Financing Constraints

Introduction

As Krug (2004) cited, Chinas Small and Medium sized Enterprises (SMEs) are one of important power to promote the development of economy, social improving, increasing employment, technological innovation and so on. According to NDRC (2006), 55.6 percent of gross domestic product and 46.2 percent of tax revenues are provided by SMEs. Also, as Porter (2006) indicated that a healthy and growing development of SMEs is a key factor to acquire sustainable competitive advantage and economic improving in a nation. However, as Berger and Udell (1998) and Galindo and schiantarelli (2003) indicated that there is a problem of SMEs financing constraints during their process of development both in the developing and developed countries. According to Lin and Li (2001), YU (2002), Wang and Zhang (2003) and Lin and Sun (2005), there are very few SMEs can acquire loans from state-owned banks. Financing constraints is a major obstacle to firms. According to Westhead and Wright (2000), lack of funding support is a serious problem of the development of firms. So, there is mainly about the reasons of causing about financing constraints in China and some proposals to alleviate these constraints. The dissertation discusses the reasons of financial constraints for SMEs from the view of current financial structure in China. And providing some advices improve the situation of SMEs financing difficulty from the views of banks and SMEs. It mainly includes the following parts: definition of SME in China; the development of SMEs and financial system; the characteristics of current financial system; the current situation of SMEs financing; the reasons of SMEs financing constraints which are analyzed from banks views and SMEs views; proposals to treat financing constraints and conclusion.

Literature review

There are many materials discussing the problem of SMEs financing in China. Many of them from the view of preference of financing, like Xu (2004), cited SMEs in China prefer equity financing from the view of comparative advantages. Also as Hu and Li (2005) indicated that SMEs are more likely to adopt equity financing by calculating the efficiency of financing which are affected by different factors. Besides, some acquired the same result by the test way of empirical analysis, like Zou and Xiao (2006) used the data of listed companies from 1993 to 2000 to test influencing factors on financing. Also Wu et al. (2008) are from the view of financing cost from the data of Chinas listed firms. As can be seen from the above materials, SMEs in China more adopts equity financing compared with debt financing. So, in the following, it concerns about the reasons of financial constraints in the current financial system in China.

Review of the development of SMEs and financial system

According to Chen (2006), there are mainly three stages of development of SMEs. One is from 1978 to 1992, the quick expansion of SMEs in quantity. The second one is from 1992 to 2002, which is mainly about the reform of state-owned SMEs. The last one is from 2002, which are the establishing and optimizing relevant government policies and measures to support the development and expending of SMEs. Moreover, since 1992, Chinese government has already realized the importance of increasing competitiveness in SMEs and emphasized on the improving of quality on SMEs. Furthermore, banking and financial sectors of Chinas also gradual reform from mid-1980s. As Li (2004) and Tam (2003) cited that since the Peoples Bank of China acted as the central bank in 1984, a series reforms have been commenced, which included many financial institutions have been established gradually. Excepted the state-owned banks, there are rural credit cooperatives, commercial banks, trust and investment companies, insurance companies, security companies and urban credit cooperatives. One of the aims of these financial institutions is stimulating the development of Chinese SMEs. Besides, according to Wang (2004), SMEs loan guarantee system was launched in 1999 by Chinese Ministry of Finance with other government departments. Also, as Chen (2006) cited that during the time of many financial institutions being introduced, the barriers of developing SMEs have been released gradually. One of them was that many forms of entrepreneurial, for example urban collective enterprises, township and village enterprises, individual businesses, private enterprises, have been allowed to be existed by government.

Definition of SMEs in China

According to the new tentative classification standards on the small and medium-sized enterprises (2003), China uses two measurement standards to define SME. One is referring to output capacity; the other is original value of fixed capital. The first standard is mainly about industries with a limited number of products. For example, in electricity industry, company with an annual production capability under 50,000 kilowatts is defined as small size. The second standard is about firms with diversified products, according to the standard company which is less than 200 employees, excepting construction industry with 3000 employees, with sales under 40 million US dollars or capital value less than 53 million US dollars is defined as small sized firm. As can been seen from the following table, SMEs provide a great contribution on employment opportunity, workforce training, and goods export. The Relative Importance of SMEs in Selected APEC Economies Average GDP growth 1992-1999 (%) GNP US$billion 1998 Exports as % of GDP 1999 Number of SMEs '000s SMEs as % of all enterprises % workforce employed by SMEs % of SME sales in total sales volume % of SME exports in total exports % of GDP USA 3.6 7921.3 10.8 4311.0 96.0 69.0 50.0 33.3 50.0 Japan 1.0 4089.9 10.4 6450.0 98.8 77.6 76.8 13.5 na Canada 3.1 612.2 43.3 2200.0 98.0 66.0 na na na China 10.5 928.9 20.0 4980.0 99.0 70.0 na 40-60 na Australia 4.2 380.6 18.7 530.0 97.0 46.0 na 50.0 na Korea 5.5 369.9 42.1 2400.0 99.0 69.0 50.0 43.0 50.0

The characteristics of current financial system

s Que (2004) cited that before financial reform in China, financial institutions are only cashiers for the fiscal authorities. Nowadays, financial system in China has become a relatively comprehensive. The system has the following characteristics: One is many financial institutions are parallel. As Luo (2003), Liu, Xu, Yu, Zhou and Zhao (2005) cited that there are different types of financial institutions formed after reforms in the last two decades, which includes banks, credit cooperatives, securities companies, insurance firms and trust funds.

The current situation of SMEs financing

As Wang (2004), indicated that Chinas government has paid more emphasis on SMEs during the financial reform. However, there still need an efficient developing strategy about SME and policy system. This strategy should be a long term and systematic one. And social service systems also need to be improved. Compared with European standards, the burden of taxation should be decreased. Otherwise, if there is not a support by financial institutions, the development of SMEs might be slowed down or even be ceased. As some surveys showed that seldom Chinese private enterprises depend on bank loans when ones financing. According to Hanchun (2002), who performed two surveys in 1998, in ones first survey showed that most of sampled SMEs depend on self-accumulation, which was more than 50 percent of the total assets, when ones financing. Only a few of them used loans from state-owned commercial banks. In ones second survey showed that 67 percent sampled SMEs depend on self-accumulation when raised the fixed assets investment; 81 percent sampled SMEs relied on themselves financing half of the fixed assets investment; only 3 percent used loans from financial institutions. Besides, as Li (1998) indicated that the survey about Chinese private enterprises, which conducted by China Industrial and Commercial Union and Research Commission of Chinese Private Business, showed that compared with 21 percent borrowing money from bank and rural credit cooperatives, 65.5 percent choosing self-accumulation when business start up; 13.5 percent choosing borrowing money from relatives or friends.

Proposals to treat financing constraints

First of all, SMEs should focus on cultivating ones good information. As Holtmann (2000) cited that there is not a separation between right of management and owner. This is one of reasons why inadequate financial record keeping in SMEs. According to Kao and Tan (2001), lack of financial record keeping may be caused by avoiding rivals know critical information or by releasing tax burden. However, these are not advantage of financing. So SMEs should increase ones reputation collateral to financial institutions through making accounting information transparent gradual. And establish good information on governance structure. The good information can be seen as a kind of substitute of part fixed-asset collaterals. Secondly, electronic means should be involved. According to Wattanapruttipaisan (2003), using electronic means and related computer software programs to store, process and display accounting data about SMEs is a convenient and inexpensive way. And this way can also keep accounting information recording update. Besides, these programs should be widely used by SMEs related stakeholders, like public agencies, bilateral donor organizations. The third one is designing a good business plan. As Jappelli and Pagano (2000a), indicated that a good business plan is important especially for SMEs in the phase of start up stage, which is lack fix-asset collateral, equity capital and credit track record. According to IFC (2003) and Kao and Tan (2001), one of the most important is that business plans should be treated differently to different target of financial institutions. For example, bankers more focus on financial safety, reasonable short-term profits and long-term relationship. However, as Aylward (1998) indicated that venture capitals are more like high return and safe and quick exit for capital suppliers. According to Wattanapruttinpaisan (2003), an SME business plan should 30-40 pages, which mainly concern the following parts: one is about understanding of current firm, which includes company products, mission statement and business philosophy; another one is about the understanding of market which is mainly about the SWOT analysis (strengths, weaknesses, opportunities and threats); the third one is about plans which include distribution, sales, design and development, manufacturing and operations; the forth one is about human resource of the firm; and financial plan which include ownership, equity structure and so on. The forth one is credit information should be established. According to Miller (2001), such information may be provided by credit reference agencies or public credit registers. Compared with credit reference agencies which are built by voluntary cooperative entities and relying on reciprocity principle to provide information to members, public credit registers are data banks whose first purpose is supervision by government. And public credit registers are normally managed by central banking authorities. As Jappelli and Pagano (2000a) indicated, credit information may provide accurate prediction about repayment and reducing time of appraisal process, reduce moral hazard and so on. The fifth one is credit risk scoring system should be built on the basis of credit information. As Miller (2001), credit information provide a large database about firms, and on the basis of database, credit risk scoring system could standardized these data to make it use more convenient and reliable. For example, in the United States, credit risk scoring can acquire almost 90 percent of measurable risk, and the reports are sold on market only a few dollars. However, Miller also indicated that the system about SMEs is established only a short time and needs a long way to go.

Conclusion

As can be seen from above, SMEs have acted an important role in the process of economic development in China since its economy transforming, and government also has provided many supports on promoting ones developing. These support measurements includes establishing related credit guarantee scheme and financing policies. However, SMEs financing is still a difficult problem need to be solved. One of the reasons of financing constraints is that state-owned banks dominant Chinas financial system. These state-owned banks are more likely to invest one state-owned enterprises or large firms. Compared with these state-owned banks, others financial institutions have limited capability to provide loans to large quantity of SMEs demand. Besides, as there is a great gap of economic development in different areas in China, many local branches, which belong to state-owned banks, often invest cross region. The cross region investment would deepen the financing difficulty to local SMEs. From views of SMEs, many firms provide misrepresent accounting information. And ones accounting record are also less transparent. These problems would form asymmetric information between banks and SMEs and increase the difficulty and cost of acquiring loans. Another reason is the types of collaterals regulated by law are also disadvantage of SMEs. In the end of the dissertation, there are some proposals about how to alleviate financing constraints. One of them is increasing good information provided from SMEs and also gradually establishing transparent accounting information. The second is electronic means should be involved which could strength the reliable information. The third one is business plan should be different to different target of loan providers. Besides, credit information and credit scoring system should be a promotion about alleviating financing constraints. The problems of SMEs financing are complicated which concern both aspects of macro and micro, like current financial system and SMEs accounting and auditing information respectively. There would be a long way to solve the problem. The dissertation is only a brief description about reasons and proposals of SMEs financing constraints in China. Every aspect of being mentioned above should be considered deliberately.

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