China’s economy is growing at is lowest rate in over 30 years, but if the country’s nearly 40 million small and medium-size enterprises (SMEs) could overcome a lack of access to funding, they could become a powerful engine of economic dynamism. Can digital innovators close the SME financing gap?
China’s government has certainly tried. Since 2005, policymakers have been working to expand access to financial services for SMEs, as well as for low-income households. Measures have included the establishment of more than 8,000 micro-credit companies, higher annual SME loan requirements for banks, and a mandatory reduction in the average interest rate on loans to SMEs, by one percentage point per year in 2018 and 2019.
Yet, despite these efforts, only 20% of Chinese SMEs ever borrow from banks. One reason for this is that SMEs, while plentiful, are not always easy to find, given their small size and geographical diffusion. A more important reason is that many banks are unable to employ market-based risk pricing effectively for SMEs.
With the average Chinese SME surviving for fewer than five years, one cannot claim that lending to them is not risky. But mandatory lower borrowing costs for SMEs mean that banks cannot use interest rates to offset the higher risks, and the government hasn’t offered compensatory subsidies.
While larger banks have probably adjusted by using cross-subsidisation, smaller banks do not have that option. For them, lending to SMEs means…