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Developing Small and Micro Finance: A Focus in Forthcoming Financial Reform


By Ba Shusong, Research Institute of Finance of DRC

Research Report No 47, 2012

The credit growth rate of China's commercial banking system has been lower than expected since the beginning of 2012, which is beyond the expectations of many researchers. According to research findings, one critical reason for this, apart from the restricted capacity of some commercial banks in granting loans due to constraints of regulatory indicators like the deposit-loan ratio, lies in the fact that the new credit demands of the investment and financing platforms of local governments with strong credit demand, and the real estate and the infrastructure sectors are subject to strict constraints of regulatory policy. In sharp contrast, small and micro finance is energetically encouraged by the financial authority. However, against the backdrop of decelerating economic growth, decreasing profits of micro and small enterprises (MSEs) and increasing difficulty in operating MSEs, commercial banks generally are extremely cautious about rendering services to MSEs, which is responsible for the growing financing difficulty of those enterprises during the economic downturn. This indicates from another perspective that there is still a huge gap between financial services provided by China's current financial system and the actual financial needs of MSEs, calling for substantive financial reform.

China's financial reform has made sound headway. In particular, the market-oriented restructuring of large financial institutions represented by joint-stock reform and public listing of state-owned banks has made considerable progress and financial services for large enterprises have been significantly improved. With large financial institutions shifting their business focus onto economically developed areas in the restructuring process, financial services in cities and economically developed areas have also been advanced.

Under new economic and financial circumstances, how should China's financial reform be pushed forward? In light of the achievements in financial reform and the practical needs of real economy for the financial industry, financial services for small and micro enterprises are relatively backward, the efforts in boosting market-oriented interest rates need to be intensified, and the supply of financial services is still insufficient in underdeveloped rural areas and the central and western regions. Given the general requirement of the financial sector serving the real economy, the improvement of small and micro financial services is related to above-mentioned substantive needs for financial services to various degrees and is likely to become the focus of the next phase of financial reform. In terms of functions, well-developed small and micro finance can provide support for the farmers in development of agriculture and rural areas, improve rural financial services, help redress funding shortage of rural financial markets, foster competition in rural financial markets and open up new channels to meet the funding needs of farmers and rural MSEs, thus contributing to the economic development of backward areas. In addition, the small and micro finance can facilitate the rational and efficient use of private capital, guide and promote the standardized development of private financing, and support the growth of MSEs by alleviating their financing difficulties.

I. Proactively Adjust Financial Structure, Cultivate Diversified Financing Channels and Urge Small and Micro Financial Institutions to Properly Position Themselves So As to Match up Their Financial Services with the Actual Needs of Small and Micro Enterprises

According to statistics, China has over 10 million small and medium enterprises (SMEs) with legal personality, accounting for 99% of all the enterprises nationwide, contributing to 60% of China's GDP, 50% of tax revenues and 80% of urban employment opportunities. The 2011 Statistics Report on Use of Loans Granted by Financial Institutions released by the central bank shows that as of the end of December 2011, the balance of small business loans (including bills discounted) reached RMB10.76 trillion yuan, up 25.8% year on year and down 3.9 percentage points from the end of the previous year. According to the survey of All-China Federation of Industry and Commerce, 90% of below-scale enterprises had no debtor-creditor relationship with financial institutions, neither did 95% of small and micro enterprises have such connections. Obviously, in view of the sizable social value created by small and medium-sized enterprises, they fail to get as much financial support as they deserve. Especially in the midst of economic crunch, financial institutions are inclined to grant credit and other scarce financial resources to large enterprises, a move that in actuality suppresses the development of MSEs and imposes increasing pressure on them.

To address this problem step by step, rational business positioning and viable business mode for different financial institutions should be sought to serve MSEs based on their diverse needs. On one hand, small and micro financial institutions such as rural banks and small loan companies should be vigorously encouraged; on the other hand, large commercial banks should be urged to provide services for MSEs and adjust their client structure by establishing differentiated assessment mechanisms and business models.

II. Ease Access to Financial Market and Encourage the Development of Small and Micro Financial Institutions Including Small Loan Companies

The present strict access control in the financial industry has led to markedly insufficient financial services for MSEs. Even in 2011 when private financing was highly active, the loan balance in small loan companies targeted at MSEs was only RMB 391.474 billion yuan at the end of the year, far from enough to meet market demands. In fact, in terms of the overall distribution of financial institutions, in small and medium-sized towns with a high concentration of MSEs, there are only a limited number of financial institutions that provide less than needed financial services. As thus there is insufficient competition in the financial service market for MSEs which have to accept high loan rates. In this sense, strict access control in the financial industry serving MSEs not only leads to insufficient competition in the financial service market, directly increasing the financing cost of MSEs, but also brings about significant license premium, making financial institutions become inclined to rely on premiums brought about by licensing control, but lack motivation to improve management.

Therefore, appropriate deregulation is necessary to promote small and micro financial institutions like small loan companies to provide financial services for MSEs, and new small loan companies should be introduced to augment competition in this field and thus lower the borrowing costs of MSEs.

III. Promote Market-oriented Interest Rates and Explore a Sustainable Business Model for Small and Micro Financial Institutions So As to Bolster Their Development

The sustainable development of small and micro financial institutions means that such institutions can generate adequate income from financial services to cover their operating costs and capital costs and ultimately survive and thrive, with financial sustainability as one of the core elements.

Overall, the market-oriented interest rate regime is conducive to the sustainable financial development of small and micro financial institutions. Historically, one reason for the poor performance of China's micro finance earlier on is that low interest rates were mistakenly believed to be a measure for "poverty alleviation". Such policy orientation on one hand disinclines commercialized financial institutions to undertake small credit business, or makes small loan institutions engaged in micro finance rely on special funding support and thereby fail to realize financial independence; on the other hand, it also leads to rent-seeking wherein MSEs in need of funding are unable to obtain credit and financial support. Thus, in order to promote sound and sustainable development of small and micro financial institutions, it is imperative to allow them to make necessary profits through normal operations and in particular, to progressively relax the interest rate control on financial services for MSEs.

In the implementation of the market-based interest rate regime, small and micro financial institutions should focus on the customer orientation of MSEs, provide financial services that best meet the needs of MSEs, give full play to their advantages like distinct regional characteristics, low information costs, rapid business approval and low transaction costs, concentrate on developing promising MSE clients, strengthen innovation on risk management, adjust business structure, enhance business competitiveness and take a development path distinct from that of large financial institutions. These approaches will also be conducive to boosting the adjustment of the overall financial structure.

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