Download Consumer Credit Business and the Financing Dilemma of SMBs

Consumer Credit Business and the Financing Dilemma of SMBs
∗
Mannie Manhong Liu, York Ying Wu
Mannie Manhong Liu
School of Finance, Renmin University of China, Beijing, China 100872, [email protected]
York Ying Wu
School of Finance, Renmin University of China, Beijing, China 100872, [email protected]
Abstract: It’s an apparently worldwide problem that the SMBs always face a financing dilemma. In the
developed countries and some emerging market economy countries, a series of direct or indirect
financing systems to SMBs have been set up including consumer credit, credit guarantee, venture capital
etc. after a long time’s development of market economy, which provide all-round financing services to
SMBs, and as a result, SMBs have maintained a sustained, rapid and sound development. Among all the
financing systems, consumer credit business has caught more and more eyes that is becoming a new
profit driver in the development of China’s banking industry. As a bank’s asset, consumer credit has
many good points such as low risks, high rate of collecting proportion and stable profits. The rapid
development of consumer credit is a trend of international banking business that might help to solve the
financing dilemma of SMBs on some point of view.
Keywords: Consumer Credit, SMBs, Financing Dilemma
1. Introduction
SMBs represent the heart of the world economy. In U.S., accounting for 98% of all businesses and
employing more than 60% of all workers. When it comes to job creation and wealth creation, these are
the firms that make it happen. When it comes to technology, though, SMBs can move either quickly or
cautiously, in a staged approach, depending on their needs and on the ease with which new technology
can be integrated into their current business processes (Raymond Boggs, Richard Villars,2001). The role
of the entrepreneurial enterprise as an engine of economic growth has garnered considerable public
attention in the 1990s. Much of this focus stems from the belief that innovation – particularly in the high
tech, information, and bio-technology areas – is vitally dependent on a flourishing entrepreneurial sector.
Accompanying this heightened popular interest in the general area of small business has been an
increased interest by policy makers, regulators, and academics in the nature and behavior of the
financial markets that fund small businesses.
Financial intermediaries such as banks and venture capital organizations are increasingly
understood to play a role distinct from that of other capital providers. Because they gain a detailed
knowledge of the firms that they finance, these inside investors can provide financing to young
businesses that otherwise would not receive external funds (Bhattacharya, Thakor (1993) and Barry
(1994) review the theoretical literature). A series of studies, beginning with James (1987), document that
the presence of bank loans is a favorable signal to other capital providers. Hoshi, Kashyap, and
Scharfstein (1990) and Petersen and Rajan (1994) show that relationships with banks enable firms to
receive financing at times when other businesses cannot. Petersen and Rajan (1993) demonstrate that the
concentration of bank credit can lead to highly different financing patterns across markets. The presence
or absence of venture capitalists may likewise lead to significant differences in the availability and
∗
We would like to thank Qiong Chen for her research assistance.
Biographical Notes: Mannie Manhong Liu, Professor at School of Finance, Renmin University of China, she is the
director of Venture Capital Research Institute of Renmin University. She received her Ph.D. from Cornell
University (1994), and Master’s Degree from University of Oklahoma (1990). Her main research interests in
venture capital and private equity in China.
York Wu (Ying Wu, Chinese name), Ph.D. candidate at School of Finance, Renmin University of China, he is a
researcher of Venture Capital Research Institute of Renmin University. He once served as a senior consultant and a
human resource manager in China Construction Bank. Recently, he mainly focuses on the topic of VC and
Technologic Innovation.
1516
pricing of venture capital across regions.
In the 1920’s, many experts began to study consumer credit. The comparatively characteristic
theories are Keynesianism, rational expectations school, monetary framework and the complex theory of
savings and consumer credit in China. The external consumer credit theory developed with the change
of economic cycle. In the period of economic crisis, Keynes advocates to stimulate the growth of house
demand by home mortgage loan, put stress on the government’s investment and finance to raise
economic growth. In the period of inflation and economic stagnant crisis, rational expectation school
consider rise of demand as the only solution to the crisis, consumer credit became the best way for this
rise because of its use to make infinitely consumption. Monetary framework developed the theory of
consumer credit. They related consumer credit to savings, put forward the view to modify the scale of
consumer credit by changing rate, which is the theoretic base for banks to increase consumption by
developing consumer credit. The internal expert Professor Shoukun Dong’s complex theory of savings
and consumer credit regards the complex of savings and consumer credit as the way to increase the use
of consumer fund, and then accelerate the circulate of the whole consumer product. This theory has a
theoretic use to make savings-consumer plan and a realistic meaning to conquer some significant
problems in China’s consumption sector.
2. the Financing Dilemma of SMBs
It’s an apparently worldwide problem that the SMBs always faces a financing dilemma. In the
developed countries and some emerging market economy countries, a series of direct or indirect
financing systems to SMBs have been set up including consumer credit, credit guarantee, venture capital
etc. after a long time’s development of market economy, which provide all-round financing services to
SMBs, and as a result, SMBs have maintained a sustained, rapid and sound development. However,
even in the developed countries, the financing services provided by the banks and the government are
hard to satisfy the SMBs. In USA, it is saving and borrowing money from one’s family and friends that
is deemed as the most important financing source of SMBs accounting for 58%, business loan and
capital provided by government-supported invested companies accounting for 29%, direct loan by
SBA(Small Business Administration) accounting for 1%.
In China, we began to establish financing systems such as credit guarantee system, venture capital
system, SMBs stock market etc. by the end of 20th century, however, the financing dilemma of SMBs
has never been effectively solved because of the bad credit system and competition environment.
Financing is very important to SMBs when they are making purchasing decisions (exhibit 1), more than
half of the survey respondents now view the availability of a financing option as important. This is
likely to change in the future because vendor financing and leasing options have been available to this
market segment only for a few years. As the market leaders in the SMB segment (e.g., IBM, Dell, Cisco,
Microsoft, HP) promote their financing solutions aggressively to the market, SMBs are becoming more
aware of the availability and benefits of vendor financing solutions. Most of these companies include a
financing option in all of their proposals.
1517
Financial intermediaries play a critical role in the private markets as information producers who
can assess small business quality and address information problems through the activities of screening,
contracting, and monitoring. Unlike large firms, small firms do not enter into contracts that are publicly
visible or widely reported in the press- contracts with their labor force, their suppliers, and their
customers are generally kept private. In addition, small businesses do not issue traded securities that are
continuously priced in public markets, many of the smallest firms do not have audited financial
statements at all that can be shared with any provider of outside finance. As a result, small firms often
cannot credibly convey their quality. Moreover, small firms may have difficulty building reputations to
signal high quality or non-exploitive behavior quickly to overcome informational opacity.
In China, although the banks as well as venture capitalists and business angels have supported a lot
to SMBs’ development, their financing situation is far away from perfect. In our opinions, the reasons
that SMBs in China are hard to finance lie in the following aspects:
1. SMBs in China don’t do well in their management and operation. Most of the SMBs in China
don’t have a clear operating strategy and developing target, lack of normative organization structure and
scientific management instrument, besides, they are hard to win in the market competition with high
asset-liability ratio and high risk of bankruptcy. As a result, they can hardly accord with the condition of
bank loans.
2. Some SMBs care little for credit system, they always dodge from repaying back bank debt. The
government and banks don’t do well in striking this phenomenon, the private entrepreneurs can easily
continue their business in some other places after dodging their bank debt. Even when they are asked to
repay credit by the court, the solvency ratio might be very low. As a result, banks dare not lend small
business loan.
3. SMBs can hardly get mortgage and guarantee bank loans. Lacking of credit construction systems
and competition circumstance turning to be worse and worse, the present credit guarantee and venture
capital system and SMBs stock market can’t solve the financing dilemma of SMBs.
4. The cost of SMBs’ bank loans is too high. Because the operation size of SMBs is small, the sum
of capital requirement is also comparatively small, their financial management system is not standard,
banks should pay a higher business cost. As a result, the banks, especially the state-owned banks in
China, lose their interest in loaning to the SMBs.
3. Consumer Credit Business in China
Consumer credit is becoming a new profit driver in the development of China’s banking industry.
As a bank’s asset, consumer credit has many good points such as low risks, high rate of collecting
proportion and stable profits. The rapid development of consumer credit is a trend of international
banking business. Nowadays, the rapid development of consumer credit is the solution for China’s
problems of economy and finance, and the strong lever to develop economy and finance. The view is not
only approved by the basic principle of economics, but also by the developed countries’ experiences.
Consumer credit is impelling a country’s house construction industry, automobile industry and
information industry to become the pillar industry of domestic economy. Consumer credit satisfies
people’s consumer demand, raises living standard and rapidly changes structure of consumption; Bank’s
consumer credit is a brand new financial product for individuals and families. It substantially altered the
service pattern of banks in planned economy in which banks were allowed to take deposits from
individuals but prohibited from lending loans to them. It also brought significant changes to the banking
ideology and operation model. For domestic commercial banks, consumer credit improves their asset
and debt’s structure, enhances their profitability. It is very important to study the consumer credit for the
economic growth.
In recent years, China’s consumer credit has developed rapidly especially home mortgage loan. But
compared to the developed countries, the scale of China’s consumer credit is still very small. There are
many obstacles in the way of developing consumer credit nowadays: (1) External-circumstance
restriction such as Out-of-date concept, income expectation, policy and law. (2) The rate of the bank’s
consumer credit is too high to consumers. (3) There are some problems in bank’s consumer credit
management. We have no perfect risk-transfer system of consumer credit.
1518
China’s consumer credit is still in primary grade, we should seek for solutions by both studying China’s
circumstance and learning advanced experience from foreign countries.
3.1 We should improve external circumstances to sustain the development of consumer credit.
Firstly, we should change people’s concept of consumption by advertisement, create macro
circumstances for consumer credit and increase employment and enhance the stability of employment
by macro policy, create a culture for consumer credit; Secondly, we may construct a complete individual
credit system steadily by learning from advanced experience about consumer credit report and credit
institution in American banking. Thirdly, the government should mend relative law-system, construct
and improve the whole-society security system. Forth, the banks should make a complete individual
credit assessment system with their own character and expansion plan. The individual credit assessment
system is the basic standard for bank’s credit-offer and the way to avoid risks from the source.
3.2 China’s commercial bank’s strategy for developing consumer credit.
(1) According to different commodity, different district and different demand of all kinds of
consumer group, Bank should create all kinds of individual consumer credit product to satisfy the
consumers, and then improve the development of consumer credit. For example: In home mortgage loan,
we may offer variable mortgage loan to different consumer; develop bridge loan; develop bill credit
such as credit card business; the complex of consumer credit and individual finance.
(2) Banks should have an accurate market plan. China’s bank should develop low-risk and
high-potentiality custom group, such as university students, young people with good jobs, government
officer or managers and salesmen in companies and foreign ventures.
(3) Marketing of consumer credit. One hand, banks should advocate consumer credit by adv, On
the other hand, they should train the staff in product and marketing, enhance their business quality;
change the award-punishment system, improve their marketing activity.
(4) Banks should make correct choice in some aspect such as: paying more attention to the
service-net construction, control the development of consumer credit in a reasonable scale.
3.3 Some suggestion about consumer credit rate and expectation of profit.
(1) Accelerate the proceeds of rate marketization. Banks should carry out the collateral rate policy
of fixed rate and floating rate to some long-term or high-risk home mortgage loan rapidly, or offer
variable changeable rate. Nowadays, in the condition that the credit rate is fixed, banks may learn from
this formula to analyze the amount and term of consumer credit:
(r-d-1)×S×B×(M/12)=Ca + Cc × M
3.4 Improving China’s consumer credit risk-transfer system
(1) Relating individual consumer credit to insurance. There are many successful experiences in
foreign countries. For example, the ING model of Holland international group which related home
mortgage loan to life insurance. The model takes advantage of commercial insurance skill to control
consumer risks. We should learn from foreign experiences to relate consumer individual consumer credit
to some insurance product in operation.
(2) Firstly, we should improve consumer credit security system and secure law, add detailed terms
about consumer credit to these laws. Secondly, we should develop prescriptively mortgage secondary
market to make all kinds of mortgage’s quickly realization. Thirdly, the government may create
consumer credit secure company for long-term consumer credit.
4. Conclusion
Under the tide of economic globalization, the government pays more and more attention to the
development of Hi-tech small and medium-sized business that based on high technique. The
governments have gradually realized the important status and function of Hi-tech SMBs in national
economy and they tried their best to afford series of conveniences in the conditions of society, economy,
finance and technology to accelerate the development of Hi-tech SMBs. With the adjustment of the
industrial structure, the Hi-tech enterprises of China have been in a vital transition period during which
their developments were limited by the financing bottleneck. Consumer credit satisfies people’s
consumer demand, helps to impel SMBs’ development, raises living standard and rapidly changes
structure of consumption, and turns to be the pillar industry of domestic economy, we should pay more
1519
attention to consumer credit.
References
[1]A. P. Thirluall. Growth and Development. The Mac Millan Press Ltd.1983
[2]R. G. Rajan and L. Zingales. The politics of financial development. OECD WP,1999b
[3]F. Mishikin and P. Strahan. What will technology do to financial structure? NBER,NO.6892,1999
[4]Alexander C. Risk management and analysis. N.Y., John Wiley & Sons Ltd,1998
[5]John A. Cochran. Money, Banking, and the economy. Macmillan Publishing Inc. 1979
[6]Deutsche Bundesbank: Monetary policy regulations, April 1994
[7]Allen N. Berger and Gregory F. Udell, The Economics of Small Business Finance: The Roles of
Private Equity and Debt Markets in the Financial Growth Cycle. Journal of Banking and Finance,
Volume 22, 1998
[8] Raymond Boggs, Richard Villars, How Small/ Medium Business Can Profit from the Internet. An
IDC White Paper, 2001
1520