Teamaker’s Woe Signals China Fund Deficit for Entrepreneurs

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Photographer: Ariana Lindquist/Bloomberg

A worker picks tea leaves in the early morning in Yunnan province, China.

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Photographer: Ariana Lindquist/Bloomberg

A worker picks tea leaves in the early morning in Yunnan province, China. Close

A worker picks tea leaves in the early morning in Yunnan province, China.

Photographer: Nelson Ching/Bloomberg

The largest lenders in the nation -- which are themselves state-owned -- offer credit mainly to the biggest government-backed companies. At Industrial & Commercial Bank of China Ltd., the nation’s largest, seen here, loans to small firms stood at 20 percent of its total outstanding credit, even after tripling from two years ago. Close

The largest lenders in the nation -- which are themselves state-owned -- offer credit mainly to the biggest... Read More

Photographer: Qilai Shen/Bloomberg

In Zhejiang’s Wenzhou city -- where 400,000 small businesses make products from cigarette lighters to eyewear -- entrepreneurs paid an average 16.2 percent for one-year loans from informal lenders in the week ended Aug. 2, according to the Wenzhou Private Lending Registration Center, which tracks data from 350 sources. Close

In Zhejiang’s Wenzhou city -- where 400,000 small businesses make products from cigarette lighters to eyewear --... Read More

Photographer: Nelson Ching/Bloomberg

A survey in April of 1,000 small companies in 17 provinces found that 66 percent said they hadn’t received any benefit from the People’s Bank of China, seen here, cutting interest rates twice in 2012 and lowering the floor on the lending rate to 30 percent a year ago. Close

A survey in April of 1,000 small companies in 17 provinces found that 66 percent said they hadn’t received any... Read More

Dai Jinlian has created more than 200 jobs for villagers picking tea leaves in China’s Zhejiang province since 2008. That wasn’t enough to qualify her for a loan from the nation’s state-controlled banking system.

The 65-year-old grandmother, who was denied a 40,000 yuan ($6,500) loan in 2009, relies instead on retained earnings to fund the business she started with 300,000 yuan in savings.

“Banks will send you flowers when you are rich, but they won’t even look at you if you’re poor,” said Dai, who sells her “Mother Dai” tea bags through local stores.

Dai’s failure to get financing underscores the plight of small businesses in China, which have been sidelined in the nation’s 4 1/2-year credit binge despite accounting for 60 percent of economic output and 80 percent of jobs. The elimination last month of a lower limit on banks’ lending rates -- the most significant financial reform since Premier Li Keqiang came to power in March -- may offer them little relief.

“If anyone is going to get an immediate benefit from the rate reform, it will be those big state-owned enterprises that are already awash with liquidity,” said Tang Jianwei, a Shanghai-based economist at Bank of Communications Co. “Small firms are bearing the brunt of China’s slowdown.”

The economy will probably grow 7.5 percent in 2013, the weakest pace in 23 years, according to the median estimate of economists surveyed by Bloomberg News last month, as Li expands the role of markets amid a restructuring meant to reduce China’s dependence on exports and infrastructure spending.

Credit Binge

While policymakers made an unprecedented $6.2 trillion of bank loans available to state-owned companies and local governments since the end of 2008, China’s 42 million small and mid-sized businesses have had to rely on more expensive credit from friends, relatives, pawnshops and underground lenders.

Bankruptcies and loan defaults are on the rise in Zhejiang, a region south of Shanghai that’s home to many of the country’s largest private companies. Access to capital markets remains limited amid an almost 10-month freeze in initial public offerings and a bond market that’s open mainly to the largest companies.

The People’s Bank of China, which has set the one-year lending rate at 6 percent, abolished the maximum 30 percent discount that banks can provide to favored borrowers, effective July 20. The move was aimed at making lending rates more competitive and reducing companies’ borrowing costs, it said in a statement on July 19.

Higher Rates

That may leave lenders open to pressure from their biggest borrowers -- state-owned companies that have access to alternate funding from stock and bond markets -- to cut lending rates, according to UBS AG economist Wang Tao. The banks will seek to make up their profits by charging more on loans to smaller businesses, Wang said in a July 20 note.

“It seems naive to think that banks will simply lower lending rates across the board now that they have the legal right, but not obligation, to do so,” said Jim Antos, a Hong Kong-based analyst at Mizuho Securities Asia Ltd. “SMEs are unlikely to have enough clout with banks to be successful in bringing their cost of borrowing down very much.”

Small and mid-sized companies in China are defined in the manufacturing industry as those with 400 million yuan or less in annual sales and fewer than 1,000 employees, according to China’s Ministry of Industry & Information Technology. For retailers, the bar is set at 200 million yuan of annual sales and under 300 employees.

More Loans

Banks in China have increased lending to such small businesses since 2009 as policy makers seek to bolster economic growth and lower rates erode profit on loans to large state-owned borrowers. The proportion of new credit given to small, private businesses increased to 43 percent in the first half of this year, according to a People’s Bank of China statement on July 19, from about 20 percent in 2007.

Still, the largest lenders in the nation -- which are themselves state-owned -- offer credit mainly to the biggest government-backed companies. Less than a third of banks’ $7 trillion in outstanding corporate loans was made to smaller companies, according to central bank data.

At Industrial & Commercial Bank of China Ltd., the nation’s largest, loans to small firms stood at 20 percent of its total outstanding credit, even after tripling from two years ago. At China Construction Bank Corp. (939), the second largest, the share was 10 percent at the end of 2012.

That’s given less than 10 percent of China’s small businesses access to bank loans, estimated Xiao Feifei, a Beijing-based analyst at Citic Securities Co.

Too Expensive

A survey in April of 1,000 small companies in 17 provinces found that almost a third of the respondents considered bank loans the most expensive form of borrowing, according to the Boao Review publication and China Everbright Bank Co. Meanwhile, 66 percent said they hadn’t received any benefit from the central bank cutting interest rates twice in 2012 and lowering the floor on the lending rate to 30 percent a year ago.

Following that round of rate liberalization, banks in China had set only 13 percent of loans below the benchmark rates for various tenures as of the end of June, according to the central bank. Those loans weren’t priced close to the old floor even for the most favored customers, said Mike Werner, a Hong Kong-based analyst at Sanford C. Bernstein & Co.

Higher Costs

While banks may give state-owned borrowers a discount, small businesses are typically charged a 20 percent to 30 percent premium over the 6 percent base lending rate, said Mizuho’s Antos.

For instance, China Petroleum and Chemical Corp., the state-owned refiner known as Sinopec, paid a weighted average 4.7 percent on short-term borrowings last year, according to its annual report. In contrast, closely held Hangzhou Huaxing Chuangye Communication Technology Co. (300025) in July last year paid 6.15 percent for a nine-month, 3 million yuan loan from ICBC, according to its annual report.

Businesses that turn to shadow banking -- or lending outside the official bank system -- pay even higher rates. That industry, which includes wealth management products, entrusted loans, trust and underground lending, was valued at $6 trillion by JPMorgan Chase & Co., or 69 percent of China’s GDP.

In Zhejiang’s Wenzhou city -- where 400,000 small businesses make products from cigarette lighters to eyewear -- entrepreneurs paid an average 16.2 percent for one-year loans from informal lenders in the week ended Aug. 2, according to the Wenzhou Private Lending Registration Center, which tracks data from 350 sources.

Directing more bank credit to small and mid-sized companies would be a “win-win” situation for the lenders and the economy, said Ming Tan, an analyst at Jefferies Group LLC.

‘Critical’ Funding

“SME funding is critical to the government’s objective of growing the private sector and the real economy,” Hong Kong-based Tan said. “SMEs that are able to tap bank loans instead of informal channels will see their borrowing costs come down, while the banks also benefit from lending to customers who are willing to pay above benchmark rates.”

In the meantime, courts in Zhejiang accepted 143 bankruptcy applications last year, almost twice the number from a year earlier, with 90 percent of them from small and mid-sized businesses, the region’s high court said in May. Non-performing loans at local banks also more than doubled to 95.2 billion yuan as of Dec. 31 as each business’s failure triggered a chain reaction among companies that had guaranteed its loans, according to the statement.

In the first quarter, another 65 bankruptcy applications were filed in Zhejiang. China doesn’t make such filings public or provide formal data on the collapse of companies.

Bankrupt Shoemaker

One such failed company in Wenzhou is Augustus Shoes Co., which filed for bankruptcy in March after running up more than 100 million yuan in debt owed to banks, individuals and underground lenders, according to Cai Yanjiong, head of the local shoemakers’ association, who said he’s an acquaintance of owner Li Shanghui. The local Longwan district court confirmed that it had received the bankruptcy filing, and declined to provide more details as the court is reviewing the case.

Augustus Shoes, set up in 1995 and employer to about 400 people, hit a credit crunch after some banks began demanding early repayment on loans in late 2011 on concern that defaults were climbing, Cai said.

The shoemaker borrowed at least 10 million yuan from a loan guarantee firm at a monthly rate of 6 percent to meet those demands, according to a report in Wenzhou Business News in March. The company’s real estate investments also began to sour, while banks’ refusal to lend it more money was the final blow, according to the newspaper. Two phone calls to Augustus’ listed numbers in Wenzhou weren’t answered.

Cheap Funding

China’s largest companies, in contrast, have had a period of unprecedented access to cheap funding, with bond sales offering lower borrowing costs than even bank loans.

The bond market has grown more than 10,490 percent in the 10 years since 2002 as the government allowed more sales and borrowing costs dropped, according to data compiled by Bloomberg. The biggest beneficiaries are state-owned enterprises and local government financing vehicles, which account for 99 of the 100 top issuers this year, the data show.

While the weighted average cost for corporate loans gained 27 basis points from the beginning of the year to 6.91 percent in June, according to PBOC data, the yield on five-year bonds for AAA-rated companies was 4.86 percent as of Aug. 2, according to ChinaBond, the nation’s biggest debt clearing house.

Further steps by Premier Li’s administration to open up China to market forces may pose more problems for small and mid-sized companies in China, according to Kevin Gallagher, an international relations professor at Boston University. Still, the benefits outweigh the risks, he said.

‘Too Low’

“China’s biggest problem is that rates are already too low,” Gallagher wrote in an e-mailed response to questions. “Full reform would mean higher interest rates, which is always harder and riskier for an SME.”

Dai, who had ambitions of opening her own store and expanding online, has thus far invested 900,000 yuan into her herbal tea business by holding off on salaries for herself or her son. Having failed to get bank loans, she refuses to tap the shadow-financing industry, choosing instead to pare back her ambitions at a time when China needs businesses like hers.

“I’ll never go to those underground lenders, I’ve seen too many entrepreneurs go bust because of that,” Dai said. “I’m too old and my heart can’t bear it.”

To contact Bloomberg News staff for this story: Jun Luo in Shanghai at jluo6@bloomberg.net

To contact the editor responsible for this story: Chitra Somayaji at csomayaji@bloomberg.net

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