Why Is It Difficult to Finance Now?

Yang Kaisheng, Industrial and Commercial Bank of China (ICBC) former president gave a speech at the China Reform Forum -China’s financial development strategy held jointly by Shenzhen Innovation and Development Institute and China Society of Economic Reform in Beijing. He highlighted the root of the ongoing challenges of corporate financing. Yang argues that a well-functioning mechanism to replenish capital is essential for both SOEs and private firms.

Banks are inclined to lend money to other banks or financial institutions in recent years. But why is that? In order to answer the question, Yang first explains the role of commercial banks. The primary job of banks is to bring in funds from clients and lend the money to others. They make a living on the interest spreads of deposit and loans. With the profit-seeking nature, banks are more willing to lend money to other financial institutions rather than non-financial corporates. Even if some of the financial institutions would lend the money they borrowed from banks to non-financial corporates, the accessibility of capital for the real economy decreases substantially. This is the critical issue that the financial industry has been tackling with in the past two years, says Yang.

Nevertheless, banks take into consideration a firm’s liabilities, including net assets and debts. A high leverage ratio affects a firm’s solvency. A low solvency restricts a firm’s ability to continue financing. Many firms in China lack in capital because investors of both SOEs and private firms more or less are not quite aware of the fact that capital is a must to start businesses. When a firm starts to grow, it will need capital injection. If the firm does not have sufficient capital or it fails to inject capital in time, it will have to live on debts. As the debt builds up, leverage ratio mounts, resulting in a decrease in the firm’s ability to pay back, and thus making it more difficult to finance later.

According to Yang, firms should not rely on increasing loans to supplement its capital. The key to financing is to develop a mechanism to replenish capital. In the process of deepening SOE reform, it is important to set up the ceiling of leverage ratio for each specific department. As the new round of SOE reform emphasizes the control over asset, Yang suggests that the government should focus not only on the returns and the prevention of losses of state-owned assets but also on responsibility of SOEs’ managers and regulators to replenish capital and keep the debt ratio of SOEs at a stable level. If an SOE’s debt ratio is reaching to the limit, its manger and regulator should

 find new ways to inject capital

 launch mixed ownership reform

 opt out of the market