Liquidity crunch could devastate China's SMEs

What will happen to small business as China's economy slows? The country's small and medium-sized enterprises are an important part of the economy and even more integral to employment; they account for 60 per cent of gross domestic product but a full 82 per cent of employment. With China's GDP growth dropping from over 10 per cent three years ago to 7.5 per cent or below, SMEs are going to struggle, which could have a disastrous effect on China's future.

The biggest problem facing them is a shortage of capital. The five state-owned banks, which control half of all bank assets, are much happier lending to state firms because they are generally "too big to fail". Even the smaller city and commercial banks prefer local-government-backed companies to private enterprise.

That forces small businesses to rely on the shadow banking sector. The shadow banks in China include a wide gamut of enterprises, ranging from family and friends and private lending groups to giant trusts. Figures vary but, according to the People's Bank of China, these lenders accounted for 30 per cent of credit issued last year.

We recently conducted a study of SME bank loans in China for the Shadow Banking Working Group at Guangxi University, sponsored by Beijing's Central University of Finance and Economics.

We examined data for more than 4,000 SMEs in 2007 and 2011 in two surveys conducted by China's State Administration for Industry and Commerce and collected by the Chinese University of Hong Kong.

The results were dismaying. Loans from the official state and local banks, for the most part, go to the traditional sectors of the economy, including real estate, mining, manufacturing and older registered companies. The only non-traditional lending from the banks goes to firms whose net income "increases as a result of innovation".