China’s Crippled Financial Sector

BEIJING – Even in the best of times, it is difficult for China’s small and medium-size enterprises to get bank loans. But with the current regimen of credit austerity, imposed to contain economic overheating and inflationary pressure, making conditions for SMEs worse, the financial sector – the least reformed sector in China – now is suffocating the beating heart of the country’s economic dynamism.

In normal times, the informal financial market helps SMEs to get by; but the recent woes of Wenzhou, a city in southern Zhejiang province renowned for its freewheeling private economy, have shown that the informal financial market can be very volatile and undependable. Several major lenders absconded with large amounts of deposits, and defaults by ordinary companies have become a serious concern. Things have gotten so bad as to warrant a visit by Premier Wen Jiabao.

China’s official foreign reserves are increasing at a rate of about $1 billion per business day, almost all of which is used to buy US Treasury bonds and other international assets that carry a minimal rate of return. At the same time, about 40% of China’s bank savings are not lent out. One might thus think that returns to capital are low in China. But one would be wrong: studies have consistently shown that the rate of return to capital has been more than 10% since the late 1990s.

Why then, can’t China’s SMEs rely on the formal financial sector to finance their daily operations? To be sure, it is not easy for SMEs in other countries to get formal financing. But not many countries are experiencing the same level of difficulties; surveys consistently show that only about 10% of Chinese SMEs’ finance comes from banks, while the global average doubles. Moreover, none of these countries has a capital surplus of China’s magnitude.