Easier Money for Private Firms?

What does the shift in China’s bank lending pattern from state-owned enterprises to private sectors tell us?

By Louisa Wah Hansen

2012 marks a watershed — it was the first year in which the percentage of aggregate bank loans to the private sector surpassed that of the state-owned enterprises. The amount of bank loans to the SOEs was 18.9 trillion  yuan, representing 30 percent of the total, compared with 19.8 trillion yuan for the private sector, or 31 percent.

The author of the report, Andrew Batson, wrote: “This turning point reinforces our view that China’s financial system is changing more rapidly than many observers realize… Along with the rise of so-called ‘shadow finance,’ which also serves primarily non-state firms, the shift in bank lending patterns has significantly increased the private sector’s access to credit.”

But is it really true that private firms are having an easier time borrowing money nowadays? Prof. Zhang Tianyu from the School of Accountancy at The Chinese University of Hong Kong (CUHK) Business School, has doubts about it.

“This study only looks at the total amount of loans lent in the whole country,” says Prof. Zhang. “Simply based on the country-level data, I am not so sure if it is easier for private firms to get credit.”

He says the steady growth in the size of the private sector implies that there is more intense competition for the pool of credits that are available to it now. The number of private sector employees had surpassed that in the state sector by the end of 2010 and makes up about 70 percent of total employment in China today, he notes.

For the study to be more convincing, Prof. Zhang believes a firm-level analysis is necessary. This could be done by surveys of private companies in China to gauge if it is easier for them to borrow money nowadays.

If the study indeed holds water, then it would be an encouraging sign for entrepreneurs and the overall economy of China.

“This is surprisingly good news, because researchers in this area have found that it has been very difficult for entrepreneurs in China to obtain bank loans,” says Prof. Zhang. “They face huge discrimination. If they make some donations to the local government, it may be easier for them to borrow money. In other words, you must have some ‘connections’ with the banks or with politicians.”

Prof. Zhang quotes a research at Peking University that found entrepreneurs have had to buy equity shares from commercial banks in order to access bank loans. “That’s why you can see a lot of privately owned firms having ownership in financial institutions such as commercial banks,” he says. “But you have to have enough money to do that, of course.”

For many private enterprises that simply don’t have the resources or clouts for such “connections,” they have resorted to shadow banks, which generally charge very high interest rates — 30 to 40 percent in some cases.

So, would shift in banks’ lending pattern highlighted in the study signal a turning point for the liberalization of China’s market economy?

Again, Prof. Zhang is cautious about making such a conclusion. However, he does believe that the study sheds light on the direction where commercial banks are heading.

“Their operations are more market-based now, which means they care more about their profitability when they are lending money. Previously, they were lending according to instructions of the government. For example, they were required to lend to SOEs, which might not be profitable. They ended up with lots of bad debts. But now, when they lend to private entrepreneurs, it is purely based on profitability. When they do that, the market generates returns, and they can expect to get the loans repaid in the future.”

The increase in credits to the private sector as a whole would eventually propel the Chinese economy to a more efficient and market-oriented one, according to Prof. Zhang. “The private sector must survive in the market, otherwise they would go bankrupt. When they borrow money, they must generate returns that are higher than the interest rate. So this would increase the efficiency of the economy.”

Prof. Zhang believes such a development would match the new government’s vision for economic growth. “In the past, China’s economy relied on labor-intensive industries. But now it must transition to new technologies, and for this to happen, we need to rely on private enterprises rather than SOEs,” he says. “The SOEs may be making money now, but they are making money from their monopoly position granted by the government, not by market forces. Only private enterprises can spur real economic growth.”