to compete directly with state-owned enterprises for credit.
Q: What is SPD Bank’s main incentive for lending to SMEs?
A: First, lending to SMEs diversifies our risk profile, which is important for any bank. Secondly, by lending to SMEs, we expand our customer base, which is also important to us. Thirdly, by charging higher interest rates to a high volume of SMEs, there is the potential to increase returns.
Q: How do you assess the creditworthiness of an SME?
A: SPD Bank doesn’t necessarily follow a course of lending to specific industries or sectors. Instead we have four criteria that we use to assess the risk exposure of an SME. First, we will not lend to companies that make any random investments; secondly, we will not lend to companies that are involved in underground lending platforms; thirdly, if the SME has any outbound guarantees or provides guarantees on behalf of any other privately owned companies, we will not lend to it; and fourthly – perhaps most importantly – if we suspect that the owner of the company is involved in gambling, we will not lend to the SME.
Field research is an important part of our assessment, and we have a strong network of employees all over the country that helps us with this. We often hire local people as customer relationship managers to deal with SMEs in their area because they are already familiar with the businesses in the area and the people involved with them and are best placed to assess the creditworthiness of an SME. Many other commercial banks also expand their business in this way. And those sales managers who successfully manage loans to SMEs will be given bonuses to praise their good work, which has been a major incentive introduced by the bank to encourage SME lending.
Q: Will we see what has happened in Zhejiang province happen elsewhere in China?
A: There has been a lot of publicity around Zhejiang province recently as hordes of privately owned businesses went bust, largely due to dodgy loans acquired through the underground financing system. To try to stem these mass failures from happening in this region again, the government has started to supervise the transformation of illegal lending platforms into legal banks that are allowed to operate at the village and township level.
Zhejiang province is the only place where non-performing loan ratios have risen drastically. Elsewhere, we have not as yet seen any similar patterns. The reason why this happened in Zhejiang is because the private sector is more developed there than anywhere else. Private-sector entrepreneurs in Zhejiang made lots of money and then started to aggressively invest in other risky projects that they didn’t really know much about. When these loans started to default, the situation in Zhejiang spiralled out of control pretty quickly.
On the whole, Zhejiang province’s economic development has been more reliant on the real economy, particularly on exports. As the region developed, and the locals became wealthier, there was a shift from the real economy to private investment. This pattern is not so typical of other regions.
Q: What is Beijing doing to try to quash the underground banking system in China?
A: The government is not trying to stamp out underground lending platforms. They are trying to do two main things: first, they want to give more incentives to banks to lend to SMEs so that businesses will be less inclined to go underground, and secondly, they are trying to legalize underground lending. Beijing wants to bring underground lending platforms to the surface and legalize them. But this is no easy feat.