China’s Banks Should Not Be Used As Fiscal Vehicles While Supporting Private Firms

China's banks should not be used as fiscal vehicles while supporting private firmsPostal Service Bank of China

Xu Xueming via Caixin | Private enterprises have recently faced liquidity problems, resulting from refinancing issues and the pledged-share crisis. For some of them, the reason lies in difficulties in their own operations.

According to official statistics, private firms’ bank loans currently account for only 25% of the entire balance of bank loans. Due to limited financing channels, once a liquidity problem emerges in a private firm, it will soon affect bonds, credit loans and even capital markets. Statistics show that there were 114 bond defaults worth 119 billion yuan ($17.24 billion) in 2018. About 77% of these bonds were issued by private enterprises.

How do we solve the problems of private enterprises’ rising nonperforming loans, bond defaults and refinancing difficulties, and also manage the risk of forced sales of stocks pledged as collateral by controlling shareholders? I believe that the government, regulators, banks and the enterprises themselves need to work together.

First, the government must create a quality environment for businesses. It is necessary to ensure competitive neutrality in both market and institutional systems and to fairly treat all kinds of market entities. The government should also properly restrain state-owned enterprises from borrowing too much money through bank loans in a bid to avoid crowding out private corporations.

Also, governments at all levels must implement policies with higher standards and avoid “one-size-fits-all” policies. Recently, in response to private enterprises’ debt disputes, some local judicial departments prohibited creditors from carrying out asset preservation in the name of protecting private enterprises. This is extreme.

Second, the regulatory authorities should improve monetary policy’s transmission mechanism. It is necessary to increase financial support for private enterprises with targeted cuts of required reserve ratios and expansion of acceptable collateral. In addition, compared with state-owned enterprises, private firms are more dependent on nonstandard off-balance-sheet financing and nonbank financing. Therefore, it is necessary to give full play to the role of various financing tools including off-balance-sheet financing, and securities, insurance, fund and trust products.

“Shadow banking” is an important supplement to traditional banking. In recent years, it has played a positive role in boosting private enterprises’ financing. Regulators should leave some room for the development of shadow banking based on current rules.

Third, commercial banks must support the real economy and treat all types of enterprises equally. Banks should provide lower rates for private enterprises on the premise of ensuring stable operations and preventing systemic risks.

Before tackling the private sector’s financing difficulties, there’s no point to discussing lowering financing costs. Banks should first help private enterprises raise money and then figure out how to reduce financing prices. Bank loans are subject to risk-based pricing, and loan interest income must cover capital, operating and risk costs.

At present, the average nonperforming loan ratios of large, midsize and small enterprises are 1.19%, 2.55% and 3.39%, respectively. The nonperforming-loan ratio of small firms with credit lines of 5 million yuan or less has exceeded 4%. The capital cost of commercial banks is roughly 2% to 3% of a loan, and the operating cost is about 2%. In this case, the comprehensive cost of bank loans to small businesses is about 7% to 8%. For reference, a U.S. big bank’s interest rate for loans for small businesses is set between 5% and 11%, fully taking into account risk-based pricing.

China is experiencing an economic downturn, and we should pay careful attention to the rapid rise in risk costs. “Make a bank a real bank,” Chinese late leader Deng Xiaoping once said. To my understanding, the key point is that banks should not become fiscal vehicles. In this regard, there are profound lessons from history from which we should learn.

Lastly, private enterprises must accelerate their transformation and operate at a steady pace. The liquidity difficulties some private enterprises have faced were caused by external factors as well as their own operation issues. For example, some corporations have poor governance. Some expanded wildly and blindly, diluting their main businesses. Some borrowed too much money from banks when firms were in good operating conditions. Some have low information transparency.

Xu Xueming is a vice president of Postal Savings Bank of China. This article is a translated excerpt of a speech Xu delivered at a forum in Beijing on Sunday.