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ORIENT ACADEMIC FORUM Research of Financing Obstacles and Strategies of Small and Medium-sized Enterprises ZHANG Xiaoming1, CHEN Jing2 1. School of Economics and Management, Beijing Jiaotong University, China, 100044 2. School of Finance, Renmin University of China, China, 100872 [email protected] Abstract: Financing difficulty of small and medium-sized enterprises has always been the focus of peoples. This article starts from analyzing the present situation of small and medium-sized enterprises in China. It discusses the direct and indirect financing obstacles faced by small and medium-sized enterprises, and then puts forward referenced policy suggestions. All of these are aimed to promote vigorous development of China small and medium-sized enterprises, and enhance their contributions to national economy. Keywords: Small and Medium-sized enterprises, Financing Obstacle, Strategy 1 Present Situation of Small and Medium-sized Enterprises in China Since reform and opening-up, small and medium-sized enterprises (Hereinafter called “SMEs”) have been the major impetus of economic growth in China, and their existence as well as development play an important part in the sustainable, stable, and healthy development of China’s economy. By the end of September, 2009, the number of enterprises registered in All-China Federation of Industry & Commerce has raised up to 10,300,000(31,300,000 privately-owned business not included). According to the current standard of SMEs, there are 10,231,000 SMEs, more than 99 percent of all the enterprises. At present, the final products and service values created by SMEs take up about 60 percent of GDP (Gross Domestic Product). Taxes paid by small-and-medium enterprises take up about 50 percent of national total tax account. SMEs provide nearly 80 percent of job opportunities in town and they absorbed lots of surplus rural labor. SMEs’ development helps to promote the establishment and improvement of market system. Practice of developed countries indicates that, prosperity of market economy is the prosperity from the competition. But, precondition of competition prosperity is the existence of enough independent SMEs. For example, after World Wall , the economy miracle and prosperity of Germany mostly relied on the rapid development of SMEs and fair-competition environment formed by them. However, SMEs are confront with fund shortage which can’t be solved by market during their development, and in a way, fund shortage has been the bottleneck restricting their development. (Hui Encai, 2010; Peng Runzhong Zhao Min, 2010; Xu Li, 2010ect.) From a long-term perspective, if only developing small and medium enterprises acquired considerable capital support, such a booming economy, hiring and economic growth could still be a bit more stable and consistent. In a long run, if only SMEs get powerful fund support, the prosperity of China, the rise of employment and economy is hopeful to come into the orbit of material rising. From a global perspective, shortage of funds and relatively poor credit conditions are general problems that plague the development of SMEs. On the one hand, SMEs are of small size, variable business, high risk and low credit capacity. On the other hand, funding is a special service product. It is vulnerable to erosion in rental or commission operations and becomes the so-called “Bad debts”, not to return and compensate. The resulting economy and social impact are with the chain and integrity. Therefore, precautionary principle is widely adopted in financial intermediation by owners of the general funds or financial institutions. Thus, financing difficulty of SMEs is congenitally doomed. Below we will probe into the barriers of SMEs from the two perspective of indirect and direct financing. Ⅱ 、 351 ORIENT ACADEMIC FORUM 2 Analysis of the Financing Obstacles of China’s SMEs 2.1 Indirect financing obstacles 2.1.1 Discrepancy between the demands of SMEs and the bank system China’s financial system was established back in the late 70s with mainly state-owned banks serving state-owned sectors, thus the lack of financing institutions answering the financing aspiration of the rapid expansion of SMEs. Considering the diversification of the totality of the China’s economy, it hasn’t been settled well that the overall financing system should provide the different economic bodies with different solutions, the asymmetry has appeared between the economic system and the financing structure, and among them the private-owned small businesses are at an automatic disadvantage status. R R R R0 R1 R2 Q0 Figure 1 Q1 Q (S/D) Figure 2 Q (S/D) D S Q2 Q (S/D) Figure 3 (Note: Figure 1 Equilibrium between supply and demand in the capital market with completely symmetric information; Figure 2 Supply and demand of capital with information asymmetry; Figure 3 Supply and demand of capital with information asymmetry) 2.1.2 Information asymmetry between banks and enterprises Under the condition of completely symmetric information, the capital market will be cleared in equilibrium price which is rate R0, with the result that all financing demand will be satisfied if supply is not limited (Fig.1). However, the assumption of completely symmetric information can’t be made to meet in real world. Even if we don’t consider the information cost, we can’t get exact information about how the future will be because of the limitation on human’s rationality, cognition, calculation ability and knowledge. So information asymmetry is the basic feature of human activities. Under the condition of information asymmetry, assuming that capital demand does not change, <1> when the capital supply curve is a vertical line (Fig.2), the price elasticity of capital supply is 0, which means the one which supply capital are only willing to provide the capital Q1 no matter how high the price that the one which needs capital would like to offer. As a result, not all the capital demand can be satisfied. <2> when the capital supply curve slopes downward (Fig.3), there occurs a strange phenomenon that the higher price the one which need capital would like to offer, the less the capital suppliers are willing to provide instead of more. These two kinds of situations will be met when banks loan money to small-and-medium-size enterprises. In capital market, information asymmetry definitely leads to credit risk and it’s costly to gain information about the debt side. Because of small size and high risk of their management, it costs banks more to gain information about the credit status and the state of operation of SMEs than big enterprises as well as with higher credit risk. As a result, to reduce the operation cost and risk, commercial banks will set up credit limit, which makes it difficult for SMEs to get a loan as shown in Fig.2 and Fig.3. 2.1.3 Lack necessary social guarantee mechanism. 352 ORIENT ACADEMIC FORUM In order to avoid the risk, banks almost don’t issue loans except to some big enterprises and regardless of the size and the length of time, clients can only get loans with previous credit records as well as on condition that they have conducted the guaranty of mortgage. So it excludes numerous high-tech or growth-oriented enterprises that have no record of profits and no credit record. In addition, when they want to get loans, a considerable number of SMEs, due to its credit deficiency, can’t provide adequate and effective assets mortgage or pledge but need to gain external access to credit guarantee. Because of the high risk of credit guarantee, large companies and government departments don’t want to provide credit guarantee for SMEs. The lack of effective guarantee and relative social guarantee mechanism is the main obstacle for SMEs in the process of financing from financial institutions. 2.2 Direct financing channels are blocked China's capital market has gone through 10 years. By December 25th, 2009, the total market value of Shanghai and Shenzhen storm market has been more than 23000 billion yuan. There are 1,695 A share listed companies in total. At the same time, Growth Enterprise Market (Hereinafter called “GEM”) was also launched in 2009. So far, 36 companies have listed in GEM and it has brought fresh blood to A-share market. But comparing with millions of small and medium enterprises in China, GEM didn’t provide enough support for them, and there is still a large space for development. In addition to the stock market, Chinese bond market and bill discount market are not developed, which can’t meet the financing needs of SMEs. The distempered risk investment mechanism in which exit is the premise of entrance also slowed the development of venture capital in China. This greatly restricted the growth rate of small high-tech enterprises in China. 3 Strategies to Remove Obstacles of SMEs Financing 3.1 Establish and develop medium financial institutions system to provide services for SMEs The deepen reform of market economic system have leaded to eternal multilevel of Chinese enterprises and division of financial services. This impels state-owned commercial banks and small and medium financial institutions to form their own service advantages, so that they can serve the development of enterprises better. The government should take positive measures to encourage the establishment of small and medium financial institutions. People’s bank of China should support those established small and medium sized banks, rural banks and credit unions that have good business and actively support the development of small and medium enterprises in re-loan and other aspects. People’s bank of China should support bill rediscounted business and if the bill rediscount ratio is linked with credit extended to small and medium enterprises, more credit, more rediscount, banks will have more motivation to develop new small and medium sized customer base. 3.2 Establish the system of credit evaluation for SMEs Credit rating can be the standard to tell the credit for the loan, which can play an important role in gaining trust and project capital from financial and insurance institutions. China must begin with address this point in the credit management system, otherwise the risks of bank credit and enterprises enquiry will climb. The credit evaluation for SMEs must put into accentuation of the small scale of loan, fast circulation, unpredicted period, reducing too excessive dependency on accounting statement, highlighting practical check, keeping an eye on enterprises’ performances, taking a differently standard from big enterprises by most authoritative evaluation organizations to assess risks fairly of loan for SMEs. Different rates generally made based on quality of manager, performance of enterprises ,solvency of debts, credit record and development perspective, to cut down effectively cost on seeking information for them. 3.3 Focus on financial innovation to avoid credit risks Banks make efforts to employ new financial products, taking the problem in gaining loans or guarantees 353 ORIENT ACADEMIC FORUM into thinking. As for loans, except direct loans ,banks can also offer bank bill, loans by commercial bill discounted, or using credit of buying party, to provide loan to product-using enterprises, allowing them paying financially in advance, in this way, the capital problem of high-tech small enterprises; as to guarantee, flexible ways can be used, such as equity pledge, intangible assets pledge like parent right, factory facilities mortgage, professional business right mortgage, payment guarantee and so on. But each one need complete formalities, abiding by laws, even some need evaluation from or trusteeship by professional agencies. Only under these conditions, not only enterprises can get loans, but also banks can avoid risks. 3.4 Realize the diversification of direct financing channels for SMEs The practice of enterprise development shows: when the scale of an enterprise develops to a certain extent, it will enter into the stage of capital management when the enterprise can only develop through direct financing channels. Therefore, to develop capital market to open up various forms of venture capital financing channels, to encourage the civil risk investment by allowing the SMEs to enter into the capital market to issue shares and bonds so as to diversify sources of investment of enterprises, are not only an important choice about project financing, but also the inherent requirement to promote the science and technology innovation and to develop high-tech industry and new economy. China should establish and improve the venture investment market. Based on knowledge and high-tech, venture investment, is an investment on the production and management of technology-intensive innovative products and services. It is an investment that specializes in buying shares of small and medium-sized enterprise with new ideas and new technology, and promotes the establishment of the SMEs. In a mature capital market, venture investment market is not only an important source of capital for a newly established firm and enterprises that are in shortage of capital, but also an ideal financing channel for listed companies looking for sources of capital. America's experience has shown that: venture investment plays a very active role in promoting the rapid development of the high-tech industries by creating a large number of commercial “miracles” such as Microsoft, Google, Yahoo, Apple ect. Our country should further expand the scale of GEM and encourage SMEs to become listed companies to finance in the market. The function of GEM mainly lies in providing a special financing channel for the promising newly-emerging SMEs, especially the high-tech ones as well as establishing an exit mechanism for venture investment. Therefore, the establishment of GEM will no doubt bring good opportunities of development to SMEs which take up 98% of the total enterprises in China. But how to increase the liquidity of GEM and attract more investors to participate is the key to the success of the GEM. A very important reason of the success of America’s NASDAQ market is that it adopts the market-maker system successfully. Therefore, we should consider changing single automatic deal-making system to diversify trade systems, which means we adopt the market-maker system on small stocks and stocks that are not active in order to strengthen market liquidity and stability. 3.5 Intensify government support. Financial obstacle of SMEs almost exists in every country, fact tells us by foreign countries that, the rapid development of SMEs depend on the support from government. For example, Japan formulated particularly policies on loans for facilities modernization and rent system for SMEs, providing long-term loans without interest. USA has established capital aid system for them in 1950, which can offer loans directly by government, including direct loans, coordinated loans and guaranteed loans, all with lower interest than that of market through the department for SMEs . References [1]. Tang Jushang. Small Enterprises in Foreign Countries–Financing, Managing, Innovating and Moding. Beijing: China Jihu Press (in Chinese) 354 ORIENT ACADEMIC FORUM [2]. Cao Fengqi. Establish and Improve Credit Guarantee System for Small and medium-sized Enterprises. Financial Research. The fifth issue, 2001 (in Chinese) [3]. Hui Encai. Research on Pressing Forward Development of Small and medium-sized Enterprises. Compare Economic and Political System. The third issue, 2010 (in Chinese) [4]. Peng Runzhong Zhao Min. Financing Problem under Financial Crisis of Small and medium-sized Enterprises in Asia-Pacific. Asia-Pacific Economy. The econd issue, 2010 (in Chinese) [5]. Xu Li. Financing Bottleneck of Small and medium-sized Enterprises in International Financial Crisis. The first issue, 2010 (in Chinese) 355