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ORIENT ACADEMIC FORUM Pawn Financing: One of Viable Financing Channels For SMEs in China ZHOU Liming School of Economics, Zhejiang University, P.R.China, 310027 Abstract: SMEs have been playing an important role in China’s economic reform and development and, to some extent, have become a growth engine in the Chinese economy. However, financing constraints is the primary bottleneck in the development of SMEs in China. Pawnbroking has the advantage of short-term emergency financing, and we should pay more attention to it. Pawn financing is one of the way-out of the dilemma of Chinese SMEs Financing. Keywords: Pawn financing, Chinese SMEs, Financing Channel 1 Instruction With the rapid growth of the Chinese economy, many kinds of SMEs have been established and rapidly developed. There was a tremendous boost in the number of SMEs in the past two decades, and more than 10 million SMEs were registered in china. Today, SMEs are getting stronger and continue to contribute to the development of Chinese society and economy. They exert the same function as SMEs in other countries, which is mainly expressed by promoting employment, technological innovation, training of entrepreneurs, developing international economic relationships, accelerating market competition, maintaining economic vitality, and so on. Comparatively speaking, the special nature of Chinese SMEs manifests their specific influence on the transition of China’s economic system and social structure. These SMEs lay an important foundation in the process of developing China’s market economy. However, the SMEs’ financial resources are incompatible with its important role playing in the national economy and social development. most smes can not successfully obtain financing from the national banking system, difficulty in financing has greatly hindered the development of smes. For example, state-owned commercial banks only increase loans for enterprises with at least an “AA” rating. Some state-owned commercial banks even stipulate that they will usually not consider an application for a loan below 3 million yuan1. However, normally, it is difficult for SMEs to obtain an “AA” credit rating, and the capital needs of most SMEs present “urgent, small, frequent” characteristics. The loan structure for SMEs is mainly concentrated on working capital loans and short-term loans. In general, the production and management of SMEs is not stable due to scale limitations. Market luctuation and some seasonal and temporary factors also influence enterprises operations. The borrowed capital is usually for short-term purposes, most of which is turnover working capital. According to a survey, the frequency of SME loans is five times that of large companies, but the sum of loans per enterprise is 0.5 percent that of large companies. For capital difficulties, a lot of non-state-owned SMEs left the market. At present, the major financing channels for SMEs remain private loans. There are a lot of cases about underground-bank financing, loan-sharking and other illegal channels of financing. The underground financing is large in scale. The private financing is not only high-interest-rate, but also high-risk. In some areas of Zhejiang province, the monthly interest rate of short-term private loans is 15%, that is 180% a year2. Therefore, in addition to bank loans, private loans, stock and bond issuance, SMEs need to explore actively new financing channels. Pawn financing is one of viable financing channels. There has been less research on pawn financing both at home and abroad. The pawnbroking has been 1 Yanzhong Wang, Financing Difficulties and Structural Characteristics of SMEs in China, China & World Economy, 34-49,vol.12,No.2,2004 2 http://nb.dsqq.cn/dsqqcn/article/2010/0711/article_116260.html. 410 ORIENT ACADEMIC FORUM overlooked by economists for a long time. There have been no studies of pawnbroking in North America using data from past fifty years3. Prior to that, the best studies were William Patterson’s(1899a and 1899b)comparative study of American and European pawnshops. Samuel Levine’s(1913) extensive description of the pawnbroking business, and Rolf Nugent’s(1939) estimate of total pawnshop credit. In Britain, pawnbroking has received more attention. Kenneth Hudson(1982) and Melanie Tebbutt(1983) have written fascinating accounts of the historical development of British pawnbroking, and A.L.Minkes(1953)studied the dramatic decline of pawnbroking in Britain between 1910 and 1950. With pawnshops common in much of Latin America and Asia, some attention has been given to their role in developing countries. F.J.A.Bauman and R.Houtman(1988),for example, provide a good description of the functioning of pawnshops in Sri Lanka and Mario Lamberte(1988) studies their role in the financial system of the Philippines. John P.Caskey(1991) had the first comprehensive analysis of pawnbroking in America. He analyzed the importance of pawnbroking to the American economy, and elaborated the management , regulation, as well as prospects of pawnbroking. Dr. Robert W. Johnson 1998 Analyzed the financial markets that serve consumers’ credit needs, with emphasis on the costs and benefits to consumers of public policies and business practices. The Author explained the rapid growth of pawnshops in the United States over the past decade and provides an in-depth analysis of the characteristics of consumers who borrow at pawnshops. Pawnbroking studies in China started in 1930s. Yang Zhaoyu(1932) introduced initially pawn industry in China in his book Chinese Pawn Industry. It’s the first studying on pawnbroking in China.Mi Gonggan(1936) carried on with a comprehensive analysis of Chinese pawnbroking. Wang Zongpei(1934), Zhang Youliang(1935) and Lu Guoxiang(1936) analyzed the reasons of the decline of pawnbroking during the Republic of China time and proposed the reform measures. Luo Bingmian(1977),Wei Qingyuan(1984), Pan Minde(1985) analyzed the socio-economic status and role of pawnbroking. Liu Qiugeng(1993) studied systematically the evolution of the pawn system. Qu Yanbin(1993),Li Sha(1993),Ma Junya(2002),Li Jinzheng(2002) carried on a series of basic research on pawnbroking for the reality application. Wang Hongbing(2002),Ren Liqin(2003),Liuhui(2004),Zeng Guangyu,Zhao Jing(2005), Zhang Yongcan(2006), Tang Xiaowei(2007),Dai Yahui(2007), Wang Chenyin(2008), Zhou Ling(2009) analyzed the characteristics of pawn financing, discussed the possibility of pawn financing of SMEs and the proposed corresponding suggestions ( ) , 2 Pawnbroking in China Pawn is one of the oldest form of consumer lending. It existed in China 2,000 to 3,000 years ago. At the time of the Southern and Northern Dynasties(about 1,800 years ago) pawnbroking became an industry4. In China, pawnbroking early operation by the temples, as charitable organizations to helps the poor. From the Tang Dynasty, pawnbroking as a single temple loan had gradually evolved into a government-run or private financial behavior. Pawn industry had been a sustained boom in The Song Dynasty and Yuan Dynasty. In the Ming and Qing Dynasties, Chinese pawnbroking had its most prosperous time, which played an important role in social economy, and had greatly affected the Chinese economy and the process of market. Late Qing Dynasty, pawnbroking began to decline. In early years of the People's Republic of China, as a result of long-term negative publicity, pawnbroking was considered a tool of exploitation of the old society and was banned. The ban lasted for more than two decades. In the late-1980s, China’s economic reform had been achieved initial success, a large number of SMEs and individuals presented the new financing needs. On December 30, 1987, the first pawnshop after Reform and Open Policy—Chengdu Huamao Pawn Services Firm came into being, symbolized the pawnbroking as the traditional financial sector in mainland China re-entered the , 3 John P.Caskey. Pawnbroking in America: The Economics of a Forgotten Credit Market. Jounal of Money, Credit and Banking, 1991,23(1):86. 4 most scholars hold that pawnbroking as a industry originated 1600-1800 years ago. 411 ORIENT ACADEMIC FORUM economical stage. Till 1995, the number of pawnshops is reaching to 3013. However, because of the lack of formal authorities, there were 22 different agencies have authority to vet and approve at that time, pawnbroking in the management of chaos. In 1996, the People’s Bank of China officially took over the pawnbroking, and promulgated the Interim Measures for Pawnshop Management. After the clean-up and rectification, 1300 pawnshops were remained, and pawnshop was considered as a “non-bank financial institution”. In June, 2000, the regulatory authority of pawnbroking was transfered to the State Economic and Trade Commission, and pawnshops were considered as “special industrial and commercial enterprises”. In August, 2001, the State Economic and Trade Commission had released Pawnshop Management Measures. In July, 2003, State Economic and Trade Commission was abolished, pawnbroking was supervised by the Department of Commercial Affairs. In April, 2005, the Department of Commercial Affairs and Ministry of Public Security promulgated jointly Pawnbroking Management Measures, the legal nature of pawnshop changed as “enterprise legal person who is engaged in specially pawnbroking activity”. Compared to other financial institutions’ financing, the first advantage of pawn financing lies in its simple form of loans. At present, most Chinese commercial banks adopt credit and mortgage lending, and generally do not accept Pledge lending. These lendings have cumbersome procedures and long approval cycle. However, with characteristics different from above, pawnbroking can make loans by both of mortgage and pledge form, and its procedures are more simple. A lot of businesses just take a few minutes. Therefore pawn financing is suitable for small and medium-sized emergency loans. The second advantage is its flexibility and less financing constraints. Pawnbroking have greater flexibility than other financial institutions in terms of loan interest rate line of credit loan process and operating hours. Best of all, pawn business is easy to acess for credit. There has hardly any requirements for enterprise's credit. As a result of the loan amount are generally lower than the item’s circulation price in the secondary market, pawnbroking has a good risk management. It is beneficial for the SMEs who have poor credit to obtain loans. The third advantage lies that pawnbrokers are not concerned with the use of the loans. Therefore, the business of SMEs will never be interfered with. As we know, banks have many restrictions on the use of the business loans. If the use of the loan does not meet the requirements of banks, the loans will be likely to be recovered. For this reason, enterprises are unable to adjust its business strategy timely when market changes have taken place. Pawn loans is different from bank loans. The use of the pawn loans is unrestricted. The SMEs can freely dispose of the funds obtained from pawnshops. Besides the above advantages, pawn financing also has two distinct disadvantages: First, its interest rates are much higher than bank interest rates. Second, some SMEs’ property are not available for mortgage or pledge. How to understand the above-mentioned disadvantages? Firstly, there is no denying that the interest rates of pawn financing are higher than the lending rates of banks5. But I believe that financing transaction costs should include not only the explicit costs but also the hidden costs—such as the costs of capital acquisition and the losses caused by shortage of funds. Because of serious information asymmetry between banks and enterprises, banks can’t be well aware of the profitability of investment projects and whether funds were properly used. So adverse selection and moral hazard will arising inevitably. For lack of confidence in SMEs, banks will ask for a higher risk premium, so as to force the SMEs tend to choose high-risk projects. As a result, the rate of bad debts increase, bank profits suffer finally. To avoid such situations, bank will not raise interest rates to clear market, but at a lower level of competitive interest rates allocate to the loans applicants. The SMEs are restricted more stringent on credit rationing by banks, so that a large number of SMEs being excluded from bank credit system. If explicit transaction costs and the hidden transaction costs are considered, with respect to short-term and urgent-need financing, pawn financing have a greater comparative , 5 , , For example in the current pawnshops to take 3.2% of the general interest charge (interest plus a comprehensive cost) equivalent to the annual interest rate as high as 38.4%. , 412 ORIENT ACADEMIC FORUM advantage than bank financing. Secondly, the property can be used for mortgage or pledge in pawnshops is widely than imagined. In the current lending business subject to conditions banks have to give up the pledge lending business, and mortgage only for high value items. Some other institutions are needed to supply that type of service, and pawnshop is precisely this type of institution. As a result of the constraints of their asset scale and structure, SMEs usually unable to provide adequate and effective mortgage items which banks asked for. Mortgage or pledge business in pawn should be much more flexible. Besides the common house and land-use right, enterprises can also use the production of goods, commodity stocks, unmarketable goods, motor vehicle, jewelry, securities and other property rights all can be used as a mortgage or pledge. It allows a large number of “dead items” will become the “live money”, so that the resources of SMEs can be fully utilized. Up to the first half of 2010, there were more than 3600 pawnshops in China. From January to October, 2009, Chinese pawnbrokers had paid accumulatively 136.8 billion yuan to 240,000 SMEs, an increase of 18%. Pawn financing has already become fast financing “the green passage” of SMEs. Some larger pawnshops, more than 80% clients are SMEs, private enterprises and partnership. , , 3 Some Problems in Chinese SMEs’ Pawn Financing The recovery and development of pawnbroking has brought great convenience to SMEs for its short-term emergency financing. Simple and convenient approval, flexible loan, broad range of pledge products, unlimited usage of funds, all the advantages of pawnbroking have met the short-term emergency financing needs of SMEs, and to some extent, filled the vacancies of bank loans and other financing channels. However, there are Some problems in Chinese pawn financing. The first problem is the over-regulated. Chinese government have imposed too many strict regulations to pawn business, and it became a major obstacle to the development of pawnbroking. In China, pawnbroking has long been regarded as a practice usury industry, as a result, it was naturally faced a lot of institutional constraints since its return of 1987. Many traditional functions of pawnbroking were canceled or changed, pawnbroking was classified as corporate enterprises, but can not enjoy preferential policies of corporation enterprises. So it is difficult to make big business rely on their own. The shortage of funds has constrained the development of pawnshops. According to Pawnbroking Management Measures, a pawnshop can obtain bank loans only a maximum of 1:1 ratio of its registered capital. However, banks generally do not advance the enterprises who engaging in lending business. It means, in fact, it is very difficult for pawnshops to obtain bank loans. The legislation also provides that pawnshop may not lend money from the non-bank business units or individuals. Therefore, the funds pawnshops have used for lending, mostly from their own funds. As a result, many pawnshops are short of funds. It affects directly the scale of SMEs financing from pawnbroking. Pawnbroking is the essence of a retail financial services industry, the growth of its scale to a large extent relies on the new varieties of in-depth development and the expansion of network operators. Chain operation in pawnbroking had been banned by supervisory authorities for a long time. After the enactment of Pawnbroking Management Measures in 2005, although setting up branchs cross-province was permitted, but there were a number of restrictions to pawnshops on the registered capital, profit and operating records, all of which restricted the development of pawnbroking. The ultra vires management of consignment stores, second-hand goods firms also had a very great impact on pawnbroking. In fact, these stores and firms engaged in pawn businesses in disguise, and took away a large portion of pawn businesses on civilian products. Some consignment stores even engaged in mortgage business on real estate, and raising funds from private loans to engage in illegal loans. The illegal operation had a bad effect on the normal development of pawnbroking. In addition, the imperfections of the law have also hindered the development of pawnbroking. The authorities of pawnbroking had been replaced frequently, and pawnshop had changed frequently in role. 413 ORIENT ACADEMIC FORUM It reflects the departments of government have not yet reached a consensus on the nature of pawnbroking. Up to now, the Pawnbroking Management Measures is only a division of rules promulgated by the ministry of commerce and the ministry of public security in 2005. Compared with Guarantee Law and Property Law, it has lower levels of legal authority and less binding, and in a passive position when had conflicts with them. Because of the lack of Pawnbroking Law, pawn business can’t be independent from the businesses of pledge loan or mortgage loan. It cause pawn business lose its characteristics, and led to a number of disputes. 4 Countermeasures to the SMEs Pawn Financing Difficulty To promote employment, economic development and social stability, preferential policies must be adopted to support SMEs. Financing constraints of SMEs will continue to be a financial barrier which is unable to overstep in present stage. There is no doubt that pawnbroking should provide more support to SMEs financing. Here, we will put forward some countermeasures in response to the problems discussed above. Firstly the capital resources of pawnshops should be given more auxiliaries. One possible suggestion is to expand the proportion of the loans from commercial banks,for example, the existing loan proportion which no more than the registered capital of the pawnshop can be enlarge to five times or more. The restrictions on lending in the same industry can also be relaxed appropriately. The lending in pawnbroking can be led by pawn association in certain regions, it can balance the fund surplus and deficiency between pawnshops, improve efficiency in the use of funds. Further proposal is to learn from the experience of western countries, arrange some pawn enterprises listing or issuing bonds to raise funds. Chinese pawnbroking has small-scale and weak ability to resist risks. Therefore, it is necessary to integrate the resources. A good business model is the implementation of the chain. It can play a scale effect to reduce costs, and conducive to the formation of brand. For example, the Shanghai Hualian Pawnshop, learned from the advanced experience of the mode of US pawn chain, combined with its own characteristics and carried on a successful chain manages. Government should give more preferential policies to pawn chain, and implement more liberal policies to the cross-province or cross-nation management. Secondly, business innovation in pawnbroking is also very important. In view of the financing demand for SMEs pawnshops can develop the characteristics of business based on the needs of different consumers, such as the provision of venture capital financing for SMEs, or set up preferential interest rate specifically for SMEs financing. In addition, the experience came from developed countries can be learned, and using the internet to build a network of SMEs pawn. Pawnbroking can be considered to be open for retail and consignment business. It not only accords with the traditional practice of Chinese pawnbroking,but is in line with the operation of pawnbroking in developed countries. Although China has not yet allowed the pawnbroker to carry out retail and consignment, such operations are very common in pawnshops abroad. In the United States, some large and medium-sized pawnshops have achieved optimal distribution of resources and resource-sharing in pawnbroking, consignment, auction and other areas by chain operation. These pawnshops have unified standards and operational procedures in the assessment, marketing and management, so that they have achieved maximize revenue from economies of scale in operations and modern management. Thirdly, to recognize and protect the unique operating rules of pawnbroking under the premise of without disturbing the existing financial order. Pawn, as a special kind of civil acts, has nearly two thousand years time. The operating rules accumulated for thousands of years, can not be totally changed by several simple provisions of law. I believe that some hidden rules in pawnbroking should be recognized and protected if those rules didn’t affect the existing financial and social order, didn’t break the law and the principle of fairness. For example, the treatment on the unredeemed pledges. According to the article 43 of Pawnbroking Management Measures, the unredeemed items which more than 30,000 yuan should be sold by public auction. However, a lot of pawnbrokers did not comply with the legal , , 414 ORIENT ACADEMIC FORUM provisions. They usually agreed in the contract that the ownership of the items transferred directly to the pawnbrokers when the consumers failed to redeem. Of course, these contracts should be null and void, but there are a large number of such provisions existing in Chinese pawnbroking. No conclusive evidence to show that such provisions has led to increasing disputes in pawnbroking, and regulatory authorities have not yet taken more stringent control measures. Why do they dare to violate the regulations Perhaps a reasonable explanation is pawnbrokers and consumers have no serious loss in these transactions, even it’s a Kaldor-Hicks Improvement from the whole. As a reduction in the transactions of the disputes and saving transaction costs, the society welfare increased as a whole. ? References [1]. 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