China’s small businesses fight for financing as state-run banks favor larger firms

SHENZHEN, China — The gamers at China’s tiny Glacier Internet Technology Co. had little to show when the bankers came calling — no signed export contracts or production orders and none of the land or buildings that the country’s financiers typically demand before they will trust a small business. One meeting room was furnished only with plastic stools.

What they did have was a growing batch of software and an emerging online presence for their main product, Long Trip, a multi-player game with a narrative drawn from Chinese mythology.

To their surprise, it got them a $1.5 million loan from China Merchants Bank, a small sign of change in a country where a dearth of small-business financing is seen as a critical problem in the evolution of the economy. For China to create more jobs and depend less on exports, financing needs to flow more freely to small and medium-size firms, according to economists, bankers and small-business owners.

Those firms tend to hire more workers and rely more on local markets. But the companies traditionally have been shunned by a banking industry hesitant to lend until a company has proved itself — an industry dominated by four large state-owned firms whose lending has been slanted toward larger and state-affiliated companies.

“We don’t have any fixed assets, so for us it had been almost impossible to get loans,” said Jiang Kiade, Glacier’s vice general manager. “. . . Intellectual property for the banks has meant nothing.”

China’s financial system is regarded as a sort of final frontier in its integration with the global economy; it is heavily regulated and used by the top authorities to steer economic development through controls on capital, currency, interest rates and other means.

Even after China joined the World Trade Organization and opened parts of its economy to world markets, the financial system remained an important lever of state power. There are private banks, such as China Merchants, but the government tells them how much interest they can pay depositors for savings or how much they can charge for loans — as opposed to letting banks set those levels themselves through competition.

The overall effect has been a massive investment — some say over-investment — in infrastructure and large industrial projects.

Big-project bias

For the companies favored by the state, “capital is cheap,” said Xiao Geng, an economist and head of Columbia University’s Global Centers in Beijing. He said the policy has helped the government keep growth rates high by steering resources to large projects.

“It is like rebuilding after a war,” he said. “But from now on, once you have finished subways and highways and airports, the low price of capital will have consequences” because those sorts of investments are no longer what the economy needs.

The government’s official aim is to channel more lending and resources to private entrepreneurs. The country’s financial regulator recently told banks that their loans to small and mid-size enterprises should grow at least as fast as their overall lending. Finance companies are being encouraged by the government to set up new “microcredit” and other services tailored to small companies.

Nicholas Lardy, an analyst at the Peterson Institute for International Economics, said recent data seemed to show a shift, with the growth in lending to households and small businesses outpacing the growth in loans to larger firms.

But there is much ground to make up. According to a recent study of small and medium-size companies in China by Standard Chartered Bank, 40 percent of the businesses said they had no access to financing at all. In those cases, business investment or expansion had to be paid for out of the companies’ savings. The companies that received bank funding tended to be those that were already well established.

In favoring proven firms over emerging ones, banks take on less risk. But this presents what the authors of the study called “a paradox” for China’s economy. Smaller businesses “were unable to access financing due to their small size, but were also unable to expand without access to financing,” the study concluded — a situation that is probably slowing China’s transition to a more market-based and consumer-driven society.

“China is still the factory of the world, but it’s also the market of the world,” said Betty Ku, Standard Chartered’s head of small- and medium-enterprise banking for China and northeast Asia. “To strengthen China’s consumer power, small and medium enterprises are clearly important. . . . It is a huge, underserved market.”

U.S. interests

Ultimately, U.S. business and government officials say they hope China will continue to open up its financial sector. The most prominent part of the debate is the dispute over how China manages its exchange rate, keeping the currency artificially cheap and thus helping Chinese exporters. But the discussion extends to the controls China places on capital moving into and out of the country, the limits it places on foreign ownership and the lack of competition in the banking sector.

Banking policy in China is an emerging priority for the Obama administration. U.S. Treasury Secretary Timothy F. Geithner has said that liberalizing the sector would put more economic power in the hands of families and open the country more to imports and investment from around the world. He said he plans to press the issue with top Chinese officials in meetings next week.

The global financial crisis set back the discussion over banking-policy changes, according to U.S. business and government officials familiar with China, because the upheaval raised concerns here about the financial model advocated by Western countries.

Any transition inevitably will be slow and, given the starting point, complex. It would put the state-owned banks on a competitive footing with private ones — making them compete for deposits and become adept in areas, such as assessing the business prospects of a small software company, where private banks would have a clear head start. Similarly, it would force state-owned companies and their advocates in the government to compete for credit.

“The money that the state vacuums up, they don’t want it reshuffled,” said Daniel Rosen, director of the Rhodium Group consulting firm’s China practice, who is conducting a study of China’s economic policies with Lardy, of the Peterson Institute.

But for some, at least, the traditional banks have begun to open their wallets.

At Glacier’s offices in a technology park in this commercial hub, a roomful of young programmers designed the landscape, characters and battle scenes for the company’s next online release. Begun with savings from Jiang and a partner, the firm already employs 200. The bank loan, with a favorable 6.25 percent interest rate, will give them the funds to begin expanding.

“China is not like Silicon Valley where there are lots of options for start-ups,” he said.

Researcher Liu Liu contributed to this report.

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