The Chinese government campaign to get more funding into the hands of small business owners is struggling. And a solution to the problem is being more urgent as the trade war with the United States starts to weigh on the economy. Small and medium-sized business (SMEs) account for most jobs in the country – up to 80 per cent by some measures. Each produces a single or a small range of products or services and operates on small profit margins that are far less resilient to economic disruptions than those at larger firms. The government has pumped money into the banking system to spur lending to smaller business and has recently stepped up its verbal intervention demanding action. Anecdotal evidence suggests the situation has improved, but only modestly. That is because the push to get banks to lend more to small firms is in direct conflict with the government’s effort to reduce risk in the financial system. A manager with a regional bank in the southwestern Sichuan province said her bank had increased lending to small businesses in response to the government’s policy push, but economic uncertainties and stronger financial regulation continued to limit their incentives to do more. “It is hard for a bank to handle credit policy now,” the manager, who only gave her surname as Li, told the South China Morning Post . “The outlook for small firms has greater risk due to the cooling economy. And the trade war between China and the US, as well as exchange rate fluctuations, have created a more complicated situation,” she said. “Given regulators have stressed the need to maintain a bottom line of no systematic financial risks, we have to operate more compliantly,” she said. An employee at a state policy bank told the Post that, given the government initiative, the bank now makes special evaluations of the loan requests by SMEs. But loan officers prefer to lend to large companies rather than smaller firms, so that they can achieve their loan performance targets more quickly. “Lending to small companies is riskier since [small company] managers often transfer company assets to their personal accounts,” said the official, who declined to gave his name. “It also costs so much time to identify their risks, given low transparency.” As far as his bank is concerned, the government is trying to use its “visible hand” to push banks to do “uneconomical business.” Opinion: China’s plan for a soft landing hinges on bank lending The Chinese government recognises the problem and has demanded action in a series of pronouncements in the last several weeks. At a meeting chaired by Chinese Premier Li Keqiang last Wednesday, the State Council, the country’s cabinet, called on financial institutions to boost loans to micro-and-small-sized enterprises, and lower borrowing costs for small business. The government will make special assessments of banks’ small business financing performance, according to the statement after the State Council meeting. The instruction came merely two days after a similar order from a key government policy group focused on promoting SMEs. The so-called leading group, led by Vice-Premier Liu He, a top economic adviser to President Xi Jinping, urged banks to expand their financing channels for SMEs to address their credit woes. Earlier this month, the Financial Stability and Development Committee, the government financial regulation coordinating agency led by Liu, also told banks to lend more to small business. Last year, each of China’s top five state-owned commercial banks established a special department to focus on boosting lending to small businesses. Other banks have begun to make similar moves. Further Reading: China cuts amount of funds banks are required to set aside for bad loans But, so far, the process is falling short of expectations. At the end of the second quarter, loans to micro and small businesses accounted for 32.3 per cent of the total outstanding corporate loans, 0.4 percentage point lower than at the end of March, according to data from the People’s Bank of China, the central bank. In the first half of this year, new loans for micro and small businesses made up mere 20.9 per cent of new corporate loans, the lowest rate since the data was first published in 2012. Ding Shuang, chief China economist with Standard Chartered, said because the policy focus switched suddenly to stabilising growth from controlling financial risks, banks have not had enough time to adapt. “Unless there is some loosening of capital requirement for banks, lending to small business will not rebound rapidly,” Ding told the Post . Grace Wu, head of China Bank Ratings at Fitch, said if banks are being told to lend to riskier sectors but at a lower rate than they would normally charge, that would run counter to their prudent risk management. “That means banks are not being adequately compensated for the risks they take in,” Wu said. But if the government would be willing to provide guarantees to these small loans, that could lower the risk of such lending. For instance, the Hong Kong government runs a scheme that provides guarantees to help SMEs secure loans from certain banks to buy manufacturing equipment or meet working capital needs for their business, but SMEs cannot use such new financing to repay their old loans. In the past, the shortage of affordable bank credit forced small businesses to turn to other avenues for financing, particularly shadow bank lending. Peer-to-peer (P2P) lending to SMEs soared to 872.3 billion yuan (US$128 billion) in 2017, more than 70 times the 12.4 billion yuan in 2013, according to a report from WDZJ.com, an information platform for the online lending industry, in December last year. Chinese SMEs, which accounted for more than 60 per cent of the country’s gross domestic product last year, have been underserved by the traditional banking system for years, so the government’s programme to reduce financial leverage and debt by underregulated shadow banking institutions has made their situation worse. Further Reading: How banks are tightening their credit policies, cherry-picking the customers most likely to deliver them highest profits as year-end nears Jiang Pengming, chairman of a tech entrepreneurs association in Beijing, said small firms, at least in the green industry, still face egregious requirements to get a bank loan. Banks sometimes demand collateral that not only includes company assets, but also managers’ personal assets. Unless there is some loosening of capital requirement for banks, lending to small business will not rebound rapidly Ding Shuang, chief China economist with Standard Chartered “Entrepreneurs, their spouses and children over 18 all have to sign loan agreements, businessmen over 60 even need to do psychiatric examinations on the same day of signing,” he told the Post . “Still, firms cannot ensure that they will get a loan by doing so.” He said that financing difficulties only scratch the surface of the problems facing small businesses in China. Freeing up more money for lending will not resolve these problems facing SMEs, most of which are private enterprises. “State-owned enterprises [SOEs] are badly exploiting the profits of the private sector,” Jiang said. “Take the green industry. Some local governments or their SOEs, usually delay paying small and medium-sized environmental protection companies. That makes the capital demand of small firms look like a black hole.” “The government needs to set up a specific association for private companies, a counterpart to the State-owned Assets Supervision and Administration Commission [for SOEs], to protect the interests of small businesses,” he added.